What’s This Asset Retirement Obligation I Keep Hearing About?

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

As we’ve described previously, one of the components of “getting back in the game” for small independent E&P companies is producing financial statements that are compliant with Generally Accepted Accounting Principles (GAAP). One of the items required by GAAP is something called an asset retirement obligation liability.

So what does this mean? And how is it calculated?

To put it simply, an asset retirement obligation (ARO) liability represents your costs to plug a well. However, it does not necessarily mean the amount you’re laying out today in cash to have someone plug a well for you (or to do it yourself). What it really measures is your liability today for wells to be plugged in the future. Per GAAP, you can’t just wait to expense those costs as they occur.

GAAP dictates that liability is created once a legal obligation to retire an asset exists. So once you commence drilling a well (or acquire a well) you have already established a liability; in other words, once you’ve punched a hole in the ground, that hole has to be plugged at some point by state law. The questions now become:
1) How long is this well going to last and when are we going to plug it?
2) How much is it going to cost to plug the well, at the point that we’re
actually going to plug it?

One thing to remember when thinking about an ARO calculation: it’s an estimate. Obviously, we don’t know how long each well is going to last. We don’t know to the penny how much it’s going to cost to plug each well. And we don’t know where commodity prices are headed, which might have an effect on which wells get plugged and when. However, even though it’s an estimate, it’s still critical to calculate the amount using solid, reasonable assumptions that can be supported with evidence.

The best way to determine “well lives” is to obtain an engineer’s reserve report on all of your wells. This step may be expensive, but it is essential for a reasonable basis of determining the life of a well. Most companies have this report done every year, due to changes in the market that might change “well lives” and thus affect the calculation. For example, if price per MCF is $2, that might mean many more of your wells are going to be uneconomical to operate and may dictate candidates for plugging. If the price per MCF is $8, now those wells are economic and viable, and plugging is going to get pushed further into the future. An engineer will use estimates of future pricing and other factors such as the formation the wells are in to generate an estimated life for each well.

As mentioned above, the other question is how much is it going to cost? Remember, these wells might be plugged 30 years (or more) from now. Calculating an ARO involves inflation factors and also a present value factor to determine what the obligation in the future is valued at in today’s dollars. However, to do that correctly, you have to start with a sound, reasonable estimate that can be supported (sound familiar?). This might require an analysis by company engineers of the depth of a certain type of well, or how much cement might be needed, or the cost of labor to have a crew plug the well, or how much it would cost to do it internally vs. outsourcing, or vice versa. It might also require looking at the Department of Natural Resources filings. It might even be helpful to talk to other companies in the industry to get a feel for what they see regarding costs to plug their wells.

As you can see, calculating an ARO requires some critical thought and analysis, and good, conservative judgment. These are the most critical and essential steps for any accounting estimate. It may seem like a lot of work for something that just exists on paper, but remember, it’s a critical part of producing GAAP-compliant statements. Proper financial statements are going to be a necessity as your company grows.

For other blog posts on this topic, search under the Category “Oil and 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 field 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 the sidelines and BACK INTO THE GAME.

Get Back in the Game: E&P Financial Reporting

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

During the mad dash for deep shale acreage, when exploration and production companies like Chesapeake, Gulfport, Ascent, and others were acquiring leases, many independent producers in the Utica Shale region sold their deep acreage rights. For several years, these independent producers watched from the sidelines, sometimes just breaking even while operating their shallow wells in a very tough environment for commodity prices.

Now, time has passed and many of the larger exploration and production (E&P) companies, due to their large overhead, are unloading their acreage and wells because they are not able to economically produce in the current market. However, many independent smaller producers have found that they are able to produce economically — by observing and studying the processes of the larger companies and benefiting from the new technologies those companies developed over the years.

To use a football analogy, independent producers have studied the offense and watched the game film, and are now coming off the sidelines and getting back in the game.

At this point, any E&P company will find that, in order to obtain financing or enter into credit facilities with financial institutions, one of the requirements is usually going to be a set of financial statements that follow generally accepted accounting principles (GAAP). GAAP requires several items and adjustments that are somewhat unique to the oil and gas world. As we help producers with their financial statements, the following questions usually come up:

• What’s this “asset retirement obligation” I keep hearing about?

• Why do I need to record any accrued production? Payments are usually two to three months behind in the oil and gas world.

• Do I really need to spend the money to get a reserve report from an engineer?

• My banker told me we’ll need financial statements with footnotes and disclosures? What does that mean? Am I disclosing everything that needs to be in there?

• This is the first year we entered into any hedging transactions – where do these go on our books?

We are going to answer each of these questions in upcoming blog posts, so search our blog under the Category “Oil & Gas.” You can also subscribe to our newsletter or contact us for more information about our oil and gas services and experience.

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.

Family Business Succession Planning

I’m often asked by my clients, “How do I transition my company to the next generation?”.

In order for a succession to be successful, it needs to work for both parties. Clients are advised early in our business relationship about succession planning so that they are in a stronger financial position when the time comes to transition the company. The objective is to eliminate debt and maximize their retirement so there is not a significant strain on cash flow during the transition process.

One of the first issues we discuss is what their cash flow needs are to fund their lifestyle. Once I know how much is needed to maintain their desired lifestyle and the value of their company has been assessed, I will work with them to determine how the next generation and the company can make a smooth transition.

I recently worked on a transition plan to the fourth generation (father to son’s) in which we did a combination of gifting and the sale of stock in order to make the transition cash flow. This provided the third generation the cash flow needed for their lifestyle and allowed the fourth generation and the company to cash flow the transition without overburdening the company.

Succession planning takes a coordinated effort between the shareholders, your accountant and your attorney to make the transition as smooth as possible. If you or someone you know is struggling with or is curious about succession planning, do not hesitate to contact me at franklin@hallkistler.com or 330-453-7633.

Ohio Tax Amnesty is January 1, 2018, through February 15, 2018, for Individuals and Businesses

Avoid ALL penalties and HALF of your interest!

If you have unpaid taxes, Ohio Tax Amnesty could help you avoid 100% of penalties and 50% of interest due. Ohio Tax Amnesty will help you achieve a fresh start and settle your unpaid taxes that you have unreported* or underreported that were due and payable as of May 1, 2017.

You may qualify if you have certain unpaid taxes that were due as of May 1, 2017, and have NOT been contacted by the Ohio Department of Taxation. Not all taxes are eligible for Ohio Tax Amnesty; however, the following taxes are eligible:
• Individual Income Tax
• Individual School District Income Tax
• Employer Withholding Tax
• Employer Withholding School District Income Tax
• Pass-Through Entity Tax
• Sales Tax
• Use Tax
• Commercial Activity Tax
• Financial Institution Tax
• Cigarette or Other Tobacco Products Tax
• Alcoholic Beverage Tax

To be approved for Ohio Tax Amnesty, you must submit an application, all appropriate tax return(s) and full payment before the deadline. No partial payments or credit card payments can be accepted. The Ohio Tax Amnesty does not apply to you if the Ohio Department of Taxation has been in contact with you about your tax debt or if you filed a tax return but did not pay taxes.

If you are unsure if you have unreported or underreported taxes, please contact me at 330-453-7633 or sandrao@hallkistler.com.

*Unreported means you know you owe back tax but have not yet been contacted by the Ohio Department of Taxation.

Credit for Production of Natural Gas from Marginal Wells – Why it’s not too late to claim!

This past fall Notice 2017-51 was issued by the IRS to provide guidance on the marginal well production credit. The notice computed the credit amount for calendar year 2016 at $0.14 per mcf as well as provided guidance on claiming the credit. This credit is computed on a taxpayers production from a marginal well as defined by the code in which the taxpayer holds an operating interest. The notice states that a taxpayer who filed a 2016 return on or before October 2, 2017, and either did not claim the credit or claimed the credit in an amount that differs from the amount determined using the applicable reference price stated in this notice may file an amended return.
Although the credit is not as high as was predicted, we have found this credit to be very beneficial to our conventional producers. If you need any assistance in amending returns or calculating the credit, please contact me at 330-453-7633 or keith@hallkistler.com.