Accounting

BTU Method And Relative Cost Method Of Joint Cost Allocation

British Thermal Unit (BTU Method): The BTU method uses the relative heat content of oil and gas, expressed in British Thermal Unit.

Equivalent BTU content ratios of gas to oil used range from 4.8 to 6 mcf to 1 bbl. of oil. Joint costs are allocated in proportion to BTU content of the products and can be applied to the output of the test year as well as to average remaining reserves . The rationale of the method is that the consumer is interested in energy, not in gas, oil, or coal. The BTU method allocates joint costs based on readily ascertainable physical data and can be applied to all the products connected with gas and oil.

The British thermal unit method (BTU method) has been criticized for not properly reflecting the value of all the joint products produced. Only a part of the products resulting from crude oil are valuable for BTU content alone. Gasoline is valuable because of its form. Various modifications of the basic BTU formula have been suggested to give proper weighting to energy form.

Relative Cost Method: Under this method which has been accepted by the Federal Power Commission, production costs from joint product leases are allocated to the oil  and gas produced on the basis of the relationship between costs actually incurred in producing the  same products from single product leases (i.e. leases from which only oil or only gas is produced).

This method has considerable appeal where the company has sufficient single product leases for computing representative single product costs. In addition, the company should be large enough to assume an averaging of economic and geological lease characteristics. Of course, this method does not provide for allocation of exploration  expenditures which represent a significant portion of total costs and are incurred on a company-wide basis.

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