Review of Accounting Studies, 8, 5–28, 2003
2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
Relative Value Relevance of the Successful Efforts
and Full Cost Accounting Methods in the Oil
and Gas Industry
Fisher College of Business, The Ohio State University, Columbus, OH 43210 Tel.: 614.292.4023
Abstract. This paper examines the value relevance of two alternative accounting methods for exploration and
development (E&D) expenditures for oil and gas ﬁrms. I ﬁnd that full cost (FC) accounting data is more value-
relevant than successful efforts (SE) accounting data. Further analysis reveals that the smooth earnings provided
by the FC method contributes to the higher value relevance of the FC method. This study concludes that a policy of
full capitalization of expenditures with uncertain future economic beneﬁts better summarizes information relevant
to investors relative to a policy of partial capitalization.
Keywords: value relevance, oil and gas accounting, alternative accounting methods
JEL Classiﬁcation: M40, M41
Accounting for oil and gas ﬁrms has been debated since the 1970s. While there have been
numerous academic studies, the question as to which historical cost accounting method,
the successful efforts (SE) or the full cost (FC), best captures the underlying economic
transactions is still unresolved. This study expands the extant literature by examining the
association between market values and accounting data under the alternative accounting
methods using a within-ﬁrm design, rather than a cross-ﬁrm design. The within-ﬁrm design
allows the analysis to focus solely on which accounting method better captures the economic
events of oil and gas ﬁrms.
Currently, the International Accounting Standards Board (IASB) is developing a standard
for accounting in the oil and gas industry. Consistent with the Financial Accounting Stan-
dards Board (FASB), the IASB plans to base the primary ﬁnancial statements on a historical
cost method of accounting. While prior academic research has found reserve estimates to be
a more useful measure in ﬁrm valuation (e.g., Magliolo, 1986), the IASB still plans to use
historical cost measures, such as the SE or FC methods, but plans to require supplemental
disclosures about reserve estimates (IASC, 2000). Given the IASB’s reliance on historical
cost accounting, it is important to provide empirical evidence regarding the usefulness of the
alternative historical cost accounting methods. While there are alternative users of ﬁnancial
statements, and therefore alternative measures of usefulness, I focus on the usefulness of
accounting to investors. As such, I examine the ability of summary accounting measures to
explain market value and stock returns.
Oil and gas ﬁrms currently have the option to select either the SE or FC accounting method
to account for their exploration and development (E&D) activities. Managers have different
motivations for choosing particular accounting methods (see Fields, Lys and Vincent, 2001).