Accounting

Joint Cost Allocation Methods In Petroleum Industries

Joint Cost Allocation Methods In Petroleum Industries : Joint cost allocation plays significant role in connection with the Federal regulation of prices in the petroleum industry. Real cost cannot be ascertained if allocation of indirect cost is not done.

Oil and gas are often joint products. The wildcatter drilling a well generally cannot know whether he will discover oil and /or gas, or nothing. One third of all gas is produced by oil wells. Obviously, there are substantial joint costs, and these costs relate to both crude oil and natural gas. Traditionally, accounting in the oil industry looked upon gas as a by-product; and no serious effort was made to separate gas cost from total joint costs. With the dramatic increase in natural gas demand, coupled with long-distance pipe lines, natural gas has emerged as a full joint product. So, proper Joint Cost Allocation Methods should be chosen to allocate them accurately.

In recent years, the problem in Cost Allocation between crude oil and natural gas has been intensified due to the Federal Power Commission’s role in attempting to established just and reasonable prices for natural gas. A landmark court decision required the FPC to consider gas  costs, at least as a basis of comparison with other regulatory methods.

Accordingly, accountants representing the FPC, the gas producers, and the gas distributors have searched for a solution to a problem of allocating joint costs which theoretically is incapable of other than an arbitrary solution; i.e., splitting joint costs for the purpose of setting a selling price for one of the products, based on actual costs. Despite the best efforts of accountants and economists, the basic problem remains in allocating joint costs.

The following Joint Cost Allocation Methods have been used or suggested in order to arrive at some answer to this vexing problem of allocating joint costs:

  1. The sales realization method often referred to as the sales allocation or the Federal Trade Commission method
  1. The BTU (British Thermal Units) allocation method
  2. The relative cost method

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