FORM 10-K CONTANGO OIL & GAS COMPANY

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)
Income Taxes. The Company follows the liability method of accounting for income taxes under which
deferred tax assets and liabilities are recognized for the future tax consequences of (i) temporary differences
between the tax basis of assets and liabilities and their reported amounts in the financial statements and (ii) operating
loss and tax credit carryforwards for tax purposes. Deferred tax assets are reduced by a valuation allowance when,
based upon management’s estimates, it is more likely than not that a portion of the deferred tax assets will not be
realized in a future period. In accordance with Financial Accounting Standards Board (“FASB”) Interpretation No.
48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”, the Company
reviews its tax position for tax uncertainties.
The Company files income tax returns in the United States and various state jurisdictions. The Company’s
tax returns for 2006, 2007 and 2008 remain open for examination by the taxing authorities in the respective
jurisdictions where those returns were filed.
Concentration of Credit Risk. Substantially all of the Company’s accounts receivable result from natural
gas and oil sales or joint interest billings to a limited number of third parties in the natural gas and oil industry. This
concentration of customers and joint interest owners may impact the Company’s overall credit risk in that these
entities may be similarly affected by changes in economic and other conditions.
Consolidated Statements of Cash Flows. For the purpose of cash flows, the Company considers all highly
liquid investments with a maturity date of three months or less when purchased to be cash equivalents. Significant
transactions may occur that do not directly affect cash balances and, as such, are not disclosed in the Consolidated
Statements of Cash Flows. Certain such non-cash transactions are disclosed in the Consolidated Statements of
Shareholders’ Equity, including shares issued as compensation and issuance of stock options.
Fair Value of Financial Instruments. The carrying amounts of the Company’s short-term financial
instruments, including cash equivalents, short-term investments, trade accounts receivable and accounts payable,
approximate their fair values based on the short maturities of those instruments. The Company’s long-term debt is
variable rate debt and, as such, approximates fair value, as interest rates are variable based on prevailing market
rates.
Successful Efforts Method of Accounting. The Company follows the successful efforts method of
accounting for its natural gas and oil activities. Under the successful efforts method, lease acquisition costs and all
development costs are capitalized. Unproved properties are reviewed quarterly to determine if there has been
impairment of the carrying value, and any such impairment is charged to expense in the period. Exploratory drilling
costs are capitalized until the results are determined. If proved reserves are not discovered, the exploratory drilling
costs are expensed. Other exploratory costs, such as seismic costs and other geological and geophysical expenses,
are expensed as incurred. The provision for depreciation, depletion and amortization is based on the capitalized
costs as determined above. Depreciation, depletion and amortization is on a cost center by cost center basis using
the unit of production method, with lease acquisition costs amortized over total proved reserves and other costs
amortized over proved developed reserves.
When circumstances indicate that proved properties may be impaired, the Company compares expected
undiscounted future cash flows on a cost center basis to the unamortized capitalized cost of the asset. If the future
undiscounted cash flows, based on the Company’s estimate of future natural gas and oil prices and operating costs
and anticipated production from proved reserves, are lower than the unamortized capitalized cost, then the
capitalized cost is reduced to fair market value.
The Company amortizes and impairs natural gas and oil properties on a field-by-field cost center basis.
Management believes this policy provides greater comparability with other successful efforts natural gas and oil
companies by conforming to predominant industry practice. In addition, the field level is consistent with the
Company’s operational and strategic assessment of its natural gas and oil investments.
DB2/21043537.7 F-9