Full Cost vs Successful Efforts: A Simple Comparison

Full cost and successful efforts are the two accepted U.S. GAAP methods oil and gas producers use for exploration costs. Full cost capitalizes all acquisition, exploration, and development costs, including dry holes, in a country-wide cost pool. Successful efforts expenses exploratory dry holes and geological and geophysical costs, and capitalizes successful wells, acquisition costs, and development wells.

The key question is whether a failed search belongs in the cost of finding the successful reserves. The answer changes the timing of expense, the reported asset balance, and the depletion amounts recognized later.

Full cost vs successful efforts: the central difference

An exploratory dry hole is an exploratory well that does not find commercially recoverable reserves. Cash has been spent, but the particular well has not produced a successful discovery.

The full-cost view treats searching as a combined activity: some failures are part of finding the successful properties. The successful-efforts view focuses more narrowly on whether the specific exploration activity produced a qualifying asset.

Capitalizing means putting a cost on the balance sheet for later allocation. Expensing means recognizing the cost in income now. Neither treatment changes the amount of cash already spent.

ZaZa Energy’s successful-efforts policy note (Form 10-Q, March 31, 2014) illustrates the distinction between other exploration costs and exploratory drilling costs. Exploratory drilling can initially remain capitalized while the outcome is being evaluated under the applicable conditions.

A useful caution: “successful efforts” does not mean every unsuccessful well is expensed. The dry-hole expense rule applies to exploratory wells. Development wells, which are drilled to produce reserves that have already been proved, are capitalized under successful efforts even when one turns out dry. This lesson’s comparison concerns exploration, so do not stretch its shortcut into a rule about all drilling.

A simple comparison using the same cash spending

Hypothetical example: Beacon Energy spends $800,000 on qualifying productive exploratory drilling and $200,000 on an exploratory well that is confirmed dry before year-end. Assume both amounts belong to the relevant full-cost pool. Ignore taxes, production, depletion, and ceiling write-downs for this first comparison.

The full-cost company did not earn an extra $200,000 of cash. It deferred a cost that the successful-efforts company recognized immediately. The phrase “from these costs alone” matters: other expenses, depletion, and write-downs can alter the overall comparison.

Journal Entries For The Example

Full cost: Beacon puts all $1,000,000 into its cost pool.

Successful efforts: Beacon keeps the successful well as an asset and expenses the dry hole.

In practice, a successful-efforts company often records exploratory drilling as an asset first, while it waits to learn whether the well found reserves. Once the well is confirmed dry, it moves that cost to expense. Because this well was confirmed dry before year-end, the year-end result matches the entry above. The capitalized amounts in both entries end up in the company’s property disclosures, which our PP&E disclosures guide walks through.

Does full cost avoid the expense? No, it delays it

Capitalization postpones allocation; it does not make the cost vanish. Assume, only to illustrate the timing, that all retained amounts above are ready for depletion, both methods use the same 500,000-unit denominator, and there are no other costs or salvage amounts.

The full-cost rate would be $2 per unit, compared with $1.60 under successful efforts. Extracting 50,000 units would allocate $100,000 versus $80,000. If all those units were sold, the full-cost company would recognize $20,000 more depletion-related expense for that production.

Now follow the costs all the way to the end. Once all 500,000 units are extracted and sold, the full-cost company has expensed $1,000,000 of depletion ($2 x 500,000). The successful-efforts company has expensed $800,000 of depletion ($1.60 x 500,000) plus the $200,000 dry hole, which also totals $1,000,000. Same total, different timing. That is the heart of this comparison.

This is a simplified teaching comparison, not a complete oil-and-gas depletion model. Actual cost pools and reserve denominators follow method-specific rules. Use our depletion calculation guide to review the basic rate logic, and the depletion journal entry guide to distinguish extracted costs from sold costs.

What does the full-cost ceiling do?

Full-cost accounting does not let costs pile up without limit. SEC Regulation S-X Rule 4-10 sets a ceiling on how much can stay capitalized in each cost center. Cost centers are established on a country-by-country basis. Companies run this test every quarter.

The ceiling is built mainly from the future net revenues of proved reserves, valued using a 12-month average price and discounted at 10%. If capitalized costs, net of accumulated depletion and related deferred income taxes, exceed the ceiling, the excess is written down as an expense. Under the SEC rules, that write-down is permanent. It is not reversed later, even if prices recover.

The SEC’s final oil-and-gas reporting release, section III explains that this is a standardized limitation calculation, not a fair-value measurement of the properties. Reserve-related future net revenues are central to the calculation, but “the market value of the oil field” is not an adequate substitute.

For a small conceptual example, suppose the amount being tested is $920,000 and the properly computed ceiling is $860,000. The excess is $60,000. This lesson asks you to understand the limitation, not to construct the detailed regulatory ceiling calculation.

Falling resource prices can reduce the support for the ceiling and trigger a write-down. Consequently, full cost does not guarantee higher income in every period.

Why Are There Still Two Methods?

In 1977, the FASB issued Statement No. 19, which would have required successful efforts for every company. Many smaller producers pushed back. They argued that expensing dry holes would hurt their reported earnings and their ability to raise money for exploration. In 1978, the SEC decided it would accept both methods in filings, and in 1979 the FASB issued Statement No. 25, which suspended the successful-efforts requirement. Both methods have stayed acceptable ever since, which is why textbooks still call this a continuing controversy.

Common comparison mistakes

• Calling capitalization “no expense”: the cost normally affects later periods through depletion or a write-down.
• Treating company size as the rule: size may describe an observed tendency; the company’s accounting policy governs its reporting.
• Changing the cash-flow total: the method does not change the original cash paid. Cash-flow classification depends on the type of cost. Under successful efforts, payments to drill exploratory wells are investing outflows, including wells subsequently determined to be dry. Geological and geophysical payments are operating outflows under successful efforts and are generally investing outflows when capitalized under full cost. See the SEC staff guidance on exploratory disbursements.
• Assuming the ceiling equals fair value: it is a prescribed limitation, with its own inputs and adjustments.

The standard-setting debate also illustrates why neutrality matters. A method’s effect on reported earnings can be economically significant, but accounting should represent transactions faithfully rather than target a preferred profit number.

Key Takeaways

• Full cost capitalizes exploratory dry holes and geological and geophysical costs in a country-wide pool. Successful efforts expenses them.
• Both methods capitalize successful wells, acquisition costs, and development wells.
• The difference is timing. In a simple case, total expense over the life of the reserves is the same.
• Full-cost companies run a quarterly SEC ceiling test, and a ceiling write-down cannot be reversed.
• Cash paid is identical under both methods.

Interactive CPA Practice on Full Cost vs. Successful Efforts

Apply the two oil and gas accounting methods to a successful exploratory well and a confirmed dry hole. Use the hints to work through the capitalization and expense decisions, then review how those decisions affect current-period earnings.

Practice questions and explained answers

1. Classify a failed search

A hypothetical exploratory well costs $90,000 and is confirmed unsuccessful. Ignore special timing exceptions. How does full cost vs successful efforts treat it?

Answer: Full cost generally keeps the amount in the appropriate capitalized pool; successful efforts recognizes a $90,000 exploration expense. The contrast concerns the failed exploratory well.

2. Compare cash and income

Before depletion or write-downs, does capitalizing that $90,000 create $90,000 of extra operating cash?

Answer: No. It changes expense recognition and the asset balance. The underlying spending is still $90,000.

3. Apply a given ceiling

The amount subject to a full-cost ceiling test is $1,150,000 and the correctly computed ceiling is $1,080,000. What is the excess?

Answer: $70,000. The excess is written down; the existence of a cost pool does not justify carrying costs above the applicable limit.

Want more practice like this? The Intermediate Accounting course continues this chapter with video lectures, and the free sample course lets you try Farhat Lectures first.

Frequently asked questions

Are both methods used under U.S. GAAP?

Yes. Both methods are acceptable under U.S. GAAP. Successful-efforts guidance is codified in FASB ASC 932, Extractive Activities: Oil and Gas. Companies that use full cost and file with the SEC must also follow SEC Regulation S-X Rule 4-10(c) and the SEC staff guidance in SAB Topic 12.D.

Is full cost the same as units of production?

No. Full cost answers which costs are capitalized. Units of production describes how an applicable capitalized amount is allocated as resources are extracted.

Does successful efforts expense every exploration payment immediately?

No. Certain exploratory drilling costs can be held temporarily while results are assessed. That timing issue is different from keeping confirmed unsuccessful exploratory costs in a full-cost pool.

Which Method Reports Higher Net Income?

Usually full cost, in years when a company drills dry holes, because it capitalizes those costs instead of expensing them right away. That advantage is not guaranteed. Full cost spreads the cost through higher depletion later, and a ceiling write-down during a price drop can make full-cost earnings much lower in that period.

Can A Full-Cost Ceiling Write-Down Be Reversed?

No. Under the SEC full-cost rules, a ceiling write-down is permanent. If oil and gas prices recover later, the written-down costs are not added back.

Are Development Dry Holes Expensed Under Successful Efforts?

No. Under successful efforts, development well costs are capitalized, including development wells that turn out dry. The dry-hole expense rule applies to exploratory wells.

How Does IFRS Handle Exploration Costs?

IFRS has a separate standard, IFRS 6, for exploration and evaluation spending. It lets a company choose an accounting policy for which of those costs to capitalize, apply it consistently, and test the assets for impairment when facts suggest the carrying amount may not be recovered. Once a project is shown to be technically feasible and commercially viable, the costs are reclassified and follow the normal property and intangible asset standards.

Sources and lesson context

This article follows the “Continuing Controversy” discussion in Wiley section 10.3. Primary references include the SEC release and company accounting-policy note linked above, plus FASB ASC 932, Extractive Activities—Oil and Gas. The examples are original and intentionally simplified.

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About The Author

Mansour Farhat, DBA, CPA, CIA, MAcc, is the founder of Farhat Lectures and teaches the accounting, CPA, CMA, and EA courses on this site. Learn more about his background on the About page.