ACCOUNTANTS’ HANDBOOK VOLUM phần 1 pdf

He previously was the first secretary eral of the International Accounting Standards Committee, director of the Technical ResearchDivision of the American Institute of Certified Public Acc

D R Carmichael Paul H Rosenfield

JOHN WILEY & SONS, INC.

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D R Carmichael Paul H Rosenfield

JOHN WILEY & SONS, INC.

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Library of Congress Cataloging-in-Publication Data:

Accountant’s handbook / [edited by] D.R Carmichael, Paul Rosenfield.—,

10th ed

p cm

Includes bibliographical references

Contents: v 1 Financial accounting and general topics —

ISBN 0-471-26993-X (set : alk paper)—ISBN 0-471-26991-3 (pbk : v

1 : alk paper).—ISBN 0-471-26992-1 (pbk : v 2 : alk paper)

1 Accounting—Encyclopedias 2 Accounting—Handbooks, manuals,

etc I Carmichael, D R (Douglas R.), 1941– II Rosenfield, Paul

HF5621 A22 2003

657—dc21 2002153108

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

ABOUT THE EDITORS

D R Carmichael, PhD, CPA, CFE, is the Wollman Distinguished Professor of Accountancy

at the Zicklin School of Business, The Stan Ross Department of Accountancy at Bernard M.Baruch College, The City University of New York Until 1983, he was the vice president, au-diting, at the AICPA, where he was in charge of the development of professional standards

Dr Carmichael has written numerous professional books, college texts, and articles in sional as well as academic journals He has acted as a consultant to CPA firms, state and federalgovernment agencies, public corporations, and attorneys He has dealt with issues related toaccounting, auditing, ethics, and controls standards and practices He has testified as an expertwitness in civil and criminal litigation and proceedings

profes-Paul Rosenfield, CPA, was director of the Accounting Standards Division of the American

In-stitute of Certified Public Accountants for 14 years He previously was the first secretary eral of the International Accounting Standards Committee, director of the Technical ResearchDivision of the American Institute of Certified Public Accountants, and a member of the staff

gen-of its Accounting Research Division He has authored two books and numerous articles on nancial reporting in professional and academic journals

fi-v

ABOUT THE CONTRIBUTORS

James R Adler, PhD, CPA, CFE, is founder of Adler Consulting Ltd., which specializes in

forensic accounting He has 40 years of public accounting and academic experience workingwith generally accepted accounting principles (GAAP) and generally accepted auditing stan-dards (GAAS) He has had a diversified clientele, including public and private entities as well

as governmental bodies such as the SEC, the U.S Department of Justice, and the FDIC He haswritten and lectured extensively on the professional standards and other accounting and eco-nomic issues

Juan Aguerrebere, Jr., CPA, is a founding member of Perez-Abreu, Aguerrebere, Sueiro LLC

in Coral Gables, Florida He has served on numerous AICPA and FICPA committees, includingthe AICPA Technical Issues Committee, Group of 100, AICPA Joint Trial Board, and FICPA Ac-counting and Auditing Committee He has over 13 years of experience in public accounting andauditing and over 20 years of experience in accounting for financial institutions He has lectured

on numerous accounting and auditing issues He is a member of the AICPA, FICPA, a Diplomat

of the American Board of Forensic Accounting, and a Neutral/Arbitrator for the American tration Association

Arbi-Vincent Amoroso, FSA, is a principal in the employee benefits section of Deloitte & Touche

LLP’s Washington National Office He has published and spoken frequently in the employeebenefits accounting area, both on pensions and retiree medical care

Ian J Benjamin, CPA, is a managing director in the Not-for-Profit Services Group of American

Express Tax and Business Services, Inc Prior to joining American Express, Mr Benjamin was apartner at Deloitte & Touche in their Tri-State Not-for-Profit and Higher Education ServicesGroup He is currently a member of the FASB working group on not-for-profit organizations andthe Professional Ethics Committee of the New York State Society of CPAs He is a former mem-ber of the International Accounting Committee and the Not-for-Profit Organizations Committee

of the New York State Society of CPAs

Martin Benis, PhD, CPA, is a professor and former chairman of The Stan Ross Department of

Accountancy at the Zicklin School of Business, Bernard M Baruch College, CUNY He is rently a consultant on accounting and auditing matters to more than 50 accounting firms and or-ganizations throughout the United States His articles have appeared in major accounting andauditing journals

cur-Andrew J Blossom, CPA, is a senior manager in the Public Services line of business of KPMG

Peat Marwick LLP He is assigned to KPMG’s Department of Professional Practice, where he isresponsible for handling technical inquiries related to governmental accounting, auditing, andreporting Mr Blossom is a member of the AICPA Government Accounting and Auditing Com-mittee He received his BS degree from the University of Kansas

Stephen Bryan, MBA, PhD, is an associate professor of the Stan Ross Department of

Accoun-tancy at the Zicklin School of Business, Bernard M Baruch College, CUNY He received hisdoctorate in accounting from New York University

vii

Luis E Cabrera, CPA, is a technical manager with the AICPA’s Professional Standards and

Ser-vices Team Mr Cabrera was previously responsible for technical research activities as a senioraccountant in the national office of Pannell Kerr Forster, PC He was also an audit senior withCoopers & Lybrand and has served as an adjunct professor of Accountancy at the Zicklin School

of Business in the Stan Ross Department of Accountancy at Bernard M Baruch College, CUNY

Joseph V Carcello, PhD, CPA, CMA, CIA, is a William B Stokely Distinguished Scholar and

an associate professor in the Department of Accounting and Business Law at the University of

Tennessee Dr Carcello is the coauthor of the 2003 Miller GAAP Practice Manual Dr Carcello

has taught professional development courses and conducted funded research for three of the Big

4 firms He also has taught continuing professional education courses for the AICPA, the tute of Internal Auditors, the Institute of Management Accountants, and the Tennessee andFlorida Societies of CPAs

Insti-Peter T Chingos, CPA, is a principal in the New York office of Mercer Human Resource

Con-sulting and a member of the firm’s Worldwide Partners Group He is the U.S leader for thefirm’s Executive Compensation Consulting Practice For more than 25 years he has consultedwith senior management, compensation committees, and boards of directors of leading globalcorporations on executive compensation and strategic business issues He is a frequent keynotespeaker at professional conferences, writes extensively on all aspects of executive compensa-tion, and is often quoted in the press He is a member of the advisory Board of the National As-sociation of Stock Plan Professionals and currently teaches basic and advanced courses inexecutive compensation in the certification program for compensation professionals sponsored

by Worldatwork

Walton T Conn, Jr., CPA, is an SEC Reviewing Partner in the Silicon Valley office of KPMG

Peat Marwick LLP, where he works in the information, communication, and entertainment tice He has spent four years in his firm’s Department of Professional Practice in New York and

prac-is a former practice fellow of the AICPA Auditing Standards Board

John R Deming, CPA, is a partner in the Department of Professional Practice of KPMG Peat

Marwick LLP in New York He is a former member of the AICPA Accounting Standards tive Committee and has served on a number of FASB task forces and EITF working groups Mr.Deming has written numerous articles on a variety of accounting issues, including leases, busi-ness combinations, pensions, and employee stock-based compensation

Execu-Jason Flynn, FSA, is a senior manager in the employee benefits section of Deloitte & Touche

LLP’s Detroit office

Martha Garner, CPA, is a director in the national office of PricewaterhouseCoopers LLP,

where she is the firm’s industry specialist for healthcare accounting and financial reporting ters She has served on numerous AICPA, FASB, and Healthcare Financial Management Associ-ation task forces and committees dealing with healthcare financial reporting issues She is a

mat-contributing author on healthcare matters for Montgomery’s Auditing and the Financial and

Ac-counting Guide for Not-for-Profit Organizations, and has authored numerous healthcare articles

and publications

Frederick Gill, CPA, is senior technical manager on the Accounting Standards Team at the

AICPA, where he provides broad technical support to the Accounting Standards ExecutiveCommittee During 19 years with the AICPA, he participated in the development of numerousAICPA Statements of Position, Audit and Accounting Guides, Practice Bulletins, issues papers,journal articles, and practice aids He was a member of the U.S delegation to the InternationalAccounting Standards Committee, represented the U.S accounting profession on the United

Nations Intergovernmental Working Group of Experts on International Standards of Accountingand Reporting, and was a member of the National Accounting Curriculum Task Force Previ-ously he held several accounting faculty positions.

Alan S Glazer, PhD, CPA, is professor of Business Administration at Franklin & Marshall

College, Lancaster, Pennsylvania He was associate director of the Independence StandardsBoard’s conceptual framework project and has been a consultant to several AICPA committees.His articles on auditor independence, not-for-profit organizations, and other issues have beenpublished in academic and professional journals

Andrew F Gottschalk, CPA, is a senior manger in the public services practice of KPMG Peat

Marwick LLP He has over 13 years of experience serving state and local governments He is amember of the Government Finance Officers Association, the Association of Government Ac-countants, and the New York and Illinois Societies of CPAs

Richard P Graff, CPA, is CEO of The Graff Consulting Group He serves as a financial and

business adviser to the natural resources industry and has coauthored numerous publications.Prior to that, he was a partner in the international accounting firm of PricewaterhouseCoopersLLP, where he served as audit leader of the U.S Mining Industry Group

Dan M Guy, PhD, CPA, is a writer and consultant Formerly he served as a vice-president of

Professional Standards and Services at the AICPA He is a coauthor of Practitioner’s Guide to

GAAS and Ethics for CPAs (John Wiley & Sons); Guide to Compilation and Review ments (Practitioners Publishing Company, 1988); and has published numerous articles in pro-

Engage-fessional journals, an auditing textbook (Dryden Press), and an audit sampling textbook (JohnWiley & Sons)

Wendy Hambleton, CPA, is an audit partner working in the National SEC Department in BDO

Seidman LLP’s Chicago office Prior to joining the SEC Department, Ms Hambleton worked inthe firm’s Washington, DC, practice office She works extensively with clients and engagementteams to prepare SEC filings and resolve related accounting and reporting issues Ms Hamble-

ton coauthors a number of internal and external publications, including the AICPA’s Guide to

SEC Reporting and Warren Gorham & Lamont’s Controller’s Handbook chapter on public

of-fering requirements

Philip M Herr, JD, CPA, is the director of Advanced Planning of Kingsbridge Financial

Group, Inc., Point Pleasant Beach, New Jersey, and is an adjunct professor at Fairleigh son University, School of Continuing Education, Certified Employee Benefits Specialist Pro-gram and Certified Financial Planner Program He is admitted to the New York and U.S TaxCourt Bars and is a member of the New York State Bar Association, New York State Society ofCPAs, New Jersey Society of CPAs, and Association for Advanced Life Underwriting He spe-cializes in the areas of: tax; estates and trusts; estate, business, and financial planning; ERISAissues and transactions; retirement, employee benefit, and executive compensation planning;and use of life insurance and insurance products He also holds the NASD 7, 24, 63, and 65 se-curities licenses

Dickin-Karen L Hooks, PhD, CPA, is a professor of accountancy at Florida Atlantic University

(FAU) Her primary research areas are the public accounting work environment, sociology ofprofessions, gender, ethics, and communication She teaches undergraduate classes, as well as

in the Master of Accounting, MBA, and Master of Science in International Business at FAU

Professor Hooks has been published in Accounting Organizations and Society, Behavioral

Re-search in Accounting, Auditing: A Journal of Practice and Theory, Accounting Horizons, ical Perspectives on Accounting, Advances in Accounting, Advances in Public Interest

Accounting, Journal of Accountancy, among others She received her PhD from

Georgia State University

Keith M Housum, CPA, is a senior manager in the tax consulting practice of Ernst &Young

LLP He specializes in the Financial Services area Mr Housum has over six years of experienceassisting financial services clients with a variety of tax issues Clients have ranged in size fromsmall community-based banks to large regional financial institutions He began his career withErnst & Young LLP upon graduation from Case Western Reserve University with a bachelor’sdegree in Accounting He is a member of the Ohio Society of Certified Public Accountants

Henry R Jaenicke, PhD, CPA, is the C D Clarkson Professor of Accounting at Drexel

Uni-versity He is the author of Survey of Present Practiced in Recognizing Revenues, Expenses,

Gains, and Losses (FASB, 1981) and is the coauthor of the 12th edition of Montgomery’s ing (John Wiley & Sons, 1998) He has served as a consultant to several AICPA committees, the

Audit-Independence Standards Board, and the Public Oversight Board

Richard C Jones, PhD, CPA, is an assistant professor in the Accounting/Taxation/Business Law

Department of Hofstra University Dr Jones’s teaching interests include managerial accounting andfinancial reporting His research interests focus on auditing and the international self-regulatory ac-counting environment Dr Jones has also contributed extensively to AICPA publications

Richard R Jones, CPA, is a senior partner in the National Accounting Standards Professional

Practice Group of Ernst & Young LLP, where he is responsible for assisting the firm’s clients inunderstanding and implementing today’s complex accounting requirements Mr Jones’s partic-ular fields of expertise are in the areas of impairments, equity accounting, real estate, leasing,and various financing arrangements

Allyn A Joyce has been a business appraiser for 40 years He is principal of Allyn A Joyce & Co.,

Inc., which specializes in litigation support appraisals and litigation support appraisal reviews

Alan M Kall is a principal in the tax consulting practice of Ernst & Young LLP specializing in

the Financial Services area Mr Kall has over 17 years of experience assisting financial servicesclients with a variety of tax and accounting issues His clients’ range in size from small commu-nity-based banks to large regional financial institutions He began his career with Ernst & YoungLLP upon graduation from Cleveland State University with a BBA in Accounting He is a CPAand a member of the Ohio Society of Certified Public Accountants

Eric Klis, ASA, is a manager in the employee benefits section of Deloitte & Touche LLP’s

Min-neapolis office

Margaret R Kolb, CPA, is a senior manager in Litigation Consulting Department of the New

York office of American Express Tax and Business Services, Inc., where she provides litigationconsulting, forensic accounting, and expert witness services to law firms and insurance compa-nies She has prepared expert reports and provided testimony in a variety of forums Ms Kolb is

a certified public accountant in the State of New York, a member of the American Institute ofCertified Public Accountants and the New York State Society of Certified Public Accountants.She recently served for two years on the Litigation Consulting Committee of the New YorkState Society of Certified Public Accountants

Debra J MacLaughlin, CPA, is a partner and the Deputy National SEC Director in BDO

Sei-dman LLP’s Chicago office She has over 23 years of professional accounting experience andhas served clients in both the public and private sectors As Deputy National SEC Director, Ms

MacLaughlin assists the firm’s clients and engagement teams in preparing SEC filings, performsprerelease reviews of registration statements and selected Form 10-Ks, and consults on relatedaccounting and reporting issues.

Susan McElyea, CPA, is a director in PricewaterhouseCoopers Transaction Services Group.

Her 22 years of industry experience includes corporations owning real estate not used in theirbusiness, commercial and industrial developers, home-builders, hotel owners, operators, syndi-cators, property managers, and retail clients with substantial real estate properties Experienceincludes off balance sheet structuring, lease and transaction structuring, lease analysis, securiti-zation and bulk sales transactions, cash flow modeling, due diligence services, private and pub-lic debt offerings, development of cash flow projections related to real estate syndications, andconsultation regarding accounting and reporting matters with clients in structuring various realestate transactions Additionally, she has served as an instructor for many real estate accountingand auditing continuing education courses and contributed significantly to the 1995 John Wiley

& Sons technical research book entitled Real Estate Accounting and Reporting.

Benjamin A McKnight III, CPA, is a retired partner at Arthur Andersen LLP in its Chicago

of-fice He specializes in services to regulated enterprises, is a frequent speaker, and provides pert testimony on utility and telecommunication accounting and regulatory topics

ex-Francine Mellors, CPA, is a director in Ernst & Young’s National Department of Professional

Practice in New York Her duties include consulting and writing on various accounting topics, cluding employee benefit issues, as well as serving as knowledge leader and publications directorfor the National AABS Practice Prior to this role, Ms Mellors served as a vice-president in theAccounting Policy Group at the Chase Manhattan Bank and as an auditor at Deloitte and Touche.She holds a BA and an MA in Hispanic Studies and an MBA in Accounting and Management

in-John R Miller, CPA, CGFM, is a partner and member of the board of directors of KPMG Peat

Marwick LLP He is partner-in-charge of the firm’s Public Services Assurance and ResourceManagement Services Mr Miller is a member of the Comptroller General’s Audit AdvisoryCommittee and a former chairman of the AICPA’s Government and Auditing Committee and is

a recognized authority on governmental financial management

Lailani Moody, CPA, MBA, is a partner in Grant Thornton LLP’s Professional Standards

Group Her responsibilities are primarily in the area of accounting and financial reporting, and,

in particular, stock compensation, equity transactions, and newly issued accounting ments from the FASB and the FASB’s Emerging Issues Task Force She was formerly a techni-cal manager in the AICPA’s Accounting Standards Division

pronounce-Richard H Moseley, CPA, is a managing director in the Chicago Metro office of American

Ex-press Tax and Business Services, Inc and the co-director of the Quality Assurance Department

Mr Moseley is responsible for providing consultation services on accounting technical issuesand preparing implementation guidance for new accounting standards He is a member of theAICPA’s Accounting Standards Executive Committee and a former member of the PCPS Tech-nical Issues Committee

Anthony J Mottola, CPA, CFE, is president of Mottola & Associates, Inc., a consulting firm

in areas such as litigation support, financial services, strategic planning, corporate oversight,transactions structuring, and systems and business evaluation Previously he was a partner withCoopers & Lybrand, Spicer & Oppenheim, and EVP, and a member of the board of directors ofShearson Lehman He was special assistant to New York City’s Deputy Mayor of Finance dur-ing its fiscal crises and served as the first Practice Fellow at FASB

Dennis S Neier, CPA, is a partner in the accounting firm of Goldstein Golub Kessler LLP, a

managing director in the New York office of American Express Tax and Business Services, Inc.,and the associate director of the New York Litigation Consulting Department Mr Neier pro-vides litigation consulting and support, expert witness, and forensic accounting services to lawfirms, insurance companies, and in-house counsel He assists in all phases of the litigationprocess, from precomplaint through posttrial, and has testimony experience in a variety of fo-rums He is certified in New York and Louisiana and is a member of the American Institute ofCertified Public Accountants, the New York State Society of Certified Public Accountants, theAmerican Arbitration Association, the Association of Certified Fraud Examiners, and the Amer-ican College of Forensic Examiners, and is a diplomat of the American Board of Forensic Ac-counting

Grant W Newton, PhD, CPA, CMA, is a professor of accounting at Pepperdine University He

is the author of the two-volume set Bankruptcy and Insolvency Accounting: Practice and

Proce-dures: Forms and Exhibits, Sixth Edition (John Wiley & Sons, 2000), and coauthor of ruptcy and Insolvency Taxation, Second Edition (John Wiley & Sons, 1994) He is a frequent

Bank-contributor to professional journals and has lectured widely to professional organizations onbankruptcy-related topics

Paul Pacter, PhD, CPA, is director, Deloitte Touche Tohmatsu IAS Global Office, Hong

Kong His responsibilities include IAS technical questions, developing his firm’s commentletters to the IASB, advising the Ministry of Finance of China on developing accounting

standards, and managing the web site, www.iasplus.com From 1996 to 2000 he was

Interna-tional Accounting Fellow at the InternaInterna-tional Accounting Standards Committee, London Inthat capacity, he managed a number of IASC’s agenda projects, including financial instru-ments recognition and measurement, interim financial reporting, segment reporting, and dis-continued operations Previously Mr Pacter worked for the U.S FASB from its inception in

1973 and, for seven years, as commissioner of Finance of the City of Stamford, Connecticut

He has published nearly 100 professional monographs and articles He received his PhDfrom Michigan State University and has taught in several MBA programs for working busi-ness managers

Don M Pallais, CPA, has his own practice in Richmond, Virginia He is a former member of

the AICPA Auditing Standards Board and the AICPA Accounting and Review Services tee He has written a host of books, articles, and CPE courses on accounting topics

Commit-Ronald J Patten, PhD, CPA, is the dean emeritus of the College of Commerce and Kellstadt

Graduate School at DePaul University He was the first director of research for the FASB and a

former associate in the firm of Arthur D Little International He is the coauthor of CPA

Re-view: Practice, Theory, Auditing and Law, First and Second Edition (John Wiley & Sons, 1974,

1978)

Laura J Phillips, CPA, is a senior manager in the Cleveland office of Ernst & Young LLP She

was formerly assigned to the firm’s national offices in New York and Cleveland, specializing inthe financial services industry She has been a Technical Audit Advisor to the Auditing Stan-dards Board of the AICPA as well as a member of the AICPA Auditing Financial Instruments

Task Force Her articles have appeared in Bank Accounting and Finance and Commercial

Lend-ing Review She currently serves commercial bankLend-ing clients.

Ronald F Ries, CPA, is the managing director in charge of the Not-for-Profit Services Group

in the New York office of the American Express Tax and Business Services, Inc Prior to ing American Express, Mr Ries was controller, treasurer, and vice president of finance for Spi-

ral Metal Company, Inc He is an active member of the Accounting for Non-Profit tions Committee of the New York State Society of Certified Public Accountants and active in

Organiza-the AICPA He is a contributing editor to Organiza-the Practical Accountant and lectures and writes

fre-quently on various business and financial matters in both the commercial and not-for-profitsectors

Jacob P Roosma, CPA, is director of the New York office of Willamette Management

Associ-ates, specializing in business valuation He was previously a partner in the New York office ofDeloitte & Touche LLP and, before that, vice president of Management Planning, Inc

Mark R Rouchard, CPA, MBA, is a partner in Ernst & Young’s financial services practice.

Mr Rouchard has spent his entire career serving financial institution clients and has provided

a wide range of accounting and auditing services to some of Ernst & Young’s largest bankingclients Mark currently serves on the AICPA’s Regulatory Task Force He has spoken at

AICPA conferences and written for Bank Accounting and Finance magazine.

Robert L Royall II, CPA, CFA, MBA, is a partner in Ernst & Young’s National Professional

Practices Group in New York City, specializing in accounting for derivatives and hedging ities and financial instruments Mr Royall has authored or edited all of his firm’s technical liter-

activ-ature related to FASB Statement No 133, Accounting for Derivative Instruments and Hedging

Activities He regularly works with the FASB staff and SEC regulators to monitor emerging

in-terpretations in this rapidly changing area Mr Royall is a member of the Association for vestment Management and Research

In-Steven Rubin, CPA, is a firm director in the national assurance, accounting and advisory

services department of Deloitte & Touche LLP Previously he was the director of accounting

at another national firm and a principal and the director of quality control at a local firm.Prior to that he held key staff positions at the AICPA and taught accounting as an adjunct as-sistant professor at Brooklyn College of CUNY, his alma mater A frequent writer and lec-turer, he is active in the New York State Society of Certified Public Accountants, where hechairs its Financial Accounting Standards Committee, and is former member of its board ofdirectors

Warren Ruppel, CPA, is the assistant comptroller for accounting of the City of New York,

where he is responsible for all aspects of the city’s accounting and financial reporting Hehas over 20 years of experience in governmental and not-for-profit accounting and financialreporting He began his career at KPMG after graduating from St John’s University, NewYork, in 1979 His involvement with governmental accounting and auditing began with hisfirst audit assignment—the second audit ever performed of the financial statements of theCity of New York After that he served many governmental and commercial clients until hejoined Deloitte & Touche in 1989 to specialize in audits of governments and not-for-profitorganizations Mr Ruppel has also served as the CFO of an international not-for-profit orga-nization Mr Ruppel has served as instructor for many training courses, including special-ized governmental and not-for-profit programs and seminars He has also been an adjunctlecturer of accounting at the Bernard M Baruch College, CUNY He is the author of four

books, OMP Circular A-133 Audits, Wiley GAAP for Governments, Not-for-Profit

Organiza-tion Audits, and Not-for-Profit Accounting Made Easy Mr Ruppel is a member of the AICPA

as well as the New York State Society of Certified Public Accountants, where he serves onthe Governmental Accounting and Auditing and Not-for-Profit Organizations committees

He is also a member of the Institute of Management Accountants and is a past president ofthe New York chapter Mr Ruppel is a member of the Government Financial Officers Asso-ciation and serves on its Special Review Committee

Clifford H Schwartz, CPA, is a consultant Formerly he served as a senior technical manager

at the AICPA and a manager at Price Waterhouse LLP (now PricewaterhouseCoopers LLP)

E Raymond Simpson, CPA, is a project manager at the FASB He served as project manager

for SFAS No 109, “Accounting for Income Taxes,” and SFAS No 52, “Foreign CurrencyTranslation.”

Gary L Smith, CPA, is an Ernst & Young senior manager in the National Accounting

Stan-dards Professional Practice group with over 13 years of experience serving clients in a wide riety of industries and development stages He is responsible for assisting the firm’s clients inunderstanding and implementing today’s complex accounting requirements His particular fields

va-of expertise are in the areas va-of inventories, income taxes, consolidations, financial instruments,pensions, and commitments and contingencies Prior to joining national, he spent 10 yearsworking in the Washington, DC area serving multinational, middle market, and entrepreneurialclients in the technology, communications, manufacturing, distribution, professional services,and real estate industries

Ashwinpaul C Sondi, PhD, is president of A C Sondi & Associates, LLC, a financial

consult-ing firm and a member of the Accountconsult-ing Standards Executive Committee (AcSEC) of the

AICPA He is a coauthor with G I White and Dov Fried of The Analysis and Use of Financial

Statements, Third Edition, 2001 His consulting and research activities include the analysis of

financial statements, use of accounting data in capital markets, analysis of the financial industry,and international accounting differences

Joel O Steinberg, CPA, is partner at Goldstein Golub Kessler LLP in New York City, where he

specializes in accounting and auditing standards He is a member of the New York State Society

of CPA’s Financial Accounting Standards Committee He has authored several articles, and heprovides continuing professional education in accounting and auditing

Reva Steinberg, CPA, is a director in the National SEC Department in BDO Seidman LLP’s

Chicago office She has over 30 years of professional accounting experience and has servedclients in both the public and private sectors She works extensively with clients and engage-ment teams to prepare SEC filings and resolve related accounting and reporting issues

Reed K Storey, PhD, CPA, had more than 30 years of experience on the framework of

finan-cial accounting concepts, standards, and principles, working with both the Accounting ples Board, as director of Accounting Research of the AICPA, and the FASB, as senior technicaladviser He was also a member of the accounting faculties of the University of California,Berkeley, the University of Washington, Seattle, and Bernard M Baruch College, CUNY, and aconsultant in the executive offices of Coopers & Lybrand (now PricewaterhouseCoopers LLP)and Haskins & Sells (now Deloitte & Touche, LLP)

Princi-Dale K Thompson, CPA, is a senior manager in the Asset Management Services Group at

Ernst &Young He is responsible for accounting, regulatory, and business analysis of currentdevelopments effecting mutual fund, alternative products, and investment advisory organiza-tions He is a frequent speaker on regulatory matters at industry and firm-sponsored events He

is a member of the AICPAs and the Massachusetts Society of CPAs

Judith Weiss, CPA, received her MS in Accounting from Long Island University, Greenvale,

New York, and holds an MS in Education from Queens College, CUNY After several years inpublic accounting and private industry, she became a technical manager in the AICPA’s Ac-counting Standards Division, where she worked with industry committees in the development

of Audit and Accounting Guides and Statements of Position As a senior manager in the tional offices of Deloitte & Touche LLP and Grant Thornton LLP, she was involved in proj-ects related to standard setting by the FASB and the AICPA Since 1993 Ms Weiss has con-tributed to several books in the area of accounting and auditing She has coauthored articles

na-on accounting standards for several publicatina-ons, including the Journal of Accountancy, The

CPA Journal, and The Journal of Real Estate Accounting and Taxation.

Gerald I White, CFA, is the president of Grace & White, Inc., an investment counsel firm

located in New York City During the past 30 years he has engaged in numerous professionalactivities relating to the use of accounting information in making investment decisions He is

coauthor of The Analysis and Use of Financial Statements, Third Edition (John Wiley & Sons,

2003)

Jan R Williams, PhD, CPA, is the Ernst & Young Professor and Dean, College of Business

Administration, at the University of Tennessee He is past president of the American ing Association and a frequent contributor to academic and professional literature on financialreporting and accounting education Most recently he has been involved in the redesign of theCPA examination and is a frequent speaker on this and other topics of professional signifi-cance

Account-Alan J Winters, PhD, CPA, is director of the School of Accountancy and Legal Studies at

Clemson University Previously the director of auditing research at the AICPA, he has writtenmany articles for professional and academic journals and an auditing textbook He is a formermember of the AICPA’s Accounting and Review Services Committee

Margaret M Worthington, CPA, is a government contracts consultant Prior to her retirement

from PricewaterhouseCoopers LLP, she was a partner in the firm’s Government Contract sulting Services practice She has over 35 years of experience in federal contracting matters

Con-She is coauthor of Contracting with the Federal Government, Fourth Edition (John Wiley &

Sons, 1998) and has published numerous articles on a variety of federal contracting topics Sheearned her BS at UCLA

Gerard L Yarnall, CPA, is a partner in the New York Office Dispute Consulting and Forensic

Investigations Practice of Deloitte & Touche LLP Mr Yarnall was previously Director of Auditand Accounting Publications at the AICPA He has published and spoken frequently on a widevariety of accounting and auditing topics

The tenth edition of Accountants’ Handbook has the same goal as the first edition, written over

79 years ago: to provide in a single reference source answers to all reasonable questions on counting and financial reporting that might be asked by accountants, auditors, executives,bankers, lawyers, financial analysts, and other preparers and users of accounting information

ac-The Accountants’ Handbook is accounting’s oldest handbook and has the longest tradition of

providing comprehensive coverage of the field to both accounting professionals and als in other fields who need or desire to obtain quick, understandable, and thorough exposure tocomplex accounting-related subjects

profession-This edition of the Handbook continues the presentation initiated in the ninth edition of

two soft-cover volumes; the current edition contains a total of 44 chapters To provide a

re-source with the encyclopedic coverage that has been the hallmark of this Handbook series,

this edition again focuses on financial accounting and related topics, including auditing dards and audit reports, that are the common ground of interest for accounting and businessprofessionals

stan-This edition was prepared during the unfolding of the Enron and WorldCom collapses, thelargest bankruptcies in U.S history, accompanied by severe financial reporting breakdowns.The collapse and the breakdown at Enron destroyed Arthur Andersen & Co., one of the fivelargest international CPA firms WorldCom’s breakdown was called “the most sweeping book-keeping deception in history.”1 Those financial reporting breakdowns were accompanied byother reported large-scale breakdowns, for example, at Adelphi, Cedant Corporation, GlobalCrossing, Qwest Communications, Rite Aid, Waste Management, The Baptist Foundation,Vivendi Universal (a French company), and Xerox

Though the breakdowns led to the Sarbanes-Oxley Act of 2002, described in Chapter 2, atthis writing, only a hint of the eventual effects of those events on financial accounting and re-porting is available Nevertheless, this edition contains a chapter on the lesson of those eventsfor accountants In addition, earnings management became a topic of regulatory interest sincethe ninth edition was published A chapter on this form of abuse has also been added Further, a

chapter on price change reporting, a topic formerly covered by the Handbook, has been added in

connection with the problem of earnings management, plus a chapter on producers or tors of film

distribu-The explosion in the scope and complexity of accounting principles and practice that nated the preparation of the eighth and ninth editions has not abated Though the FASB contin-ues to be the primary source of authoritative accounting guidance, other sources of guidance areprominent Pronouncements by the AICPA, SEC, GASB, and EITF are considerably important

domi-in particular areas It is necessary to look to the EITF and to the AICPA SOPs and guides forguidance in specialized areas All of those sources of accounting guidance are included in this

edition of the Handbook.

The tenth edition of the Handbook is divided into two convenient volumes:

xvii

1Daniel Kadlec, “Worldcon: The Fall of a Telecom Titan,” Time, July 8, 2002, p 21.

Volume One: Financial Accounting and General Topics includes:

• A comprehensive review of the framework of accounting guidance today and the organizationsinvolved in its development, including the development of international standards

• Material on the Enron collapse, earnings management, and price change reporting

• A compendium of specific guidance on general aspects of financial statement presentation, closure, and analysis

dis-• Encyclopedic coverage of each specific financial statement area from cash though ers’ equity, including coverage of financial instruments

sharehold-Volume Two: Special Industries and Special Topics includes:

• Comprehensive single-source coverage of the specialized environmental and accounting siderations for key industries, including, for the first time, a chapter on the film industry

con-• Thorough coverage of accounting standards applying to pension plans, retirement plans, andemployee stock compensation and other capital accumulation plans

• Diverse topics including reporting by partnerships, estates, and trusts and valuation, ruptcy, and forensic accounting

bank-For convenience, the pronoun “he” is used in this book to refer nonspecifically to the countant and the person in business We are aware that many women are also active in account-ing practice and business We intend the traditional choice of pronoun to include women.The specialized expertise of the individual authors remains the critical element of this edi-tion as it was in all prior editions The editors worked closely with the authors, reviewing andcritically editing their manuscripts However, in the final analysis, each chapter is the work andviewpoint of the individual author or authors

ac-Some of the chapters in this edition have been prepared by university professors However,over two-thirds of the chapters have been prepared by partners in accounting firms, financial ex-ecutives, or financial analysts Every major international accounting firm is represented amongthe authors These professionals bring to bear their own and their firms’ experiences in dealingwith accounting practice problems All of the 67 authors are recognized authorities in their

fields and have made significant contributions to the tenth edition of the Handbook.

Our greatest debt is to these 67 authors of the 44 chapters of this edition We deeply ate the value and importance of their time and effort We also acknowledge our debt to the edi-

appreci-tors of and contribuappreci-tors to nine earlier editions of the Handbook This edition draws heavily on

the accumulated knowledge of those earlier editions Finally, we wish to thank Judy Howarthand Sujin Hong at John Wiley & Sons, Inc., for handling the many details of organizing and co-ordinating this effort

D R CARMICHAEL

P H ROSENFIELD

xviii PREFACE

VOLUME ONE: FINANCIAL ACCOUNTING AND GENERAL TOPICS

1 The Framework of Financial Accounting Concepts and Standards

REEDK STOREY, PhD, CPA

Financial Accounting Standards Board

2 Financial Accounting Regulations and Organizations

JOSEPHV CARCELLO, PhD, CPA, CIA, CMA

University of Tennessee

3 SEC Reporting Requirements

DEBRAJ MACLAUGHLIN, CPA

BDO Seidman LLP

WENDYHAMBLETON, CPA

BDO Seidman LLP

4 Earnings Management

PAULROSENFIELD, CPA

5 Forgetting Our Duties to the Users of Financial Reports: The Lesson of Enron

PAULROSENFIELD, CPA

6 Management Discussion and Analysis

STEPHENBRYAN, MBA, PhD

The Stan Ross Department of Accountancy

Zicklin School of Business

Bernard M Baruch College, CUNY

7 Global Accounting and Auditing

RICHARDC JONES, PhD, CPA

9 Income Statement Presentation and Earnings per Share

JUANAGUERREBERE, JR., CPA

Perez-Abreu, Aguerrebere, Sueiro LLC

xix

10 Accounting for Business Combinations

PAULPACTER, PhD, CPA

Director

IAS Global Office

Deloitte Touche Tohmatsu

11 Consolidation, Translation, and the Equity Method

STEVENRUBIN, CPA

Deloitte & Touche LLP

12 Statement of Cash Flows

JUDITHWEISS, CPA

13 Interim Financial Statements

ANTHONYJ MOTTOLA, CPA

Mottola & Associates, Inc.

14 Analyzing Financial Statements

GERALDI WHITE, CFA

Grace & White, Inc.

ASHWINPAULC SONDHI, PhD

A C Sondhi and Associates, LLC

15 Price-Change Reporting

PAULROSENFIELD, CPA

16 Cash and Investments

LUISE CABRERA, CPA

American Institute of Certified Public Accountants

17 Revenues and Receivables

ALANS GLAZER, PhD, CPA

Franklin & Marshall College

HENRYR JAENICKE, PhD, CPA

Drexel University

18 Inventory

RICHARDR JONES, CPA

Ernst & Young LLP

GARYL SMITH, CPA

Ernst & Young LLP

19 Property, Plant, Equipment, and Depreciation

RICHARDH MOSELEY, CPA

American Express Tax and Business Services, Inc.

20 Goodwill and Other Intangible Assets

LAILANIMOODY, CPA, MBA

22 Accounting for Income Taxes

E RAYMONDSIMPSON, CPA

Financial Accounting Standards Board

23 Liabilities

FREDERICKGILL, CPA

Senior Technical Manager

Accounting Standards Team

American Institute of Certified Public Accountants

24 Derivatives and Hedge Accounting

ROBERTL ROYALLII, CPA, CFA, MBA

Ernst & Young LLP

FRANCINEMELLORS, CPA

Ernst & Young LLP

25 Shareholders’ Equity

MARTINBENIS, PhD, CPA

The Stan Ross Department of Accountancy

Zicklin School of Business

Bernard M Baruch College, CUNY

26 Auditing Standards and Audit Reports

DANM GUY, PhD, CPA

Clemson University

ALANJ WINTERS, PhD, CPA

Clemson University

VOLUME TWO: SPECIAL INDUSTRIES AND SPECIAL TOPICS

27 Oil, Gas, and Other Natural Resources

RICHARDP GRAFF, CPA

The Graff Consulting Group

JOSEPHB FEITEN, CPA

28 Real Estate and Construction

CLIFFORDH SCHWARTZ, CPA

PricewaterhouseCoopers LLP

SUZANNEMCELYEA, CPA

PricewaterhouseCoopers LLP

29 Financial Institutions

LAURAJ PHILLIPS, CPA

Ernst & Young LLP

MARKR ROUCHARD, CPA

Ernst & Young LLP

DALEK THOMPSON, CPA

Ernst & Young LLP

ALANM KALL, CPA

Ernst & Young LLP

KEITHM HOUSUM, CPA

Ernst & Young LLP

30 Producers or Distributors of Films

PAULROSENFIELD, CPA

31 Regulated Utilities

BENJAMINA MCKNIGHTIII, CPA

Arthur Andersen LLP, Retired

32 State and Local Government Accounting

ANDREWJ BLOSSOM, CPA

WARRENRUPPEL, CPA

DiTomasso & Ruppel, CPAs

33 Not-for-Profit Organizations

RONALDF RIES, CPA

American Express Tax and Business Services, Inc.

IANJ BENJAMIN, CPA

American Express Tax and Business Services, Inc.

34 Providers of Health Care Services

MARTHAGARNER, CPA

PricewaterhouseCoopers LLP

35 Accounting for Government Contracts

MARGARETM WORTHINGTON, CPA

36 Pension Plans and Other Postretirement and Postemployment Benefits

VINCENTAMOROSO, FSA

Deloitte & Touche LLP

JASONFLYNN, FSA

Deloitte & Touche LLP

ERICKLIS, FSA

Deloitte & Touche LLP

37 Stock-Based Compensation

PETERT CHINGOS, CPA

Mercer Human Resources Consulting

WALTONT CONN, JR., CPA

39 Personal Financial Statements

DENNISS NEIER, CPA

Goldstein Golub Kessler LLP

JOELO STEINBERG, CPA

Goldstein Golub Kessler LLP

40 Partnerships and Joint Ventures

GERARDL YARNALL, CPA

Deloitte & Touche, LLP

RONALDJ PATTEN, PhD, CPA

DePaul University

41 Estates and Trusts

PHILIPM HERR, JD, CPA

Kingsbridge Financial Group, Inc.

42 Valuation of Nonpublic Companies

ALLYNA JOYCE

Allyn A Joyce & Co., Inc.

JACOBP ROOSMA, CPA

Williamette Management Associates

43 Bankruptcy

GRANTW NEWTON, PhD, CPA, CIRA

Pepperdine University

44 Forensic Accounting and Litigation Consulting Services

DENNISS NEIER, CPA

American Express Tax and Business Services, Inc.

MARGARETR KOLB, CPA

American Express Tax and Business Services, Inc.

Index

IMPORTANT NOTE:

Because of the rapidly changing nature of information in this field, this product may be

updated with annual supplements or with future editions Please call 1-877-762-2974

or email us at subscriber@wiley.com to receive any current update at no tional charge We will send on approval any future supplements or new editions when

addi-they become available If you purchased this product directly from John Wiley & Sons, Inc., we have already recorded your subscription for this update service.

27.1 INTRODUCTION

Accounting for oil and gas activities can be extremely complex because it encompasses a wide riety of business strategies and vehicles The industry’s diversity developed in response to the riskinvolved in the exploration process, the volatility of prices, and the fluctuations in supply and de-mand for oil and gas In addition to having a working knowledge of accounting procedures, the oiland gas accountant should be familiar with the operating characteristics of companies involved inoil and gas activities and understand the impact of individual transactions

va-Oil and gas activities cover a wide spectrum—ranging from exploration and production activities tothe refining, transportation, and marketing of products to consumers Special accounting rules exist forexploration and production activities Accounting for refining activities is similar in many ways toother process manufacturing businesses Likewise, transportation and marketing do not differ signifi-cantly from one end product to another This chapter focuses on the special accounting rules for petro-leum exploration and production

The same may be said for the mining and processing of minerals except that the accounting rulesfor mineral exploration and production are not so formalized as for petroleum

27.2 OIL AND GAS EXPLORATION AND

PRODUCING OPERATIONS

Oil- and gas-producing activities begin with the search for prospects—parcels of acreage that ment thinks may contain economically viable oil or gas formations For the most likely prospects, theenterprise may contract with a geological and geophysical (G&G) company to test and assess the sub-surface formations and their depths Three-dimensional (3-D) seismic studies send sound waves thou-sands of feet below the earth’s surface, record the million echoes from underground strata, and usepowerful computers to read the echoes to create 3-D electronic images of the underground formations.With these ultrasounds of Mother Earth, the enterprise evaluates the various prospects, rejecting someand accepting others as suitable for acquisition of lease rights (prospecting may be done before or afterobtaining lease rights)

manage-Specialists called landmen may be used to obtain lease rights A landman is in effect a lease ker who searches titles and negotiates with property owners Although the landman may be part ofthe company’s staff, oil and gas companies often acquire lease rights to properties through indepen-dent landmen Consideration for leasing the mineral rights usually includes a bonus (an immediatecash payment to the lessor) and a royalty interest retained by the lessor (a specified percentage ofsubsequent production minus applicable production taxes)

bro-Once the leases have been obtained and the rights and obligations of all parties have beendetermined, exploratory drilling begins Because drilling costs run to hundreds of thousands ormillions of dollars, many companies reduce their capital commitment and related risks byseeking others to participate in joint venture arrangements Participants in a joint venture arecalled joint interest owners; one owner, usually the enterprise that obtained the leases, acts as

(a) Sales of Minerals 20

(b) Tolling and Royalty Revenues 20

operator The operator manages the venture and reports to the other, nonoperator participants.The operator initially pays the drilling costs and then bills those costs to the nonoperators Insome cases, the operator may collect these costs from nonoperators in advance.

The operator acquires the necessary supplies and subcontracts with a drilling company fordrilling the well The drilling time may be a few days, several months, or even a year or longerdepending on many factors, particularly well depth and location When the hole reaches thedesired depth, various instruments are lowered that “log the well” to detect the presence of oil

or gas The joint interest owners evaluate the drilling and logging results to determine whethersufficient oil or gas can be extracted to justify the cost of completing the well If the evalua-tion is negative, the well is plugged and abandoned as a dry hole If sufficient quantities ofcrude oil or natural gas (hydrocarbons) appear to be present, the well is completed and equip-ment is installed to extract and separate the hydrocarbons from the water coming from the un-derground reservoir Completion costs are substantial and may even exceed the initial drillingcosts

Before production begins (sometimes even before the well is drilled), the enterprise selectsoil and gas purchasers and negotiates sales contracts To transport the oil or gas from the well,

a trunk line may be built to the nearest major pipeline; crude oil also may be stored in tanks atthe production site and removed later by truck The production owner and purchasers prepareand sign division orders, which are revenue distribution contracts specifying each owner’sshare of revenues If the division order specifies that the purchaser is to pay all revenues to theoperator, the operator must distribute the appropriate amounts to the other joint interest ownersand the lessor(s)

The various factors that determine the success or failure of oil and gas exploration activities clude many uncertainties These factors set the oil and gas industry apart from many other capital-intensive industries Some of these factors include the following:

in-• Anticipated Success of Drilling Even with the recent technological advances in 3-D seismic,

there is still substantial risk of not finding a commercial petroleum reservoir after spending dreds of thousands of dollars (or more) drilling a well to the target formation Exploration suc-cess is also affected by drilling risks such as stuck drill pipes, blowouts, and impropercompletions

hun-• Taxation A substantial portion of the revenues from the sale of crude oil and natural gas goes

directly or indirectly to the federal and state governments in the form of severance taxes, advalorem taxes, and income taxes In the late 1970s, Congress enacted the Windfall Profit Tax

on domestic crude oil On August 25, 1988, the Windfall Profit Tax was repealed for all crudeoil removed after that date After the various taxes, royalties to the landowner, and productioncosts have been deducted, the producer’s income from the sale of crude oil and natural gas may

be only a small percentage of gross revenues Except for certain tax credits relating to “TightSands” and coalbed methane gas production, most tax-related incentives have been eliminatedthrough tax legislation since 1986

• Product Price and Marketability U.S crude oil production meets only half of the country’s

demand and is readily marketable The United States imports crude oil from Venezuela,Canada, and other countries For the past several years, U.S prices of crude oil have fluctu-ated widely due to numerous factors including world politics, economic conditions, andtechnology advances High-quality crude oil sold for $42 per barrel in late 1979, $12 briefly

in 1986, $40 briefly in 1990, in the $20 range in 1991, $18 at the end of 1995, $24 at the end

of 1996, $15.50 at the end of 1997, and under $14 by spring of 1997 Oil prices also varydue to the quality of the oil and the location of the oil field In a given month, heavy sourcrude oil in California may sell for half or two-thirds the price of light, sweet crude oil pro-duced in Oklahoma

In the 1990s, natural gas price volatility exceeded that of crude oil U.S natural gas duction met substantially all of the country’s needs, after competition from gas imported

from Canada Demand for natural gas is seasonal in the United States—high in the wintermonths for space heating and low in the summer for most areas of the country Significantquantities of gas produced in the summer are transported by pipelines to underground forma-tions for temporary storage until the winter season Such temporary storage helps to reducethe seasonal price fluctuations.

Because of the volatility in oil and gas prices, a number of price hedging mechanismshave been developed, including futures contracts, long-term hedging arrangements, andproduct swaps

• Timing of Production How quickly oil and gas are produced directly affects the payback period

of an investment and its financial success or failure The timing of production varies with thegeologic characteristics of the reservoir and the marketability of the product Reservoirs maycontain the same gross producible reserves, yet the timing of production causes significant dif-ferences in the present value of the future revenue stream

• Acreage and Drilling Costs Many U.S companies are focusing on exploration outside

the United States The United States is a mature exploration area producing 10% of theworld’s oil production from 63% of the world’s oil wells The global availability ofquality exploration acreage, drilling personnel, and supplies has increased, whereas therelated costs have dropped significantly since the boom period of the late 1970s andearly 1980s

27.3 ACCOUNTING FOR JOINT OPERATIONS

Oil- and gas-producing activities are recorded in the same general manner as most other activitiesthat use manual or automated revenue, accounts payable, and general ledger systems There aresignificant differences in the data gathering and reporting requirements, however, depending onwhether the entity is an operator or a nonoperator for a given joint venture The two major ac-counting systems unique to oil- and gas-producing activities are the joint interest billing systemand the revenue distribution system The operator’s joint interest billing system must properly cal-culate and record the operator’s net cost as well as the costs to be billed to the nonoperators Like-wise, the revenue distribution system should properly allocate cash receipts among ventureparticipants; this entails first recording the amounts payable to the participants and later makingthe appropriate payments

As discussed previously, joint interest operations evolved because of the need to share the cial burden and risks of oil- and gas-producing activities Joint operations typically take the form of

finan-a simple joint venture evidenced by two formfinan-al finan-agreements, generfinan-ally referred to finan-as finan-an explorfinan-ationagreement and an operating agreement These agreements define the geographic area involved, des-ignate which party will act as operator of the venture, define how revenue and expenses will be di-vided, and set forth the rights and responsibilities of all parties to the agreement The operatingagreement also establishes how the operator is to bill the nonoperators for joint venture expendituresand provides nonoperators with the right to conduct “joint interest audits” of the operator’s account-ing records

Accounting for joint operations is basically the same as accounting for operations when

a property is completely owned by one party, except that in joint operations, revenues and penses are divided among all of the joint venture partners The following section discussesaccounting for joint operations, first from the operator’s standpoint and then from the non-operators’ perspective

ex-(a) OPERATOR ACCOUNTING The operator typically records revenue and expenses for a

well on a 100%, or “gross,” basis and then allocates the revenue and expenses to the nonoperatorsbased on ownership percentages maintained in the division order and joint interest master files One

approach is to record the full invoice or remittance advice amount and use contra or clearing counts that set up the amounts due from or to the nonoperators Recording transactions by means ofcontra accounts facilitates generation of information that management uses to review operations on

ac-a gross bac-asis

Before drilling and completing a well, the operator prepares an authorization for expenditure(AFE) itemizing the estimated costs to drill and complete the well Although AFEs are normally re-quired by the operating agreement, they are so useful as a capital budgeting tool that they are rou-tinely used for all major expenditures by oil and gas companies, even if no joint venture exists Inaddition to AFEs, the operator’s field supervisor or engineer at the well site prepares a daily drillingreport, which is an abbreviated report of the current status and the drilling or completion activity ofthe past 24 hours That report may be compared with a drilling report prepared by the drilling com-pany (also called a “tour” report) Some daily drilling reports indicate estimated cumulative costsincurred to date

For shallow wells that are quickly and easily drilled, the AFE subsidiary ledger, combined withthe daily drilling report, may provide the basis for the operator’s estimate of costs incurred but not in-voiced For other wells, however, the engineering department prepares an estimate of cumulativecosts incurred through year end as a basis for recording the accrual and, if material, the commitmentsfor future expenditures

The operator normally furnishes the nonoperators with a monthly summary billing thatshows the amount owed the operator on a property-by-property basis The summary billing isaccompanied by a separate joint operating statement for each property The joint operatingstatement contains a description of each expenditure and shows the total expenditures for theproperty The statement also shows the allocation of expenditures among the joint interest par-ticipants The operator usually does not furnish copies of third-party invoices supporting itemsappearing on the joint interest billing, but the third-party invoices can be examined and copiedduring the nonoperators’ audit of the joint account The operator may also furnish the nonoper-ators a production report and at a later date remit checks to the nonoperators for their share ofproduction

(b) NONOPERATOR ACCOUNTING From the nonoperators’ standpoint, the accounting for

joint operations is basically the same as that followed by the operator It is not unusual for a company

to act as an operator on some properties and a nonoperator on others To be able to make isons and evaluations that include both types of properties, nonoperators should also record items on

compar-a gross bcompar-asis A nonopercompar-ator should develop compar-a control procedure for reviewing the joint opercompar-atingstatement to determine whether the operator is complying with the joint operating agreement, isbilling the nonoperator only valid charges at the appropriate percentages, and is distributing the ap-propriate share of revenue

(c) OTHER ACCOUNTING PROCEDURES. The operating agreement may permit the tor to charge the joint venture a monthly fixed fee to cover its internal costs incurred in operatingthe joint venture Alternatively, the agreement may provide for reimbursement of the operator’sactual costs

opera-The parties in a joint operation may agree either to share costs in a proportion that is differentfrom that used for sharing revenue or to change the sharing percentages after a specific event takesplace Typically, that event is “payout,” the point at which certain venturers have recovered their ini-tial investment or an agreed-upon multiple of the investment All parties involved in joint operationsencounter payout situations at some time Controls must be designed to monitor payout status to en-sure that all parties are satisfied that revenues and costs have been properly allocated in accordancewith the joint operating agreement

(d) OVERVIEW OF ACCOUNTING STANDARDS The following pronouncements set forth

generally accepted accounting principles unique to oil and gas producing activities:

• Statement of Financial Accounting Standards (SFAS) No 19, which describes a “successful forts” method of accounting

ef-• SFAS No 25, which recognizes that other methods may be appropriate

• SEC Regulation S-X, Article 4, Section 10 (also referred to as S-X Rule 4-10), which prescribestwo acceptable methods for public entities—either the successful efforts method described inSFAS No 19 or a “full cost” method, as described in S-X Rule 4-10

• SFAS No 69, which requires supplementary disclosures of oil- and gas-producing activitiesAdditional guidance and interpretations are found in Financial Accounting Standards Board (FASB)Interpretations, Securities and Exchange Commission (SEC) Staff Accounting Bulletins (SABs),surveys in industry accounting practices, and petroleum accounting journals and petroleum account-ing textbooks

The primary differences between the successful efforts and full cost methods center around costs

to be capitalized and those to be expensed As the name implies, under the successful efforts method,only those costs that lead to the successful discovery of reserves are capitalized, while the costs ofunsuccessful exploratory activities are charged directly to expense Under the full cost method, allexploration efforts are treated as capital costs under the theory that the reserves found are the result

of all costs incurred Both methods are widely used; however, larger companies tend to follow thesuccessful efforts method

Under income tax law and regulations, all exploration and development costs, except leaseholdand equipment costs, are generally expensed as incurred Petroleum producing companies with sig-nificant refining or marketing activities (called “integrateds” as opposed to “independents”) mustcapitalize 30% of intangible well costs to be amortized over 60 months Leasehold costs are ex-pensed by complex depletion deductions that, for independents, can exceed actual costs Equipmentcosts are depreciated using accelerated methods Many independent U.S oil- and gas-producingcompanies pay the alternative minimum tax

27.4 ACCEPTABLE ACCOUNTING METHODS

(a) THE SUCCESSFUL EFFORTS METHOD

(i) Basic Rules The following points summarize the major aspects of the successful efforts

method of accounting for oil and gas property costs:

• The costs of all G&G studies to find reserves are charged to expense as incurred

• Lease acquisition costs for unproved properties are initially capitalized Unproved propertiesare those on which no economically recoverable oil or gas has been demonstrated to exist Un-proved properties are to be assessed for impairment at least annually

• If an unproved property becomes impaired because of such events as pending lease tion or an unsuccessful exploratory well (dry hole), the loss is recognized and a valuation al-lowance is established to reflect the property’s impairment Two approaches to impairmentare used: (1) Property by property (typically used by small companies or situations involvingsignificant acreage costs), or (2) a formula approach based on factors such as historical successratios and average lease terms (typically used by larger companies with a significant number ofsmaller properties)

expira-• Once proved reserves are found on a property, the property is considered proved and theacquisition costs are amortized on a unit-of-production basis over the property’s produc-ing life based on total proved reserves (both developed and undeveloped reserves) TheSFAS No 25 definition of proved reserves may be summarized as the estimated volumes

of oil and gas that geological and engineering data demonstrate with reasonable certainty

to be recoverable in future years from known reservoirs under existing economic and erating conditions

op-• If both oil and gas are produced from the property, the unit is normally equivalent barrels ormcfs, whereby gas is converted to equivalent barrels (or barrels are converted to equivalentmcfs) based on relative energy content A common conversion factor is 5.6 mcf to 1 equiva-lent barrel

• For a property containing both oil and gas, the unit may reflect either oil or gas if:

—The relative property of oil and gas extracted in the current period is expected to continue inthe future, or

—The reflected mineral clearly dominates the other for both current production and reserves

• Carrying costs required to retain rights to unproved properties (delay rentals, ad valorem taxes,etc.) are charged to expense

• Exploratory wells are capitalized initially as wells-in-progress and expensed if proved reservesare not found Successful exploratory wells are capitalized, as are their completion costs (set-ting casing and other costs necessary to begin producing the well)

• Costs of drilling development wells (even the rare dry ones) are capitalized

• Costs of successful exploratory wells, along with the costs of drilling development wells on thelease, are amortized on a unit-of-production basis over the property’s proved developed re-serves on:

—A property-by-property basis, or

—The basis of some reasonable aggregation of properties with a common geologic or tural feature or stratigraphic condition, such as a reservoir or field

struc-• Once production has begun, all regular production costs are charged to expense

• Capitalized interest, under the requirements of SFAS 34, would also be capitalized as part ofthe cost of unevaluated properties during the evaluation phase

(ii) Exploratory versus Development Well Definition Because Reg S-X requires that the

costs of dry exploratory wells be charged to expense, whereas the costs of dry development wells arecapitalized, it is important to properly classify wells Regulation S-X, Rule 4-10, defines the two cat-egories of wells as follows:

1 Development Well A well drilled within the proved area of an oil or gas reservoir to the depth

of a stratigraphic horizon known to be productive

2 Exploratory Well A well drilled to find and produce oil or gas in an unproved area, to find a

new reservoir in a field previously found to be productive of oil or gas in another reservoir, or

to extend a known reservoir Generally, an exploratory well is any well that is not a ment well, a service well, or a stratigraphic test well

develop-These definitions may not coincide with those that have been commonly used in the industry(typically, the industry definition of a development well is more liberal than Reg S-X, Rule 4-10).This results in two problems:

1 Improper classification of certain exploratory dry holes as development wells (the problem

occurs primarily with stepout or delineation wells drilled at the edge of a producing voir)

reser-2 Inconsistencies between the drilling statistics found in the forepart of Form 10-K (usually

ppared by operational personnel) and the supplementary financial statement information quired by SFAS No 69 (usually prepared by accounting personnel)

(iii) Treatment of Costs of Exploratory Wells Whose Outcome Is Undetermined As set out

below, SFAS No 19 effectively curtails extended deferral of the costs of an exploratory well whoseoutcome has not yet been determined

Accounting When Drilling of an Exploration Well Is Completed.

Par 31: the costs of drilling an exploratory well are capitalized as part of the enterprise’s completed wells, equipment, and facilities pending determination of whether the well has foundproved reserves That determination is usually made on or shortly after completion of drilling thewell, and the capitalized costs shall either be charged to expense or be reclassified as part of thecosts of the enterprise’s wells and related equipment and facilities at that time Occasionally, how-ever, an exploratory well may be determined to have found oil and gas reserves, but classification

un-of those reserves as proved cannot be made when drilling is completed In those cases, one or theother of the following subparagraphs shall apply depending on whether the well is drilled in anarea requiring a major capital expenditure, such as a trunk pipeline, before production from thatwell could begin:

a Exploratory wells that find oil and gas reserves in an area requiring a major capital

expendi-ture, such as a trunk pipeline, before production could begin On completion of drilling, anexploratory well may be determined to have found oil and gas reserves, but classification ofthose reserves as proved depends on whether a major capital expenditure can be justifiedwhich, in turn, depends on whether additional exploratory wells find a sufficient quantity ofadditional reserves That situation arises principally with exploratory wells drilled in a re-mote area for which production would require constructing a trunk pipeline In that case, thecost of drilling the exploratory well shall continue to be carried as an asset pending determi-nation of whether proved reserves have been found only as long as both of the followingconditions are met:

(1) The well has found a sufficient quantity of reserves to justify its completion as a producing

well if the required capital expenditure is made

(2) Drilling of the additional exploratory wells is under way or firmly planned for the near

future

Thus, if drilling in the area is not under way or firmly planned, or if the well has not found

a commercially producible quantity of reserves, the exploratory well shall be assumed to beimpaired, and its costs shall be charged to expense

b All other exploratory wells that find oil and gas reserves In the absence of a determination as

to whether the reserves that have been found can be classified as proved, the costs of drillingsuch an exploratory well shall not be carried as an asset for more than one year following com-pletion of drilling If, after that year has passed, a determination that proved reserves have beenfound cannot be made, the well shall be assumed to be impaired, and its costs shall be charged

to expense

Par 32: Paragraph 32 is intended to prohibit, in all cases, the deferral of the costs of exploratorywells that find some oil and gas reserves merely on the chance that some event totally beyond thecontrol of the enterprise will occur, for example, on the chance that the selling prices of oil and gaswill increase sufficiently to result in classification of reserves as proved that are not commerciallyrecoverable at current prices

Accounting When Drilling of an Exploratory-Type Stratigraphic Test Well Is Completed.

Par 33: As specified in paragraph 110, the costs of drilling an exploratory-type stratigraphic testwell are capitalized as part of the enterprise’s uncompleted wells, equipment, and facilities pendingdetermination of whether the well has found proved reserves When that determination is made, thecapitalized costs shall be charged to expense if proved reserves are not found or shall be reclassified

as part of the costs of the enterprise’s wells and related equipment and facilities if proved reservesare found

Par 34: Exploratory-type stratigraphic test wells are normally drilled on unproved offshore ties Frequently, on completion of drilling, such a well may be determined to have found oil and gasreserves, but classification of those reserves as proved depends on whether a major capital expendi-ture—usually a production platform—can be justified which, in turn, depends on whether addi-

tional exploratory-type stratigraphic test wells find a sufficient quantity of additional reserves Inthat case, the cost of drilling the exploratory-type stratigraphic test well shall continue to be carried

as an asset pending determination of whether proved reserves have been found only as long as both

of the following conditions are met:

1 The well has found a quantity of reserves that would justify its completion for production had it

not been simply a stratigraphic test well

2 Drilling of the additional exploratory-type stratigraphic test wells is under way or firmly

planned for the near future

Thus, if associated stratigraphic test drilling is not under way or firmly planned, or if the well has notfound a commercially producible quantity of reserves, the exploratory-type stratigraphic test wellshall be assumed to be impaired, and its costs shall be charged to expense

(iv) Successful Efforts Impairment Test. SFAS No 121 on impairment of long-lived assetsamends SFAS No 19 and requires application of SFAS No 121 impairment rules to capitalizedcosts of proved oil and gas properties for companies following the successful efforts method ofaccounting

(v) Conveyances. SFAS No 19 and Reg S-X, Rule 4-10(m) provides rules to account for eral property conveyances and related transactions Conveyances of “production payments” re-payable in fixed monetary terms, that is, loans in substance, are accounted for as loans.Conveyances of production payments repayable in fixed production volumes from specified pro-duction are deemed to be property sales whereby proved reserves are reduced but the proceedsfrom sale of a production payment are credited to deferred revenue to be recognized as revenue asthe seller delivers future petroleum volumes to the holder of the production payment Gain or loss

min-is not recognized for conveyances of (1) a pooling of assets in a joint venture to find, develop, orproduce oil and gas or (2) such assets in exchange for other assets used in oil- and gas-producingactivities Gain is not recognized (but loss is) for conveyance of a partial property interest whensubstantial uncertainty exists as to the recovery of costs for the retained interest portion or whenthe seller has substantial obligation for future performance such as drilling a well For other con-veyances, gain or loss is recognized unless prohibited under accounting principles applicable toenterprises in general

(b) THE FULL COST METHOD

(i) Basic Rules Under Reg S-X, Rule 4-10, oil and gas property costs are accounted for

as follows:

• All costs associated with property acquisition, exploration and development activities

shall be capitalized by country-wide cost center Any internal costs that are capitalized shall be limited to those costs that can be directly identified with the acquisition, explo-

ration and development activities undertaken by the reporting entity for its own account,and shall not include any costs related to production, general corporate overhead or similaractivities

• Capitalized costs within a cost center shall be amortized on the unit-of-production basis usingproved oil and gas reserves, as follows:

— Costs to be amortized shall include (A) all capitalized costs, less accumulated tion, excluding the cost of certain unevaluated properties not being amortized;(B) the estimated future expenditures (based on current costs) to be incurred in develop-ing proved reserves; and (C) estimated dismantlement and abandonment costs, net of es-timated salvage values [The current rule is referring to undiscounted futuredecommissioning, restoration and abandonment costs, net of estimated salvage val-ues (“net abandonment costs”) In early 1996, the FASB issued an exposure draftfor a proposed SFAS on accounting for certain liabilities related to closure or re-moval of long-lived assets If adopted as drafted, the new SFAS would amortize

capitalized costs that include a charge corresponding to the accrued liability for netabandonment costs The liability reflects a present value discounted at a safe rate ofinterest.]

— 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, less economic circumstances (related to the effects of regulated prices) indicated that use

un-of revenue is a more appropriate basis un-of computing amortization In the latter case, tization shall be computed on the basis of current gross revenues from production in rela-tion to future gross revenues (excluding royalty payments and net profits disbursements)based on current prices from estimated future production of proved oil and gas reserves(including consideration of changes in existing prices provided for only by contractualarrangements) The effect on estimated future gross revenues of a significant price increaseduring the year shall be reflected in the amortization provision only for the period after theprice increase occurs

amor-In some cases it may be more appropriate to depreciate natural gas cycling and processingplants by a method other than the unit-of-production method

Amortization computations shall be made on a consolidated basis, including investees counted for on a proportionate consolidation basis Investees accounted for on the equitymethod shall be treated separately

ac-(ii) Exclusion of Costs from Amortization SEC Financial Report Reg S-X, Rule 4–10, allows

two alternatives:

1 Immediate inclusion of all costs incurred in the amortization base

2 Temporary exclusion of all acquisition and exploration costs incurred that directly relate to

unevaluated properties and certain costs of major development projects

Unevaluated properties are defined as those for which no determination has been made of the istence or nonexistence of proved reserves Costs that may be excluded are all those costs directly re-lated to the unevaluated properties (i.e., leasehold acquisitions costs, delay rentals, G&G,exploratory drilling, and capitalized interest) The cost of exploratory dry holes should be included inthe amortization base as soon as the well is deemed dry

ex-These excluded costs must be assessed for impairment annually, either:

• Individually for each significant property (i.e., capitalized cost exceeds 10% of the net full costpool), or

• In the aggregate for insignificant properties (i.e., by transferring the excluded property costsinto the amortization base ratably on the basis of such factors as the primary lease terms of theproperties, the average holding period, and the relative proportion of properties on whichproved reserves have been found previously)

(iii) The Full Cost Ceiling Test SFAS No 121 impairment rules are effectively superseded by

the following full cost “ceiling test” specified in Reg S-X, Rule 4–10(e)(4):

• For each cost center capitalized costs, less accumulated amortization and related deferred incometaxes, shall not exceed an amount (the cost center ceiling) equal to the sum of:

(A) 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 bycontractual arrangements) to estimated future production of proved oil and gas reserves as

of the date of the latest balance sheet presented, less estimated future expenditures (based

on current costs) to be incurred in developing and producing the proved reserves computedusing a discount factor of ten percent and assuming continuation of existing economic con-ditions; plus (B) the cost of properties not being amortized pursuant to paragraph (c)(3)(ii)

of this section; plus (C) the lower of cost or estimated fair value of unproven properties

cluded in the costs being amortized; less (D) income tax effects related to differences tween the book and tax basis of the properties referred to in paragraphs (c)(4)(i)(B) and (C)

be-of this section

• If unamortized costs capitalized within a cost center, less related deferred income taxes, exceed the cost center ceiling, the excess shall be charged to expense and sepa-rately disclosed during the period in which the excess occurs Amounts thus required

to be written off shall not be reinstated for any subsequent increase in the cost centerceiling

Part D, income tax effects, is poorly worded and refers to the income tax effects related to the ceilingcomponents in parts A, B, and C allowing for consideration of the oil and gas properties’ tax bases andrelated depletion carryforwards and related net operating loss carryforwards

Two other unique aspects of the full cost ceiling test are:

1 Ceiling Test Exemption for Purchases of Proved Properties A petroleum producing company

might purchase proved properties for more than the present value of estimated future net enues, causing net capitalized costs to exceed the cost center ceiling on the date of purchase

rev-To avoid the writedown, the company may request from the SEC staff a temporary (usuallyone year) waiver of applying the ceiling test The company must be prepared to demonstratethat the purchased properties’ additional value exists beyond reasonable doubt For more de-tails see SAB No 47, Topic 12, D-3a

2 Effect of Subsequent Event If, after year end but prior to the audit report date, either

(a) additional reserves are proved up on properties owned at year end, or (b) price increasesbecome known, then such subsequent events may be considered in the year-end ceiling test tomitigate a writedown of capitalized costs

The avoidance of a writedown must be adequately disclosed, but the subsequent eventsshould not be considered in the required disclosures of the company’s proved reserves andstandardized measure of discounted future net cash flows relating to such reserves (as furtherdescribed here in Section 27.11, “Financial Statement Disclosures”) For more details, seeSAB No 47, Topic 12, D-3b

(iv) Conveyances. Reg S-X, Rule 4-10(c)(6), provides that accounting for conveyances will

be the same as for successful efforts accounting except that sales of oil and gas properties are to beaccounted for as adjustments of capitalized costs with no recognition of gain or loss (“unless suchadjustments would significantly alter the relationship between capitalized costs and proved re-serves”) Exceptions are also made in some circumstances for property sales to partnerships andjoint ventures in that (1) proceeds that are reimbursements of identifiable, current transaction ex-penses may be credited to income and (2) a petroleum company may recognize in income “man-agement fees” from certain types of managed limited partnerships When a company acquires anoil and gas property interest in exchange for services (such as drilling wells), income may be rec-ognized in limited circumstances

27.5 ACCOUNTING FOR NATURAL GAS IMBALANCES

Accounting techniques are basically the same whether revenue is generated by selling crude oil ornatural gas However, joint venture participants usually sell their crude oil collectively but may in-dividually market and sell their shares of natural gas production When a joint venture owner phys-ically takes and sells more or less gas than its entitled share, a “gas imbalance” is created that islater reversed by an equal, but opposite, imbalance or by settlement in cash

For example, if two joint venture participants each own 50% working interests in a well, and onecompany decides to sell gas on the spot market but the other company declines to sell due to a low

spot price (or other factors), the company selling gas will receive 100% of revenue after paying theroyalty interests The selling company is in an overproduced capacity with respect to the well (thecompany is entitled to 50% of the gas after royalties but had received 100%) A gas imbalance canalso occur between a gas producer and the gas transmission company that receives the producer’s gasbut delivers a different volume to the producer’s customer.

Gas-producing companies account for gas imbalances under either the sales method or the tlements method

enti-(a) SALES METHOD Under the sales method, the company recognizes revenue and a receivable

for the volume of gas sold, regardless of ownership of the property For example, if Company Aowns a 50% net revenue interest in a gas property but sells 100% of the production in a givenmonth, the company would recognize 100% of the revenue generated In a subsequent month, ifCompany A sells no gas (and the other owners “make up” the imbalance), Company A would rec-ognize zero revenue Company A would reduce its estimate of proved reserves for any future pro-duction that it must give up to meet a gas imbalance obligation and increase proved reserves for anyadditional future production it has a right to receive from other joint venture participants to elimi-nate an existing gas imbalance

Although this method is rather simple from a revenue accounting standpoint, it presents otherproblems Regardless of the revenue method chosen, the operator will issue joint interest billingstatements for expenses based on the ownership of the property Depending on the gas-balancing sit-uation, the sales method may present a problem with the matching of revenues and expenses in a pe-riod If a significant imbalance exists at the end of an accounting period, the accountant may berequired to analyze the situation and record additional expenses (or reduce expenses depending onwhether the property is overproduced or underproduced)

(b) ENTITLEMENTS METHOD Under the entitlements method, the company recognizes

rev-enue based on the volume of sales to which it is entitled by its ownership interest For example, ifCompany A owns a 50% net revenue interest but sells 100% of the production in a given month, thecompany would recognize 50% of the revenue generated Company A would recognize a receivablefor 100% of the revenue with the difference being recorded in a payable (or deferred revenue) ac-count When the imbalance is corrected, the payable account will become zero, thus indicating thatthe property is “in balance.”

This method correctly matches revenues and expenses but presents another accountingissue If a property is significantly imbalanced, Company A may find itself in a position that re-serves are insufficient to bring the well back to a balanced condition If Company A is under-produced in this situation, a receivable (or deferred charge) may be recorded in the assetcategory that has a questionable realization In addition, the company is really under- or over-produced in terms of volumes (measured in cubic feet) of gas A value per cubic foot is as-signed based on the sale price at the period of imbalance If the price is significantly differentwhen the correction occurs, the receivable may not show a zero balance in the accountingrecords

(c) GAS BALANCING EXAMPLE

Facts: Company A owns a 50% net revenue

Gas sales for January are 5,000 mcf @ $2.00 per Mcf

Gas sales for February are 5,000 mcf @ $2.00 per Mcf

In January, Company A sells 100% of gas production to its purchaser

In February, Company A sells zero gas to its purchaser