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CHK » Topics » Note 13 - Divestitures, page 110

This excerpt taken from the CHK 8-K filed Jul 9, 2008.

Note 13 - Divestitures, page 110

 

11. We note the variable production payment (VPP) terms require you to purchase the VPP production you are required to deliver to the buyer. You have recorded the proceeds as a reduction of oil and gas properties and an investing activity cash flow. Please clarify how you determined that the VPP should be accounted for as a reduction to the full cost pool and explain how you determined that the VPP should not be recorded as a borrowing. As part of this analysis, tell us the financial impact of the hedges sold to the buyer of your VPP.

Response: Based on the VPP buyers’ assumption of significant production and reserve risks and substantially all price risk, Chesapeake concluded that the production payment should be accounted for as a sale of a volumetric production payment. Below is a more detailed analysis of the conclusions reached with respect to the accounting for this transaction.

Chesapeake follows the full-cost method of accounting under which all costs associated with oil and natural gas property acquisition, exploration and development activities are capitalized. Pursuant to Regulation S-X Rule 4-10(c)(6)(i), proceeds from the sale of oil and natural gas properties are accounted for as reductions of capitalized costs unless such sales involve a significant change in the relationship between costs and the value of proved reserves or the underlying value of unproved properties, in which case a gain or loss is recognized.

To determine the appropriate accounting for the VPP production payment, we examined the substance of the transaction to identify which party had the risks of ownership following the transaction, including price and production and reserve risks. We were guided by the principles included in the following table, which is adapted from Petroleum Accounting – Principles, Procedures, & Issues, PricewaterhouseCoopers LLP and Professional Development Institute of the University of North Texas, 6th ed. We believe this publication provides an important and relevant source of industry practice for the accounting for volumetric production payments.

Securities and Exchange Commission

June 13, 2008

Page 11 of 14

 

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