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August 04, 2023

An Introduction To Oil And Gas Accounting

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The O&G industry is an ever-changing landscape. Businesses in this sector need precise and effective accounting practices in order to weather the uncertainties, guarantee transparency, and optimize operations. Additionally, O&G companies grapple with their own unique set of challenges; not only are they subject to ambiguous revenue recognition norms and legal compliance issues, but they also need to generate financial statements in real-time. Given these obstacles, it is no surprise that many O&G enterprises struggle with financial management. In this article, we will explore oil and gas accounting and explain how to properly execute financial reporting tasks for your organization.

What Is O&G Bookkeeping, And Why Does It Matter

Accounting for the oil and gas industry involves documenting and summarizing financial transactions associated with the extraction, sale, and transport of minerals. These transactions include every economic activity that your business encounters, from drilling costs and production to the sale of commodities.

Bookkeeping plays a crucial role in the petroleum industry, as it allows companies to accurately forecast their profits and losses. Without proper recordkeeping and reporting, it would be exponentially more difficult to both assess the financial health of your business and make informed decisions. To stay profitable in this complex and ever-changing industry, O&G companies need sound fiscal management based on financial accounting, strategic planning, and informed decision-making.

Bookkeeping and Accounting for Businesses

Keeping proper financial records is time-intensive and small mistakes can be costly. BooksTime makes sure your numbers are 100% accurate so you can focus on growing your business.

How To Make O&G Accounting

When working on bookkeeping tasks, you must adhere to the Generally Accepted Accounting Principles (GAAP), regardless of your enterprise’s manufacturing volume or the type of ownership. These standards, which are created by the Financial Accounting Standards Board (FASB), ensure honesty and transparency in financial reporting.

While GAAP provides a consistent standard, modern bookkeeping practices are constantly evolving. Technological advances and changing macroeconomic conditions create demand for new methods, as does the need for businesses to cut back on general and administrative spending. Thus, modern accounting offers a variety of techniques, and solutions need to be tailored to the industry at hand. With this in mind, let’s go through the fundamentals of oil and gas accounting and explore best practices for financial reporting in this sector.

Defining the key aspects of O&G bookkeeping

In 2022, the global demand for crude oil was 99.57 million barrels daily. This figure is projected to rise to a staggering 101.89 million in 2023. O&G is clearly a massive industry that is still on the rise. This sector is also fairly complex in its number of sub-sectors, each of which corresponds to a different stage of the process. These stages include:

  • research
  • development
  • production
  • transport
  • processing
  • marketing to final consumers.

This process can be divided into three general stages: upstream, midstream, and downstream. Upstream firms are mainly engaged in research, development, and manufacturing. Midstream enterprises are only responsible for transportation. Downstream firms, on the other hand, oversee processing and marketing to final consumers. Each of these groups is responsible for its part of the accounting process. Their respective financial teams work together to establish financial records and guarantee that every transaction is accounted for correctly.

Controlling income

In many industries, income accounting is a straightforward procedure. A firm produces a product, sets a price, sells the product, and gets money. Oil and gas accounting, however, presents unique challenges. This is largely because the inventory is undefined. Nobody knows for certain how much oil or gas is contained in a particular field. O&G firms can only rely on estimates of mineral reserves, which is a process that takes place over the field’s life. This uncertainty around inventory makes it impossible to establish stable prices in the O&G sector; instead, prices fluctuate wildly depending on market conditions, derivatives, and other factors.

Suppose you are trying to calculate refining revenues. In this case, refining margins refer to the difference between the price of an oil product at the outlet and the cost of raw materials and other costs expressed per barrel (bbl). The refining margin is calculated based on the oil product in question:

  • Gasoline crack = 1 bbl gasoline – 1 bbl crude oil
  • Heat crack = 1 bbl heating oil – 1 bbl crude oil.

More complex refineries have higher refining margins. They can process cheaper (heavy or sour) oils and adjust the proportions of mixtures.

Selecting a Successful Effort or Full Cost bookkeeping algorithm

There are different methods for energy accounting, and each one determines how an organization reports its net revenue and cash flow.

Most O&G firms prefer the Successful Efforts (SE) cost method for its transparency. In this approach, organizations only benefit from expenditures connected with successfully discovered and undefined O&G reserves. If discovery fails or produces unsatisfactory results, an enterprise immediately writes off the related operating costs.

An alternative to Successful Efforts is Full-Cost (FC) production accounting. With this technique, organizations are able to benefit from all the operating costs of finding undefined O&G reserves, regardless of the result. The reasoning behind this financial practice is simple. Since O&G firms primarily deal with research and development of mineral resources, they should capitalize on all expenditures they incur at these stages of the process.

Setting up JIB bookkeeping

O&G firms almost always collaborate with other companies in the industry to cut the risks of capital-intensive projects, like drilling wells or building pipelines. When this happens, they use a procedure called joint interest billing (JIB) to properly allocate costs to owners. Typically, one firm is in charge of operations, another is in charge of finances, and a third non-operator is billed monthly for their share. It is crucial to ensure that each firm pays their fair share as specified by the operating contract.

An Introduction To Oil And Gas Accounting

Key Responsibilities Of An O&G Bookkeeper

The O&G sector has unique circumstances. As such, oil and gas accountants face particular challenges in financial record-keeping and reporting. As a rule, they offer the following services:

  • Accounts Payable bookkeeping: despite being a time-consuming and labor-intensive process, it is crucial to establish an effective system for accounts payable. This will protect your cash flows and ensure that you receive timely payment from counterparties.
  • Managing invoices: Invoices are another important part of getting paid. In order to expedite your accountant’s work, authorizations for expenditure (AFE), bills, and delivered materials should be as consistent as possible.
  • Correct use of deposits and accumulated accounts payable: according to statistics, your chances of recovering accounts receivable fall by more than 50% after 90 days. It is vital to carefully oversee payments; otherwise, you may lose money.
  • Financial reporting: the accounting processes will generate vital information for external and internal purposes. Internally, financial analysis helps management make informed and effective decisions. Externally, these insights are necessary for attracting direct investment and obtaining bank loans.

In addition to providing these services, a qualified O&G accountant will thoroughly understand your needs at every step of the accounting cycle. They should organize regular audits, including owner audits, tax inspections, financial checks, and peer reviews, as well as fulfill any other financial reporting task that your organization needs.

Primary Problems With O&G Accounting

Oil and gas industry differs from other sectors in several ways, and these particularities influence accounting needs for O&G firms. For example, doing business in this sector requires significant speculative investment no guaranteed  return on capital. As such, economic activity in oil and gas is characterized by long wait times between making investments and receiving income.

Bookkeeping procedures vary across the fuel industry, depending mainly on your organization’s area of specialization. If you focus on research and production, the accounting process is more complex than, say, if you worked in processing activities. Furthermore, if your business focuses on mining, you will be responsible for evaluating reserves and determining the actual value of your enterprise based on these estimates.

Another factor complicating O&G accounting is the frequent use of complex contracts, which carry different consequences for the accounting process. Your finance team must be able to understand these contractual issues and provide the appropriate bookkeeping solutions.

Like all enterprises, O&G firms must be able to accurately calculate and pay taxes. This is easier said than done, especially since different countries have their own tax laws. It is crucial that your organizational leaders and financial specialists not only fully understand the rules surrounding mandatory payments, but also strategically manage them in order to generate value for the business.

Final Words

Are you an independent operator? An investor in the petroleum industry? Royalty trust or mineral owner? Regardless of your speciality within oil and gas, you may be facing bookkeeping challenges that make it difficult to protect your business and bottom line.

BooksTime’s dedicated back office team will assist you in making a petroleum accounting solution that meets your financial needs today and scales with your growing business, whether you plan to delegate all financial functions or need help managing an overflow job. While you’re focused on making the most of your resources, our experts will figure out how to increase your profit and reduce your tax liability. Our team is made up of seasoned financial professionals with ample experience in the O&G industry, and we know how to help put your business on the path to success. Schedule a free consultation to get expert assistance.

This article is not intended to provide tax, legal, or investment advice, and BooksTime does not provide any services in these areas. This material has been prepared for informational purposes only, and should not be relied upon for tax, legal, or investment purposes. These topics are complex and constantly changing. The information presented here may be incomplete or out of date. Be sure to consult a relevant professional. BooksTime is not responsible for your compliance or noncompliance with any laws or regulations.

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Author: Charles Lutwidge

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