The information content of reserve recognition accounting

Abstract

In 1977 the Financial Accounting Standards Board (FASB) selected a form of the successful efforts (SE) method of accounting as the only generally acceptable method for oil and gas producing companies to use in order to report their oil and gas activities. The SEC, in effect, overturned the FASB's ruling by allowing companies to use either SE or full cost (FC) accounting in their financial statements and by selecting the reserve recognition accounting (RRA) method to use for supplemental disclosures of oil and gas producing activities. The SEC stated that neither of the traditional historical cost accounting methods (FC or SE) provides sufficient information to enable readers to make good economic decisions. It proposed that financial statements that are issued for fiscal years ending after December 25, 1979, contain RRA data as supplemental information. After a hearing on the 1979 and the 1980 RRA data, the SEC decided that RRA was not appropriate for formal financial statements. The SEC returned the problem to the FASB with the strong suggestion that some type of valuation of reserves be included in oil and gas companies' disclosures. The FASB included in its Exposure Draft on Oil and Gas disclosures an adapted form of RRA valuation to be disclosed as supplemental information for oil and gas companies. This project attempts to determine if RRA data have information content. The methodology uses the efficient market theory to determine if some accounting data have information content. Four treatment portfolios are formed, based on the percentage change in the present value of estimated future net revenues from proved oil and gas reserves for the years 1979 and 1980. The portfolios' risk-adjusted rates of returns are tested for significant differences which would indicate information content. The portfolios' weekly average residuals (WAR) are tested for unusual movements and both the WAR's and cumulative WAR's risk-adjusted returns are plotted for each portfolio for the test period. The result of the test of differences and T-tests of the WAR's and the plots of the portfolios' WAR's and the portfolios' cumulative WAR's is that there appear to be no significant differences between the four portfolios.