Oil and Gas Accounting – What is It?

The oil and gas industry is one of the most influential sectors in the world. The United States alone generated an estimated 332.9 billion dollars in 2022. As the demands placed on this massive industry continue to shift, it’s essential for O&G companies to have effective and precise accounting practices to optimize operations. From ambiguous revenue recognition norms to compliance issues to generating financial statements in real-time, O&G companies take on unique challenges and responsibilities with their accounting practices. Keeping up with financial management can be challenging and overwhelming, which is why the innovative technology of a unified SaaS platform can make all the difference. In this article, we’ll explore the different fields and principles associated with accounting for the oil and gas industry. Let’s dive in!

What is Oil and Gas Accounting?

Oil and gas accounting is a specialized discipline essential for accurately tracking and reporting financial activities in the oil and gas industry. It ensures transparent financial reporting, compliance with regulations, and strategic decision-making. As an intricate discipline, oil and gas accounting plays a pivotal role in valuing assets, managing risks, and supporting sustainable practices in the exploration, extraction, and production of oil and gas resources.

Seven key aspects of oil and gas accounting include:

Reserve Accounting

Reserves are estimated quantities of oil and gas that can be economically recovered from known reservoirs under existing economic conditions and operating methods. Companies in the oil and gas industry need to account for their proven reserves.

Revenue Recognition

Revenue recognition in oil and gas accounting can be complex due to factors such as production-sharing agreements, joint ventures, and royalty payments. Different arrangements may impact when and how revenue is recognized.

Exploration and Development Costs

Whether you’re drilling, conducting seismic testing, or carrying out other exploration activities, companies need to account for the costs of exploring and developing gas reserves.

Depreciation, Depletion, and Amortization (DD&A)

As oil and gas reserves are extracted, companies need to allocate the costs of acquiring and developing these reserves over time. DD&A is the accounting method used to spread these costs over the life of the reserves.

Joint Venture Accounting

Many oil and gas projects involve joint ventures where multiple companies collaborate. Joint venture accounting is crucial to accurately reflect each participant’s share of costs, revenues, and other financial aspects.

Hedging Activities

Given the volatility of oil and gas prices, companies in this industry often engage in hedging activities to manage their exposure to price fluctuations. Accounting for hedging transactions is an integral part of oil and gas accounting.

Reporting Compliance

Oil and gas companies need to adhere to specific regulatory and tax reporting requirements, and their financial reporting has to comply with industry standards and guidelines. These requirements vary widely from state to state, and it’s important to have a system that can support these requirements and make compliance a breeze.

Fields of Oil and Gas Accounting

From finding oil and gas reserves to distributing them for consumer use, accounting is a big part of all areas of the industry. The three major oil and gas accounting fields are upstream, midstream, and downstream.

Upstream Accounting

• Involves accounting for exploration, drilling, and production activities.
• Addresses costs associated with finding and extracting oil and gas reserves.
• Reserves estimation and depletion accounting are crucial components.

Midstream Accounting

• Covers financial activities related to the transportation and storage of oil and gas.
• Involves accounting for pipeline operations, transportation costs, and storage facilities.

Downstream Accounting

• Focuses on the refining, distribution, and marketing of oil and gas products.
• Involves accounting for refining costs, inventory valuation, and sales revenue.

Principles of Oil and Gas Accounting

Regardless of industry, all publicly traded companies in the United States follow accounting principles set forth by U.S. Generally Accepted Accounting Principles (GAAP). The oil and gas industry is no different. The Financial Accounting Standards Board (FASB) develops and maintains U.S. GAAP, which encompasses a broad set of principles, standards, and guidelines. Oil and gas accounting principles should be in line with GAAP.

GAAP’s Ten Major Accounting Principles

Revenue Recognition

The principle outlines when and how to recognize revenue from the sale of goods or services. It provides guidance on the recognition criteria, measurement, and disclosure of revenue in financial statements.

Expense Recognition (Matching Principle)

Expenses should be recognized in the period in which they are incurred, helping to match costs with the revenue they generate. This principle supports the accurate portrayal of a company’s profitability.

Historical Cost Principle

Assets are generally recorded at their original cost, which is the amount paid to acquire them. The historical cost principle emphasizes reliability and verifiability in financial reporting.

Full Disclosure Principle

Financial statements should include all necessary information to ensure that users can make informed decisions. Under this principle, notes to the financial statements, supplementary disclosures, and other relevant information should be included.

Conservatism Principle

When faced with uncertainty, accountants should choose methods that are less likely to overstate assets and income. This principle encourages a prudent approach to financial reporting.

Consistency Principle

Accounting methods and principles should be applied consistently from one period to another. Consistency enhances comparability in financial statements over time.

Materiality Principle

Information is considered material if its omission or misstatement could influence the economic decisions of users. Material items should be disclosed in financial statements.

Entity Concept

The financial activities of a business entity are separate from those of its owners. This principle emphasizes the need to keep personal and business transactions separate.

Going Concern Assumption

Financial statements are prepared under the assumption that the entity will continue to operate for the foreseeable future. This assumption influences the valuation of assets and liabilities.

Hierarchy of Accounting Principles

When there are conflicts between different accounting principles or methods, a hierarchy exists to guide the selection of the most appropriate principle. The hierarchy includes authoritative guidance from standard-setting bodies.

These principles, among others, provide the foundation for financial reporting under U.S. GAAP. It’s important to note that U.S. GAAP is dynamic, and the FASB continually updates and issues new standards to address emerging issues and improve the quality of financial reporting. All oil and gas companies are expected to stay current with the latest accounting standards to ensure compliance with U.S. GAAP.

Importance of Oil and Gas Accounting

Proper oil and gas accounting is crucial for businesses to remain profitable and compliant with regulations. Here are five key reasons why oil and gas accounting is important:

Asset Valuation

Oil and gas reserves are significant assets for energy companies. Accurate accounting helps in valuing these reserves, determining depletion, and providing insights into the company’s overall asset base, influencing strategic decisions and financial planning.

Financial Reporting and Transparency

Precise financial reporting is crucial for transparency. Stakeholders rely on financial statements to assess the financial health of oil and gas companies. Proper accounting practices build trust among investors, regulators, and the public, fostering confidence in the industry.

Regulatory Compliance

The oil and gas industry is subject to specific regulations. Adherence to accounting standards and compliance with regulations is essential to avoid legal issues, ensure regulatory compliance, and maintain industry integrity.

Risk Management

Oil and gas prices are volatile, and companies engage in risk management strategies. Effective accounting allows for the assessment of the impact of these strategies, helping companies manage risks associated with price fluctuations.

Strategic Decision-Making

Exact accounting data is critical for evaluating project economics, making informed investment decisions, and planning for the future. It enables companies to assess project viability, allocate resources efficiently, and make strategic decisions that contribute to long-term success in the industry.

Oil and gas accounting is fundamental to the industry’s efficient operation, regulatory compliance, and strategic decision-making. It ensures that financial information is accurate, transparent, and aligned with industry standards, contributing to the overall integrity and sustainability of the oil and gas sector.

Whether upstream or midstream, W Energy can help you streamline your financial operations. Our cloud-based platform is built specifically for energy companies. By utilizing one integrated platform, you’ll be able to manage your financial information with remarkable efficiency and accuracy. That includes Revenue Accounting, Accounts Payable, Joint Venture Accounting, Division Orders, and more. When you streamline your financial workflow with W Energy accounting solutions, accounting processes accelerate, results are validated with ease, and hassle-free compliance can be achieved. Interested in learning more? Contact us for a demo today!