Proved oil and gas(O&G)reserves represent the primary operating assets of O&G producing firms.Based on the historical costs incurred in finding and developing O&G reserves,these assets are accounted for using either the mil cost(FC)method or the successful efforts(SE)method.The two methods mainly differ in how they account for the drilling cost of exploratory wells.Under SE accounting,exploration costs associated with unsuccessful wells are expensed and exploration costs relating to commercially-viable wells are capitalized.Under FC accounting,exploration costs associated with both successful and unsuccessful wells are capitalized.Of the two methods,FC accounting produces on average the higher operating income and assets,allowing for the risk characteristics of the drilling program and the rate of growth in exploration expenditures.However,regardless of the accounting method used-or the degree of conservatism imbedded in accounting rules and estimates-movements in O&G prices(as well as revisions to reserve estimates and changes in development and production costs)may lead to significant changes in the level of accounting conservatism applied to O&G assets and may,under certain circumstances,result in aggressive accounting treatments by both FC and SE firms.
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