Audit in Oil & Gas Sector

Impact of IFRS 15 in Oil and gas industry in the United Arab Emirates

Oil and gas industry in the United Arab Emirates

Oil and gas in the UAE represent one of the core elements of the UAE national economy. Since the opening of the first oil fields, this economic sector has completely replaced such traditional activities as pearl fishing, date palm plantations and fishery. The products of the oil industry are also the main source of revenue from the export of raw materials. The industry of oil and gas has provided the United Arab Emirates with a sufficiently high level of per capita income.

It should be noted that the Government of the UAE carries out an active diversification of the national economy. In particular, all the assets coming from the oil and gas sector are invested into the other industries such as tourism, trade, agriculture, manufacturing industry and social sector. Thus, oil and gas in the UAE made it possible to create a well-developed infrastructure and to attract foreign investors. Experts note that the share of the oil and gas industry in the GDP decrease constantly and gives a way to other industries.

Oil and natural gas in the UAE – production infrastructure

As to the oil extraction, a system of pipelines, which connects field facilities, refineries and port terminals, is created in the United Arab Emirates. The same piping system enables an effective operation of the companies involved in the gas sector. A gas pipeline, which connects the Emirates and Qatar, is one of the major regional projects.

The larger share of the oil produced on the territory of the United Arab Emirates is being exported. Export of the oil and gas sector products is carried out in various ways. The United Arab Emirates is located in the Persian Gulf and has shipping ports for international transportation. Shipping terminals are supplied with the modern equipment and the appropriate infrastructure. Transportation is carried out by oil tankers. Japan, South Korea, Thailand, the countries of Western Europe and the USA can be distinguished among the main importers of oil.

Gas production in the UAE

Natural gas in the UAE is the main resource for the electric energy production. Moreover, experts note a gradual increase in domestic consumption over the volumes of natural gas production. A stable economic and population growth stimulate the government to increase the volumes of the produced gas constantly, and also contribute to the search for new alternative energy sources.

Despite the fact that the gas production in the UAE is of a relatively high prime cost and there are certain difficulties in the course of extraction, production volumes are characterized by the annual growth. The development of a network of the connecting pipelines and the construction of modern processing plants both within the country and abroad contribute to the increase in production volumes. Today, natural gas in the Emirates is used not only for the production of electrical energy, but it is also used in the process of oil production for pumping into the wells and for desalination of water resources.

According to the independent experts, natural gas consumption in the United Arab Emirates has doubled over the last decade. Both growth of the domestic demand and the ever increasing demands of the oil and chemical industries contribute to the expansion of the area of natural gas usage.

Impact of IFRS 15 in Oil and Gas Industry

International Financial Reporting standards (IFRS) are a set of accounting standards developed by the International Accounting Standard Board (IASB). IFRS is based more on principles when compared with US GAAP which is more rule based standard. One of the reasons for adapting to IFRS is the need for a business to present its financial statements on the same basis as its foreign competitors in order to make comparisons easier. IFRS is inevitable and will be the final destination for public companies in the U.S. and for most companies around the globe. Hence, it is very crucial to understand the impact of IFRS.

Revenue Recognition

IASB and FASB jointly issued in May 2014 IFRS 15 “Revenue from contract with Customers” which will replace the existing IFRS revenue guidance. The new standard took effect in January 2017 for calendar year companies.

IFRS 15 excludes from its scope contract with a collaborator or a partner that are not customers.

Five steps approach the entity need to apply when determining the timing and the amount of revenue recognition:

  1. Identify the Contract with customer
  2. Identify performance obligation in a contract
  3. Determine the transaction price
  4. Allocate the transaction price to the performance obligation in the contract
  5. Recognize revenue when (or as) the entity satisfies a performance obligation

Entities are required to provide disclose about amount, timing and uncertainty of revenue (and related cash flows) from contracts with customers and the judgments (including if change in judgement) used in applying the revenue model.

Challenges: It may be challenging for Oil & Gas companies to determine whether counterparties to contracts are collaborators or customers due to its entering into complex arrangements. Performance obligation identification of upstream, midstream & downstream contracts may be complex. Oil & Gas entities need to evaluate accounting for certain arrangements including commodity exchange arrangements, production imbalances, take or pay arrangements, drilling contracts etc. in light of new revenue recognition standard, i.e., Oil & Gas entities need to assess importantly whether refining or processing counterparty meets the definition of customer or not.

Inventory

Under US GAAP companies can apply LIFO rules to their inventory balances, application of which lead to higher cost of sales and thus reduce taxable income. LIFO method is very useful in saving tax in period of rising commodity prices. However, IFRS does not permitted LIFO accounting, which in turn require the companies a need to recast recorded inventory balances under weighted average or FIFO rules for financial reporting purpose.

Exploration and Evaluation Assets

IFRS 6 applies to Exploration and Evaluation expenditure.

Exploration and evaluation expenditure are those costs that are incurred by oil & gas companies in connection with the exploration for and evaluation of mineral resources before the technical feasibility and the prospect of extracting a commercially viable quality of oil, natural gas and similar non-regenerative resources are established. Exploration is a risky and complex activity.

Exploration and evaluation cost are categorized into pre-exploration costs, exploration and evaluation costs and development costs. IFRS 6 excludes pre-licence expenditure from the scope of Exploration and evaluation cost. However, IFRS does not define the accounting methods: the successful efforts method or full cost method for exploration and evaluation activities which was defined under US GAAP. Please note: The most significant difference between the two methods relates to the accounting treatment of drilling costs for unsuccessful exploration cost. Full cost method capitalizes both successful & unsuccessful efforts, however successful effort method capitalizes only the cost of successful activities.

 IFRS 1 (First time adoption of IFRS) assist oil & gas companies in preparing their first IFRS financial statements by allowing them to measure exploration and evaluation assets at the amount determined under previous GAAP at the date of transition to IFRS. IFRS 6 relaxes the asset recognition requirement and allows the capitalization of exploration and evaluation costs by expenditure class.

Asset Impairment

Both IFRS and US GAAP require firms to write down impaired assets by recognizing a loss in income statements.

Under US GAAP, determining the impairment and calculating the loss potentially involves two steps. Firstly, carrying value of asset is compared with the undiscounted value of expected future cash flows to be generated from asset. Secondly, when the carrying amount is higher, the asset is written down to fair value.

Under IFRS, asset is impaired when its carrying value (original cost less accumulated depreciation) exceeds the recoverable amount.

The difference approach of calculations for impairment under US GAAP and IFRS leads to the effect that impairment may be recorded earlier under IFRS.

Reversal of impairment loss permitted under IFRS if external or internal indicators no longer exist or have decreased. However, US GAAP does not allow the reversal of impairment loss.

Joint Venture

IFRS 11 prescribes the accounting for joint arrangement.

Joint arrangement is the contractual arrangement which gives two or more of those parties joint control of the arrangement. Joint arrangements are classified under two types: Joint operation and joint venture.

How this IFRS could impact Oil & Gas sector? Projects within oil & gas industry sometimes undertaken by many parties, with one party being designated as the “operator” who has the responsibility of running the project on a day to day basis. Contract need to be reviewed to determine whether the operator is a principle (having control) or an agent for the correct application of IFRS.

Depletion, Depreciation & Amortization (including componentization)

What do you mean by the three terms “depletion, depreciation & amortization”? Depletion is the actual physical depletion of natural resource by a company. Depreciation is the means of allocating the cost of material assets over its useful life. Amortization is the deduction of capital expenses over a specified time period, for example, tangible non drilling cost sustained while developing the reserves.

IFRS requires the firm to depreciate the component of an asset separately, thereby requiring the useful life estimates for each component. Under component depreciation, useful life of each component is estimated and depreciation expense is computed separately for each. However, component accounting is seldom used under US GAAP.

The determination of what constitutes a component starts with individual assets and should be based on discussions with operations personnel familiar with design, construction and maintenance of the asset. Further, identification of number of components having different useful lives is a complex and time consuming process. Large oil & gas companies have installations containing many components; few examples are like offshore platforms, pipelines etc.

Fuel your Success

We offer dedicated partners and professional staff who will customize the right solutions in an industry that is essential to UAE’s continuing prosperity.

The Oil and Gas sector professionals at ALYA provide the highest level of specialized service to emerging, junior and established exploration and production companies. We apply our talents, experience and in-depth understanding of the industry to help our clients succeed at every stage of their growth.

Getting Started

We begin by helping many clients long before their first barrel is pumped or their first well is spudded. Our early involvement ensures that appropriate accounting systems and controls are established in the beginning and can accommodate future growth. We know that emerging companies often face time, staffing and financial constraints, so we work closely with you to tailor systems that best meet your specific needs.

New players need ownership structures that are tax-effective and support strategic business goals. Our experts can advise on the optimum solutions, including the possible use of multiple share classes, flow-through shares, partnerships, trusts and other scenarios. New public or widely-held private companies need governance structures that will meet increasing levels of scrutiny.

Initial and ongoing financing is very often the key to the success of emerging companies. Our extensive experience with all forms of financing transactions includes prospectuses, private placements, flow-through shares and debt financings. When companies go public, we have the expertise to fulfill the requirements of securities regulators.

Managing Growth

Companies face new challenges as they become larger and more complex. Alya can assist you with evaluating financial controls and enhancing reporting systems so that managers have the timely and accurate information they need to make good decisions. Further, if you are looking at acquisitions, we can provide corporate due diligence and assist with Take-Over Bids and Information Circulars required in the public arena. Alya has significant experience with companies in the field of Oil and Gas industry , so we are well suited to meet your needs as your company continues to grow.

Harvesting Value

For both private and public companies, a sound exit strategy is essential to maximize returns. In many situations, this strategy is developed before a sale is even being contemplated. Our substantial experience in both corporate and asset sales, including the structuring of transactions, ensures that you make the best use of capital gains exemptions, capital dividends and refundable taxes for private companies. For public or private companies, if your exit strategy is a corporate sale, we have extensive experience in securities legislation and reporting requirements that will help any sale that has public reporting requirements go smoothly.

From a mergers and acquisitions perspective, Alya assists companies to identify and mitigate corporate, financial and political risks that may be encountered when entering new territories. We draw from our corporate finance and industry professionals and examine critical areas including ownership of underlying assets, the mechanics of production-sharing contracts, geographic – specific risk and concerns which inevitably impact transaction structure and success.

Our Services for the Oil and Gas sector include:

  • Audit/ Assurance
  • Tax Compliance
  • Comprehensive Tax Planning
  • Mergers, Acquisitions Planning and Integration
  • Internal Control Assurance
  • Shareholder Value Analysis
  • Business Process Standardization and Optimization
  • Financial Management

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