What is Discovery Value Accounting?
Discovery value accounting is an accounting method frequently employed by extractive enterprises, such as oil and gas companies, in the United States. This approach allows firms to recognize the value of newly discovered reserves as assets. Consequently, as new reserves are identified, the company’s assets and potential future earnings are reported to increase. This form of accounting provides a more dynamic and potentially optimistic financial outlook compared to traditional accounting methods, particularly regarding the valuation of a company’s natural resources.
Key Characteristics:
- Asset Recognition: New discoveries are treated as new assets on the company’s balance sheet.
- Future Earnings: The addition of discovered reserves is anticipated to contribute to future revenue streams.
- Valuation: The method inherently involves valuing reserves, which are typically difficult to quantify precisely.
Examples
Example 1: Oil Company
Let’s assume OilCorp discovers a new oil field with estimates of sufficient reserves that are expected to generate $500 million in future revenue. Through discovery value accounting, OilCorp can immediately recognize these reserves as increasing their asset base by $500 million.
Example 2: Natural Gas Enterprise
GasCo finds a new gas deposit believed to have $300 million worth of resources. Upon discovery, GasCo can record this as a $300 million asset on its balance sheet, indicating potential future revenue derived from this discovery.
Frequently Asked Questions
What kinds of companies typically use discovery value accounting?
Discovery value accounting is commonly used by companies in the extractive industry, particularly those involved in oil, gas, and mining.
How does discovery value accounting affect financial statements?
By recognizing new discoveries as assets, it can significantly increase a company’s reported asset value and anticipated future earnings, which might provide a more favorable view of the company’s financial health.
What is the benefit of using discovery value accounting?
This method allows companies to reflect the potential economic benefits of new reserves promptly. It can provide a more accurate depiction of a company’s future revenue potential.
Are there drawbacks to discovery value accounting?
Yes, the primary drawback is the difficulty in accurately estimating the value of unextracted resources, which can lead to overvaluation or undervaluation of assets.
How is the value of new reserves estimated?
The value is usually estimated based on probable and possible reserves and anticipated market prices, but precise valuation remains inherently uncertain and often involves expert appraisals.
Related Terms
Reserve Estimation
The practice of predicting the quantity and quality of resources available in a deposit, crucial for applying discovery value accounting.
Full Cost Accounting
An alternate method where all costs associated with obtaining reserves are capitalized and amortized over time.
Successful Efforts Accounting
Another accounting method in the extractive industry where only successful exploration costs are capitalized and unsuccessful costs are expensed.
Online References
- Investopedia on Discovery Value Accounting
- U.S. Securities and Exchange Commission Guidelines
- Financial Accounting Standards Board (FASB) Resources
Suggested Books for Further Studies
- “Extractive Industries Accounting” by Nigel Courtenay
- “Petroleum Accounting: Principles, Procedures, & Issues” by Charlotte Wright
- “Fundamentals of Oil & Gas Accounting” by Rebecca A. Gallun and John W. Mertes
Accounting Basics: “Discovery Value Accounting” Fundamentals Quiz
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