Allocation of Purchase Price in Business Combinations.
Accounting for business combinations
requires the allocation of the purchase price to the various assets and liabilities of the acquired
business at their respective fair values. The most significant estimates in our allocation typically relate
to the value assigned to future recoverable oil and gas reserves and unproved properties. To the
extent the consideration paid exceeds the fair value of the net assets acquired, we are required to
record the excess as goodwill. As the allocation of the purchase price is subject to significant estimates
and subjective judgments, the accuracy of this assessment is inherently uncertain. The value allocated
to recoverable oil and gas reserves and unproved properties is subject to the full cost ceiling limitation
as described in Impairments of Oil and Gas Properties above.
Goodwill.
In a purchase transaction, goodwill represents the excess of the purchase price plus
the liabilities assumed (including deferred income taxes recorded in connection with the transaction)
over the fair value of the net assets acquired. At December 31, 2011, goodwill totaled $535 million and
represented approximately 5% of our total assets.
Goodwill is not amortized; instead it is tested at least annually for impairment at a level of reporting
referred to as a reporting unit. Impairment occurs when the carrying amount of goodwill exceeds its
implied fair value. A two-step impairment test is used to identify potential goodwill impairment and
measure the amount of goodwill impairment loss to be recognized, if any. The first step of the goodwill
impairment test compares the fair value of a reporting unit with its carrying amount, including goodwill.
If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is
considered not to be impaired, thus the second step of the impairment test is unnecessary.
The second step of the goodwill impairment test, used to measure the amount of impairment loss,
compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that
goodwill. If the carrying amount of that reporting unit’s goodwill exceeds the implied fair value of that
goodwill, an impairment loss is recognized in an amount equal to that excess. The loss recognized
cannot exceed the carrying amount of goodwill.
We follow the full cost method of accounting for oil and gas activities and all of our producing
properties are located in the United States. We have determined that for the purpose of performing an
impairment test, we have one reporting unit.
In September 2011, the Financial Accounting Standards Board, or FASB, issued authoritative
guidance which amends the rules for testing goodwill for impairment. Under the new rules, companies
are permitted to make a qualitative assessment of a reporting unit’s fair value prior to performing the
two-step goodwill impairment test. If it is determined through the qualitative assessment that it is not
more likely than not that the fair value of a reporting unit is less than its carrying amount, then
performing the two-step impairment test is unnecessary. The qualitative assessment is optional,
allowing companies to go directly to the quantitative assessment. As of December 31, 2011, we have
elected to continue performing our annual goodwill impairment assessment under the quantitative
two-step impairment test.
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