Natural resources are assets such as mines containing gold, silver, copper, or other minerals; wells containing oil or gas; and timberlands. Natural resources (also called wasting assets) are important assets of firms in the extractive industries.
Natural resources acquired from others are valued at their historical cost, but many firms self-explore and develop natural resource sites. The accounting for this type of situation is somewhat controversial. The issue involves the treatment of exploration costs associated with unsuccessful sites.
One approach, the full cost method, capitalizes the exploration costs of both successful and unsuccessful sites as an asset. This approach recognizes that a firm cannot expect success every time it attempts to locate valuable resources. Accordingly, the expenditures associated with both successful and unsuccessful sites are viewed as costs incurred to obtain successful sites.
The successful efforts method immediately expenses the cost of unsuccessful sites. Only the costs directly associated with locating and developing successful sites are capitalized. Because assets are recorded at lower amounts and expenses are recognized more quickly, successful efforts is the more conservative method.
GAAP permits the use of either method. Large firms such as Exxon tend to use successful efforts, while small firms tend to use full cost because higher net income and larger asset values make them appear more profitable in the short term. The higher net income and larger asset values under the full cost method also reduce the likelihood of violating loan covenants based on accounting ratios. Large, established firms are in much less danger of violating loan covenants. They select the conservative successful efforts method because the lower reported net income helps reduce the political costs of the very visible oil industry. That is, lower net income numbers help the oil industry to argue that it is not unduly profiting at the public’s expense.
Natural Resources Topics
- Acquisition of Intangible Assets
- Amortization of Intangible Assets