Incurred Cost

Test Your Knowledge

Quiz on Incurred Costs in Oil & Gas

Instructions: Choose the best answer for each question.

1. What does "Incurred Cost" encompass?

a) Only the direct costs of a project b) All expenses paid to date c) Total financial obligation, including liabilities d) Only the cost of materials used

2. How does Incurred Cost differ from Total Expenditure to Date?

a) Incurred Cost includes only actual payments made b) Total Expenditure to Date includes future liabilities c) Incurred Cost reflects all financial commitments, including unpaid obligations d) There is no difference between the two terms

3. Why is understanding Incurred Cost crucial for financial reporting?

a) It helps to determine the exact amount of profit made b) It provides a more accurate picture of project's financial commitment c) It is required by law for all oil & gas companies d) It is used to calculate the total cost of a project

4. Which of the following is NOT an example of an indirect cost?

a) Insurance premiums b) Salaries of administrative staff c) Cost of drilling equipment d) Overhead expenses

5. What is the key to accurately calculating Incurred Cost?

a) Having a clear understanding of project deadlines b) Maintaining detailed documentation of all costs and liabilities c) Using advanced financial software d) Consulting with a financial advisor

Exercise on Incurred Costs

Scenario:

An oil & gas company is developing a new well. They have incurred the following costs:

• Direct Costs:
  • Drilling equipment rental: $1,000,000
  • Labor costs: $500,000
  • Materials: $200,000
• Indirect Costs:
  • Administrative expenses: $100,000
  • Insurance: $50,000
• Liabilities:
  • Outstanding payments to contractors: $300,000
  • Future contractual obligations for equipment maintenance: $150,000

Task:

Calculate the total Incurred Cost for this well project.

Techniques

Incurred Costs: The Real Cost of Oil & Gas Operations

Chapter 1: Techniques for Calculating Incurred Costs

Calculating incurred costs in the oil and gas industry requires a systematic approach that accurately captures all financial obligations. Several techniques are employed to ensure comprehensive cost accounting:

1. Direct Cost Tracking: This involves meticulously recording all direct costs associated with a project. This includes:

• Materials: The cost of all raw materials, supplies, and equipment used directly in the project. Detailed purchase orders, invoices, and receipts are essential.
• Labor: Wages, salaries, benefits, and any associated taxes for personnel directly involved in the project. Time sheets and payroll records are crucial.
• Equipment Rental: Costs associated with renting or leasing equipment specifically for the project. Rental agreements and invoices provide necessary data.

2. Indirect Cost Allocation: Indirect costs are more challenging to track and allocate accurately. Common methods include:

• Overhead Rate: A predetermined percentage of direct costs is allocated as indirect costs, representing administrative overhead, insurance, and general company expenses.
• Activity-Based Costing (ABC): This more sophisticated method assigns indirect costs based on the specific activities involved in the project, providing a more accurate allocation than a simple percentage.
• Functional Cost Allocation: Costs are assigned to specific departments (e.g., engineering, operations) and then allocated to projects based on their usage.

3. Liability Accounting: This crucial aspect captures future financial obligations:

• Accruals: Recording expenses that have been incurred but not yet paid, such as outstanding invoices.
• Commitments: Recording future contractual obligations, even if work hasn't begun. This could include committed but not yet incurred expenses for future services or equipment purchases.
• Contingencies: Setting aside funds for potential unforeseen expenses, such as environmental remediation or legal liabilities.

Chapter 2: Relevant Models for Incurred Cost Analysis

Several models aid in analyzing and predicting incurred costs:

1. Earned Value Management (EVM): EVM is a project management technique that integrates scope, schedule, and cost to provide a comprehensive assessment of project performance. It uses metrics like planned value, earned value, and actual cost to track progress and identify variances. This allows for early detection of cost overruns and enables proactive adjustments.

2. Cost Estimation Models: Various models, ranging from simple parametric estimations to complex probabilistic models, predict project costs based on historical data and project characteristics. These models help in budgeting and forecasting incurred costs. Examples include:

• Bottom-up Estimating: Aggregating individual cost estimates for each project task.
• Top-down Estimating: Using analogous projects or historical data to estimate total project costs.

3. Monte Carlo Simulation: This probabilistic model uses random sampling to simulate a range of possible outcomes for incurred costs, considering uncertainties in various cost elements. This provides a more realistic picture than deterministic models.

4. Life Cycle Costing (LCC): This model considers all costs associated with a project over its entire life cycle, from initial investment to decommissioning and environmental remediation. This holistic approach provides a complete picture of the total financial commitment.

Chapter 3: Software for Incurred Cost Management

Efficient incurred cost management relies on appropriate software solutions:

1. Enterprise Resource Planning (ERP) Systems: ERP systems like SAP, Oracle, and Microsoft Dynamics 365 provide comprehensive functionalities for tracking costs, managing projects, and generating financial reports. They integrate various business functions, streamlining data flow and providing a holistic view of incurred costs.

2. Project Management Software: Tools like Microsoft Project, Primavera P6, and Asana aid in scheduling, tracking progress, and monitoring costs associated with individual projects. They often integrate with accounting software for seamless data transfer.

3. Specialized Oil & Gas Accounting Software: Some software packages are specifically designed for the oil & gas industry, incorporating specific functionalities for managing complex cost structures, regulatory compliance, and reservoir modeling.

4. Data Analytics Platforms: Tools like Tableau and Power BI allow for visualization and analysis of incurred cost data, enabling identification of trends, outliers, and potential areas of concern.

Chapter 4: Best Practices for Incurred Cost Management

Effective incurred cost management requires adherence to best practices:

1. Accurate Data Collection: Implementing robust data collection procedures is paramount. This includes using standardized forms, regular data entry, and data validation checks.

2. Timely Reporting: Regular reporting on incurred costs provides early warnings of potential cost overruns. This allows for timely intervention and corrective actions.

3. Cost Control Measures: Employing cost-control measures, such as competitive bidding, efficient resource allocation, and value engineering, is crucial in keeping costs in check.

4. Internal Controls: Establishing robust internal controls, including segregation of duties and regular audits, helps to prevent fraud and ensure data accuracy.

5. Collaboration & Communication: Fostering collaboration between project teams, accounting departments, and management ensures transparency and facilitates efficient cost management.

6. Continuous Improvement: Regular review and assessment of incurred cost management processes allow for identification of areas for improvement and optimization.

Chapter 5: Case Studies of Incurred Cost Management in Oil & Gas

(Note: Specific case studies would require confidential data and would not be appropriate for inclusion here. However, a chapter could detail hypothetical scenarios illustrating best practices and the consequences of poor cost management. For example, one case study could illustrate how a company successfully used EVM to prevent a major cost overrun on a deepwater drilling project, while another could highlight a scenario where a lack of robust cost tracking resulted in significant financial losses.) Examples of case study areas could include:

• Successful application of EVM in a major offshore platform project.
• Cost overruns on a shale gas development and the lessons learned.
• The impact of accurate cost accounting on investment decisions for a new pipeline project.
• How a company used data analytics to identify and mitigate cost inefficiencies.