Explain and critically evaluate the full cost and successful efforts methods of accounting for pre-production costs?

Answer 1

Pre-production costs can be defined as those costs related to acquisition and retention, exploration and development. The treatment of these three categories of cost vary based on whether one has elected the full cost or successful efforts method of accounting. The critical difference between the two methods is whether certain costs are capitalized or expensed and how the capitalized costs are depleted. Under the full cost method, all costs (by country) of exploring and developing wells (whether proven or unproved) are capitalized and then depleted using the units of production method whereby your total proven reserves are considered. Basically, all of the costs of developing wells, whether successful or unsuccessful, are depleted as production units are realized from your proven wells. This method is allowed by the SEC but not preferred by the FASB and is intended as an incentive for the exploration of further oil and gas resources since costs related to unsuccessful exploration can be expensed over time rather than as incurred. Under the successful efforts method, costs are grouped by some smaller basis, usually fields, and are capitalized by group if the costs directly result in the development of proved reserves. Costs not resulting in proved reserves are expensed as incurred (or as a determination of proven reserves is made). Basically, within a cost group, exploratory dry wells are expensed and exploratory successful wells are capitalized.