Question

The following statement appeared in a financial magazine: “RRA—or Rah-Rah, as it’s sometimes dubbed— has kicked up quite a storm. Oil companies, for example, are convinced that the approach is misleading. Major accounting firms agree.” What is RRA? Why might oil companies believe that this approach is misleading?

Short answer

Answer

Oil companies are concerned because the valuation issue is extremely tenuous.

Step-by-step solution

Step-by-Step SolutionStep 1: Meaning of RRA

The SEC recommended Reserve Recognition Accounting (RRA) as a mechanism (a fair value approach) of accounting for oil and gas resources. According to proponents of this concept, oil and gas should be priced at the time of discovery. The reserve value that remains on earth is calculated, and this amount is recorded on the balance sheet as "oil deposits" after being correctly discounted.

Explaining the reasons for the approach that is misleading.

Oil firms are worried because the value situation is precarious. To appropriately evaluate reserves, for example, the following must be estimated:

1. reserve value,
2. future production costs,
3. estimated disposal times,
4. discount rate, and
5. selling price.