Full cost method

The full cost method is a cost accounting method used in the oil and gas industry. Under this method, all property acquisition, exploration, and development costs are aggregated and capitalized into a country-wide cost pool. This capitalization occurs whether or not a well is deemed successful.

These costs are then charged to expense using the unit-of-production system, based on proven oil and gas reserves. If the stream of expected cash flows from a project is expected to decline, either due to a reduction in estimated reserves or a decline in the market price of the commodity in question, then the full cost pool associated with that project may be impaired. If so, the amount of the impairment is charged to expense at once.

The full cost method makes a company more susceptible to large non-cash charges whenever the preceding factors result in an expected cash flow decline. Until an impairment occurs, reported profit levels can appear to be inordinately high, since the expense recognition for so many costs has been deferred to a future date. The need for periodic impairment reviews also increases the accounting cost associated with this method.

A more conservative approach is the successful efforts method, under which exploration costs are only capitalized if a well is deemed successful. If a well is not considered successful, then the related costs are charged to expense. It is less likely that the successful efforts method will result in large non-cash charges, since the capitalized costs that could be subject to impairment are smaller than under the full cost method.

Neither of these methods capitalize the costs of corporate overhead or ongoing production activities.

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Oil and Gas Accounting