an analysis of international financial reporting...

14 ISSN 1849-5664 (online) http://researchleap.com/category/international-journal-of-management-science-and-business-administration ISSN 1849-5419 (print) International Journal of Management Science And Business Administration Vol. 1, No. 9, August 2015, pp. 14-87

International Journal of Management Science and

Business Administration

Volume 1, Issue 9, August 2015, Pages 14-32

An Analysis of International Financial Reporting Standards (IFRS)

Issues Concerning Some Elements of Accounting in Oil and Gas

Industries in Nigeria

Uwaoma Ironkwe1, Ordu Promise A.

2

1Department of Accounting, Faculty of Management Sciences, University of Port Harcourt, Nigeria Jose

Antonio 2School of Graduate Studies, Department of Accounting, Faculty of Management Sciences, University of

Port Harcourt, Nigeria

Email (corresponding author): [email protected], [email protected]

Abstract: IFRS cut across all segments of industries. However, concerning the Oil and Gas industry sectors, IFRS has

significant impact. IFRS has various guidelines that help to make the convergence to the new system, especially, in Oil

and Gas accounting and reporting easy. Interestingly, accounting for Oil and Gas activities presents many difficulties.

Significant upfront investment, uncertainty over prospects and long project lives have led to a variety of approaches

being developed by companies and a range of country-specific guidance for the sector. The main objective of this paper

is to critically look at the recent IFRS pronouncements on specific issues concerning the Oil and Gas industries

accounting in order to simplify these difficulties. This paper looks at some of the main accounting issues across Oil and

Gas Companies IFRS guideline has provided. Specifically, the paper looks at the provisions of IFRS 6 and 13

concerning the Evaluation and Exploration of Oil and Gas; certain elements such as Joint Arrangements, Fair value

representations, deferred taxation as well as Impairments issues. It considers current effective standards and notes

future developments that can impact accounting in the sector as reflected on their financial statements.

Keywords: International Financial Reporting Standards (IFRS), IFRS 6 and 13, Oil and Gas Companies, Nigeria

1. Introduction The adoption of International Reporting Standards (IFRS) in over 120 countries is an issue of global relevance among

various countries of the world due to quest for uniformity, reliability and comparability of financial statements of

companies. Nigeria has joined the League of Nations reporting IFRS and is currently in her second phase of IFRS

implementation with phase one closed on 31 December 2012 when all listed significant public entities submitted their

first IFRS financial statements. Hence, that adoption has ushered in the use of IFRS guidelines in preparation of

financial statements for public companies quoted on Nigerian Stock exchange. No doubt, the world economy is

wearing a distress look following the global economic crises which led to the collapse of many viable institutions in

some countries with its attendant alarming rate of unemployment. The financial crisis has shown how difficult it is to

retain investor confidence when investors are uncertain about the information available to them. By providing reliable

and internationally comparable financial information, IFRS is a very important framework and is fundamental of the

market economy. In the words of the Chairman of International Accounting standards Board (IASB): “I believe that the

bedrock of support for our work is an understanding of this public interest of IFRS”. Furthermore, according to

Demarki, a fellow of the Institute of Chartered Accountants of Nigerian, with the adoption of IFRS in Nigeria, a lot

stands to be gained from the seemingly distressed global economy. With successful implementation of IFRS, Nigeria

will benefit economically by receiving a boost on foreign direct investments (FDIs) (2013).

As countries adopt a single set of high quality, global accounting and financial reporting standards, there should be

greater global consistency and transparency. However, it is recognized that extractive activities is an area in which

mailto:[email protected]

Uwaoma Ironkwe, Ordu Promise A.

An Analysis of International Financial Reporting Standards (IFRS) Issues Concerning Some Elements of Accounting

in Oil and Gas Industries in Nigeria

15 ISSN 1849-5664 (online) http://researchleap.com/category/international-journal-of-management-science-and-business-administration ISSN 1849-5419 (print) International Journal of Management Science And Business Administration Vol. 1, No 9, August 2015, pp. 14–32

there is little IFRS guidance. There is also variation in practice between companies applying IFRS, which was

highlighted in KPMG‟s survey “The Application of IFRS: Oil and Gas” published in October 2008. IFRS cut across all

segments of industries. However, concerning the Oil and Gas industries, IFRS has significant impact on this sector.

IFRS has various guidelines that helps to make the convergence to the new system especially in Oil and Gas accounting

and Reporting easier. Furthermore, there are specific guidelines on how to treat the items that appear on the financial

statements of Oil and Gas Companies.It will be on interest to note that accounting for Oil and Gas activities presents

many difficulties. Significant upfront investment, uncertainty over prospects and long project lives have led to a variety

of approaches being developed by companies and a range of country-specific guidance for the sector (KPMG, 2011).

As countries around the world adopt IFRS, accounting approaches for affected companies may need to be reassessed.

This paper however, looks at some of the main accounting issues across Oil and Gas Companies as IFRS guideline has

provided. Specifically the paper looks at the provisions of IFRS 6 and 13 as concerning the Evaluation and Exploration

of Oil and Gas and as it has to do with certain elements such as Joint Arrangements, Fair value representations,

deferred taxation as well as Impairments issues. It considers currently effective standards and notes future

developments that can impact accounting in the sector. This work has been divided into several sections. Section one is

an introduction to the topic. Section two deals with conceptual issues and theoretical underpinnings. Section three

reviews literatures as regard to IFRS adoption and its consequent benefits as well as challenges as it cuts across all

sectors of economy including Oil and Gas sectors. Further, it also looks at the components of financial statements that

are likely affected by IFRS provisions. Section Four highlights the provisions of IFRS on Joint Venture, Fair value,

Impairment as well as deferred taxation issues. Section Five summarizes and concludes the paper.

2. Conceptual Framework

2.1 Overview of International Accounting standards convergence to IFRS in

different countries According to Ajibade (2011), in 1973, the International Accounting Standard Committee (IASC), professional

accounting bodies of major countries comprising UK, Ireland, United States (US), Australia, Canada, France,

Germany, Japan, Mexico, Netherlands agreed to develop a uniform set of accounting principles that would be

applicable globally and supersede the International Accounting Standards (IAS) which allowed for different treatments

of transactions and events making comparative analysis difficult. Membership of IASC expanded to 140 professional

bodies including the International Federation of Accountants (IFAC) under which Nigeria belongs. Because of

globalization and comparability issues, IASC was restructured leading to the creation of International Accounting

Standard Board (IASB) that issues IFRS. This ushered in the convergence (both local and international) of accounting

standards to IFRS which has become globally adopted including in Nigeria. However, convergence is still going on

various areas of accounting.Additionally, International convergence of accounting standards refers to the goal of

establishing a single set of high-quality accounting standards to be used internationally. The effort of standard-setters,

particularly, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board

(IASB) is to achieve that goal. The essence of convergence is to avoid conflict and confusion, promote simplicity,

streamlining, consistency and transparency and avoid any future financial crises or meltdowns. Convergence is also

already taking place in other countries, with “all major economies” planning to either adopt IFRS or converge towards

it in the near future. For example, Canada required all listed entities to use IFRS from January 1, 2012 and Japan

permitted the use of IFRS for certain multinational companies from 2010 and made a decision on mandatory adoption

in 2012 (IFRS Foundation, 2012).

2.2 Accounting Standard Setting Standard setting bodies, such as IASB and FASB, experience lobbying from preparers and governmental self-interest

(Nobes, 2008). The lobbying is motivated by different reasons. The major one is related to revenue and earning

management. Managers want to show higher revenue in the financial statements of their companies due to the fact that

their compensation is most often associated with it. Governments also lobby the formulation of standard that can lead

to a higher earning (Nobes, 2008). Cortese Irvine and Kaidonis (2010) describe the lobbying that IFRS 6 has gone prior

to becoming a standard. In this study, it is mentioned that extractive industry encompasses companies that have

significant share in the global capital. Those companies have influenced IASB to issue IFRS 6. Similarly, Nobes (2008)





discusses lobbying from historical as well as current instances by raising titles of some of the standards issued in the

US, UK and IASB. In spite of this, accounting standard setting bodies imposes their standards by getting the help of

enforcement bodies (Nobes, 2008). Different forms of bodies in different accounting regimes perform the enforcement.

Stock exchanges, regulators of stock exchanges, government departments and agencies and private sector bodies are

used as an enforcer in various accounting regimes. In countries such as US, Norway, Sweden, Switzerland and

Australia, stock exchange regulators perform enforcement. On the other hand, in Belgium, Italy, France, Portugal and

Spain, the task is left to the private body panel. In the UK, government department carries out enforcement (Nobes,

2008). The enforcement action of those bodies makes a standard mandatory in their jurisdiction. The mandatory

standard may be new or a change to the existing standard. As the topic of this research is related to an existing

standard, mandatory accounting change is worth mentioning (Endale, 2011).

2.3 Mandatory Accounting Change

Business entities can change their accounting methods voluntarily or regulatory bodies may require them. The

mandatory accounting change may take the form of changing accounting method or standard. A standard change in

many cases brings about method change. With regard to standard change, the mandatory adoption of IFRS by European

Union (EU) and European Economic Area (EEA) countries is historic. Christensen, Lee and Walker (2007) labeled this

change as “the largest regulatory experiments in financial reporting ever”. Further, they state that some companies

economically benefited and others become losers from the mandatory adoption of IFRS. Jeanjean and Stolowy (2008)

also state that the adoption has impact on the earning quality of firms. They found that the effect of mandatory adoption

of IFRS differs from firm to firm depending on institutional factors. Identical to the motives for the accounting choice

under the voluntary accounting change, mandatory method change which follows from mandatory standard change is

triggered by determinants of accounting choice. Balsam Haw and Lilien (1995) describe that in a mandated accounting

change, in which managers have flexibility in timing of implementation, they tend to choose time when they can

maximize their benefit.

2.4 Motives for the Formulation of Accounting for Oil and Gas Accounting regimes formulate industry specific accounting standard when they find that the industry has special

features. For instance, in US there are accounting standards for real estate, healthcare, motor carriers, television and

computer software (Luther, et al., 2008) due to their special characteristics. Likewise, US GAAP has industry specific

standard for Oil and Gas industry. IASB is also endeavoring to formulate standard for extractive industry - an industry

that encompasses Oil and Gas and mineral industries. The peculiar features of Oil and Gas industry that urge the

standard setting organs to issue industry specific standard is presented here.

Oil and Gas industry, identical to the mineral industry, is mainly characterized by lack of association between the

amount of investment made and return obtained thereof (Wright and Gallun, et al., 2008). A simple exploration effort

of companies may generate a high return or contrary to this, after extensive drilling, the companies may discover

unsatisfying result. The industry also encompasses high level of risk. The 2009 Ernest and Young business risk report

(Ernest and Young, 2009) ranks business risks that the Oil and Gas industry faces with. In the ranking, political

constraints, uncertain energy policy and price volatility take the three leading positions. Price volatility in most cases is

related to stability in and around Oil and Gas producing countries. Oil and Gas is major source of income for many

countries besides it is one of the sources of energy for other primary, secondary and tertiary human activities. Thus, this

arouses political interest from governments and they design stiff energy policies and regulations. Roggenkamp (2001)

states that regulations can be enacted by international bodies or can be emanated by treaties between nations.

Additionally, governments can decree regulations within their own jurisdictions. Prevention of Marine pollution from

Continental Shelf Exploration and Exploitation, Law of Sea Convention (LOSC), Liability and Compensation for Oil

Pollution Damage (Roggenkamp et al., 2001) can be considered as instances of international laws and regulations.

Frigg Treaty which is made between United Kingdom and Norway (Roggenkamp et al., 2001) is one example of a

treaty. National laws such as the Norwegian Petroleum Act (Hammer, 2010) serves as a regulatory framework in

relation to regulating the activities of the bodies involved in the business within the country.

All these regulations situate the industry to be in a high level of regulation. Moreover, the industry is characterized by

complex tax rules and unique cost sharing agreements (Wright and Gallun, et al., 2008). In Norway, for instance, a





special tax is levied on Oil and Gas activities. The Oil and Gas Companies are expected to pay 28% ordinary tax and

50% special tax. However, there is a 7.5% tax shield which is called uplift by which companies protect themselves

from the effect of the special tax (Norwegian Petroleum Directorate, 2010). These peculiarities of the industry urge the

accounting regimes to formulate accounting standard specific to the industry. The next section is dedicated to Oil and

Gas industry specific accounting

2.5 Theoretical Review

2.5.1 Accounting theory According to Coetsee (2010), there are different schools of thought on accounting theory. Of these, two of them are

dominant. The first one emphasizes on the development of accounting principle and defines accounting theory as a

logical reasoning in the form of a set of broad principles that provides a general frame of reference by which

accounting practice can be evaluated (Endale, 2011). Thus, accounting theory guide the development of new practices

and procedures (Hendriksen, 1982, as cited in Coetsee, et al., 2010). Therefore, accounting theory is the basic

assumptions, definitions, principles and concepts that underlie accounting rule making.

According to the second school of thought, accounting theory has primary objectives of providing a basis for the

prediction and explanation of accounting behavior, events and practice. Therefore, this school of thought considers

accounting theory as an attempt to evaluate practice. The difference between the two is that the first one emphasizes on

principle and it is normative while the second one assesses practice, thus, it is descriptive. Normative theory

methodologically describes what the theory should be; in contrast, the descriptive one shows what the realty is. Coetsee

(2010) states that accounting theories were developed through normative or descriptive process. Nowadays, normative

and positivistic are both used to develop accounting theory. Positive accounting theory and decision usefulness theory

are two of the most important theories in the field of accounting. Positive accounting theory was introduced by Watts

and Zimmerman (Al-Adeem, 2010). There are many positive accounting versions but their positive accounting theory

differs from that of others by giving importance to prediction and explanation though it is descriptive like the other

positive theories. The positive accounting theory known as PAT in short, deals, among other things, with accounting

choice (Kabir, 2007). Watts and Zimmerman introduced transaction and information costs with respect to accounting

choice. Decision usefulness theory gives prime focus to the outcome of the accounting process i.e. the information

which accounting provides (Coetsee, et al., 2010). Inanga and Schneider (2003) describes that decision usefulness

theory of accounting considers that accountants know the needs of financial statement users and those needs are

common. Therefore, accountants can prepare general-purpose financial statements that can be useful for decision-

making. Inanga and Schneider (2003) further explain that this theory is the foundation of the Concept Statement of the

Financial Accounting Standards Board (FASB). Coetsee (2010) also states that the conceptual framework of both

FASB and IASB is decision usefulness theory.

The issues put forward in both positive accounting theory and decision usefulness theory are relevant to this study.

Hagerman and Zmijewski (1978) state that “a positive theory of accounting is a prerequisite to understanding how

firms will react to changes in accounting standards”. Positive accounting theory raises accounting choice and the

political process that surrounds it.

2.5.2 The Rational Utility Maximization Theory

Marnet (2008) emphasized that Rational Utility Maximization Theory evokes the presence of calculating utility

maximizer which is not succumbed to what presumably amount to irrational behavior. Furthermore, many conventional

means for improving corporate governance depend on the premise that business managers are strongly rational agents

with long-term horizon. Freeman (1957) also disclosed that the rational maximization theory is based on the following

assumptions: the individual is self-interested maximizer (a); has stable and consistent preferences or taste (b); is

capability of rationale choice behavior in accordance to certain decision rules (axioms) (c); independent/neutral

monitors (gatekeepers) motivated by reputational and legal concern to withstand pressures (d).

However, observed monitors/gatekeeper behavior appears to be odd in contrast to these assumptions of self-interest and

rationality. Logically, a gatekeeper (i.e auditors) does not sacrifice reputational capital for small amount of financial

gains. Yet gatekeepers (auditors) have been observed to jeopardize their reputation for financial gains that were far





smaller than potential losses. The obvious answer about why management including directors engage in fraud and

gatekeepers (auditors) were complicit is that they did so because it was profitable to them or at least appeared to be so.

Adeside (2008) argued that corporate governance, corporate code violator connive or evade the regulators through

fraudulent mechanisms whereby principally, the audited financials sent to the Central Bank of Nigeria (CBN) is usually

profit-oriented since it is that same audited account that would be published showing bogus profit in order to make their

shares attractive at the capital market after a compromised approval have been obtained from the CBN. For the same

accounting period, the audited account that would be forwarded to the Nigeria Deposit Insurance Corporation (NDIC)

would have a depleted deposit base for the bank to pay an inconsequential 1% insurance premium to NDIC. For the

same accounting year, the audited accounts that is sent to the Federal Inland Revenue Services (IFRS) would have a

reduced profit so that these banks would not pay any corporate tax to the coffers of the Federal Government of Nigeria

while at the same time concealing withholding tax and value added tax (VAT) deductions thereby defrauding the

federal government of Nigeria. Akpan-Essien (2011) stated also that the adoption of IFRS will ensure transparency,

accountability and integrity in financial reporting necessary for addressing the crisis in the financial sector in Nigeria

which was responsible for the loss of the Foreign Direct Investment (FDI) in the Oil and Gas sector. Countries such as

Ghana that have begun oil production in commercial quantity and is perceived to have better financial reporting

standards in place. This theory applies both in developed as well as in developing economy such as Nigeria.

Furthermore, as this paper is about the effect of accounting gap created due to the political decision made on the

issuance as well as the implementation of a standard i.e. IFRS 6, issues covered under positive accounting theory are

significant. Likewise, decision usefulness theory is the foundation for the frameworks of the two standard setting

bodies. Thus, it has relevance as the standards are formulated by basing those frameworks.

3. Literature Review

3.1 Theoretical Discussion about Impacts of the Gap on IFRS The gap between IFRS 6 and US GAAP can have impact on entities if they are required to change from one to the

other. For instance, when IFRS 6 was formulated, entities that are under IASB regime were required to follow it;

Norwegian Oil and Gas Companies can be examples for this as they were following the US GAAP and subsequently

demanded to obey IFRS. Changing the accounting standard has impact on them. Accordingly, here the author discusses

theoretical impacts that changing the standard from US GAAP to IFRS can bring on firms. Moreover, theoretical

shortfalls that IFRS 6 has on newly established entities are covered as well. The presentation made on the gap between

the two standards shows that the US GAAP‟s successful-efforts method is consistent with IASB ‟s framework. There

must be a match between revenue earned and expense incurred thereto. Capitalizing all the expenditures incurred will

overcapitalize an entity and defer recording of expenses so that companies register excess income in their first years.

The framework (IASB framework paragraph 4.52) states “An expense is recognized immediately in the income

statement when an expenditure produces no future economic benefits” Thus, expensing unsuccessful drilling effort,

which is the practice in successful-efforts method corresponds this framework.

Cortese, Irvine and Kaidonis (2008 ) state that the prime users of full cost accounting method are smaller Oil and Gas

Companies. When FASB was trying to abolish this method, smaller firms made strong lobbying effort by claiming the

method helped them in raising more fund. The success of their effort helped the method to be one alternative despite it

is inconsistent with the US GAAP‟s matching principle (SFAS). Due to this fund raising benefit and other reasons

explained, imposing regulation on entities to change and retrospectively adjust their method and balances from full cost

to IFRS can have a huge impact. Therefore, IASB exempts Oil and Gas Companies from making retrospective

adjustments by making amendment on IFRS 1 (IFRS 1 Appendix “DD and A”). With regard to upstream activities, the

US GAAP covers all the activities while IFRS considers obtaining legal right to explore as a starting and the outcome

of technical feasibility study as a final point. Thus, activities performed before and after them are unaddressed issues.

Absence of guideline also exists on depreciation, depletion and amortization issues. IFRS 6 does not give a unit of

account to be considered for calculation. In this respect, entities that follow full cost take country as a unit of account.

However, it is apparent that reserves in one country may have different economic life and depreciation in reality;

differs so that full cost method follow unit of account that deviates from actual decline on value of property.

Successful-efforts method sometimes depreciates a single property, nonetheless, under IFRS properties have to be

composited. Nichols (2010) explains that depreciation; depletion and amortization change from US GAAP to IFRS is

difficult hence; there is no separate calculation for each property under IFRS and creating composite assets and





applying it retrospectively is tricky. Newly adopting entities, however, experience only problem of finding unit of

account. Impairment test is another point of departure between the two standards. It is one of the reasons for the

exemption of retrospective amendment of accounting balance prepared under the full cost method (Nichols, 2010).

Entities that use successful-efforts method experiences difficulty when they change their accounting practice from US

GAAP to IFRS, as they have to amend their balances by going back to several years. The other main differences are

reversibility of impairment when impairment is made. Under IFRS impairment is reversed when circumstance indicate

betterment. This has to be applied retrospectively when a change is made under successful method. With regard to

regularity, IFRS requires impairment test to be made annually but US GAAP requires the test to be made only

impairing circumstances happen. This per se has no effect on new adopters but a changing entity has to apply

retrospectively, if it follows successful-efforts method. The case of inventory has similarity with impairment in that

lower of cost or market adjustment is reversed in some situations. Moreover, entities that follow LIFO have to change it

into FIFO or average and amend the balance as if they had been following the new cost flow assumption in the

previous years. New adopters will not be affected by the difference between the allowed cost flow assumptions. The

disclosure difference is a matter of creating clarity about the financial statements of the entities. Thus, the impact is not

significant on the accounting of them (Endale, 2011).

3.2 Empirical Studies on the Impact of Financial Reporting to Economic

Development Portes and Rey (2005) in their studies showed that most stock market investors prefers domestic asset but a

geographical pattern of international asset transaction proves that financial information is not equally available to all

market participants but where they are readily available in easily understood format, there have been significant

consequences on the level of investors activities. UNCTAD (2001) report shows that FDI inflow to Africa declined by

(9%) between 2010 ($50 billion) and 2009 ($55 billion). Mangena and Tauringana (2006) in their studies also provided

firm level evidence for a sub-Saharan African country, Zimbabwe, of positive effect of governance on the fraction

accounted by Foreign Share Ownership of companies. They contended and postulated that because greater disclosure

reduces information asymmetry for foreign investors, there should be a positive relationship between foreign share

ownership in a listed company and firm level disclosure, especially, due to the fact that the foreign investor portfolio

are usually minority shareholders and therefore, more susceptible to expropriation by local managers or controlling

shareholders. They investigated foreign share ownership in Zimbabwe by examining whether differences in foreign

share ownership (i.e. percentage shareholding owed by foreign investors) across companies listed in the country‟s stock

exchange are related to the country-specific difference in disclosure and corporate governance mechanisms. The study

reports that foreign share ownership is positively associated with high standard of disclosure and audit committee

independence.

3.3 Components of IFRS Financial Statements Alistair (2010) defined IFRS as a series of accounting pronouncements published by the International Accounting

Standard Board (IASB) to help prepare financial statements throughout the world, to provide and present high quality,

transparent and comparable financial information. According to Essien-Akpan (2011), the components of IFRS

financial statements includes fair representation, accounting policies, going concern, accrual basis of accounting,

consistency, materiality, off-setting. Fair presentation is the appropriate application of IFRS result in Financial

Statements that achieve fair presentation resulting from the selection of appropriate accounting policies and their

application. Accounting policies are the specific principles, bases, conventions, rules and practices adopted by an entity

in preparing and presenting financial statements. Policies selected must comply with the interpretation of the

International Financial Reporting Interpretation Committee (IFRIC), where there are no specific requirements; policies

should ensure relevance and reliability of information. Such financial statements should disclose that they comply with

IFRS. Compliance should not be claimed unless all applicable IFRS and interpretations have been applied. A

company‟s financial statements should disclose the accounting policies that have been selected and used.

3.3.1. Going Concern - is described as an entity‟s ability to continue operating in the foreseeable future, usually one

year and especially if certain conditions ceases to exist. An entity prepares financial statements on a going concern

basis unless management either intends to liquidate the entity or to cease trading or has no realistic alternatives but to

do so. Where there are material uncertainties related to events or conditions that may cast significant doubts on the





entity‟s ability to continue as a going concern, the entity shall disclose those uncertainties. Management, when

preparing financial statement, makes an assessment of an entity‟s ability to continue as a going concern.

3.3.2 Accrual Basis of Accounting – recognizes transactions and events when they occur and not when cash is

received or paid. They are recorded in accounting records and reported in the financial statements of the periods to

which they relate. An enterprise should prepare its financial statements under the accrual basis of accounting except for

cash flow statements. Cash flow statements look at the cash transactions within the period. Consistency - arises when

an item‟s presentation and classification is retained from one period to the next.

3.3.3 Materiality - Information is material if its omission or misstatement can influence the economic decisions of

users taken on the basis of the financial statements. Each material class of similarities should be presented separately in

financial statements. Each material class of similar items should be presented separately in the financial statement.

Materiality depends on the size and nature of the item. Items of dissimilar nature shall be presented separately unless

they are immaterial.

3.3.4. Offsetting - Emphasizes that assets and liabilities and income and expenditure shall not be offset unless

required or permitted by a standard or interpretation.

3.3.5 Comparativeness - should be provided for all numerical information except when a standard offers an

exemption.

4. IFRS Impacts on Oil and Gas Accounting

4.1 Exploration and Evaluation (E and E) of Assets The costs involved in “E and E” and development activities are considerable and often there are years between the start

of exploration and the commencement of production. Even with today‟s advanced technology, exploration is a risky

and complex activity. These factors create specific challenges in accounting for “E and E” expenditure. There was no

IFRS that specifically addressed “E and E” activities until IFRS 6 became effective in 2006. IFRS 6 was intended to be

a temporary standard while IASB undertook an in-depth project on extractive activities. With that in mind, the standard

was written with a view to allowing companies to carry over to IFRS their previous Generally Acceptable Accounting

Principles (GAAP) practices to a large extent (KPMG, 2011). Traditionally under national GAAPs, Oil and Gas

Companies have accounted for “E and E” costs using one of two broadly defined methods: the successful efforts

method or the full cost method. However, as there is no single accepted definition of either method under IFRS, the

application of these approaches can vary.

4.1.1. Capitalization of “E and E” expenditure IFRS 6 relaxes asset recognition requirements for “E and E” expenditure

Without the benefit of IFRS 6, expenditure would not be recognized as an asset unless it is probable that it will give

rise to future economic benefits. This would mean that expenditure on an exploration activity likely would be expensed

until the earlier of the time at which the following occurs:

1) the estimated fair value less costs to sell of the exploration prospect is positive; and

2) It is determined that commercial reserves are present.

Applying this test, it would be rare for expenditure other than license acquisition costs to be capitalized prior to the

determination of commercial reserves. IFRS 6 relaxes this approach for “E and E” assets, allowing capitalization of “E

and E” costs by expenditure class if the company elects that accounting policy.

4.1.2 Definition of “E and E” expenditure The stage of a project is important in determining the accounting standards to be applied. IFRS 6 applies only to “E and

E” expenditure. Outside of the scope of IFRS 6 the usual IFRS accounting requirements apply, including in respect of

impairment testing.





The standard provides a non-exhaustive list of “E and E” expenditure that may be capitalized, including the cost of

geological and geophysical studies, the acquisition of rights to explore, exploratory drilling, trenching and sampling.

The stage of projects needs to be monitored to ensure that accounting policies are applied appropriately. IFRS 6

however, excludes pre-license expenditure from the scope of “E and E” costs, implying that “E and E” activities

commence on acquisition of the legal rights to explore an area. Also, IFRS 6 does not apply to expenditure incurred

after the technical feasibility and commercial viability of extracting the Oil and Gas are demonstrable. Determining

when this is demonstrable and the level of detail at which this assessment should be made, can involve considerable

judgement and requires close communication between finance and technical specialists.

4.1.3 Classification Classification of expenditure forms the basis of presentation and subsequent measurement of assets.

“E and E” assets are a separate class of asset that is measured initially at cost. “E and E” assets are classified as tangible

or intangible assets depending on their nature. Tangible “E and E” assets may include the items of plant and equipment

used for exploration activity, such as vehicles and drilling rigs. Intangible “E and E” assets may include costs of

exploration permits and licenses as well as depreciation of tangible assets consumed in developing intangible assets

such as exploratory wells.

4.1.4 Implication for First-time adoption of IFRS

Oil and Gas deemed cost election: There is an Oil and Gas industry-specific exemption in IFRS 1 “First-time

Adoption of IFRS”. Oil and Gas Companies can elect to measure “E and E” assets at the amount determined under

previous GAAP at the date of transition to IFRS. Development and production assets can be measured at the amount

determined for the cost center under previous GAAP, with an allocation to the underlying assets on “a pro rata” basis

using reserve volumes or reserve values at transition date. This exemption can assist Oil and Gas Companies in

preparing their first IFRS financial statements without having to revisit all previous accounting for these items (KPMG,

2011).

4.2. Impairment Issues The standard under paragraph 18 states that, impairment test shall be conducted when circumstances indicate that the

carrying amount of the exploration and evaluation assets exceeds their recoverable amount. Moreover, ii provides

instances of situations this may happen. Thus, when a company‟s right to explore has become near to expire or expired,

the project is out of the priority of the company‟s management in terms of planning and budgeting and the exploration

do not provide commercially viable quantities of resources impairment has occur. Following the occurrence of these

circumstances, companies shall perform impairment as per IAS 36. Nichols (2010) presents the impairment of assets of

Oil and Gas Companies under IFRS. First, assets are categorized into cash generating unit. Here it should be noted that

IFRS 6 paragraph 21 states that a cash-generating unit must not be larger than operating segment. For Oil and Gas

Companies, cash-generating unit is usually a field. Secondly, comparison is made between the book value and fair

value of the cash-generating unit. Fair value is reached by discounting the estimated future net cash flows. If this

amount is less than the book value, then impairment is recognized by the amount of the difference. The impairment is

charged to expense and a contra asset account such as accumulated capitalized cost account. Annual impairment testing

for intangible assets that are not yet available for use is relaxed for “E and E” assets

The standard provides the following examples of „trigger events‟ that indicate that an “E and E” asset should be tested

for impairment:

1. expiration of the right to explore;

2. substantive expenditure on further exploration for and evaluation of mineral resources in the specific area is

neither budgeted nor planned;

3. commercially viable reserves have not been discovered and the company plans to discontinue activities in the

specific area; and

4. Data exists to show that while development activity will proceed, the carrying amount of the “E and E” asset

will not be recovered in full through such activity.





This provides relief from the general requirements of IFRS, which require annual impairment testing for intangible

assets that are not yet available for use. Impairment testing calculations are performed in line with general impairment

requirements and take into account the time value of money.

4.2.1 Reporting date consideration of impairment indicators For non-current assets (other than goodwill and “E and E” assets) IAS 36 Impairment of Assets requires companies to

assess at the end of each reporting period whether there are any indicators that an asset is impaired. If there is such an

indication, then recoverable amount needs to be assessed.

An impairment loss is recognized for any excess of carrying amount over recoverable amount. If recoverable amount

cannot be determined for the individual asset, because the asset does not generate independent cash inflows separate

from those of other assets, then the impairment loss is recognized and measured based on the cash-generating unit to

which the asset belongs.

4.2.2 Cash-generating units (CGUs)

Identification of appropriate CGUs can be complex

A CGU is the smallest group of assets that generates cash inflows from continuing use that are largely independent of

the cash inflows from other assets or group of assets of the Oil and Gas company. According to KPMG report, many

companies in the Oil and Gas sector base the identification of CGUs on license, field or core areas. For some

companies that operate a number of areas or fields that have shared infrastructure and “E and E” assets, the

identification of CGUs can be more complex (2010). An accounting policy is also needed for allocating “E and E”

assets to CGUs when an impairment test is to be performed. For assets during the “E and E” phase, CGUs can be

aggregated to form a group of units for impairment testing purposes. Allocation of assets to CGUs and impairment

groups requires judgement and the interaction with indicators of impairment will require consideration.

4.2.3 Indicators of impairment

Some examples of indicators of impairment are outlined below.

1) Market value has declined significantly or the company has operating or cash losses: a significant downward

movement in the oil price may result in operating cash losses and represent a trigger for impairment. These triggers

include: a) Technological obsolescence; b) Competition.

2) Market capitalization: the carrying amount of the Oil and Gas company‟s net assets exceeds its market

capitalization. This may be a particular risk for companies with large “E and E” assets.

3) Significant regulatory changes: increased regulation of environmental rehabilitation processes.

4) Physical damage to the asset: damage to a drilling rig caused by an explosion.

5) Significant adverse effect on the company that will change the way in which the asset is used/ expected to be

used: the re-nationalization requirements of some governments may lead to some projects being diluted to

accommodate a government interest.

4.2.4 Goodwill - Impairment testing at least annually

Under IFRS, Oil and Gas Companies are required to test goodwill (and intangible assets with indefinite useful lives) for

impairment at least annually, irrespective of whether indicators of impairment exist. Additional testing at interim

reporting dates is required if impairment indicators are present. Goodwill by itself does not generate cash inflows

independently of other assets or group of assets and therefore is not tested for impairment separately.

Instead, it should be allocated to the acquirer‟s CGUs that are expected to benefit from the synergies of the related

business combination. Goodwill is allocated to a CGU that represents the lowest level within the company at which the

goodwill is monitored for internal management purposes. The CGU cannot be larger than an operating segment as

defined in IFRS 8 Operating Segments, before aggregation. An impairment loss is recognized and measured at the

amount by which the CGU‟s carrying amount, including goodwill, exceeds its recoverable amount.





4.2.5 Impairment reversals - Reversal of impairment losses restricted

Impairment losses related to goodwill cannot be reversed. However, for other assets companies assess whether there is

an indication that a previously recognized impairment loss has reversed. If there is such an indication, then impairment

losses are reversed if the recoverable amount has increased, subject to certain restrictions.

4.3 JOINT ARRANGEMENTS The term joint venture is a widely used operational term, although not all such arrangements are joint ventures for

accounting purposes. A recently issued standard can significantly impact the accounting for Joint arrangements.

4.3.1 Determining whether an arrangement is a joint arrangement

Companies need to review their arrangements to determine whether they should be accounted for as a joint

arrangement or not.

Joint arrangements are a common way for Oil and Gas Companies to share the risks and costs of exploration and

production activities and come in a variety of forms. Within the sector, the term joint venture is used widely as an all-

encompassing operational expression to describe shared working arrangements. However, under IFRS there are strict

criteria that must be met in order for joint arrangement accounting to be applied.

For an arrangement to be a joint arrangement for accounting purposes there must be a contractual arrangement that

gives joint control. Joint control is not determined by economic interest. Control is based on the contractual

arrangements and exists when decisions about the relevant activities require the unanimous consent of more than one

party to the arrangement. Companies must review their arrangements to determine whether joint control exists. When

the company does not have joint control, the arrangement likely will be accounted for as an investment, subsidiary or

associate.

4.3.2 Accounting for joint ventures prior to adoption of IFRS 11

Accounting is based on whether there is a separate legal entity. An accounting policy choice is available for jointly

controlled entities.

Accounting for joint arrangements (currently referred to as joint ventures) before the adoption of IFRS 11 Joint

Arrangements is governed by IAS 31 “Interests in Joint Ventures”. There are three classifications of joint venture under

IAS 31: jointly controlled entity, jointly controlled asset and jointly controlled operation.

4.3.3 Jointly controlled entities

A jointly controlled entity is a joint arrangement that is carried out through a separate legal entity. Currently there is an

accounting policy choice that applied when accounting for jointly controlled entities. A venturer accounts for its

interest using either proportionate consolidation or the equity method. In KPMG‟s (2008) survey “The Application of

IFRS: Oil and Gas” there was an almost even split between companies applying the equity method and those using

proportionate consolidation.

4.3.4 Jointly controlled assets and jointly controlled operations

Jointly controlled assets and jointly controlled operations are joint ventures that are not separate legal entities.

Venturers in jointly controlled assets and jointly controlled operations recognize the assets and liabilities or share of

assets and liabilities, that they control, as well as the costs incurred and income received in relation to that arrangement.

4.3.5 Accounting for joint arrangements from 2013

A new standard issued in 2011 significantly impacts the accounting for joint arrangements. IASB issued IFRS 11 in

May 2011. The standard is effective for periods beginning on or after 1 January 2013, with early adoption permitted

subject to some conditions.





There are two classifications of joint arrangements under IFRS 11: Joint ventures and joint operations. The

definitions of each category differ from those in IAS 31. The classification of arrangements under IFRS 11 is more

judgmental and the terms of arrangements and the nature of any related agreements must be considered to determine

the classification of the arrangement for accounting purposes.

Joint venture under IFRS 11

A joint venture is a joint arrangement in which the jointly controlling parties have rights to the net assets of the

arrangement. Joint ventures include only arrangements that are structured through a separate vehicle (such as a separate

company). However, not all joint arrangements that are companies will necessarily be joint ventures.

The nature and terms of arrangements need to be reviewed to determine the appropriate classification of the

arrangement. The legal form is only one factor to be considered. When the contractual arrangements and other facts

and circumstances indicate that the joint venturers have rights to assets or obligations for liabilities of the arrangement,

the arrangement will be a joint operation. One circumstance that can indicate that an arrangement is a joint operation is

if the arrangement is designed so that the jointly controlled company cannot undertake its own trade and can only trade

with the parties to the joint arrangement. Related agreements and other facts and circumstances also need to be

considered. A joint venturer will account for its involvement in the joint venture using the equity method in accordance

with IAS 28 (2011) Investments in Associates and Joint Ventures.

Joint operation under IFRS 11

A joint operation is an arrangement in which the jointly controlling parties have rights to assets and obligations for

liabilities relating to the arrangement. An arrangement that is not structured through a separate vehicle will be a joint

operation; however, other arrangements may also fall into this classification depending on the rights and obligations of

the parties to the arrangement. A joint operator recognizes its own assets, liabilities and transactions, including its share

of those incurred jointly.

4.4 Provisions on Deferred Taxation Reserve Reporting: There is no specific IFRS reporting requirement on reserves, although many Oil and Gas

Companies include an accounting policy for reserves or a commentary in the critical estimates and judgements note or

in the management discussion and analysis section of the annual report (KPMG, 2011).

Oil and Gas reserve estimates are critical information in the evaluation of Oil and Gas Companies and reserves

disclosure is an important component of annual reports in the sector. The purpose of reserves reporting is to make

available information about the Oil and Gas reserves controlled by companies in the sector. This is vital in assessing

their current performance and future prospects. Despite their importance to both the company and the financial

statements, there are no explicit requirements for the disclosure of reserve information in IFRS.

Disclosures: In the absence of specific guidance, Oil and Gas Companies tend to refer to other requirements, such as

those in the US, Canada, Australia and the UK. The nature of reserves estimates is such that, even if all companies

provided disclosure based on a single classification, meaningful comparison between companies would be difficult

without in-depth analysis of the many assumptions inherent in the core disclosures.

The US Securities and Exchange Commission‟s rules require any issuer providing disclosure under ASC 932-235

Extractive Activities – Oil and Gas – Notes to Financial Statements to continue to provide that disclosure even if the

issuer is preparing financial statements in accordance with IFRS.

4.4.1 Impact of reserve estimates on financial statement balances

While the reporting of reserves data is important in its own right, reserves measures are also used in deriving a number

of accounting estimates. Financial analysts posit that the following are usually applicable in company‟s financial

statements:

- “DD and A” calculations usually are based on the unit-of-production method and the volume of reserves used

in the calculation affects the calculation of the associated “DD and A” charge.





- Reserves estimates are a key factor in determining the economic life of an oil field and therefore impact on the

calculation of decommissioning and environmental rehabilitation provisions.

- Impairment calculations include assumptions for reserves. Downward revisions in reserve estimates often

represent an indicator of impairment.

- Reserves are a key input to fair value calculations in accounting for a business combination.

- Assumptions about future profit potential based on reserves estimates may be the basis for the recognition of

deferred tax assets arising from unused tax losses. Because of the impact of reserves information in the financial

statements, Oil and Gas Companies typically include some information about reserves in the critical estimates and

judgments note to the financial statements.

4.5 Fair Value Issues- Financial Instruments

The conversion process must include a review of the existence, classification and accounting for financial instruments,

including derivatives. Future changes in the accounting are expected. Oil and Gas Companies generally have financial

instrument accounting issues owing to the significant commodity price risk that they face and the structures in place to

manage this and other exposures such as currency fluctuations. A thorough review of the existence, classification and

accounting for financial instruments will be required on conversion.

4.5.1 Current requirements under IFRS

Accounting and disclosure requirements may be significantly different from national GAAP. Contracts to buy and sell

Oil and Gas and other non-financial items may be included in the scope of the financial instruments standards. There is

an exemption for contracts that are held for physical delivery or receipt for the company‟s expected purchase, sale or

usage requirements (the „own use exemption‟). However, specific conditions must be met to apply this exemption and

its applicability should be reviewed carefully.

Specific types of Oil and Gas contracts also commonly contain embedded derivatives that may need to be accounted

for separately. For example, gas contracts that are not derivatives themselves may contain embedded derivatives as a

result of a pricing mechanism linked to an index other than a gas pricing index.

As it currently stands, IAS 39 “Financial Instruments: Recognition and Measurement” requires financial assets to be

classified into one of four categories:

1) at fair value through profit or loss; 2) loans and receivables; 3) held to maturity; and 4) available for sale.

Financial liabilities are categorized as either financial liabilities at fair value through profit or loss or „other‟ liabilities.

Financial assets and financial liabilities are measured initially at fair value. After initial recognition, loans and

receivables and held-to-maturity investments are measured at amortized cost. All derivative instruments are measured

at fair value with gains and losses recognized in profit or loss except when they qualify as hedging instruments in a

cash flow or net investment hedge. A financial asset is derecognized only when the contractual rights to cash flows

from that particular asset expire or when substantially all risks and rewards of ownership of the asset are transferred. A

financial liability is derecognized when it is extinguished or when the terms are modified substantially.

4.5.2 Forthcoming requirements/ Future developments

Simplified classifications

In November 2009 IASB published the first chapters of IFRS 9 “Financial Instruments”, which will supersede the

requirements of IAS 39 “Financial Instruments: Recognition and Measurement” on the classification and measurement

of financial assets. In October 2010 requirements with respect to the classification and measurement of financial

liabilities and de-recognition of financial assets and financial liabilities were added to IFRS 9. Most of these

requirements have been carried forward without substantive amendment from IAS 39. However, to address the issue of

own credit risk some changes were made to the fair value option for financial liabilities. The effective date of IFRS 9 is

periods beginning on or after 1 January 2013 but an exposure draft, open for comment until 21 October 2011, requests

views on whether the effective date should be pushed back to 1 January 2015. IFRS 9 includes two primary

measurement categories for financial assets: amortized cost and fair value.





Other classifications, such as held to maturity and available for sale, have been eliminated. The classification and

measurement requirements for financial liabilities are generally unchanged other than a change to the treatment of

changes in fair value as a result of own credit risk.

4.5.3 IASB‟s review of financial instruments accounting may result in significant changes in

accounting

IASB continues to work on elements of its comprehensive financial instruments project, most notably hedging and

impairment. In November 2009 IASB issued Exposure Draft “Financial Instruments: Amortized Cost and Impairment”,

with supplementary proposals in January 2011 relating to the impairment of financial assets managed in an open

portfolio (the supplement). The supplement proposes to replace the incurred loss approach to impairment of financial

assets with an approach based on expected losses. Extensive disclosures were also proposed. IASB issued Exposure

Draft “Hedge Accounting” in December 2010, proposing significant changes to the current hedge accounting

requirements. The proposals were designed to integrate hedge accounting more closely with risk management policies

and objectives. For companies applying hedge accounting to commodity price transactions, the process for assessing

hedge effectiveness would change. The proposals also expanded the range of instruments that can be designated as

hedged instruments. IASB deliberations on both projects are ongoing.

4.6 Other Areas in Oil And Gas Accounting That IFRS Affects

4.6.1 Revenue Recognition

Oil and Gas Companies face challenges when applying the revenue recognition requirements under IFRS due to

common industry arrangements that can give rise to complex revenue issues Oil and Gas Companies reporting under

IFRS need to assess whether the risks and rewards of ownership have been transferred in order to determine when to

recognize revenue. The determination of when this occurs can present challenges for Oil and Gas Companies. The

individual facts and circumstances will need careful consideration as they may vary between contracts.

4.6.2 Timing of revenue recognition

There is no industry standard as to the timing of the transfer of ownership in Oil and Gas transactions. The revenue

arising from each transaction is recognized based on the terms of the underlying sales agreement. For most transactions

involving the sale of physical Oil and Gas, the contractual terms for the transfer of ownership will be based on the

delivery or lifting of production. For example, for crude oil sales generally there are two points at which title can pass

from seller to buyer: when the crude oil is lifted from the site of production; or when the crude oil is delivered to the

refinery/ storage depot. For petroleum products sold to retail distribution networks, generally revenue is recognized on

delivery to service stations.

4.6.3 Physical exchange of products

The physical exchange of products is common within the Oil and Gas industry. For example, under crude oil buy/sell

arrangements a company agrees to buy a specified quantity and grade of oil to be delivered at a specified location,

while simultaneously agreeing to sell a specified quantity and grade of oil at a different location with the same

counterparty, generally to facilitate operational requirements. In accordance with IAS 18 “Revenue”, the swapping of

goods or services that are of a similar nature and value is a transaction that does not generate revenue. The nature of the

exchange will determine if it is a like-for-like exchange accounted for at book value or an exchange of dissimilar goods

within the scope of IAS 18. The quantum of the balancing payment is one important factor in deciding whether the

transaction is a sale and a purchase or a swap of similar products. The more significant the balancing payment is

compared to the value of the products being exchanged, the more likely the transaction is to be a swap of dissimilar

products.

4.6.4 Over-lift and under-lift

In many joint arrangements the timing of revenue recognition will coincide with a fixed schedule of lifting, which

stipulates when each participant lifts its share of crude oil or gas from the production facility. The practicalities of

loading an oil tanker mean that any single lifting can be more or less than a company‟s entitlement, resulting in an

over-lift (a lifting in excess of the company‟s contractual allocation of production) or an under-lift (a lifting less than





the company‟s contractual allocation of production). Oil and Gas Companies need to consider how they account for

any over-lift or under-lift balances, including what measurement base to apply to any resulting asset or liability.

4.6.5 Future developments- A new standard on revenue recognition is expected

IASB and the US Financial Accounting Standards Board are working on a joint project to develop a comprehensive set

of principles for revenue recognition. An exposure draft published in 2010 proposed a single revenue recognition

model in which an entity would recognize revenue as it satisfies a performance obligation by transferring control of

promised goods or services to a customer. The model was proposed to be applied to all contracts with customers except

leases, financial instruments, insurance contracts and non-monetary exchanges between entities in the same line of

business to facilitate sales to customers other than the parties to the exchange. The Boards redeliberated the proposals

contained in the exposure draft during the first half of 2011 and agreed tentatively to revise a number of aspects of the

proposals, including the criteria for identifying separate performance obligations, the guidance on transfer of control

and the measurement of the transaction price, particularly for arrangements including uncertain consideration. The

Boards concluded that, although there was no formal due process requirement to re-expose the proposals, it was

appropriate to go beyond established due process given the importance of this topic to all entities. A revised exposure

draft is expected in the second half of 2011.

4.7 Decommissioning and Environmental Provisions IFRS may result in the earlier recognition of provisions than many national GAAPs. Oil and Gas Companies often are

exposed to legal, contractual and constructive obligations to meet the costs of decommissioning and dismantling assets

at the end of their production life and to restore the site. These costs are likely to be a significant item of expenditure

for most Oil and Gas Companies.

4.7.1 Timing of recognition - A present obligation that is more likely than not

Decommissioning and environmental provisions are covered by IAS 37 “Provisions, Contingent Liabilities and

Contingent Assets”. Recognition of a provision is required when there is a present obligation and an outflow of

resources is probable. Probable is defined as more likely than not. A present obligation can be legal or constructive in

nature. For Oil and Gas Companies, a legal obligation for decommissioning and remediation often is contained in the

license agreement and related contracts or in legislation. However, in some countries environmental legislation may be

less developed and it may be difficult to determine the extent of the obligation. A constructive obligation may arise

from a company‟s published policies about environmental clean-up or from past practices. An obligation to make good

damage or dismantle equipment is provided for in full when the damage is caused or the asset installed. This may result

in the recognition of additional amounts or earlier recognition of such amounts in IFRS financial statements compared

to previous GAAP. When the provision arises on initial recognition of an asset, the corresponding debit is treated as

part of the cost of the related asset and is not recognized immediately in profit or loss.

4.7.2 Measurement - Judgement is required to arrive at the „best estimate‟

The provision is measured at the best estimate of costs to be incurred. This takes the time value of money into account,

if material. The best estimate may be based on the single most likely cost of decommissioning and takes uncertainties

into account in either the cash flows or discount rate used in measuring the provision. The discount rate should reflect

the risks specific to the liability and adjusting the discount rate for risk often is complex and involves a high degree of

judgement.

There are many complexities in calculating an estimate of expenditure to be incurred. Technological advances may

reduce the ultimate cost of decommissioning and may also affect the timing by extending the expected recoveries from

reservoirs. The estimate is updated at each reporting date. For midstream and downstream assets with indefinite useful

lives, the timing of decommissioning may be so distant that the present value of liabilities is not significant. When there

is uncertainty about the useful life of the asset, this uncertainty needs to be taken into account in the measurement of

the provision. In such cases, it may be that the provision is not significant until the expected date at which the facilities

will be decommissioned is less distant. Significant judgement may be required in measuring the provision.





4.7.3 Future developments - IASB is reviewing accounting for provisions

In 2005, IASB began reviewing the accounting for provisions and an exposure draft was issued, which would have

resulted in changes to both the timing of recognition and the measurement of provisions. In 2010, IASB issued a

limited re-exposure of the 2005 proposals, which included a focus on the measurement of provisions involving

services, e.g. decommissioning. The project currently is inactive and IASB will decide whether or how to progress the

project when it considers responses to its “Agenda Consultation 2011”, which are due by 30 November 2011.

4.8 Depletion, Depreciation and Amortization (“DD and A”) A move from group depreciation methods or depreciation pools under previous GAAP to component depreciation

under IFRS can require significant effort.

4.8.1 Component accounting

Significant judgement may be required in determining components and systems needs to be capable of tracking

components separately. Companies need to allocate the cost of an item of property, plant and equipment into its

significant parts or „components‟ and depreciate each part separately. For each component the appropriate depreciation

method, rate and period needs to be considered. This process may involve significant judgement. An item of property,

plant and equipment should be separated into components when those parts are significant in relation to the total cost of

the item. This does not mean that a company should split its assets into an infinite number of components if the effect

on the financial statements would be immaterial. Some Oil and Gas Companies that have been applying full cost

accounting under previous GAAP may have been calculating “DD and A” at a cost center (typically a country) level.

While there is no cost-pool concept under IFRS, the standard does allow companies to group and depreciate

components within the same asset class together, provided they have the same useful life and depreciation method.

However, it is unlikely that development or production Oil and Gas assets will be able to be grouped at a level greater

than a field; this is because each field may be significant and the lives of the fields and therefore depreciation rates, will

vary. Companies need to consider the impact, including on accounting systems, of depleting assets on a much more

detailed level than previous GAAP.

4.8.2 Depreciation method

Companies need to choose the most appropriate depreciation method as IFRS do not specify one particular method of

depreciation as preferable. Oil and Gas Companies have the option to use the straight-line method, the reducing balance

method or the unit-of-production method, as long as it reflects the pattern in which the economic benefits associated

with the asset are consumed. The unit-of-production method is most commonly used to deplete upstream Oil and Gas

assets, using a ratio that reflects the annual production of a field in proportion to the estimate of reserves within that

field. IFRS provides no specific guidance on how the assumptions within the reserve estimates should be calculated or

approximated. Consequently, practice varies as to which reserves base is used in the calculation of “DD and A”.

4.8.3 Commencement of depreciation/amortization - Available for use

Depreciation or amortization starts when an asset is available for use. For assets in the development stage, there may be

pilot testing phases prior to the start of full production. Whether incidental production arising during such phases

triggers depreciation depends on the assessment of whether the asset is available for use.

Some “E and E” assets (e.g. a drilling rig) may be available for use immediately and so can be depreciated/amortized

during the “E and E” phase. Other assets will not be available for use until the whole field is ready to commence

operations.

4.9 Some Identified Benefits of IFRS Adoption in the Oil and Gas Industry

While the majority of this paper has focused on the micro-based risks and issues associated with IFRS and IFRS

conversions, there is need for senior management of Oil and Gas Companies not to lose sight of the macro-based

benefits to IFRS conversion. These are enumerated below:





1.) IFRS may offer more global transparency and ease access to foreign capital markets and investments and that

may help facilitate cross-border acquisitions, ventures and spin-offs.

2.) By converting to IFRS, Oil and Gas Companies should be able to present their financial reports to a wider

capital community. If this lowers the lending rate to that company, say, a quarter of a percentage point for the annuity

of the instrument, then the benefits are clearly measurable despite the short-term pain of the finance group through

IFRS conversion process.

5. Conclusion Clifford and Demaki (1999) insist that information (financial report) is the bedrock of effective management function.

Without appropriate and reliable IFRS based financial statement, management cannot plan well, hire the right labor,

provide effective control and leadership, identify managerial problems, find solutions and take decisions. Knowledge

(i.e. IFRS based financial report) is power. It provides the power to management and entrepreneurship. Adopting IFRS

guidance in Oil and Gas Accounting Reporting will no doubt make companies internationally attractive regardless of

negative perceptions – especially in environmental impact. There are also attendant challenges of fully adopting and

implementing IFRS guidelines in the Nigerian context. However, overcoming IFRS challenges will require updating

accounting curricula in all training institutions including the universities and polytechnic in Nigeria. It will also be

necessary to harmonize regulatory requirements by amending existing laws that may currently be serving as a

drawback to IFRS adoption; for example, the provision in the Company and Allied Matters Act (CAMA) 1990, the

Investment and Securities Act (ISA) 2007, Bank and other Financial Institution Act (BOFIA) 1991 must be

harmonized. Constantly keeping up with the pronouncements published by the International Accounting Standard

Board (IASB) will also be necessary for the sustainable economic development in Nigeria.

Finally, the adoption of a high quality set of harmonized accounting standards fosters trade and FDI since the

improvement of accounting information, in turn, fosters financial transparency and comparability and reduces

information asymmetries and unfamiliarity among agents in different countries. IFRS has been recognized as a global

reporting framework. It is wishful thinking to expect a reversal of events in over 120 countries that either require or

permit its use. There is no doubt that conversion to IFRS in Nigeria is a huge task and a big challenge; its revolutionary

impact requires a great deal of decisiveness and commitment. It is in the best interest of Nigeria to adopt IFRS all-

round the sector – whether Oil and Gas sector, banks or other companies, all must be involved in the training of

convergence.A countrywide intensive capacity building program to facilitate and sustain the process of adoption is

needed as early as possible. IFRS ship is already making its way around the world as a single set of high quality global

accounting standards. Nigeria is a significant donor to the International Financial Reporting Standards Foundation.

Total contribution of all donor countries in 2011 towards standard setting activities was GBP 20.50 million (Oduware,

2012). There is need for the country to ride on this global reporting platform and investment. It is imperative to note

that for Nigeria to reap the full benefits of IFRS adoption, the government must put in place an enabling political

environment as no country can achieve economic development in an atmosphere of violence and political unrest and

this will significantly impact on the operations of Oil and Gas Companies in Nigeria.

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