Unit of revenue method
/What is the Unit of Revenue Method?
The unit of revenue method is a technique used in the oil and gas industry for charging capitalized costs to expense, using the ratio of current gross revenue to future gross revenues. The current gross revenue figure is derived by multiplying actual production during the period by the actual selling price, excluding royalty payments. The future gross revenues figure is derived by multiplying current prices by the estimated quantity of proved reserves, excluding royalty payments.
Advantages of the Unit of Revenue Method
There are two main advantages to using the unit of revenue method, which are as follows:
Matches revenues to expenses. The main advantage of this method is that it directly links expense recognition to the revenue being generated, which is a good application of the matching principle.
Matches expenses to asset usage. The unit of revenue method links expense recognition to asset usage, on the assumption that assets are used as revenue is generated.
Expenses consumed with revenue. Costs are only charged to expense when revenue is being generated, which means that expenses decline when revenues decline.
When to Use the Unit of Revenue Method
A firm can only use the unit of revenue method if it employs the full cost method to account for its expenses.