4 Key Accounting Considerations for Oil and Gas Companies
According to a 2017 report from Ernst and Young, “The new lease accounting standards could have far reaching implications for oil and gas entities. The impacts go beyond accounting, to commercial decision making and strategic financial decisions.”
But before oil and gas companies develop new financial and commercial strategies, they first need to ensure that they are in compliance with the IFRS 16 and ASC 842 lease accounting standards.
That’s no easy task.
Think about the assortment of leases required for a successful oil or gas operation: from land for resource extraction to equipment used for production and transportation to the facilities used for storage, natural resource companies are involved with hundreds or thousands of leases scattered across many geographic locations.
Under the new guidance, most—if not at all—of those leases will be required to be brought on to balance sheets.
Given the operational complexity of these industries, oil and gas entities have some unique considerations to make in the waning months before the guidelines take effect.
Here are 4 key accounting considerations for oil and gas companies.
1. Do your service arrangements contain embedded leases?
Oil and gas companies employ the use of strategic service contracts as part of their operations. Service agreements may be used for transportation, drilling, or storage services. The new IFRS 16 and ASC 842 standards require companies to record leases as right-of-use assets based on economic benefit. This means, oil and gas companies need to take a look at their service agreements to determine whether they contain embedded leases that need to be placed on balance sheets.
2. Do any leased assets in your bundled service contracts?
Material assets used in oil and gas operations, such as oil rigs, are often employed through a bundled service contract which also includes the employees and other materials needed to operate the asset. If any parts of these agreements meet the definition of a lease, the new standards require companies to determine the standalone value of each element of the contract, both lease and non-lease.
3. How will you record embedded leases under an operating agreement?
It’s common for oil and gas companies to enter into joint operating agreements with other companies to use leased equipment like drill rigs. Under these joint operating agreements, organizations will need to determine whether to record these shared embedded leases on a gross or net basis.
4. How will certain triggering events effect your accounting strategy?
There are multiple reasons why an oil or gas company may decide to renew or not to renew a lease. Changing economic conditions or new strategic goals often require the use of new or different assets.
When triggering events lead to changes of leases, the new guidelines require companies to reassess the lease’s operating and financial classification. Certain triggering events may also require a revaluation of the right-of-use asset of that lease and the lease liability. As companies work to comply with the new standards, they must ensure processes are in place for reassessing their leases when these triggering events occur.
The high-level of complexity required to successfully run an oil or natural gas operation will also require a complex and well-developed system for tracking and reporting the leases that support those operations.
Nakisa Lease Administration is an end-to-end lease accounting software that helps streamline the complexities of the new lease accounting standards through lease lifecycle management, contract management, and lease determination and classification all in one solution.
For more on the lease considerations facing oil and gas companies and strategies for ensuring a smooth transition to IFRS 16 and ASC 842, check out our guide to Smarter Lease Accounting for Oil and Gas.