How do Footnotes and Disclosures Expand My Numbers?

One significant but often overlooked part of GAAP-compliant financial statements are the footnotes and disclosures that accompany the numbers. It’s easy to ignore these when you are in a rush to “see how the year went” and “see how much we made.” However, the footnotes provide additional information and color and allow a reader to obtain a better picture of the financial condition of a company. Remember, management and ownership may not be the only readers of the financial statements. Bankers and potential investors may be carefully reviewing these statements as well.

Financial statements of oil and gas producers have several footnotes that are unique to the industry. Some of these footnotes are related to items we’ve discussed previously. For example, any company with an asset retirement obligation related to their wells will generally have a footnote describing how the obligation is calculated and also showing a table with beginning balances, changes during the year, and the ending balance that ties to the balance sheet. This allows a reader to see more detail as to why the obligation increased or decreased during the year. Was it due to more wells brought online? Did the Company plug a large number of wells during the year? Was there a change in how the amount was calculated? The footnote will provide the reader with that information.

A second footnote commonly seen is related to hedging transactions and derivatives. This footnote will usually provide more detail about the Company’s hedging arrangements; for example, when do the agreements run through? What volume is the Company hedging? Is it based on NYMEX or WTI or Henry Hub? A reader will obtain a greater understanding of the accounting treatment of these transactions and how they are calculated from the footnote.

A third footnote might be related to reserves held by the Company. This is a required footnote for publicly held companies, but many private companies elect to include this information as well. For example, a table might show changes in reserves, similar to the asset retirement obligation described above. Why did reserves increase substantially this year? Or conversely, why the significant decrease? A footnote can explain the changes and show a reader that the change was due to prices going up or down. Or it might be because the Company bought or sold reserves during the year. Are the reserve totals using escalated prices? What discount rate is the Company using to determine total reserves. These and other questions can be answered and expanded upon within a footnote.

As we’ve mentioned above, the Company may not be the only reader of a financial statement. Bankers and investors read them as well. That’s why it’s essential to have strong and supportable numbers in your financial statements, and footnotes that are compliant with GAAP and allow for analysis and discussion. This is crucial for any company, whether you’re drilling your first well, or getting back into the game, or taking the next step to grow your Company.

This wraps up our series on GAAP for the oil and gas industry, To read other blog posts on this topic, search under the Category “Oil & Gas.” You can also subscribe to our newsletter or contact us at 330-453-7633 for more information about your oil and gas accounting needs.

Thanks for reading and if you have suggestions on topics, let us know at info@hallkistler.com.

Hall, Kistler & Company has been helping producers in the oil and gas industry since we opened our doors in 1941. We know what it takes to produce proper GAAP financial statements for oil and gas companies and can provide guidance along the way. Let us help when you are coming off of the sidelines and BACK INTO THE GAME.

Where do I account for Hedging Transactions?

Risk management is an important part of any business, especially in the oil and gas industry. Because oil and gas is a commodity, one significant risk that oil and gas producers have to deal with is the risk related to the price of that product. There are many strategies that producers use to deal with this risk. One strategy is to enter into agreements called derivative instruments or hedge agreements. These agreements might be a swap agreement, where the producer pays or receives amounts based on the difference between the “hedged” price and a market price from NYMEX or another index. Another strategy is to enter into what’s called a costless collar arrangement, where call and put options are used to create a net-zero effect on commodity price and reduce downside risk.

Regardless of how a company chooses to deal with the risk of price fluctuation, any time derivative instruments or hedging agreements are present the next question becomes, “How do I account for these?”.

How Do I Account for Hedging Agreements?

Accounting standards require that if these arrangements are designated as “hedges” by an entity, and function as such, they are recognized on the balance sheet at fair value, but any unrealized gains or losses associated with the arrangements are deferred through accumulated other comprehensive income on the financial statements.

As an example, think of a hedging swap agreement. Every month, the hedge agreement price is compared to an index price, and the difference is paid to or paid by the company, depending on where the agreement price fell in relation to the index price for that month. However, the agreement can run from one to two or even three years. Thus, until the agreement is finished, there’s always what’s called an “unrealized” portion that might be based on futures prices, again from an index like NYMEX. As each month is “realized,” the gain or loss hits the bottom line through the income statement, but what remains going forward still has value. Current futures prices might dictate that the Company has an asset and an unrealized gain through other comprehensive income if their hedge price is better than the futures prices. Conversely, if the company’s hedge price is less than the futures prices, a liability will be recorded as well as an unrealized loss through other comprehensive income. The objective is to reduce earnings volatility by more closely matching gains or losses from a derivative with the underlying item being hedged (usually production revenue in this case).

As if This Weren’t Complex Enough…

An entity can elect NOT to designate its derivative instruments as hedges. If this occurs, the fair value is still recorded on the balance sheet, and the realized gain is still recorded on the income statement, but the unrealized gain is now also recorded as a current period gain or loss rather than being deferred through other comprehensive income. In this instance, the gains or losses from the derivative are recorded in the current period regardless of when the gains or losses on the underlying item being hedged are realized.

As you can see, hedging transactions and derivative agreements can create complex accounting and disclosure requirements. However, these arrangements can effectively mitigate risks related to commodity price and thus can potentially be an essential component of GAAP financial statements for oil and gas producers.

Wrapping up our series on GAAP for the oil and gas industry, our last blog will discuss financial statement disclosures commonly seen in the oil and gas industry and what they might mean for your company’s financial statements.

To read other blog posts on this topic, search under the Category “Oil & Gas.” You can also subscribe to our newsletter or contact us at 330-453-7633 for more information about your oil and gas accounting needs.

Hall, Kistler & Company has been helping producers in the oil and gas industry since we opened our doors in 1941. We know what it takes to produce proper GAAP financial statements for oil and gas companies and can provide guidance along the way. Let us help when you are coming off of the sidelines and BACK INTO THE GAME.

Why You Need a Reserve Report

By Andy Griffin, CPA, Supervisor and Keith A. Arner, CPA, CVA, Partner
“Do I really need to spend money to have an engineer prepare a reserve report for me?” As an oil and gas producer, you may have asked this question before. Reserves are the most significant measure of the value of your company to an outside party. Whether you’re trying to obtain financing from a bank, attract outside investors to a drilling program, or buy or sell an oil and gas producer, the ultimate question that will have to be answered is ”What is the value of what you have in the ground?”

Some companies produce their own reports using the data they have on hand and pricing based on the situation (e.g., year-end NYMEX or possibly escalated pricing based on estimated future commodity prices); however, more common is the use of an outside petroleum engineer with experience in the field.

 One additional situation that often gets overlooked compared to the others listed above is the importance of reserve reports in producing statements that comply with generally accepted accounting principles (GAAP). 

Your calculation of depletion expense is a critical area where reserve reports play a part. One of the interesting and tricky parts of depletion is the fact that total reserves change every year. Factors such as how much you produced in the past year, and commodity price changes dictate the remaining reserves. Thus, an updated reserve report is essential in the calculation of this number. Remember, there is no way of knowing how much you depleted unless you know what you have left.

A second item that the reserve report is needed for is the calculation of your asset retirement obligation, which we have discussed in our blog in the series. Simply put, how are you going to calculate a retirement obligation or plugging liability on each well without estimating when that well is going to be plugged? Again, this is where the reserve report comes into play. The report should have an estimate of the remaining useful life of each well, or at a minimum the life remaining in each group of wells or field that you have.

Yet another important use of the reserve report is in calculating potential impairment of the value of your oil and gas properties. GAAP requires the evaluation of whether or not the fair value of an asset has fallen below the reported value on the financial statements. If the future value is less, an impairment has to be recorded, and the asset is written down to the fair value. The best way to calculate the value of your oil and gas properties to make this calculation is a reserve report using reasonable and supportable estimates of the future value of your wells/acreage/properties.

A unique twist we want to note that affects any companies following the full cost method of accounting (rather than the more common successful efforts method) is what’s called a cost ceiling test. Without getting into the intricacies of the calculation, it is similar in concept to the impairment calculation described above but is much more complex. So once again, the reserve report plays a significant role.

As you can see, it’s essential that your company has a solid and reasonable estimate of the value of “what you have in the ground.” A reserve report will allow you to make the calculations necessary to produce GAAP-compliant financial statements.

In our next blog post, we will discuss financial statement footnotes and disclosures related to oil and gas exploration and production companies.

For other blog posts on this topic, search under the Category “Oil & Gas.” You can also subscribe to our newsletter or contact us at 330-453-7633 for more information about your oil and gas accounting needs.


Hall, Kistler & Company has been helping producers in the oil and gas industry since we opened our doors in 1941. We know what it takes to produce proper GAAP financial statements for oil and gas companies and can provide guidance along the way. Let us help when you are coming off of the sidelines and BACK INTO THE GAME.

2018 Kiddie Tax on Child’s Unearned Income May Be Higher

By Sandra Orcutt, EA, Supervisor

Although the so-called “kiddie tax” will be easier to calculate thanks to the Tax Cuts and Jobs Act (TCJA) of 2017, the unearned income of eligible children (or grandchildren) could be taxed at a higher rate.

For tax years 2018 through 2025, the TCJA has changed the kiddie tax taxable structure. Unearned income is now taxed at the rates paid by trusts and estates. The highest bracket of the trust/estate rates for ordinary unearned income is 37 percent (or as high as 20 percent for long-term capital gains and dividends). Before the TCJA, the kiddie tax was taxed at the parent’s marginal tax rate. With the lowering of individual tax rates for 2018, this change to the kiddie tax could have significant tax consequences for children who derive more than half of their support from unearned income.

Earned income is defined as compensation from a job or self-employment, which is not subject to the kiddie tax. Unearned income is income other than wages, salaries, professional fees, and other amounts received as compensation for personal services. Unearned income subject to the kiddie tax may include capital gains, dividends, and interest — typically received through trusts and estates.

Under the TCJA, the IRS provides these eligibility requirements to determine if unearned income is subject to the kiddie tax:
1. The child does not file a joint return;
2. One or both of the child’s parents are alive at year-end;
3. The child’s net unearned income exceeds the threshold for that year and the child has positive taxable income after subtracting any applicable deductions (i.e., standard deduction). The unearned income threshold for 2018 is $2,100.

If the unearned income threshold is not exceeded, the kiddie tax does not apply. If the threshold is exceeded, only unearned income in excess of the threshold is applicable to the kiddie tax.

The kiddie tax can apply until the year during which the child turns age 24. For ages 19-23 at year-end, the kiddie tax can only apply if the child is a student. A child age 18 or under at year-end is almost always subject to the kiddie tax if meeting the above requirements. These age rules can be tricky, so it’s important to consult with your CPA on whether your child or grandchild is subject to this tax.

The following tax rates will be used to calculate the kiddie tax for 2018 through 2025:

[make this a chart?]
2018 Trust and Estate Tax Rates for Ordinary Income
10% tax rate $0-$2,550 = 10% of taxable income
24% tax rate $2,551-$9,151 = $255 plus 24% of the excess over $2,550
35% tax rate $9,151-$12,501 = $1,839 plus 35% of the excess over $9,150
37% tax rate $12,501+ = $3,011.50 plus 37% of the excess over
$12,500

2018 Trust and Estate Tax Rates for Long-Term Capital Gains and Dividends
• 0% tax rate $0-$2,600
• 15% tax rate $2,601-$12,700
• 20% tax rate $12,701+

One final note: Due to the tax rate change, the kiddie tax is also subject to the Net Investment Income Tax if the child has undistributed net investment income and adjusted gross income is over the dollar amount at which the highest tax bracket for a trust begins. For 2018, this threshold is $12,501. The tax rate for the Net Investment Income tax is 3.8 percent for 2018.

If your child (or grandchild) derived more than half of his or her support from unearned income sources for 2018 and meets the eligibility requirements, contact the tax team at Hall Kistler with your questions.

E&P Estimating for Accrued Revenue and Related Expenses

By Andy Griffin, CPA, Supervisor and Keith A. Arner, CPA, CVA, Partner 

In the world of oil and gas, we know that production cash receipts and income tend to lag a month or two (or sometimes three) behind when the volumes are produced. This is due to a variety of factors, including the time required to read meter charts, shipping to the marketer, and processing of the payments.

Generally Accepted Accounting Principles (GAAP) require that income be recognized when it is earned, not necessarily when it is paid, and also that related expenses need to be recognized when incurred, not when you actually write the check to pay for those expenses. If your company’s goal is to produce GAAP-compliant financial statements, it’s imperative that you have a good estimate of oil and gas produced but not yet paid at the end of the month/quarter/year.

There are several ways to estimate accrued revenue and related expenses. Some are very high-level; for example, you might take volumes produced in November and December of last year and apply current prices to those amounts to estimate this year’s revenue. For the related expenses, if those are consistent and there were no major changes, you could use amounts paid out by your company last year in January and February to represent November and December expenses of that prior year. Another quick method would be to use an average of the oil and gas revenue and related costs in the first 10 months of the year (or nine or 11, depending on your accrual period), and then multiply that amount times the months in your accrual period. These methods generally work best if your production is consistent year over year and throughout the year, but any large price swings must be taken into account at the end of the year.

Some companies prefer to use a more precise method. They might use detailed production reports to get a better estimate of what they will be paid on. They might factor various basis differences into the equation, or possibly an average of indexes (Dominion, TCO, NYMEX, etc.). Much of this will depend on the company’s ability to gather data and whether it is indeed paid on different indexes or has basis adjustments (Dominion vs. NYMEX price, for example). Other reasons to use a more precise method include when a company grows substantially during the year, making last year’s amounts outdated, or if there is a significant change in commodity prices toward the end of the year that may skew any averages used.

Another option, which depends on how quickly financial statements need to be produced for a bank or for shareholders, is to simply wait until actual cash is received for amounts produced at year-end but not paid. For example, if a company historically receives cash for November and December production by February 15, of the next year, it might be more practical to just wait until that point to record a final accrual adjustment.

As with other accounting estimates, it’s important to remember that this is just an estimate. Your calculation of accrued revenue and expenses is never going to be exact to the penny. However, it’s important to have a reasonable basis for any estimates made, one that can be supported by data and historical financial information. Critical thought and sound judgment are required for this essential part of GAAP-compliant oil and gas financial statements.

In our next blog post, we will discuss the importance of getting an official reserve report, specifically for calculating plugging costs on your financial statements.

For other blog posts on this topic, search under the Category “Oil & Gas.” You can also subscribe to our newsletter or contact us for more information about your oil and gas accounting needs.

Hall, Kistler & Company has been helping producers in the oil and gas industry since we opened our doors in 1941. We know what it takes to produce proper GAAP financial statements for oil and gas companies and can provide guidance along the way. Let us help when you are coming off of the sidelines and BACK INTO THE GAME.