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Early Abandonment

Most wells in OilFinancier should run longer than their estimated life. When this happens, the accounting to record the abandonment is fairly easy to understand.

But a few wells will be abandoned before they have been fully amortized or accrued the full liability for abandonment. There will have to be some special accounting techniques to properly record this event. We will explain it with the following example.

A well in Ghawar had a market value of $400,000. It has an accumulated amortization of $350,000, leaving a book value of $50,000. Its eventual abandonment liability is $500,000. But it has only accrued $475,000 as a liability.

The owner of this well has decided to abandon it. Given that it is not fully amortized and the full abandonment liability is not fully realized, it is obvious the well is being abandoned before the end of its estimated lifespan. Here are the accounting rules.

Abandonment

The $25,000 shortfall in abandonment liability will be recorded as an abandonment expense. This will likely produce a loss in the Ghawar province for that OF Day, which will then be transferred to the province(s) loss schedule.

Amortization

The $50,000 book value is essentially an asset that will produce no further revenue. It will be recorded as a loss on the “sale of an asset.” Again this amount will likely be transferred to the loss schedule for the Ghawar account.

Loss

Therefore abandoning a well before the end of its expected lifespan will generate significant losses. If the financier still has wells in Ghawar, he can use these losses to reduce corporate taxes in this province. But if the abandoned well is the last one the financier has in Ghawar, the losses cannot be applied against profit in other provinces. The loss will “stay on the books” until the financier gets another well in Ghawar. Then the losses can be applied to reduce taxes from profits of the new well.

 
© 2014 Dave Volek. All Rights Reserved.