BP Annual Report and Form 20-F 2011 - Company Reporting

Additional information for shareholdersCritical accounting policiesThe significant accounting policies of the group are summarized in Financialstatements – Note 1 on pages 182-189.Inherent in the application of many of the accounting policies usedin preparing the financial statements is the need for BP management tomake judgements, estimates and assumptions that affect the reportedamounts of assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the period. Actualoutcomes could differ from the estimates and assumptions used. Thefollowing summary provides more information about the critical accountingjudgements and estimates that could have a significant impact on theresults of the group and should be read in conjunction with the informationprovided in the Notes on financial statements, including Note 1 Significantaccounting policies.The areas requiring the most significant judgement and estimationin the preparation of the consolidated financial statements are in relationto oil and natural gas accounting, including the estimation of reserves, therecoverability of asset carrying values, business combinations, taxation,derivative financial instruments, provisions and contingencies, and inparticular, provisions and contingencies related to the Gulf of Mexico oilspill, and pensions and other post-retirement benefits.Oil and natural gas accountingThe group follows the principles of the successful efforts methodof accounting for its oil and natural gas exploration, appraisal anddevelopment expenditure. The group’s accounting policy for oil and naturalgas exploration, appraisal and development expenditure is provided inFinancial statements – Note 1 on page 184.The accounting for oil and natural gas exploration, appraisal anddevelopment expenditure requires the use of various judgements andestimates in management’s determination of the economic viability of aproject based on a range of technical and commercial considerations, theestablishment of development plans and timing, and estimates of futureexpenditure.Exploration licence and leasehold property acquisition costs arecapitalized within intangible assets and are reviewed at each reporting dateto confirm that there is no indication that the carrying amount exceedsthe recoverable amount. This review includes confirming that explorationdrilling is still under way or firmly planned or that it has been determined,or work is under way to determine, that the discovery is economicallyviable based on a range of technical and commercial considerations andsufficient progress is being made on establishing development plans andtiming. If no future activity is planned, the remaining balance of the licenceand property acquisition costs is written off. Lower value licences arepooled and amortized on a straight-line basis over the estimated period ofexploration.For exploration wells and exploratory-type stratigraphic test wells,costs directly associated with the drilling of wells are initially capitalizedwithin intangible assets, pending determination of whether potentiallyeconomic oil and gas reserves have been discovered by the drilling effort.These costs include employee remuneration, materials and fuel used, rigcosts, delay rentals and payments made to contractors. The determinationis usually made within one year after well completion, but can take longer,depending on the complexity of the geological structure. If the well didnot encounter potentially economic oil and gas quantities, the well costsare expensed as a dry hole and are reported in exploration expense.Exploration wells that discover potentially economic quantities of oil andnatural gas and are in areas where major capital expenditure (e.g. offshoreplatform or a pipeline) would be required before production could begin,and where the economic viability of that major capital expenditure dependson the successful completion of further exploration work in the area,remain capitalized on the balance sheet as long as additional explorationappraisal work is under way or firmly planned.It is not unusual to have exploration wells and exploratory-type stratigraphictest wells remaining suspended on the balance sheet for several yearswhile additional appraisal drilling and seismic work on the potential oil andnatural gas field is performed or while the optimum development plans andtiming are established.All such carried costs are subject to regular technical, commercialand management review on at least an annual basis to confirm thecontinued intent to develop, or otherwise extract value from, the discovery.Where this is no longer the case, the costs are immediately expensed.The determination of the group’s estimated oil and gas reservesrequires significant judgements and estimates to be applied and theseare regularly reviewed and updated. Factors such as the availability ofgeological and engineering data, reservoir performance data, acquisitionand divestment activity, drilling of new wells and commodity prices allimpact on the determination of the group’s estimates of its oil and gasreserves. BP bases its proved reserves estimates on the requirement ofreasonable certainty with rigorous technical and commercial assessmentsbased on conventional industry practice.The estimation of oil and natural gas reserves and BP’s processto manage reserves bookings is described in Exploration and Production– Oil and gas disclosures on page 89, which is unaudited. Details on BP’sproved reserves and production compliance and governance processes areprovided on pages 90-91.Estimates of oil and gas reserves are used to calculate depreciation,depletion and amortization charges for the group’s oil and gas properties.The impact of changes in estimated proved reserves is dealt withprospectively by amortizing the remaining carrying value of the asset overthe expected future production. As discussed below, oil and natural gasreserves also have a direct impact on the assessment of the recoverabilityof asset carrying values reported in the financial statements.If proved reserves estimates are revised downwards, earningscould be affected by higher depreciation expense or an immediate writedownof the property’s carrying value (see discussion of recoverability ofasset carrying values below).The 2011 movements in proved reserves are reflected in thetables showing movements in oil and gas reserves by region in Financialstatements – Supplementary information on oil and natural gas (unaudited)on pages 259-281. Information on the carrying amounts of the group’s oiland gas properties, together with the amounts recognized in the incomestatement as depreciation, depletion and amortization is contained inFinancial statements – Note 15 and Note 9 respectively.Recoverability of asset carrying valuesBP assesses its fixed assets, including goodwill, for possible impairmentif there are events or changes in circumstances that indicate that carryingvalues of the assets may not be recoverable and, as a result, charges forimpairment are recognized in the group’s results from time to time, withcorresponding reductions in the carrying values of the group’s assets.Such indicators include changes in the group’s business plans, changesin commodity prices leading to sustained unprofitable performance, anincrease in the discount rate, low plant utilization, evidence of physicaldamage and, for oil and natural gas properties, significant downwardrevisions of estimated volumes or increases in estimated futuredevelopment expenditure. If there are low oil prices, natural gas prices,refining margins or marketing margins during an extended period, thegroup may need to recognize significant impairment charges.The assessment for impairment entails comparing the carryingvalue of the asset or cash-generating unit with its recoverable amount,that is, the higher of fair value less costs to sell and value in use. Valuein use is usually determined on the basis of discounted estimated futurenet cash flows. Determination as to whether and how much an asset isimpaired involves management estimates on highly uncertain matters suchas future commodity prices, the effects of inflation on operating expenses,discount rates, production profiles and the outlook for global or regionalmarket supply-and-demand conditions for crude oil, natural gas and refinedproducts.154 BP Annual Report and Form 20-F 2011