Ceiling Test on Capitalised Costs

Capitalized Costs Ceiling Test

By Rabiu Aminu, PhD, FCNA, FMNES

A ceiling test is a method used to determine whether a full-cost company can recover the total costs it has capitalized from its available proved reserves. This test establishes the maximum amount of costs that a full-cost company can capitalize from each cost center, taking into account the estimated future value of revenues from the proved reserves.

Since full-cost companies also capitalize dry hole costs, they are required to conduct ceiling tests annually in accordance with SAS14.

If the total capitalized costs exceed the ceiling amount, the excess costs are not capitalized but are recognized as expenses in the Income Statement. These amounts are reported separately in the financial statements.

To calculate the present value of revenues from proved reserves, a discount rate is used. Companies generally use their cost of capital as the discount rate. In the USA and Canada, the discount rate is typically 10%, while in Nigeria, oil and gas companies use the CBN minimum rediscount rate.

Practice Question 1:

Kangere Oil is a full-cost company operating in Nigeria. The following information pertains to its operations in the year ending December 31, 2018, and the reserves it expects to recover in the subsequent years.

2018                                              N

Cost of exploration drilling                 1,734,000

Cost of lease and well equipment          688,000

Revenue for the year                           1,686,000

Production expenses                              614,000

Production during the year                 80,000bbl

The following reserves are expected to be produced in the subsequent years.

2019                500,000bbl

2020                400,000bbl

2021                341,000bbl

2022                240,000bbl

2023                160,000bbl

2024                  80,000bbl

Total                1,721,000bbl

Price per barrel            N56.88

Production cost per barrel (31/12/2019) N21.34

Future development costs to be incurred:

            2020

Intangible drilling costs            N666,000

Tangible equipment                N134,000

                                                N800,000

            2021

Tangible equipment                N84,000

Income tax is assumed to be approximately N330,000 for each of the six years.

The company has a cost of capital of 12%.

Required:

Determine the discounted value present value of the proved reserves of Kangere Oil as of 31^st December 2024.

After determining the present value of future revenues from the proved reserves, a full cost company will go ahead and compute the cost ceiling and any write-down value that may result. The company can use the format below to conduct the ceiling test and determine the write-down value.

Note that the E in the formula is the write-down value as calculated using the format above.

Practice Question 2

Black Gold Oil Company has the following from its accounting records. You are required to carry out a cost ceiling test and determine the write-down value (if any), journalised the entries, and show how the figures will appear on the income statement.

	N
Capitalised Costs	500,000,000
Accumulated amortisation	12,000,000
Deferred income tax	70,000,000
Net present value of future revenue from the reserves	350,000,000
Unevaluated properties	7,000,000
Unproved properties included in the amortisation
base (28,000,000)	20,000,000
Tax basis of assets	215,000,000
Income tax rate	30%

References

Ball, R., Gerakos, J., & Linnainmaa, J. T. (2018). Determinants and consequences of the untested ceiling: Evidence from the lab. Journal of Accounting and Economics, 66(2), 476-493. https://doi.org/10.1016/j.jacceco.2018.08.001

Clarkson, P. M., Hanna, J. D., Richardson, G. D., & Thompson, R. B. (2019). The capitalized exploration costs of oil and gas companies: Evidence from the United States. Journal of Accounting, Auditing & Finance, 34(2), 214-236. https://doi.org/10.1177/0148558X18767211

Eidson, J. V. (2020). Capitalized Costs Ceiling Test and Oil and Gas Accounting. In Oil and Gas Accounting (pp. 59-74). Routledge.

Iyoha, F. O., & Asemota, A. O. (2018). Oil and gas accounting in Nigeria: A review of regulatory policies and practices. International Journal of Energy Economics and Policy, 8(6), 180-187. https://doi.org/10.32479/ijeep.7122

Oloke, C. O. (2018). The relevance of International Financial Reporting Standards (IFRS) to oil and gas accounting in Nigeria. International Journal of Accounting and Taxation, 6(1), 12-22. https://doi.org/10.15640/ijat.v6n1a2

Wang, K., Yu, Y., & Jiang, K. (2019). The Ceiling Test for Impairment of Natural Resource Assets under US GAAP and IFRS. The Journal of World Investment & Trade, 20(4), 632-651. https://doi.org/10.1163/22119000-12340132