OT02195 | Oil Industry accounting: decommissioning

Decommissioning describes the process of plugging and abandoning wells, of dismantlement of wellhead, production and transport facilities and of restoration of producing areas in accordance with licence requirements and the relevant legislation. Owners of oil and gas installations and pipelines are required to decommission their offshore infrastructure at the end of a field’s economic life and to set out the measures to decommission disused installations and/or pipelines in a decommissioning programme.

The corporation tax reliefs available for decommissioning expenditure are explained at OT28000 onwards.

The accounting requirements for decommissioning provisions are included in:

• FRS 102 Section 21 Provisions and Contingencies (UK GAAP); and

• IAS 37 Provisions, Contingent Liabilities and Contingent Assets (IFRS).

UK GAAP

Section 21.4 of FRS 102 states that:

An entity shall recognise a provision only when:

(a) the entity has an obligation at the reporting date as a result of a past event;

(b) it is probable (i.e. more likely than not) that the entity will be required to transfer economic benefits in settlement; and

(c) the amount of the obligation can be estimated reliably.

By either constructing or acquiring oil and gas infrastructure an entity will have a legal obligation under the terms of the licence to remove the infrastructure at the end of the field’s life and to restore the sea bed to its original condition. The past event would therefore be the construction or acquisition of the oil and gas infrastructure. Given the legal obligation contained within the licence condition (a) above would be met. There will be a significant cost associated with decommissioning the infrastructure and it is likely that this can be estimated reliably. Conditions (b) and (c) would also therefore also met.

Initial measurement

A provision should be measured at the best estimate of the amount required to settle the obligation. Where the time value of money is material, the amount of the provision shall be the present value of the amount expected to be required to settle the obligation (FRS 102 21.7).

Provisions are recognised as a liability and would normally be included as an expense in the income statement unless another section of the FRS requires the cost to be recognised as part of the cost of an asset (FRS 102 21.5). Section 17.10 (c) Property, Plant and Equipment of FRS 102 states that the cost of an item of plant and machinery should include the initial estimate of the costs, recognised and measured in accordance with Section 21 Provisions and Contingencies, of dismantling and removing the item and restoring the site on which it is located. Any decommissioning provision should therefore be recorded as a liability with the corresponding amount as part of the cost of the asset.

Subsequent measurement

An entity shall charge against a provision only those expenditures for which the provision was originally recognised (FRS 102 21.10).

An entity shall review provisions at each reporting date and adjust them to reflect the current best estimate of the amount that would be required to settle the obligation at the reporting date (FRS 102 21.11).

IFRS

Accounting for decommissioning provisions is covered by IAS 37 Provisions, Contingent Liabilities and Contingent Assets. The accounting for provisions under IAS 37 is the same as in Section 21 of FRS 102.

Section C example 3 of the Implementation Guidance of IAS 37 includes an example of a decommissioning provision in relation to an offshore oil field.