Unit of production method definition
/What is the Unit of Production Method?
The unit of production method is a technique for charging capitalized costs to expense in the oil and gas industry, using the ratio of produced units to reserves. This is done by estimating the total number of units of proved oil or gas reserves and dividing actual production in the period by the beginning proved reserves to derive the amortization rate.
You should consider the following issues when using the unit of production method:
Basis of amortization. In computing the amortization rate for wells and equipment, exclude proved developed reserves that can only be produced after significant additional development costs are incurred, since additional asset investments must be made to access those reserves.
Level of ownership. When computing reserves and production, the firm can only include that portion of total reserves and production to which it is entitled. This is done using the working interest method, which is described in the following example.
Salvage value. Take into account the estimated salvage values of the various assets being charged to expense over time.
Example of the Unit of Production Method
Cutler Energy has discovered 1,000,000 barrels of proved reserves. Production during the year was 25,000 barrels. Cutler has recorded a cost of $84,000 for the related proved property. The unit of production calculation is:
($84,000 ending book value / 1 million barrels proved reserves) x 25,000 barrels
= $2,100 amortization
When to Revise Unit of Production Rates
Unit of production amortization rates should be revised at least once a year, or whenever the need for a revision is indicated.