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  • 12011 Europe, Middle East, India and Africa tax policy outlook

    Applying IFRS in Oil & Gas

    Revised proposal for revenue from contracts with customers Implications for the oil & gas sector

    March 2012

    IASB — proposed standard

    Applying IFRS in Oil & Gas_14March.indd 1 15/03/2012 14:39:29

  • Applying IFRS in Oil & Gas — March 2012 Applying IFRS in Oil & Gas — March 2012


    1 Available on

    In general, we do not expect the latest revenue recognition Exposure Draft (ED) issued by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) (collectively, the Boards), to fundamentally change the revenue recognition for many types of arrangements in the oil and gas sector. However, for some types of arrangements such as take-or-pay arrangements, a thorough analysis of the proposed model will be required to determine the potential impact, as this may not be immediately apparent when reading through the ED. After considering the facts and circumstances of each arrangement in light of the specific requirements of the ED, in combination with the impact of the decisions an entity may make in relation to the practical expedients, entities could potentially determine that the way these contracts are currently accounted for and disclosed may change.

    The ED is also unclear as to the effect of the revised proposals on some types of arrangements. This lack of clarity, combined with the fact that the arrangements in this sector can be diverse and complex, would require entities to assess the effect of these new proposals on their own arrangements to enable them to determine whether they will have any impact on the current accounting.

    This publication is an oil and gas sector-specific supplement to the recently issued Applying IFRS: Revenue from Contracts with Customers – the revised proposal (January 2012) (general publication).1 The general publication summarises the revenue recognition model proposed in the ED issued in November 2011, and highlights some issues for entities to consider in evaluating the impact of the ED and discusses some of the expected changes to current IFRS.

    This supplement summarises the key aspects of the proposed model and highlights some potentially significant implications of the ED for the oil and gas sector. This includes determining what is in scope and the potential impact on sector-specific contracts and practices. The impact for oilfield services has been considered in a separate publication entitled Revenue from Contracts with Customers: the revised proposal – impact on the Oilfield services sector.

    The issues discussed in this supplement are intended to both provoke thought and to assist entities in formulating ongoing feedback to the Boards. The discussions within this supplement represent preliminary thoughts; additional issues may be identified through continued analysis of the ED, or as elements of the ED change based upon further deliberation by the Boards.

    What you need to know • The revised revenue recognition Exposure Draft issued by

    the IASB and the FASB in November 2011 is not expected to fundamentally change the way revenue is recognised for many oil and gas transactions.

    • Also, for some types of arrangements in this sector it is not immediately apparent as to exactly how the proposed model will apply. Therefore a detailed analysis will be required to make such a determination, e.g., take-or-pay arrangements.

    • The variety and complexity of arrangements in this sector, combined with the specific requirements of the proposed model including the newly added practical expedients, means entities will need to familiarise themselves with the ED so they are able to properly assess any potential impacts.

    Applying IFRS in Oil & Gas — March 2012

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  • Applying IFRS in Oil & Gas — March 2012 Applying IFRS in Oil & Gas — March 2012

    Contents 1. Scope 4

    2. Risk sharing arrangements 5

    3. Production imbalances 6

    4. Production payments 8

    5. Purchases and sales of inventory with the same counterparty 8

    6. Royalty payments 9

    7. Take-or-pay arrangements 10

    8. Next steps 23

    9. Ernst & Young Oil & Gas contacts 24

    Applying IFRS in Oil & Gas — March 2012

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  • 4 Applying IFRS in Oil & Gas — March 2012 Applying IFRS in Oil & Gas — March 2012

    Scope Definition of revenue and a customer Revenue is currently defined in IFRS2 as:

    “Income arising in the course of an entity’s ordinary activities.”

    This definition has been carried forward unchanged in the ED from current IFRS. The Boards noted in the Basis for Conclusions to the ED that they would not amend the existing definition of revenue as part of this project. Instead, they decided that this was a matter for their joint conceptual framework project.

    The proposed revenue recognition guidance in the ED only applies to revenue from contracts with customers. That is, it only deals with a subset of an entity’s potential revenue-generating activities.

    The ED defines a customer as:

    “… a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities.”

    Neither current IFRS nor the ED defines “ordinary activities”. The Boards indicated in the Basis for Conclusions to the ED that they were not going to clarify the meaning of “ordinary activities” because that notion was derived from existing revenue definitions, which as noted, were not being revisited as part of this project.

    The ED then goes on to explain that for some contracts, while there may be payments between parties in return for what may appear to be goods or services of the entity, the counterparty might not be a customer. Instead, the counterparty may be a collaborator or partner that shares in the risks and benefits of developing a product to be marketed. Contracts with collaborators or partners would not be in the scope of the proposed standard. However, no further guidance is provided to assist an entity in determining whether such collaborative arrangements would be in scope, i.e., when the collaborator or partner would be considered to be a customer.

    There are many complex contracts in the oil and gas sector and some diversity currently exists in how these are accounted for. The decision not to revisit the definitions of “revenue” or “ordinary activities”, while proposing a model that only deals with a subset of an entity’s total revenue generating activities, does not assist in resolving the uncertainty as to what constitutes an entity’s ordinary activities and, hence, represents revenue from contracts with customers.

    Determining who the customer is, and therefore what contracts are in scope, will require an assessment of the individual facts and circumstances. The absence of specific guidance on what are considered an entity’s ordinary activities and therefore who may be customers of an entity, may lead to diverse interpretations.

    Generally, if a contract was not previously considered to be a contract with a customer, we do not believe this ED will change such a conclusion. However, in some cases, what constitutes a customer contract may not be clear. Therefore, some contracts (e.g., production sharing contracts) may need to be evaluated to determine if they do represent contracts with customers.

    It is our understanding that should a contract or arrangement not fall within the scope of this ED, it does not necessarily preclude the potential inflows from such contracts from being described as part of total revenue.

    How we see it


    The Basis for Conclusions explain that while the Boards were asked by some respondents to clarify whether parties to common types of arrangements in their industries would meet the definition of a customer, the Boards decided that it would not be feasible to develop application guidance that would apply uniformly to various industries. This was because the terms and conditions of a specific arrangement may affect whether the parties have a supplier- customer relationship or some other relationship, e.g., collaborator or partner. Instead, the parties to the arrangement would have to consider all facts and circumstances to determine if they are in scope of the revenue recognition ED or not.

    2 IASB’s Conceptual Framework for Financial Reporting paragraph 4.29

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  • 5 Applying IFRS in Oil & Gas — March 2012 Applying IFRS in Oil & Gas — March 2012

    The current accounting for operating leases and service contracts is often similar. Determining that a service arrangement contains an operating lease generally does not result in significantly different accounting for the arrangement under current accounting standards. Consequently, it is possible that to date not all embedded leases have been identified, extracted and/or accounted for separately.

    However, under the proposed leasing model, the accounting for a lease by the lessor could be significantly different from the accounting for a service arrangement. Therefore, this assessment may have significantly different accounting implications where service contracts are considere