The SEC’s new proposal on accounting for exploration efforts in the oil and gas industry undertakes to shift investors’ emphasis away from the published income statement toward one that expenses outlays for exploration immediately and treats the estimated value of the resulting discoveries as current revenue.
What effect will the SEC’s proposal have on those companies, primarily engaged in oil and gas exploration and production, who have traditionally presented their performance to investors in terms of statements based on full cost accounting? The following article, written before the SEC issued its ruling, suggests that the shift in emphasis will have an adverse effect on the way the securities market values the shares of full cost companies, making it substantially more difficult for them to obtain funds in the capital market.
A number of academic studies have concluded that elimination of full cost accounting would have little or no adverse effect on full cost firms’ equity security prices. When the authors corrected for certain methodological deficiencies in those studies, however, this conclusion was reversed. Price declines during the test periods (centering on the APB’s 1971 and FASB’s 1977 proposals to eliminate full cost accounting) were much more dramatic for full cost firms. Moreover, the impact on full cost producing companies was greater than the impact on full cost integrated companies.