What is the Successful Efforts Method?

The successful efforts method is used in the oil and gas industry to account for certain operating expenses. Under the successful efforts method, a company only capitalizes those costs associated with the location of new oil and gas reserves when those reserves have been found. If exploration costs are incurred and no new reserves are found, then the costs are instead charged to expense as incurred. Some costs may be capitalized as wells-in-progress until there is additional information about the existence of future benefits; as soon as the additional information becomes available, these costs can either be charged to expense (if there are no future benefits) or reclassified as a fixed asset (if there are future benefits). In the latter case, these costs are amortized as production occurs, so that expenses offset revenues.

The successful efforts method is a conservative approach to oil and gas accounting, since it mandates immediate charges to expense when a "dry hole" is drilled. By doing so, expense recognition is accelerated, leaving the smallest amount of expenditures recorded as assets on the balance sheet. Also, since fewer expenses are capitalized, there is less risk that a large amount of capitalized assets will be suddenly charged to expense due to the impairment of a firm's oil and gas reserves.

Treatment of Exploratory Dry Holes

An essential accounting issue is that exploratory dry holes are charged to expense, while development dry holes are capitalized. Since this distinction can have a profound effect on the financial statements, you should carefully classify each well prior to the commencement of drilling.

The Full Cost Method

An alternative approach that allows for the capitalization of a larger amount of expenditures is the full cost method. Under this approach, all property acquisition, exploration, and development costs are aggregated and capitalized into a country-wide cost pool. This capitalization occurs whether or not a well is deemed successful. These costs are then charged to expense using the unit-of-production system, based on proven oil and gas reserves.