This research paper analyses the impact of Suncor’s transition from Canadian GAAP to IFRS. Suncor is a leading Canadian fully integrated company in the oil and gas industry and is listed on the TSX and NYSE. The analysis will reveal extent to which the qualitative characteristics of the Conceptual Framework for Financial Reporting, i.e. understandability, comparability, reliability and relevance, are affected by this transition in accounting standards.
Major reporting issues that are analyzed include accounting for exploration and evaluation costs, depreciation method for oil and gas reserves, decommissioning and restoration costs, pension liabilities and employee benefits, ...view middle of the document...
The oil and gas industry is one of the most internationally recognized sectors. As a pioneer in the commercial development of Canada's oil sands, Suncor is “one of the largest petroleum resource basins in the world” . The oil and gas is characterized by industry’s particular features namely significant upfront investments, uncertainties about exploration phases, long lead periods related to revenue recognition and extensive project lives. However, IFRS offers guidance specifically designed for extractive activities, therefore forcing industry-specific judgments.
When transitioning to IFRS, Suncor had to carefully consider the main accounting and reporting issues in its sector and how they would affect their financial statements.
The Transition to IFRS in Oil and Gas Industry
Even though the changeover date to IFRS is January 1, 2011, companies were required to disclose management’s estimates of the effect of the transition on the future financial statements in their annual reports for 2008 and 2009. In 2010, dual records had to be kept (under Canadian GAAP and IFRS) and comparative figures had to be included in the financial statements for 2011 under IFRS. Some companies elected to make the GAAP-IFRS conversion earlier and prepared comparative financial statements before 2011, but Suncor reported for the first time under IFRS in 2011. In its annual report for 2010, Suncor gave an update on its preparation for the GAAP-IFRS conversion and also included some numbers regarding the impacted area of its financial statements such as:
• In Property, Plant and Equipment (PP&E), the component level introduction reduces the January 1, 2010 PP&E balance with approximately $110 million.
• Suncor also reclassifies approximately $4.5 billion of Exploration and Evaluation (E&E) assets from PP&E to E&E.
• The difference between discount rate under IFRS and the credit-adjusted risk-free rate results in an increase of approximately $300 million to Asset Retirement Obligations (ARO) liability, a decrease of approximately $700 million to the related PP&E assets and a corresponding reduction to retained earnings at January 1, 2010.
By analysing Suncor’s 2010 annual report, a sophisticated investor would pay attention to the above mentioned disclosures, and consequently will adjust preliminary earnings expectations for 2011 at this point in time (12 months earlier) as described in the Capital Market Study of Ball & Brown (1968).
Exploration, Evaluation Costs and Efficient Securities Market Theory
Certain E&E costs are initially capitalized with the intent to establish commercially viable reserves. The company is required to make estimates and use judgment about future events and circumstances regarding the economic viability of extracting the underlying resources. The costs are subject to technical, commercial and management review to confirm the continued intent to develop and extract the underlying resources. Unsuccessful drilling, or changes to...