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Energy & Natural Resources

Revenue Recognition Considerations for Energy Companies

INTRODUCTION

August 8, 2018

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To Receive CPE Credit

• Individuals• Participate in entire webinar• Answer polls when they are provided

• Groups• Group leader is the person who registered & logged on to the webinar• Answer polls when they are provided• Complete group attendance form • Group leader sign bottom of form• Submit group attendance form to training@bkd.com within 24 hours of webinar

• If all eligibility requirements are met, each participant will be emailed their CPE certificate within 15 business days of webinar

Brian Matlock, CPANational Industry Leader: Energy & Natural Resourcesbmatlock@bkd.com

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AGENDA

Key Dates

Transition Method

The Five-Step Revenue Model

New Disclosures

What to Do Next

Key Dates

Nonpublic Entity• Annual reporting periods beginning after December 15, 2018

• Calendar year January 1, 2019–December 31, 2019• Q1 2019 – Must be ready

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Transition Method

Full retrospective – adjust each prior reporting period

Modified retrospective – cumulative effect at the beginning of the period of adoption

DETERMINE TRANSITION METHOD PRACTICAL CONSIDERATION

Most upstream companies have elected the modified retrospective approach given the public company results have not yielded a material difference in the shifting of revenue between periods.

THE FIVE-STEP REVENUE MODEL

STEP 1: Identify the contract(s) with a customer

STEP 2: Identify the separate performance obligations

STEP 3: Determine the transaction price

STEP 4: Allocate the transaction price to the separate performance obligations

STEP 5: Recognize revenue when (or as) a performance obligation is satisfied

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Step 1: Identify the Contract

ASC 606 defines a contract as “an agreement between two or more parties that creates enforceable rights and obligations.” Accounting for contracts with customers under the new model only begins when all the following criteria are met

Approval & commitment

Identifiable rights, obligations & payment terms, &

Commercial substance

Collectibility (barring credit quality issues in client base, this should be straight forward)

CONTRACT DEFINITION PRACTICAL CONSIDERATION

• Joint operating arrangements

• Commodity Exchange Arrangements (CEA)

• Derivatives vs. Normal Purchases & Normal Sales (NPNS)

Step 1: Identify the Contract

ASC 606 allows an entity to account for contracts & performance obligations as a portfolio when

Performance obligations must have similar characteristics

The entity reasonably expects that the effects on the financial statements from applying the portfolio method are not materially different than applying ASC 606 to the individual contracts

The entity must use estimates & assumptions that reflect the size & composition of the portfolio

Some public companies have found using the portfolio method can be useful for groups of similar contracts. This just has to be done carefully.

PORTFOLIO METHOD PRACTICAL CONSIDERATION

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Step 1: Identify the Contract

Contract modifications under ASC 606:

Blend-and-extend (B&E) contract modifications

Partial contract cancellations

CONTRACT MODIFICATIONS PRACTICAL CONSIDERATION

Companies will need to determine the contract duration when the initial term has passed & the contract has turned“evergreen” (meaning the contract will continue until one party cancels). A contract for which the initial term has expired & automatically renews on a month-to-month basis is effectively a month-to-month contract (a one-month contract with a right to renew).

Step 2: Identify Performance Obligations

A performance obligation is a promise to transfer goods or services to a customer that is

Capable of being distinct because the customer can benefit from the good or service on its own or with other readily available resources, &

Distinct within the contract’s context

CONTRACT MODIFICATIONS PRACTICAL CONSIDERATION

• Generally measured as the transfer of a single barrel of oil or Mcf of natural gas as defined by the marketing/sale agreement

• Can also include processing, compression, servicing, etc., as additional performance obligations

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The series provision requires goods or services to be accounted for as a single performance obligation in certain instances, even though the underlying goods or services are distinct

Each distinct good or service in the series represents a performance obligation that will be satisfied over time

The entity would measure its progress toward satisfaction of the performance obligation using the same measure of progress for each distinct good or service in the series

Step 2: Identify Performance Obligations

SERIES PROVISION

Most agree that the commodity sales contracts contain multiple performance obligations—& the sale of a single barrel generally constitutes a separate performance obligation.

PRACTICAL CONSIDERATION

A contract may contain an option to acquire additional goods or services. A separate performance obligation could exist if the option provides a material right to the customer that it would not receive without entering into that contract. Material right obligations must be separately valued to allocate part of the transaction price to those specific performance obligations.

Step 2: Identify Performance Obligations

MATERIAL RIGHT PRACTICAL CONSIDERATION

• Take-or-pay arrangements

• Volumetric production payments

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Step 3: Determine the Transaction Price

Revenues are recorded at the transaction price; Several factors go into determining the transaction price as noted below

Variable consideration

Constraining estimates of variable consideration

Significant financing

Noncash consideration

Consideration payable to a customer

• Contracts for the forward sale of commodities

• See SWD example

PRACTICAL CONSIDERATIONTRANSACTION PRICE

Step 3: Determine the Transaction Price

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Step 4: Allocate the Transaction Price

For each performance obligation, determine standalone selling price

• If one doesn’t exist, use a reasonable basis to estimate

• If not estimable, use residual if one of the following• Sold to different customers for broad range of amounts

• Has not yet been sold on a standalone basis

Spread transaction price over performance obligations using standalone selling price to weight allocation

Step 5: Recognize Revenue

An entity would recognize revenue when (or as) the entity satisfied a performance obligation by transferring a promised good

• If the performance obligations are satisfied at a point in time, the associated revenue would be recognized at that point in time

• Distinct goods or services that are substantially the same & transfer over time are a series, which may allow companies to recognize the amounts billed as revenue

• Distinct goods or services that transfer at a point in time are not eligible for the series guidance, meaning an entity would be required to estimate prices & quantities when determining transaction price & allocate the transaction price to the performance obligations based on the projected delivery quantities

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Principle vs. Agent

Production Imbalances – Balancing Arrangements

Sales of Mineral Interests

Volumetric Production Payments

Alternate Revenue Programs (ARP)

Specific Upstream Industry Items

PRACTICAL CONSIDERATIONS

New Disclosure

Disaggregation of revenue

• Point in time vs. over time

• Qualitative information

Information about performance obligations

Significant payment terms

Nature of goods & services

Obligations for returns & refunds

Types of warranties & related obligations

REQUIREMENTS PRACTICAL CONSIDERATION

PIONEER NATURAL RESOURCES COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2018

(Unaudited)

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Disclosure: Impact of 606 Adoption Example

Impact of ASC 606 adoption. On January 1, 2018, the Company adopted ASC 606 by applying the modified retrospective method to all revenue contracts as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with historic accounting under ASC 605. The Company completed a detailed review of its revenue contracts, which represent all of the Company's revenue streams including oil, NGL and gas sales and sales of purchased oil and gas, to determine the effect of the new standard for the three months ended March 31, 2018. The Company did not record a change to its opening retained earnings as of January 1, 2018 as there was no material change to the timing or pattern of revenue recognition due to the adoption of ASC 606. The adoption of ASC 606 as of January 1, 2018 had the following impact on the Company's results of operations for the three months ended March 31, 2018:

PER >> 10-Q PIONEER NATURAL RESOURCES COMPANY – NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – March 31, 2018 (Unaudited)

Disclosure: Impact of 606 Adoption Example

Changes in oil and gas revenues and oil and gas production costs (specifically gathering, processing and transportation costs) are due to the conclusion under the control model in ASC 606 that the third-party processor or transporter is only providing gas processing or transportation services and that the Company remains the principal owner of the commodity until sold to the ultimate purchaser. This is a change from ASC 605 where the Company historically recorded gas processing fees as a reduction of revenue recognized by the Company, as these fees were considered necessary to separate the wet gas stream into its sellable components (i.e. dry gas and individual NGL components). Under ASC 605, third-party processing and transportation companies were determined to have control of the commodities being processed and transported. As a result of adopting ASC 606, the Company has modified its presentation of revenues and expenses for these arrangements. Revenues related to these agreements are now presented on a gross basis for amounts expected to be received from third-party purchasers through the marketing process. Gathering, processing and transportation expenses related to these agreements, incurred prior to the transfer of control to the purchaser, are now presented as oil and gas production costs.

PER >> 10-Q PIONEER NATURAL RESOURCES COMPANY – NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – March 31, 2018 (Unaudited)

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Disclosure: Disaggregated Revenue from Contracts with Purchasers Example

Disaggregated revenue from contracts with purchasers. Revenues on sales of oil, NGLs, gas and purchased oil and gas are recognized when control of the product is transferred to the purchaser and payment can be reasonably assured. Sales prices for oil, NGL and gas production are negotiated based on factors normally considered in the industry, such as an index or spot price, distance from the well to the pipeline or market, commodity quality and prevailing supply and demand conditions. As such, the prices of oil, NGLs and gas generally fluctuate based on the relevant market index rates. The following table provides information about disaggregated revenue from contracts with purchasers by product type:

PER >> 10-Q PIONEER NATURAL RESOURCES COMPANY – NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – March 31, 2018 (Unaudited)

Disclosure: Disaggregated Revenue from Contracts with Purchasers Example

Oil sales. Sales under the Company's oil contracts are generally considered performed when the Company sells oil production at the wellhead and receives an agreed-upon index price, net of any price differentials. The Company recognizes revenue when control transfers to the purchaser at the wellhead based on the net price received.

NGL and gas sales. Sales under the Company's gas processing contracts are recognized when the Company delivers gas to a midstream processing entity at the wellhead or the inlet of the midstream processing entity's system. The midstream processing entity gathers and processes the gas and remits proceeds to the Company for the resulting sales of NGLs and gas. In many cases, the Company elects to take its NGLs and residue gas in-kind at the tailgate of the midstream entity's processing plant and subsequently market the products itself. When the Company elects to take-in-kind, it delivers NGLs and gas to a third-party purchaser at a contractually agreed-upon delivery point and receives a specified index price from the purchaser.

PER >> 10-Q PIONEER NATURAL RESOURCES COMPANY – NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – March 31, 2018 (Unaudited)

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Disclosure: Disaggregated Revenue from Contracts with Purchasers Example

The Company evaluated whether it was the principal or the agent in the natural gas processing transactions and concluded that it is the principal when it has the ability to take-in-kind, which is the case in the majority of the Company's gas processing and transportation contracts. Therefore, beginning January 1, 2018, the Company began recognizing revenue on a gross basis, with the gathering, processing and transportation costsassociated with its take-in-kind arrangements being recognized as oil and gas production costs in the Company's accompanying consolidated statement of operations.

Sales of purchased oil and gas. The Company periodically enters into pipeline capacity commitments in order to secure available oil, NGL and gas transportation capacity from the Company's areas of production. The Company enters into purchase transactions with third parties and separate sale transactions with third parties to diversify a portion of the Company's WTI oil sales to the Gulf Coast refinery or international export markets and to satisfy unused pipeline capacity commitments. Revenues and expenses from these transactions are presented on a gross basis as the Company acts as a principal in the transaction by assuming control of the commodities purchased and the responsibility to deliver the commodities sold. Revenue is recognized when control transfers to the purchaser at the delivery point based on the price received from the purchaser. The transportation costs associated with these transactions are presented as a component of purchased oil and gas expense. Firm transportation payments on excess pipeline capacity are included in other expense in the accompanying consolidated statements of operations.

PER >> 10-Q PIONEER NATURAL RESOURCES COMPANY – NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – March 31, 2018 (Unaudited)

Disclosure: Disaggregated Revenue from Contracts with Purchasers Example

Performance obligations and contract balances. The majority of the Company's product sale commitments are short-term in nature with a contract term of one year or less. The Company typically satisfies its performance obligations upon transfer of control as described above in Disaggregated revenue from contracts with purchasers and records the related revenue in the month production is delivered to the purchaser. Settlement statements for sales of oil, NGLs and gas and sales of purchased oil and gas may not be received for 30 to 60 days after the date production is delivered, and as a result, the Company is required to estimate the amount of production delivered to the purchaser and the price that will be received for the sale of the product. The Company records the differences between estimates and the actual amounts received for product sales in the month that payment is received from the purchaser. The implementation of ASC 606 has not changed existing controls around revenue estimates and the accrual process. Historically, differences between the Company's revenue estimates and actual revenue received have not been significant. As of March 31, 2018, the accounts receivable balance representing amounts due or billable under the terms of contracts with purchasers was $793 million.

PER >> 10-Q PIONEER NATURAL RESOURCES COMPANY – NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – March 31, 2018 (Unaudited)

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What to Do Next

Remember even if nothing changes, this has to be proven through documentation• Decide transition method

• Determine revenue streams

• Determine contracts in revenue streams & if they can be grouped together (portfolio method)

• Analyze contracts to determine recognition under new standard

• Gather information for disclosures

Document decisions made, document significant judgments, document, document, document

PROJECT MANAGEMENT EXERCISE

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Continuing Professional Education (CPE) Credit

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The information contained in these slides is presented by professionals for your information only & is not to be considered as legal advice. Applying specific information to your situation requires careful consideration of facts & circumstances. Consult your BKD advisor or legal counsel before acting on any matters covered.

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CPE Credit

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