Oil and Gas Accounting and Disclosure Rules Revised under SEC Release 33-8995

Oil & Gas AccountingLast Friday, the AICPA released a discussion draft of the audit and accounting guide for Entities with Oil and Gas  Producing Activities. While not authoritative  it is anticipated to reflect the current standards being revised by both the Financial Accounting Standards Board which sets US GAAP, and the International Accounting Standards Board, all of which is being done in response to SEC Release 33-8995.

While the changes are too voluminous and complex to even summarize here, I’ve included links and welcome questions,comments to this post or phone calls to discuss the implications.

The definitions in Rule 4-10 have been significantly changed. The pricing mechanism for reserves has been defined as a twelve month average. The definition of what is and is not considered ‘oil and gas’ has been clarified to include bitumen and other saleable hydrocarbon resources (geothermal has been excluded); the definitions of ‘proved’ ‘unproved’, ‘developed’ and ‘undeveloped’ reserves has been amended and clarified; and the disclosure requirements under Regulation S-K has been expanded.

Additionally, the disclosure requirements within the financials and for the K’s and Q’s  have been expanded and clarified including the disclosure requirements for MD & A. The SEC continues to coordinate with the FASB and the IASB who continue to develop their standards for the oil and gas entities. Given the SEC has come to the party first, it’s hard to imagine the other standard setting bodies will do anything but comply.

Foreign filers using Form 20-F will be subject to the same disclosure as opposed to the previous disclosure requirements summarized under Appendix A. Canadian filers, however, will not be subject to the new disclosure rules given that the requirements under the Multi-Jurisdictional Disclosure System (MJDS) using form 40-F are already consistent.

Now some good news. The implementation date  for registrations filed and for annual reports on Forms 10-K and 20-F is for fiscal years ending on or  after January 1, 2010. While the implementation is mandatory, “a company may not apply the new rules to disclosures in quarterly reports prior to the first annual report in which the revised disclosures are required”.  Implementation may  be deferred as discussions between the SEC, FASB and IASB go forward.

EITF 07-5 Highlights

Financial IstrumentsIt appears the Emerging Issue Task Force (EITF) has provided some seemingly useful guidance as to the determination of the application of SFAS 133.  As I see more and more companies issuing various types of hybrid financial instruments in order to fund ongoing capital needs, I also see varying degrees of application of SFAS 133 and its next cousin EITF 00-19.

Sifting through the guidance and corresponding AICPA roadmap to properly account for these transactions seems to be the equivalent of ………  The recent issuance and 2009 implementation of EITF 07-5 Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock seems to alleviate some of the confusion surrounding certain redundant conditions in most financial instrument agreements that we have seen.

For example, several recent issuers entering into convertible debt transactions, with certain similar terms, each have radically different balance sheet presentations.  Ignoring the SFAS 155 election (which is another matter of discussion), one issuer determined that SFAS 133 didn’t actual apply to the convertible debt and presented the standard convertible note payable; while another determined that SFAS 133 applied, jumped to EITF 00-19 to determine the classification of the derivative instrument requiring bifurcation, and concluded permanent equity treatment was appropriate; and the third issuer determined SFAS 133 in fact applied, required bifurcation, and treated the derivative instrument as an additional liability requiring periodic revaluation.

While having many recent discussions with CPAs, CFOs, University Professors, and anyone else that might have some insight, including the FASB Staff themselves, we were pointed to the seemingly useful guidance contained in EITF 07-5.  In the example above, I see most issuers spending most of the time reaching for non-application of SFAS 133 under the exceptions contained in paragraph 11(a) that states that “contracts issued that are both indexed to an entity’s own stock and classified in stockholders’ equity are not considered derivative instruments”.   If the complete blow off of SFAS 133 does not work, as in the case of the second issuer above, permanent equity treatment becomes the next best option under the general guise that the issuer has control over adjustments to conversion prices and amounts or that the likelihood of significant detrimental adjustment in the derivative value is de minimis.  This example, in particular, appears to be clarified by EITF 07-5.

For all instruments outstanding in fiscal years beginning after December 15, 2008 it appears the application of EITF 07-5 will correspond with increased application of SFAS 133.  The EITF guidance indicates several financial instruments are not actually indexed to a companies and stock and would infer SFAS 133 treatment (liability classification).  Paragraph 15 eliminates both common arguments against bifurcation:  i) the issuer has the ability to control any conversion adjustment and ii) the probably of making detrimental adjustments is de-minimis.  The paragraph further indicates that any adjustment to the fixed amount (either conversion price or number of shares) of the instrument, regardless of the probability or whether or not within the issuers’ control, is not indexed to the issuers own stock.

The inability to conclude that financial instruments are actually not indexed to the issuers own stock, thereby, significantly eliminating the derivative instrument exception paragraphs of SFAS 133 will likely result presentation changes of a large number of small reporting companies and may result in some interesting earnings swings.

Maybe the little used SFAS 155 election for financial instruments warrants further discussion?