© 2004 KPMG LLP, the Canadian member firm of KPMG International, a Swiss cooperative. All rights...

1© 2004 KPMG LLP, the Canadian member firm of KPMG International, a Swiss cooperative. All rights reserved.© 2004 KPMG LLP, the Canadian member firm of KPMG International, a Swiss cooperative. All rights reserved.

3rd QUARTER

OIL & GAS UPDATE

Breakfast SeminarOctober 5, 2004


Regulation 105

Jim Samuel403.691.8349

[email protected]

3© 2004 KPMG LLP, the Canadian member firm of KPMG International, a Swiss cooperative. All rights reserved.

Agenda

• Regulation 105 Refresher


Regulation 105

• Applies to every person paying a non-resident person for services rendered in Canada

• Withholding of 15%


Regulation 105

• Non-resident may apply for a waiver based on:

– Net profits

– Treaty

• Shifting of withholding tax burden to payer by grossing up fees


Failure to Withhold Under Regulation 105

• Tax, interest, and penalties

• Arrangement with non-resident to obtain refund from the CRA?


Regulation 105 Example

Cdn Sub

US Parent3rd Party

ContractorManagement fee

Payment

Services providedIn Canada

US

Canada


2004 Federal Budget Update

Chris Post403.691.8434

[email protected]


2004 Federal Budget Update: Oil & Gas Mutual Funds

• Timeline:

– March 23, 2004 budget was tabled

– September 16, 2004 draft legislation issued

– To be held open until October 15, 2004

• Budget changes for non-resident investors:

– TCP gain distributions subject to tax

– Limitation of non-resident investors to 50%

– New 15% withholding tax on all distributions



• Limitation of non-resident ownership of resource mutual funds to 50%

– Deferral of “new rule” to January 1, 2005

– New rule to be fair market value based

• Significant problem area!!!

– Still have grandfathering of entities off-side on March 22, 2004 until December 31, 2006



• New 15% withholding tax

– Part XIII.2 tax

– Withhold from payments made after 2004

– “Assessable distributions”

– Investor claims refund if experiences loss

– No tax returns to file unless want refund

– May make administration easier…..


Crown Charge ReimbursementCraig Natland403.691.8022

[email protected]


Crown Charge ReimbursementsMutual Fund Trust

• PURPOSE

– Since inception, MFT have been organized to earn oil and gas royalty income and have reimbursed the Producer Corporation their non-deductible Crown Charges

• RESULT

– The Income Tax Act facilitated these reimbursements and allowed for all of the income tax attributes related to non-deductible Crown Charges to be integrated with the distribution of cash to unit holders

– This ensured that the Producer Corporation and the MFT generally would be non-taxable entities and that all income tax attributes were assigned to the public unit holders


LEGAL RELATIONSHIP

– The legal relationships among all the parties are documented in a set of sophisticated legal documents including:

• Royalty Agreement

• Trust Indenture

– These Agreements document the detailed calculation of the amount and the timing of payments of such items as royalties, reimbursements, and cash distributions

– Any amendment to these documents must be well thought out, and generally must be approved by unit holders at a future AGM



2003 AMENDMENTS TO INCOME TAX ACT

• PURPOSE

– To phase-in the deduction of Crown charges

– To phase-out the deduction of Resource Allowance

• RESULT

– MFT had to follow existing legal agreements in computation and timing of royalties, reimbursements, cash distributions

– Integration was lost. In many cases the result is two deductions for Crown Charges – in aggregate approximately $19 versus expected amount of $10. Generally some portion (approximately $4) of this excess of $9 is locked inside the Producer Corporation and not available




2004 AMENDMENTS

• PURPOSE

– To eliminate (up to the) $9 of additional deductible amount

– Retroactive

• RESULT

– Based on (interpreting the) press release (versus actual draft legislation) integration is not achieved

– In many cases, the result is the Producer Corporation will increase its income for tax by $9

(Query: What cash is available to pay this 2003 tax?)

– Integration cannot be achieved without amending existing legal relationships. If integration is possible, additional 2003 taxable income to unit holders

(Query: Requires amended tax filings)


Crown Charge ReimbursementsPartnerships

• Many have utilized Reimbursement process

• For 2003 – Many others adopted a reimbursement policy

– To adjust for mis-match of rates between

• Resource Allowance

• Crown Charges

• Department of Finance

– Accepts higher rate to match Resource Allowance

– Wants to eliminate aggregate deductions in excess of their phase in rate


Stock Option Update

Jason Brown403.691.8293

[email protected]


Stock-Based Compensation


1) What models are in use today?

2) What issues are entities facing?



Fair value models in use today:

1) Black-scholes

2) Binomial models

3) Others?

The fair value of an option estimated at the grant date is not subsequently adjusted for changes in any of the underlying factors.


Stock-based Compensation

What are some of the key considerations in calculating fair value?

1) Volatility

2) Expected life of the option

3) Dividends

4) Risk-free interest rate



Factors to consider in estimating expected volatility include:

1) the historical volatility of the stock over the most recent period

2) the length of time an enterprise’s stock has been publicly traded

3) appropriate and regular intervals for price observations



Larger Public Oil and Gas Companies

• Volatility ranged from 16% to 56% with the average volatility being 30%.

Medium Sized Public Oil and Gas Companies

• Volatility ranged from 20% to 102% with the average volatility being 43%

Smaller Sized Public Oil and Gas Companies

• Volatility ranged from 30% to 118% with the average volatility being 62%



Private companies/entities may choose to include expected volatility or to exclude it. The result of excluding volatility in estimating an option’s value is an amount commonly termed the minimum value.



Factors to consider in estimating the expected life:

Factors to consider in estimating the expected life of an award of options include:

a) the vesting period of the grant. The expected life must at least include the vesting period

b) the average length of time similar grants have remained outstanding in the past

c) expected volatility of the underlying stock



Forfeitures:

No compensation cost should be recognized for awards that employees forfeit either because they fail to satisfy a service requirement for vesting or because the enterprise does not achieve a performance condition.

Previously recognized compensation cost is not reversed if a vested employee stock option expires unexercised.



Fair value as a percentage of the exercise price of the option:

• Larger Public Oil and Gas Companies

– Fair value ranged from 22% to 57% with the average fair value being 36%.

• Medium Sized Public Oil and Gas Companies

– Fair value ranged from 12% to 88% with the average fair value being 43%

• Smaller Sized Public Oil and Gas Companies

– Fair value ranged from 27% to 72% with the average fair value being 52%



Earnings per share calculation:

In calculating diluted earnings per share, the weighted average unrecognized compensation cost is added to the assumed proceeds in determining shares to be repurchased.



• What is the status of stock-based compensation in the U.S.?

• In October 2003 the FASB has stated that the proposed statement would be effective for all employee awards granted, modified, or settled after the beginning of the first fiscal year for fiscal years beginning after December 15, 2004

• As a result, ultimate standards arrived at by the U.S. and the IAS may differ from those that presently exist in Canada

• In addition, a Canadian to U.S. GAAP difference may exist for companies for fiscal 2004 depending upon their particular situation


ARO Update


Implementation Observations

• Observations based on review of interim disclosures of over 60 Canadian public oil and gas companies and client experiences

• Restatement adjustment – Both increases and decreases in retained earnings in earliest presented opening balance sheet on restatement; so, no easy rule

• Fair values – No required fair value disclosures on per unit basis (eg. well, facility, etc); average ARO as a % of the NBV of PP&E was 4.6% with the range being between 0.65% and 20.24%

– More data available for well ARO verses facilities, gathering systems and pipelines

– some clients used the AEUB tool to challenge their internal estimates

• Credit-adjusted risk free rate – As expected, senior producers (5%-6%) generally used a lower rate than juniors/intermediates (up to almost 11%); but several juniors/intermediates used relatively low rates (5% to 7% range)



• Statement of cash flow – Almost all producers appropriately treated actual expenditures as operating items; some still treating as an investing items

• Legal liability – While not common, have seen examples of previously recognized liabilities removed (eg. interests in cost centres outside Canada or other assets without legal liability)

• Indeterminate amount or settlement date – Did not observe these exceptions being disclosed. Have seen such instance for pipelines and certain facilities

• Level of aggregation – Have observed a number of producers aggregating at the field level (as permitted)



• Salvage values – Salvage values have appropriately been considered in depletion calculations and have not reduced the ARO liability

• Settlement of ARO liability – Full cost companies appeared to have taken the view that, since they prepare their estimates on a field level, it is inappropriate to record gains and losses on settlement of ARO liabilities (as envisage in the standard). Instead producers are recording revisions with offset to ARC (depleted in future periods)

• Settlement date – Large ranges provided with narrower ranges of when majority of expenditures expected; consider reserve life of proved, probable and possible reserves

• Inflation rate – Not required disclosure, but when provide, inflation rate was between 1.5% to 2.0%


Hedging Update

Anna Alderson403.691.8119

[email protected]


Accounting Guideline 13

• Hedge accounting is optional and many of the majors have chosen not to bother

– MTM used instead, with changes in fair value recorded in earnings each quarter

• Biggest challenge is appropriate and complete documentation:

– specific identification of the hedged item

– proper effectiveness testing (both prospective and retrospective)

• Be careful when assuming that “critical terms match” – do they really?

• New KPMG publication available at www.kpmg.ca

– Services, Audit, Publications, Catalogue


Proposed New Accounting Standards

• Canadian accounting for hedging relationships will soon be “Americanized”

– FAS 133 “Light”

• In September, AcSB approved new Handbook Section 1530, Comprehensive Income and moved forward with its proposals for a new Section on Hedging

– HB 1530 not to be used until the rest of the project is finalized

– The June 2004 Re-Exposure Draft on Hedging was substantially confirmed, although implementation dates and provisions will be reconsidered at the October meeting

– Re-Exposure Draft of a new Handbook Section on Financial Instruments, Recognition and Measurement, will also be considered at the October meeting

• So how will this impact my financial statements????


Cash Flow Hedges

• Most oil and gas company hedges are the cash flow variety

• Under proposed HB Section 3855, the effective portion of the gain or loss on the derivative is recorded in “other comprehensive income”

• Any ineffective portion is recorded in income

• Accumulated gains and losses in other comprehensive income are recognized in income in the same period as the hedged item (e.g., when the hedged anticipated sales are recorded)

• So effectiveness calculations become even more critical!!


Fair Value Hedges

• For example, a hedge of the fair value of fixed rate debt

• All gains and losses from both the hedged item and the derivative are recorded in income. The carrying amount of the hedged item is adjusted for the gain or loss (e.g., the carrying value of the debt is adjusted for the gain or loss)


Asset Impairment Update

Phil Scherman403.691.8001

[email protected]


Impairment of Long-Lived Assets

• HB 3063

• Prospective application

• For years beginning on or after April 1, 2003

• Applies to all long-lived assets held for use, including successful efforts entities


AcG16

• For fiscal years beginning on or after January 1, 2004

• Specific Ceiling Test Guidance

– Frequency

– Two-steps

• Directive on Discontinued Operations

– Sub-set

– Cost Centre


Discontinued Operations

• HB 3475 Applies to Successful Efforts Entities

• Disposal/Sales Program

– Qualifying transactions

– Distinguishable cash flows

• Reportable Segment

• Operating Segment

• Reporting Unit

• Subsidiary

• Asset Group


Q & A

1. Can I use expected sales proceeds?

2. Should expected cash flows include site restoration costs?

3. Can disposition proceeds reduce goodwill?


Trust Issues Update

Murray Suey403.691.8474

[email protected]


Trust Issues Update

• Stock-based Compensation

• Continuous Disclosure Review Results

• EIC Abstract-Exchangeable Securities

• Proposed National Policy – Income Trust Offerings



• Standards for recognition, measurement and disclosure of stock-based compensation

• Estimate fair value except when “virtually impossible to estimate the instrument’s fair value”

• Trust Unit Option Plan with declining strike price

• Inconsistency in practice

– Compensation cost based on fair value vs intrinsic value

• Securities regulator perspective


CSA – Staff Notice 51-310Continuous Disclosure Review of Income Trusts

• Results released February 2004

– 72% of filers reviewed agreed to amend practice prospectively

– 5% of filers reviewed refiled documents

• Issues addressed include:

– Non-GAAP measures and distributable cash

– Components of Unitholders’ Equity

– Goodwill and intangibles

– Comparative financial information


EIC RD37 -Exchangeable Securities Issued by Subsidiaries of Income Trusts

• Originally issued for comments November 2003

• Issue: Classification and measurement of securities on consolidated balance sheet

– Minority interest vs Equity

• Substantial revisions made by EIC

• Classify as equity if

– Holders of exchangeable securities receive equivalent distributions; and

– Exchangable securities ultimately required to be exchanged for trust units

• RD37 to be issued for comments late September 2004


Proposed National Policy 41-201Income Trusts and Other Indirect Offerings

• Issued for comments October 2003. Comments due December 2003.

• Concerns over the quality and nature of prospectus disclosure and continuous disclosure

• Prospectus items addressed include

– distributable cash

• fluctuates vs constant

• assumptions used in estimates of future distributions

• risks and uncertainties that may impact distributions

– short-term debt and impact on future cash distributions

– stability rating or why no rating obtained

• Continuous disclosure – comparative financial information


Accounting Developments, Professional Standards and Regulatory Matters

Herb Snowdon403.691.8481

[email protected]


Accounting Issues

• GAAP Hierarchy – HB 1100

• Employee Future Benefits – HB 3461

• Comprehensive Income – ED

• Subsequent Events – ED

• Non Monterey Transactions – HB 3830

• Earnings Per Share – HB 3500


GAAP Hierarchy

• HB 1100 – Jan 2004

• Primary sources of GAAP

• Eliminates “Industry GAAP”

• New EIC 147 – Transition

• OSC – Must use more detailed guidance in harmonized standards


Employment Future Benefits

• HB 3461 - March 2004

• Disclosure rather then measurement

• Effective for 2004 year ends

• Pensions, health, disability, severance, compensated absences


Comprehensive Income

• ED in 2003

• Requires separate statement of Comprehensive Income

• Includes ETA, unrealized gains and losses

• Delayed to years beginning after October 15, 2005


Subsequent Events

• ED March 2004

• Subsequent event period up to “authorization date”

• Final Planned for Q4/04


Non Monetary Transactions

• Amend HB 3830

• All at fair value unless

– No commercial substance

– Like exchanges

– Unreliable fair values


Earnings Per Share

• July 2004 – amend HB 3500

• Computational guidance on the treasury stock method

• Mandatorily redeemable shares in basic rather than diluted

• Contracts that allow cash or share settlement presumed to be cash settled

• Effective for 2005


EIC’S

• EIC 146 – Flow Through Shares

• EIC 145 – Income Trusts

• D44 – Arrangements containing a Lease

• RD40 – Mandatorily Reedemable Pref’s


Auditors and Offering Documents

• HB 7110 and ED 7200 (amendments)

• PCAOB


Regulatory Matters

• 51-312 – Review Program.

– All New IPO’s

– Market Cap > $750 million

– Audit Committee

• 51-713 – Report on MD+A Review

• Internal Controls


Management’s Discussion and Analysis

Mike McKerracher403.691.8056

[email protected]


Management’s Discussion and Analysis –Items to Consider

• Rolling eight quarters

– Provide summary information on the eight most recently completed interim periods

• Updates for material changes relating to:

– Contractual Obligations

– Off Balance Sheet Arrangements

– Financial Instruments

– Critical Accounting Estimates

– Changes in accounting polices

• Fourth quarter

– Requirement to discuss and analyze fourth quarter events in your annual MD&A


Management’s Discussion and Analysis –Items to Consider

• Non-GAAP measures

– Why the measurement provides useful information

– How management uses the measure

• MD&A should be reviewed by audit committee and approved by board

• Consider rules on MD&A on other public filings

• Annual reporting timeframes

– Annual financial statements and MD&A mailed within 90 days of year end

• MD&A Resources

– Form 51-102F1

– CSA staff Notice 51-311


Business Acquisition Report


Business Acquisition Report (BAR)

• Filing Requirements

– File within 75 days of acquisition

– Significance tests

• Financial Statement Requirements of the Acquisition

– 20% to 40% - 1 year audited and most recent interim period

– 40% or greater - 2 years audited and most recent interim period

• Exemptions for Acquisition of an Interest in an Oil and Gas Property

– If certain exemptions are met the report may include an operating statement instead of full financial statements


Business Acquisition Report (BAR)

• Pro forma Disclosures

– Balance Sheet at most recent annual or interim period

– Income Statement for most recent interim period and year ended

– Compilation Report from auditors

• Exemptions on filing a BAR

– Filing of an information circular or filing statement


Upcoming Events

• Audit Committee Roundtable (for directors) – December 2004

• Q4 Oil & Gas Update Conference call – January 2005

• International Tax Seminar – Spring 2005

• KPMG’s Global Energy Conference (Houston) – May 2005

Resources

• Oil & Gas Update – www.kpmg.ca/oilandgas

• Tax News Flash – www.kpmg.ca/services/tax/publications

• Regulatory and Financial Reporting Update for Income Trusts and REITs – www.kpmg.ca/services/audit/publications

Events & Resources


The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2004 KPMG LLP, the Canadian member firm of KPMG International, a Swiss cooperative. All rights...

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Transcript of © 2004 KPMG LLP, the Canadian member firm of KPMG International, a Swiss cooperative. All rights...