What is Working Interest?

Working Interest

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Working Interest

In accounting, the term “working interest” typically refers to a share of ownership in an oil and gas property, which is often recorded as an asset on the balance sheet. However, unlike royalty interest or overriding royalty interest, working interest carries with it a share of the costs associated with exploration, development, and operations of a well or mining operation. These costs include drilling, maintenance, equipment costs, and labor, among others.

Accounting for Working Interest:

  • Balance Sheet: A company’s working interest in a property or project is typically accounted for as an asset. This asset is then subject to depreciation, depletion, and amortization (DD&A).
  • Income Statement: Revenue generated from the asset—proportional to the working interest—is recorded as income. On the other side, expenses associated with the asset, such as operational costs and any relevant depreciation or amortization, are recorded as costs or expenses.
  • Cash Flow Statement: Cash flows from operating activities may include the revenue generated from the asset and expenses paid out for operating the well or project.
  • Joint Operating Agreements (JOAs): Often, the operational aspects of a working interest are governed by a JOA, which stipulates the roles, responsibilities, and financial commitments of each partner.
  • Impairment: The carrying value of the asset on the balance sheet might need to be reassessed if the property’s future cash flows are expected to be lower than its carrying value. If it’s impaired, the asset value may need to be written down.
  • Tax Implications: Because of the expense and revenue sharing nature of working interest, there are often specific tax forms and implications. The cost of drilling and development, for example, can sometimes be capitalized and then depreciated over the life of the asset, providing a potential tax shield.

Example of Working Interest

Let’s consider a fictional example to illustrate the concept of “working interest” from an accounting perspective.

“GeoEnergy Inc.” has a 40% working interest in an oil well called “BlackGold#2,” operated by another company, “PetroMaster.”

  • The well has an initial value (capitalized cost) of $10 million.
  • It generates a monthly revenue of $300,000.
  • The monthly operating expenses are $100,000.

Accounting for Working Interest:

Balance Sheet:

  • Asset Value: GeoEnergy would record 40% of the well’s initial value as an asset. Therefore, 40% of $10 million = $4 million would be recorded under “Oil & Gas Properties” or a similar asset account.

Income Statement:

  • Revenue: GeoEnergy’s share of the revenue would be 40% of $300,000, which is $120,000. This would be recorded as revenue for the period.
  • Operating Expenses: GeoEnergy’s share of the monthly operating cost would be 40% of $100,000, or $40,000. This would be recorded as an operating expense for the period.
  • Net Income: The net income from the well for GeoEnergy for the month would be the revenue ($120,000) minus the operating expense ($40,000), which equals $80,000.

Cash Flow Statement:

  • Cash Flows from Operating Activities: The net income of $80,000 would flow into the cash from operations section, along with adjustments for any non-cash items like depreciation.

Tax Forms and Implications:

  • GeoEnergy can also take advantage of tax benefits, like depreciation and depletion, based on their working interest.

Here’s how it may look in simplified financial statements:

  • Balance Sheet Asset: Oil & Gas Properties = $4,000,000
  • Income Statement:
    • Revenue = $120,000
    • Operating Expenses = $40,000
    • Net Income = $80,000
  • Cash Flow Statement: Cash from Operations would include the net $80,000.

By meticulously accounting for its working interest, GeoEnergy provides a clearer picture of its asset’s performance and financial standing, thereby allowing investors, regulators, and other stakeholders to make informed decisions.

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