Definition
The term discovery value accounting refers to an accounting method used in the natural resources industry when there is a change in extractable assets. Also known as reserve recognition accounting in the oil and gas industry, this approach allows companies to adjust their financial statements for these changes.
A change in the value of assets will flow from the company's balance sheet to the income statement. Supplemental schedules detailing these changes must accompany the company's financial statements.
Explanation
Typically, companies will record assets on the balance sheet at what is known as historical cost. Discovery value and reserve recognition accounting (RRA) use an approach known as current value. Historical cost advocates believe the balance sheet should be used to support the income statement. Advocates of current value accounting believe the income statement is used to explain changes to assets and liabilities appearing on the balance sheet.
The Securities and Exchange Commission favors the RRA since:
The financial position of oil and gas producers is not accurately portrayed by historical cost accounting.
Additional information, external to the company's financial statements, is needed to provide a fair comparison between companies in the oil and gas industry and those external to this industry.
A method that relies on current value of oil and gas reserves is needed to provide sufficiently useful information to potential shareholders, creditors, and analysts.
While RRA is unique to the oil and gas industry, discovery value applies to all natural resources, including mining, livestock, timber, and other extractive industries. One method used to record an increase in value involves a debit (or credit when a decrease) to the asset account and a corresponding credit (or debit when a decrease) to a revenue account.
Example
Company A has determined the current value of its Marcellus Shale reserves is $10,000,000 higher than originally estimated due to a change in the quantity of proved reserves. The reserve recognition accounting method would record this change using the following journal entry:
Debit | Credit | |
Oil and Natural Gas Reserves (Asset Account) | $10,000,000 | |
Change in Quantities of Proved Reserves (Revenue Account) | $10,000,000 |
The earnings statement for Company A would reflect this increase as follows:
Earnings Summary | |
Revenues from Oil and Gas Sales | $125,000,000 |
Cost of Production | $80,000,000 |
Income from Producing Activities | $45,000,000 |
Revisions to Proved Properties | |
Change in Quantities of Proved Reserves | $10,000,000 |
Change in Production Rates | $0 |
Change in Current Price | $0 |
Total Revisions | $10,000,000 |
Profit Before Income Taxes | $55,000,000 |
Related Terms
The accounting term used to describe an economic resource, which is owned by the corporation and expected to provide future benefits to its operation, is asset. Appearing on the balance sheet, assets are typically broken down into two categories:
Moneyzine EditorNovember 6th, 2024
The financial accounting term Historical Cost Principle refers to a valuation technique used in the preparation of financial statements. The Historical Cost Principle states the value of an asset or liability is recorded on the balance sheet at its cost at the time of acquisition.Moneyzine EditorJanuary 19th, 2024
Also known as a statement of financial position, the balance sheet is used to show the financial health of a company at a particular point in time. The balance sheet consists of assets, liabilities, and owner's equity in the company. It is one of the four key financial statements issued by public companies.Moneyzine EditorNovember 6th, 2024
The income statement is a financial accounting report that demonstrates how net income, or profit, is derived from revenues. The main categories appearing on an income statement include revenues, cost of goods sold, operating expenses, non-recurring items and net income.Moneyzine EditorNovember 6th, 2024
The financial accounting term depletion refers to the allocation of cost to an accounting period as units of a natural resource are mined, cut, pumped or otherwise harvested or consumed.Moneyzine EditorSeptember 19th, 2023
The financial accounting term depletion base refers to the total cost associated with assets that are a natural resource too. The depletion base typically includes three costs: acquisition, exploration and development. This base is the value used when determining the company's depletion expense.Moneyzine EditorNovember 6th, 2024- The term recoverable reserves is used in the natural resource industry to describe assets considered economically and technically feasible to extract. The process of estimating recoverable reserves relies on the expertise of subject matter experts, and estimates will change as processes become more sophisticated.Moneyzine EditorNovember 6th, 2024
