[Federal Register Volume 74, Number 212 (Wednesday, November 4, 2009)]
[Rules and Regulations]
[Pages 57062-57070]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-26525]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 211

[Release No. SAB 113]


Staff Accounting Bulletin No. 113

AGENCY: Securities and Exchange Commission.

ACTION: Publication of staff accounting bulletin.

-----------------------------------------------------------------------

SUMMARY: This Staff Accounting Bulletin (SAB) revises or rescinds 
portions of the interpretive guidance included in the section of the 
Staff Accounting Bulletin Series titled ``Topic 12: Oil and Gas 
Producing Activities'' (Topic 12) and revises a technical reference in 
``Topic 3: Senior Securities'' (Topic 3). This update is intended to 
make the relevant interpretive guidance consistent with

[[Page 57063]]

current authoritative accounting and auditing guidance and Commission 
rules and regulations. The principal changes involve revision or 
removal of material due to recent Commission rulemaking. Specifically, 
the staff is updating the Series in order to bring existing guidance 
into conformity with the contents of Financial Reporting Release No. 78 
(Release No. 33-8995), Modernization of Oil and Gas Reporting, issued 
December 31, 2008 (FR-78), and, in the case of the technical amendment 
to SAB Topic 3, Financial Reporting Release No. 79 (Release Nos. 33-
9026; 34-59775), Technical Amendments to Rules, Forms, Schedules and 
Codification of Financial Reporting Policies (FR-79), issued April 15, 
2009. This SAB also updates related interpretive responses and examples 
in Topic 12. The staff expects registrants to apply the updated 
guidance in this SAB related to Topic 12 on a prospective basis in 
conjunction with the application of FR-78 and retroactively for the 
technical amendment to Topic 3 in conjunction with the effective date 
of FR-79. FR-78 is effective for registration statements filed on or 
after January 1, 2010, and for annual reports on Forms 10-K and 20-F 
for fiscal years ending on or after December 31, 2009. FR-79 is 
effective as of April 23, 2009.

DATES: Effective Date: November 4, 2009.

FOR FURTHER INFORMATION CONTACT: Jonathan W. Duersch, Assistant Chief 
Accountant, Office of the Chief Accountant, at (202) 551-3719, Doug 
Parker, Professional Accounting Fellow, Office of the Chief Accountant, 
at (202) 551-5316 or Leslie A. Overton, Associate Chief Accountant, 
Division of Corporation Finance, at (202) 551-3518, Securities and 
Exchange Commission, 100 F Street, NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The statements in staff accounting bulletins 
are not rules or interpretations of the Commission, nor are they 
published as bearing the Commission's official approval. They represent 
interpretations and practices followed by the Division of Corporation 
Finance and the Office of the Chief Accountant in administering the 
disclosure requirements of the Federal securities laws.

    Dated: October 29, 2009.
Elizabeth M. Murphy,
Secretary.

PART 211--[AMENDED]

0
Accordingly, Part 211 of Title 17 of the Code of Federal Regulations is 
amended by adding Staff Accounting Bulletin No. 113 to the table found 
in Subpart B.

Staff Accounting Bulletin No. 113

    This staff accounting bulletin revises or rescinds portions of the 
interpretive guidance in Topic 12, ``Oil and Gas Producing 
Activities,'' included in the Staff Accounting Bulletin Series, in 
order to make the relevant interpretive guidance consistent with 
current authoritative accounting and auditing guidance and Financial 
Reporting Release No. 78 (Release No. 33-8995), Modernization of Oil 
and Gas Reporting, issued December 31, 2008 (2008 Oil & Gas Release). 
This SAB also updates related interpretive responses and examples. This 
SAB also includes an amendment to Topic 3 ``Senior Securities,'' for a 
technical reference revision to conform to Financial Reporting Release 
No. 79 (Release Nos. 33-9026; 34-59775), Technical Amendments to Rules, 
Forms, Schedules and Codification of Financial Reporting Policies, 
issued April 15, 2009.
    The following describes the changes made to the Staff Accounting 
Bulletin Series that are presented at the end of this release:

Topic 3: Senior Securities

    Topic 3.C, the introductory facts are amended to replace the 
reference ``Rule 5-02.28 of Regulation S-X'' with ``Rule 5-02.27 of 
Regulation S-X'' to conform to paragraph numbering amendments made by 
FR-79.

Topic 12: Oil and Gas Producing Activities

    a. Topic 12 is amended to update authoritative accounting 
literature references to the FASB's Accounting Standards Codification 
(FASB ASC) throughout.
    b. Topic 12.A.1, the introductory facts have been amended, and 
questions 1, 2, and 3 are removed, leaving question 4 in place (without 
a numerical designation). Questions 1 and 2 are no longer applicable to 
the amended definition of ``reliable technology'' in Rule 4-10 of 
Regulation S-X. Question 3 is removed to conform to Instruction 1 of 
Item 1204 of Regulation S-K, which no longer addresses reserves 
attributable to production from processing plant ownership as 
previously included in Instruction B of Item 3 of former Industry Guide 
2.
    c. Topic 12.A.2, the facts and the interpretive response to 
question 1 are amended to conform to changes made by the 2008 Oil & Gas 
Release by replacing the use of a year-end price when determining 
reserve quantities with the use of the average price during the 12-
month period prior to the ending date of the period covered by the 
balance sheet, determined as the unweighted arithmetic average of the 
first-day-of-the-month market price within such period for that oil and 
gas (the average price). Questions 2 and 3 are removed because the 
average price is applied in all cases where contractual prices do not 
exist as specified under Rule 4-10(a)(22) of Regulation S-X.
    d. Topic 12.A.3.b is removed to conform to the 2008 Oil & Gas 
Release which permits the disclosure of probable and possible reserve 
quantities but does not provide a basis to present estimated values 
attributed to those reserve quantities.
    e. Topic 12.A.3.c, the facts are amended to remove references to 
Industry Guide 2, which has been replaced by amendments to Regulation 
S-K and to remove unnecessary references to Regulation S-X and 
Financial Accounting Standards Board (FASB) Statement No. 69. The 
interpretive response is amended to replace the term ``merger'' with 
the term ``business combination'' and replace the term ``combined'' 
with the term ``consolidated or combined''.
    f. Topic 12.A.3.d is removed to conform to the Commission's rules 
and regulations which do not require (and the Division of Corporation 
Finance no longer requests) a balance sheet of the general partner to 
be included in a registration statement for an offering of limited 
partnership interests.
    g. Topic 12.C.1, the facts are amended to remove a reference to 
FASB Statement No. 25, which is not included in the FASB ASC. In 
addition, non-substantive editorial changes are made to Topic 12.C.2.
    h. Topic 12.D.1, non-substantive editorial changes are made to 
question 1 and question 2 is amended to simplify the illustrative 
example in the interpretive response and thereby promote a clearer 
understanding of the calculation using the ``shortcut'' method for 
determining the tax effects in computing the full cost ceiling 
limitation and the resulting gross write-off attributed to the full 
cost pool.
    i. Topic 12.D.3.b is amended to conform to changes made by the 2008 
Oil & Gas Release by replacing the use of a year-end spot price when 
determining reserve quantities with the use of the average price during 
the 12-month period prior to the ending date of the period covered by 
the balance sheet, determined as the unweighted arithmetic average of 
the first-day-of-the-month market price within such period for that oil 
and gas. Additionally,

[[Page 57064]]

the interpretive response is amended to remove unnecessary references 
to guidance in FASB Statements 52 and 80, which is now provided in FASB 
ASC Topic 815, Derivatives and Hedging, and to add a reference to 
Financial Reporting Release No. 72 (Release Nos. 33-8350; 34-48960), 
Commission Guidance Regarding Management's Discussion and Analysis of 
Financial Condition and Results of Operations, which is more recent 
guidance pertinent to Management's Discussion and Analysis disclosures.
    j. Topic 12.D.3.c is amended to conform to changes made by the 2008 
Oil & Gas Release by removing the provision to apply a recovery of oil 
and gas prices subsequent to period-end, when assessing whether a 
write-off computed under the full cost ceiling limitation should be 
recognized. As stated in the 2008 Oil & Gas Release, this guidance is 
no longer necessary because use of the average price would effectively 
eliminate anomalies caused by the single-day period-end price.
    k. Topic 12.D.4, Footnote 1 is removed to eliminate unnecessary 
references specifically related to the adoption of FASB Statement 143, 
which is now referenced to FASB ASC Subtopic 410-20, Asset Retirement 
and Environmental Obligations--Asset Retirement Obligations. Footnotes 
previously numbered 2, 3 and 4 are renumbered 1, 2 and 3, respectively.
    l. Topic 12.D.4.a, question 1 and the facts and interpretive 
response related to question 1 are amended and question 2 is removed to 
eliminate unnecessary references and guidance specifically related to 
the adoption of FASB Statement 143.
    m. Topic 12.D.4.b, the facts, question and interpretive response 
are amended to eliminate unnecessary references and guidance 
specifically related to the adoption of FASB Statement 143.
    n. Topic 12.D.4.c is removed to eliminate unnecessary transition 
guidance specifically related to the adoption of FASB Statement 143.
    o. Topic 12.F, Footnote 4 is added to reference the definition of 
current prices used in Rule 4-10(c) of Regulation S-X, which was 
amended to conform to the 2008 Oil & Gas Release. As amended, Rule 4-
10(c)(8) of Regulation S-X defines current price as the average price 
during the 12-month period prior to the ending date of the period 
covered by the report, determined as an unweighted arithmetic average 
of the first-day-of-the-month price for each month within such period, 
unless prices are defined by contractual arrangements, excluding 
escalations based upon future conditions.
    p. Topic 12.G and Footnotes 5 and 6 are removed to conform to 
changes made by the 2008 Oil & Gas Release. This conforming change 
reflects the fact that, under amended Rule 4-10(a)(16) the definition 
of ``oil and gas producing activities'' includes the extraction of 
natural gas from coal beds.

    Note:  The text of SAB 113 will not appear in the Code of 
Federal Regulations.

* * * * *

TOPIC 3: SENIOR SECURITIES

* * * * *

C. Redeemable Preferred Stock

    Facts: Rule 5-02.27 of Regulation S-X states that redeemable 
preferred stocks are not to be included in amounts reported as 
stockholders' equity, and that their redemption amounts are to be shown 
on the face of the balance sheet. However, the Commission's rules and 
regulations do not address the carrying amount at which redeemable 
preferred stock should be reported, or how changes in its carrying 
amount should be treated in calculations of earnings per share and the 
ratio of earnings to combined fixed charges and preferred stock 
dividends.
* * * * *

TOPIC 12: OIL AND GAS PRODUCING ACTIVITIES

A. Accounting Series Release 257--Requirements for Financial Accounting 
and Reporting Practices for Oil and Gas Producing Activities

1. Estimates of Reserve Quantities
    Facts: Rule 4-10 of Regulation S-X contains definitions of possible 
reserves, probable reserves, and proved and developed oil and gas 
reserves to be used in determining quantities of oil and gas reserves 
to be reported in filings with the Commission.
    Question: What pressure base should be used for reporting gas and 
production, 14.73 psia or the pressure base specified by the state?
    Interpretive Response: The reporting instructions to the Department 
of Energy's Form EIA-28 specify that natural gas reserves are to be 
reported at 14.73 psia and 60 degrees F. There is no pressure base 
specified in Regulation S-X or S-K. At the present time staff will not 
object to natural gas reserves and production data calculated at other 
pressure bases, if such pressure bases are identified in the filing.
2. Estimates of Future Net Revenues
    Facts: U.S. GAAP requires the disclosure of the standardized 
measure of discounted future net cash flows from production of proved 
oil and gas reserves.
    Question: For purposes of determining reserves and estimated future 
net revenues, what price should be used for oil and gas which will be 
produced after an existing contract expires or after the 
redetermination date in a contract?
    Interpretive Response: The price to be used for oil and gas which 
will be produced after a contract expires or has a redetermination is 
the average price during the 12-month period prior to the ending date 
of the period covered by the balance sheet, determined as an unweighted 
arithmetic average of the first-day-of-the-month price for each month 
within such period for that oil and gas. This average price, which 
should be based on the first-day-of-the-month market prices, may be 
increased thereafter only for additional fixed and determinable 
escalations, as appropriate. A fixed and determinable escalation is one 
which is specified in amount and is not based on future events such as 
rates of inflation.
3. Disclosure of Reserve Information
a. Removed by SAB 103
b. Removed by SAB 113
c. Limited Partnership 10-K Reports
    Facts: Item 1201(a) of Regulation S-K contains an exemption from 
the requirements to disclose certain information relating to oil and 
gas operations for ``limited partnerships or joint ventures that 
conduct, operate, manage, or report upon oil and gas drilling income 
programs that acquire properties either for drilling and production, or 
for production of oil, gas, or geothermal steam. * * *
    Limited partnership agreements often contain buy-out provisions 
under which the general partner agrees to purchase limited partnership 
interests that are offered for sale, based upon a specified valuation 
formula. Because of these arrangements, the requirements for disclosure 
of reserve value information may be of little significance to the 
limited partners.
    Question: Must the financial statements of limited partnerships 
included in reports on Form 10-K contain the disclosures of estimated 
future net revenues, present values and changes therein, and 
supplemental summary of oil and gas activities specified in paragraphs 
23 through 36 of FASB Accounting Standards Codification (FASB ASC) 
Section 932-235-50, Extractive Activities--Oil and Gas--Notes to 
Financial Statements--Disclosure?

[[Page 57065]]

    Interpretive Response: The staff will not take exception to the 
omission of these disclosures in a limited partnership Form 10-K if 
reserve value information is available to the limited partners pursuant 
to the partnership agreement (even though the valuations may be 
computed differently and may be as of a date other than year end). 
However, the staff will require all of the information listed in 
paragraphs 23 through 36 of FASB ASC Section 932-235-50 for 
partnerships which are the subject of a business combination or 
exchange offer under which various limited partnerships are to be 
consolidated or combined into a single entity.
d. Removed by SAB 113
e. Rate Regulated Companies
    Question: If a company has cost-of-service oil and gas producing 
properties, how should they be treated in the supplemental disclosures 
of reserve quantities and related future net revenues provided pursuant 
to paragraphs 29 through 36 of FASB ASC Section 932-235-50, Extractive 
Activities--Oil and Gas--Notes to Financial Statements--Disclosure?
    Interpretive Response: Rule 4-10 provides that registrants may give 
effect to differences arising from the ratemaking process for cost-of-
service oil and gas properties. Accordingly, in these circumstances, 
the staff believes that the company's supplemental reserve quantity 
disclosures should indicate separately the quantities associated with 
properties subject to cost-of-service ratemaking, and that it is 
appropriate to exclude those quantities from the future net revenue 
disclosures. The company should also disclose the nature and impact of 
its cost-of-service ratemaking, including the unamortized cost included 
in the balance sheet.
4. Removed by SAB 103

B. Removed by SAB 103

C. Methods of Accounting by Oil and Gas Producers

1. First-Time Registrants
    Facts: In ASR 300, the Commission announced that it would allow 
registrants to change methods of accounting for oil and gas producing 
activities so long as such changes were in accordance with GAAP. 
Accordingly, the Commission stated that changes from the full cost 
method to the successful efforts method would not require a 
preferability letter. Changes to full cost, however, would require 
justification by the company making the change and filing of a 
preferability letter from the company's independent accountants.
    Question: How does this policy apply to a nonpublic company which 
changes its accounting method in connection with a forthcoming public 
offering or initial registration under either the 1933 Act or 1934 Act?
    Interpretive Response: The Commission's policy that first-time 
registrants may change their previous accounting methods without filing 
a preferability letter is applicable. Therefore, such a company may 
change to the full cost method without filing a preferability letter.
2. Consistent Use of Accounting Methods Within a Consolidated Entity
    Facts: Rule 4-10(c) of Regulation S-X states in part that ``[a] 
reporting entity that follows the full cost method shall apply that 
method to all of its operations and to the operations of its 
subsidiaries * * *''
    Question 1: May a subsidiary of the parent use the full cost method 
if the parent company uses the successful efforts method of accounting 
for oil and gas producing activities?
    Interpretive Response: No. The use of different methods of 
accounting in the consolidated financial statements by a parent company 
and its subsidiary would be inconsistent with the full cost requirement 
that a parent and its subsidiaries all use the same method of 
accounting.
    The staff's general policy is that an enterprise should account for 
all its like operations in the same manner. However, Rule 4-10 of 
Regulation S-X provides that oil and gas companies with cost-of-service 
oil and gas properties may give effect to any differences resulting 
from the ratemaking process, including regulatory requirements that a 
certain accounting method be used for the cost-of-service properties.
    Question 2: Must the method of accounting (full cost or successful 
efforts) followed by a registrant for its oil and gas producing 
activities also be followed by any fifty percent or less owned 
companies in which the registrant carries its investment on the equity 
method (equity investees)?
    Interpretive Response: No. Conformity of accounting methods between 
a registrant and its equity investees, although desirable, may not be 
practicable and thus is not required. However, if a registrant 
proportionately consolidates its equity investees, it will be necessary 
to present them all on the same basis of accounting.

D. Application of Full Cost Method of Accounting

1. Treatment of Income Tax Effects in the Computation of the Limitation 
on Capitalized Costs
    Facts: Item (D) in Rule 4-10(c)(4)(i) of Regulation S-X provides 
that the income tax effects related to the properties involved should 
be deducted in computing the full cost ceiling.
    Question 1: What specific types of income tax effects should be 
considered in computing the income tax effects to be deducted from 
estimated future net revenues?
    Interpretive Response: The rule refers to income tax effects 
generally. Thus, the computation should take into account (i) the tax 
basis of oil and gas properties, (ii) net operating loss carryforwards, 
(iii) foreign tax credit carryforwards, (iv) investment tax credits, 
(v) alternative minimum taxes on tax preference items, and (vi) the 
impact of statutory (percentage) depletion.
    It may often be difficult to allocate a net operating loss (NOL) 
carryforward between oil and gas assets and other assets. However, to 
the extent that the NOL is clearly attributable to oil and gas 
operations and is expected to be realized within the carryforward 
period, it should be added to tax basis.
    Similarly, to the extent that investment tax credit (ITC) 
carryforwards and foreign tax credit carryforwards are attributable to 
oil and gas operations and are expected to be realized within the 
carryforward period, they should be considered as a deduction from the 
tax effect otherwise computed. Consideration of NOL and ITC or foreign 
tax credit carryforwards should not, of course, reduce the total tax 
effect below zero.
    Question 2: How should the tax effect be computed considering the 
various factors discussed above?
    Interpretive Response: Theoretically, taxable income and tax could 
be determined on a year-by-year basis and the present value of the 
related tax computed. However, the ``shortcut'' method illustrated 
below is also acceptable.

ASSUMPTIONS:
    Cost of proved properties being amortized................  ...............        $396,000   ...............
    Lower of cost or estimated fair value of unproved          ...............          49,000   ...............
     properties to be amortized..............................

[[Page 57066]]

 
    Cost of properties not being amortized...................  ...............          55,000   ...............
                                                                               -----------------
    Capitalized costs of oil and gas assets..................  ...............         500,000   ...............
    Accumulated DD&A.........................................  ...............        (100,000)  ...............
                                                                               -----------------
        Book basis of oil and gas assets.....................  ...............  ...............        $400,000
    Excess of book basis over tax basis ($270,000) of oil and  ...............       $(130,000)  ...............
     gas assets..............................................
    NOL carryforward*........................................  ...............          20,000   ...............
                                                                               -----------------
                                                               ...............        (110,000)  ...............
                                                                               -----------------
    Statutory tax rate (percent).............................  ...............           x 46%   ...............
                                                                               -----------------
                                                               ...............         (50,600)  ...............
    Foreign tax credit carryforward*.........................  ...............           1,000   ...............
    ITC carryforward*........................................  ...............           2,000   ...............
                                                                               -----------------
    Related net deferred income tax liability................  ...............  ...............         (47,600)
                                                                                                ----------------
        Net book basis to be recovered.......................  ...............  ...............        $352,400
                                                                                                ----------------
Other Assumptions:
    Present value of ITC relating to future development costs  ...............          $1,500   ...............
    Present value of statutory depletion attributable to       ...............         $10,000   ...............
     future deductions.......................................
    Estimated preference (minimum) tax on percentage           ...............            $500   ...............
     depletion in excess of cost depletion...................
    Present value of future net revenue from proved oil and    ...............        $272,000   ...............
     gas reserves............................................
CALCULATION:
    Present value of future net revenue......................  ...............        $272,000   ...............
    Cost of properties not being amortized...................  ...............          55,000   ...............
    Lower of cost or estimated fair value of unproved          ...............          49,000   ...............
     properties included in costs being amortized............
                                                                               -----------------
        Total ceiling limitation before tax effects..........  ...............  ...............        $376,000
Tax Effects:
    Total ceiling limitation before tax effects..............  ...............        $376,000   ...............
    Less: Tax basis of properties............................       $(270,000)  ...............  ...............
        Statutory depletion..................................         (10,000)  ...............  ...............
                                                              -----------------
        NOL carryforward.....................................         (20,000)  ...............  ...............
                                                              -----------------
                                                               ...............        (300,000)  ...............
                                                                               -----------------
    Future taxable income....................................  ...............          76,000   ...............
    Tax rate (percent).......................................  ...............           x 46%   ...............
                                                                               -----------------
    Tax at statutory rate....................................  ...............         (34,960)  ...............
    ITC (future development costs and carryforward)..........  ...............           3,500   ...............
    Foreign tax credit carryforward..........................  ...............           1,000   ...............
    Estimated preference tax.................................  ...............            (500)  ...............
                                                                               -----------------
        Net tax effects......................................  ...............  ...............         (30,960)
                                                                                                ----------------
        Cost Center Ceiling..................................  ...............  ...............        $345,040
    Less: Net book basis to be recovered.....................  ...............  ...............         352,400
                                                                                                ----------------
    REQUIRED WRITE-OFF, net of tax**.........................  ...............  ...............         $(7,360)
 
*All carryforward amounts in this example represent amounts which are available for tax purposes and which
  relate to oil and gas operations.
**For accounting purposes, the gross write-off should be recorded to adjust both the oil and gas properties
  account and the related deferred income taxes.


CALCULATION OF GROSS PRE-TAX WRITE-OFF:
    Required write-off, net of tax.............................  ..............  ..............         $(7,360)
                                                                                                ----------------
    Divided by (100% minus the statutory rate of 46%)..........  ..............  ..............             54%
                                                                                                ----------------
        Gross pre-tax write-off................................  ..............  ..............        $(13,630)
                                                                                                ----------------
                    Related Journal Entries                            DR              CR        ...............
Full cost ceiling impairment...................................         $13,630  ..............  ...............
Oil and gas assets.............................................  ..............         $13,630  ...............
Deferred income tax liability..................................          $6,270  ..............  ...............
Deferred income tax benefit....................................  ..............          $6,270  ...............
 


[[Page 57067]]

2. Exclusion of Costs From Amortization
    Facts: Rule 4-10(c)(3)(ii) indicates that the costs of acquiring 
and evaluating unproved properties may be excluded from capitalized 
costs to be amortized if the costs are unusually significant in 
relation to aggregate costs to be amortized. Costs of major development 
projects may also be incurred prior to ascertaining the quantities of 
proved reserves attributable to such properties.
    Question: At what point should amortization of previously excluded 
costs commence--when proved reserves have been established or when 
those reserves become marketable? For instance, a determination of 
proved reserves may be made before completion of an extraction plant 
necessary to process sour crude or a pipeline necessary to market the 
reserves. May the costs continue to be excluded from amortization until 
the plant or pipeline is in service?
    Interpretive Response: No. The proved reserves and the costs 
allocable to such reserves should be transferred into the amortization 
base on an ongoing (well-by-well or property-by-property) basis as the 
project is evaluated and proved reserves are established.
    Once the determination of proved reserves has been made, there is 
no justification for continued exclusion from the full cost pool, 
regardless of whether other factors prevent immediate marketing. 
Moreover, at the same time that the costs are transferred into the 
amortization base, it is also necessary in accordance with FASB ASC 
Subtopic 932-835, Extractive Activities--Oil and Gas--Interest and FASB 
ASC Subtopic 835-20, Interest--Capitalization of Interest, to terminate 
capitalization of interest on such properties.
    In this regard, registrants are reminded of their responsibilities 
not to delay recognizing reserves as proved once they have met the 
engineering standards.
3. Full Cost Ceiling Limitation
a. Exemptions for Purchased Properties
    Facts: During 20x1, a registrant purchases proved oil and gas 
reserves in place (``the purchased reserves'') in an arm's-length 
transaction for the sum of $9.8 million. Primarily because the 
registrant expects oil and gas prices to escalate, it paid $1.2 million 
more for the purchased reserves than the ``Present Value of Estimated 
Future Net Revenues'' computed as defined in Rule 4-10(c)(4)(i)(A) of 
Regulation S-X. An analysis of the registrant's full cost center in 
which the purchased reserves are located at December 31, 20x1 is as 
follows:

                                             [Amounts in thousands]
----------------------------------------------------------------------------------------------------------------
                                                                     Purchased     Other proved      Unproved
                                                       Total         reserves       properties      properties
----------------------------------------------------------------------------------------------------------------
Present value of estimated future net revenues..         $14,100           8,600           5,500  ..............
Cost, net of amortization.......................          16,300           9,800           5,500           1,000
Related deferred taxes..........................           2,300  ..............           2,000             300
Income tax effects related to properties........           2,500  ..............           2,500  ..............
----------------------------------------------------------------------------------------------------------------
Comparison of capitalized costs with limitation                      Including       Excluding    ..............
 on capitalized costs at December 31, 20x1:                          purchased       purchased
                                                                     reserves        reserves
----------------------------------------------------------------------------------------------------------------
Capitalized costs, net of amortization..........  ..............         $16,300          $6,500  ..............
Related deferred taxes..........................  ..............         (2,300)         (2,300)  ..............
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Net book cost...................................  ..............          14,000           4,200  ..............
-------------------------------------------------
Lower of cost or market of unproved properties..  ..............           1,000           1,000  ..............
                                                                 --------------------------------
Income tax effects related to properties........  ..............         (2,500)         (2,500)  ..............
                                                                 --------------------------------
Limitation on capitalized costs.................  ..............          12,600           4,000  ..............
Excess of capitalized costs over limitation on    ..............           1,400             200  ..............
 capitalized costs, net of tax*.................
----------------------------------------------------------------------------------------------------------------
* For accounting purposes, the gross write-off should be recorded to adjust both the oil and gas properties
  account and the related deferred income taxes.

    Question: Is it necessary for the registrant to write down the 
carrying value of its full cost center at December 31, 20x1 by 
$1,400,000?
    Interpretive Response: Although the net carrying value of the full 
cost center exceeds the cost center's limitation on capitalized costs, 
the text of ASR 258 provides that a registrant may request an exemption 
from the rule if as a result of a major purchase of proved properties, 
a write down would be required even though the registrant believes the 
fair value of the properties in a cost center clearly exceeds the 
unamortized costs.
    Therefore, to the extent that the excess carrying value relates to 
the purchased reserves, the registrant may seek a temporary waiver of 
the full-cost ceiling limitation from the staff of the Commission. 
Registrants requesting a waiver should be prepared to demonstrate that 
the additional value exists beyond reasonable doubt.
    To the extent that the excess costs relate to properties other than 
the purchased reserves, however, a write-off should be recorded in the 
current period. In order to determine the portion of the total excess 
carrying value which is attributable to properties other than the 
purchased reserves, it is necessary to perform the ceiling computation 
on a ``with and without'' basis as shown in the example above. Thus in 
this case, the registrant must record a write-down of $200,000 
applicable to other reserves. An additional $1,200,000 write-down would 
be necessary unless a waiver was obtained.
b. Use of Cash Flow Hedges in the Computation of the Limitation on 
Capitalized Costs
    Facts: Rule 4-10(c)(4) of Regulation S-X provides, in pertinent 
part, that

[[Page 57068]]

capitalized costs, net of accumulated depreciation and amortization, 
and deferred income taxes, should not exceed an amount equal to the sum 
of components that include the present value of estimated future net 
revenues computed by applying current prices of oil and gas reserves 
(with consideration of price changes only to the extent provided by 
contractual arrangements) to estimated future production of proved oil 
and gas reserves as of the date of the latest balance sheet presented.
    As of the reported balance sheet date, capitalized costs of an oil 
and gas producing company exceed the full cost limitation calculated 
under the above-described rule based on current prices, as defined in 
Rule 4-10(c)(8) of Regulation S-X, for oil and natural gas. However, 
prior to the balance sheet date, the company entered into certain 
hedging arrangements for a portion of its future natural gas and oil 
production, thereby enabling the company to receive future cash flows 
that are higher or lower than the estimated future cash flows indicated 
by use of the average price during the 12-month period prior to the 
balance sheet date, determined as an unweighted arithmetic average of 
the first-day-of-the-month price for each month within such period. 
These arrangements qualify as cash flow hedges under the provisions of 
FASB ASC Topic 815, Derivatives and Hedging, and are documented, 
designated, and accounted for as such under the criteria of that 
standard.
    Question: Under these circumstances, must the company use the 
higher or lower prices to be received after taking into account the 
hedging arrangements (``hedge-adjusted prices'') in calculating the 
estimated cash flows from future production of oil and gas reserves 
covered by the hedges as of the reported balance sheet date?
    Interpretive Response: Yes. Derivative contracts that qualify as a 
hedging instrument in a cash flow hedge and are accounted for as such 
pursuant to FASB ASC Topic 815 represent the type of contractual 
arrangements for which consideration of price changes should be given 
under the existing rule. While the SEC staff has objected to previous 
proposals to consider various hedging techniques as being equivalent to 
the contractual arrangements permitted under the existing rules, the 
staff's objection was based on concerns that the lack of clear, 
consistent guidance in the accounting literature would lead to 
inconsistent application in practice. However, the staff believes that 
FASB ASC Topic 815 and related guidance (including a more systematic 
approach to documentation) provides sufficient guidance so that 
comparable financial reporting in comparable factual circumstances 
should result.
    This interpretive response reflects the SEC staff's view that, 
assuming compliance with the prerequisite accounting requirements, 
hedge-adjusted prices represent the best measure of estimated cash 
flows from future production of the affected oil and gas reserves to 
use in calculating the ceiling limitation. Nonetheless, the staff 
expects that oil and gas producing companies subject to the full cost 
rules will clearly indicate the effects of using cash flow hedges in 
calculating ceiling limitations within their financial statement 
footnotes. The staff further expects that disclosures will indicate the 
portion of future oil and gas production being hedged. The dollar 
amount that would have been charged to income had the effects of the 
cash flow hedges not been considered in calculating the ceiling 
limitation also should be disclosed.
    The use of hedge-adjusted prices should be consistently applied in 
all reporting periods, including periods in which the hedge-adjusted 
price is more or less than the average price during the 12-month period 
prior to the balance sheet date, determined as an unweighted arithmetic 
average of the first-day-of-the-month price for each month within such 
period. Oil and gas producers whose computation of the ceiling 
limitation includes hedge-adjusted prices because of the use of cash 
flow hedges also should consider the disclosure requirements under FASB 
ASC Section 275-10-50, Risks and Uncertainties--Overall-Disclosure. 
Paragraph 9 of FASB ASC Section 275-10-50 calls for disclosure when it 
is at least reasonably possible that the effects of cash flow hedges on 
capitalized costs on the reported balance sheet date will change in the 
near term due to one or more confirming events, such as potential 
future changes in commodity prices.
    In addition, the use of cash flow hedges in calculating the ceiling 
limitation may represent a type of critical accounting policy that oil 
and gas producers should consider disclosing consistent with the 
cautionary advice provided in Financial Reporting Release No. 60 
(Release Nos. 33-8040; 34-45149), Cautionary Advice Regarding 
Disclosure about Critical Accounting Policies (December 12, 2001), and 
Financial Reporting Release No. 72 (Release Nos. 33-8350; 34-48960), 
Commission Guidance Regarding Management's Discussion and Analysis of 
Financial Condition and Results of Operations (December 29, 2003). 
Through these releases, the Commission has encouraged companies to 
include, within their MD&A disclosures, full explanations, in plain 
English, of the judgments and uncertainties affecting the application 
of critical accounting policies, and the likelihood that materially 
different amounts would be reported under different conditions or using 
different assumptions.
    The staff's guidance on this issue would apply to calculations of 
ceiling limitations both in interim and annual reporting periods.

c. Effect of Subsequent Events on the Computation of the Limitation on 
Capitalized Costs

    Facts: Rule 4-10(c)(4)(ii) of Regulation S-X provides that an 
excess of unamortized capitalized costs within a cost center over the 
related cost ceiling shall be charged to expense in the period the 
excess occurs.
    Question: Assume that at the date of the company's fiscal year-end, 
its capitalized costs of oil and gas producing properties exceed the 
limitation prescribed by Rule 4-10(c)(4) of Regulation S-X. Thus, a 
write-down is indicated. Subsequent to year-end but before the date of 
the auditor's report on the company's financial statements, assume that 
additional reserves are proved up (excluding the effect of increased 
oil and gas prices subsequent to year-end) on properties owned at year-
end. The present value of future net revenues from the additional 
reserves is sufficiently large that if the full cost ceiling limitation 
were recomputed giving effect to those factors as of year-end, the 
ceiling would more than cover the costs. Is it necessary to record a 
write-down?
    Interpretive Response: No. In this case, the proving up of 
additional reserves on properties owned at year-end indicates that the 
capitalized costs were not in fact impaired at year-end. However, for 
purposes of the revised computation of the ``ceiling,'' the net book 
costs capitalized as of year-end should be increased by the amount of 
any additional costs incurred subsequent to year-end to prove the 
additional reserves or by any related costs previously excluded from 
amortization.
    While the fact pattern described herein relates to annual periods, 
the guidance on the effects of subsequent events applies equally to 
interim period calculations of the ceiling limitation.
    The registrant's financial statements should disclose that 
capitalized costs exceeded the limitation thereon at year-

[[Page 57069]]

end and should explain why the excess was not charged against earnings. 
In addition, the registrant's supplemental disclosures of estimated 
proved reserve quantities and related future net revenues and costs 
should not give effect to the reserves proved up or the cost incurred 
after year-end. However, such quantities may be disclosed separately, 
with appropriate explanations.
    Registrants should be aware that oil and gas reserves related to 
properties acquired after year-end would not justify avoiding a write-
off indicated as of year-end. Similarly, the effects of cash flow 
hedging arrangements entered into after year-end cannot be factored 
into the calculation of the ceiling limitation at year-end. Such 
acquisitions and financial arrangements do not confirm situations 
existing at year-end.
4. Interaction of FASB ASC Subtopic 410-20 Asset Retirement and 
Environmental Obligations--Asset Retirement Obligations--and the Full 
Cost Rules
    a. Impact of FASB ASC Subtopic 410-20 on the Full Cost Ceiling Test
    Facts: A company following the full cost method of accounting under 
Rule 4-10(c) of Regulation S-X must periodically calculate a limitation 
on capitalized costs, i.e., the full cost ceiling. Under FASB ASC 
Subtopic 410-20, Asset Retirement and Environmental Obligations--Asset 
Retirement Obligations, a company must recognize a liability for an 
asset retirement obligation (ARO) at fair value in the period in which 
the obligation is incurred, if a reasonable estimate of fair value can 
be made. The company also must initially capitalize the associated 
asset retirement costs by increasing long-lived oil and gas assets by 
the same amount as the liability. Any asset retirement costs 
capitalized pursuant to FASB ASC Subtopic 410-20 are subject to the 
full cost ceiling limitation under Rule 4-10(c)(4) of Regulation S-X. 
If a company were to calculate the full cost ceiling by reducing 
expected future net revenues by the cash flows required to settle the 
ARO, then the effect would be to ``double-count'' such costs in the 
ceiling test. The assets that must be recovered would be increased 
while the future net revenues available to recover the assets continue 
to be reduced by the amount of the ARO settlement cash flows.
    Question: How should a company compute the full cost ceiling to 
avoid double-counting the expected future cash outflows associated with 
asset retirement costs?
    Interpretive Response: The future cash outflows associated with 
settling AROs that have been accrued on the balance sheet should be 
excluded from the computation of the present value of estimated future 
net revenues for purposes of the full cost ceiling 
calculation.1 2
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    \1\ If an obligation for expected asset retirement costs has not 
been accrued under FASB ASC Subtopic 410-20 for certain asset 
retirement costs required to be included in the full cost ceiling 
calculation under Rule 4-10(c)(4) of Regulation S-X, such costs 
should continue to be included in the full cost ceiling calculation.
    \2\ This approach is consistent with the guidance in FASB ASC 
Subtopic 410-20 on testing for impairment under FASB ASC Section 
360-10-35 Property, Plant, and Equipment--Overall--Subsequent 
Measurement. Under that guidance, the asset tested should include 
capitalized asset retirement costs. The estimated cash flows related 
to the associated ARO that has been recognized in the financial 
statements are to be excluded from both the undiscounted cash flows 
used to test for recoverability and the discounted cash flows used 
to measure the asset's fair value.
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    b. Impact of FASB ASC Subtopic 410-20 on the Calculation of 
Depreciation, Depletion, and Amortization
    Facts: Regarding the base for depreciation, depletion, and 
amortization (DD&A) of proved reserves, Rule 4-10(c)(3)(i) of 
Regulation S-X states that ``[c]osts to be amortized shall include (A) 
all capitalized costs, less accumulated amortization, other than the 
cost of properties described in paragraph (ii) below; \3\ (B) the 
estimated future expenditures (based on current costs) to be incurred 
in developing proved reserves; and (C) estimated dismantlement and 
abandonment costs, net of estimated salvage values.'' FASB ASC Subtopic 
410-20 requires that upon initial recognition of an ARO, the associated 
asset retirement costs be included in the capitalized costs of the 
company. Therefore, the estimated dismantlement and abandonment costs 
described in (C) above may be included in the capitalized costs 
described in (A) above, at least to the extent that an ARO has been 
incurred as a result of acquisition, exploration and development 
activities to date. Future development activities on proved reserves 
may result in additional asset retirement obligations when such 
activities are performed and the associated asset retirement costs will 
be capitalized at that time.
---------------------------------------------------------------------------

    \3\ The reference to ``cost of properties described in paragraph 
(ii) below'' relates to the costs of investments in unproved 
properties and major development projects, as defined.
---------------------------------------------------------------------------

    Question: Should the costs to be amortized under Rule 4-10(c)(3) of 
Regulation S-X include an amount for estimated dismantlement and 
abandonment costs, net of estimated salvage values, that are expected 
to result from future development activities?
    Interpretive Response: Yes. Companies should estimate the amount of 
dismantlement and abandonment costs that will be incurred as a result 
of future development activities on proved reserves and include those 
amounts in the costs to be amortized.
c. Removed by SAB 113

E. Financial Statements of Royalty Trusts

    Facts: Several oil and gas exploration and production companies 
have created ``royalty trusts.'' Typically, the creating company 
conveys a net profits interest in certain of its oil and gas properties 
to the newly created trust and then distributes units in the trust to 
its shareholders. The trust is a passive entity which is prohibited 
from entering into or engaging in any business or commercial activity 
of any kind and from acquiring any oil and gas lease, royalty or other 
mineral interest. The function of the trust is to serve as an agent to 
distribute the income from the net profits interest. The amount to be 
periodically distributed to the unitholders is defined in the trust 
agreement and is typically determined based on the cash received from 
the net profits interest less expenses of the trustee. Royalty trusts 
have typically reported their earnings on the basis of cash 
distributions to unitholders. The net profits interest paid to the 
trust for any month is based on production from a preceding month; 
therefore, the method of accounting followed by the trust for the net 
profits interest income is different from the creating company's method 
of accounting for the related revenue.
    Question: Will the staff accept a statement of distributable income 
which reflects the amounts to be distributed for the period in question 
under the terms of the trust agreement in lieu of a statement of income 
prepared under GAAP?
    Interpretive Response: Yes. Although financial statements filed 
with the Commission are normally required to be prepared in accordance 
with GAAP, the Commission's rules provide that other presentations may 
be acceptable in unusual situations. Since the operations of a royalty 
trust are limited to the distribution of income from the net profits 
interests contributed to it, the staff believes that the item of 
primary importance to the reader of the financial statements of the 
royalty trust is the amount of the cash distributions to the 
unitholders for the period reported. Should there be any change in the

[[Page 57070]]

nature of the trust's operations due to revisions in the tax laws or 
other factors, the staff's interpretation would be reexamined.
    A note to the financial statements should disclose the method used 
in determining distributable income and should also describe how 
distributable income as reported differs from income determined on the 
basis of GAAP.

F. Gross Revenue Method of Amortizing Capitalized Costs

    Facts: Rule 4-10(c)(3)(iii) of Regulation S-X states in part: 
``Amortization shall be computed on the basis of physical units, with 
oil and gas converted to a common unit of measure on the basis of their 
approximate relative energy content, unless economic circumstances 
(related to the effects of regulated prices) indicate that use of units 
of revenue is a more appropriate basis of computing amortization. In 
the latter case, amortization shall be computed on the basis of current 
gross revenues (excluding royalty payments and net profits 
disbursements) from production in relation to future gross revenues 
based on current prices (including consideration of changes in existing 
prices provided only by contractual arrangements), from estimated 
production of proved oil and gas reserves.'' \4\
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    \4\ Rule 4-10(c)(8) of Regulation S-X defines current price as 
the average price during the 12-month period prior to the ending 
date of the period covered by the report, determined as an 
unweighted arithmetic average of the first-day-of-the-month price 
for each month within such period, unless prices are defined by 
contractual arrangements, excluding escalations based upon future 
conditions.
---------------------------------------------------------------------------

    Question: May entities using the full cost method of accounting for 
oil and gas producing activities compute amortization based on the 
gross revenue method described in the above rule when substantial 
production is not subject to pricing regulation?
    Interpretive Response: Yes. Under the existing rules for cost 
amortization adopted in ASR 258, the use of the gross revenue method of 
amortization was permitted in those circumstances where, because of the 
effect of existing pricing regulations, the use of the units of 
production method would result in an amortization provision that would 
be inconsistent with the current sales prices being received. While the 
effect of regulation on gas prices has lessened, factors other than 
price regulation (such as changes in typical contract lengths and 
methods of marketing natural gas) have caused oil and gas prices to be 
disproportionate to their relative energy content. The staff therefore 
believes that it may be more appropriate for registrants to compute 
amortization based on the gross revenue method whenever oil and gas 
sales prices are disproportionate to their relative energy content to 
the extent that the use of the units of production method would result 
in an improper matching of the costs of oil and gas production against 
the related revenue received. The method should be consistently applied 
and appropriately disclosed within the financial statements.

G. Removed by SAB 113

[FR Doc. E9-26525 Filed 11-3-09; 8:45 am]
BILLING CODE 8011-01-P