1.  ACCOUNTING POLICIES

VAALCO Energy, Inc. and its consolidated subsidiaries (“VAALCO” or the “Company”) is a Houston-based independent energy company principally engaged in the acquisition, exploration, development and production of crude oil and natural gas. We own producing properties and conduct exploration activities as operator in Gabon, West Africa, conduct exploration activities as an operator in Angola, West Africa, and participate in exploration and development activities as a non-operator in Equatorial Guinea, West Africa. VAALCO is the operator of unconventional resource properties in the United States in North Texas and undeveloped leasehold in Montana. We also own some minor interests in conventional production activities as a non-operator in the United States.

Our consolidated subsidiaries are VAALCO Gabon (Etame), Inc., VAALCO Production (Gabon), Inc., VAALCO Angola (Kwanza), Inc., VAALCO UK (North Sea), Ltd., VAALCO International, Inc., VAALCO Energy (EG), Inc., VAALCO Energy Mauritius (EG) Limited and VAALCO Energy (USA), Inc.

These condensed consolidated financial statements are unaudited, but in the opinion of management, reflect all adjustments necessary for a fair presentation of results for the interim periods presented. All adjustments are of a normal recurring nature unless disclosed otherwise. Interim period results are not necessarily indicative of results to be expected for the full year.

These condensed consolidated financial statements have been prepared in accordance with rules of the Securities and Exchange Commission (“SEC”) and do not include all the information and disclosures required by accounting principles generally accepted in the United States (“U.S. GAAP”) for complete financial statements. They should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2014, which include a summary of the significant accounting policies.

Correction of Immaterial Error

In connection with its assessment of impairment for the three months ended September 30, 2015, the Company identified an immaterial error in the calculation of future cash flows used to determine the impairment amount.  This immaterial error was present in the calculation of the impairment for the December 31, 2014, March 31, 2015 and June 30, 2015 periods.  As a result of this immaterial error, the impairment charge of $98.3 million recorded for the year ended December 31, 2014 was understated by $7.0 million or 7%, and the net loss of $77.6 million was understated by the same amount which represented 9% of the net loss for the period.  For the three months ended March 31, 2015, the impact of the error resulted in an overstatement of the impairment charge of $3.1 million or 57%, and for the three months ended June 30, 2015, the error resulted in an understatement of the impairment charge of $0.5 million or 9%.  As a result, and after considering the related impact on depletion which was overstated, for the three months ended March 31, 2015, the net loss was overstated by $3.5 million or 9%, and for the three months ended June 30, 2015 the net loss was understated by $0.1 million or 1%.  For the six months ended June 30, 2015, the impairment charge was overstated by $2.6 million or 23%.   After considering the related impact on depletion, the net loss for the six months ended June 30, 2015 was overstated by $3.5 million or 8%.

In accordance with Staff Accounting Bulletin (“SAB”) No. 99, Materiality, and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, the Company evaluated these errors, including both qualitative and quantitative considerations, and concluded that the errors did not, individually or in the aggregate, result in a material misstatement of our previously issued consolidated financial statements.  In addition, the Company determined that the inclusion of the correction of the error in the financial statements for the three and nine months ended September 30, 2015 would not, individually or in the aggregate, result in a material misstatement of the current period consolidated financial statements.  The Company has recorded an additional impairment charge of $4.5 million or 33% in the three months ended September 30, 2015 to correct the error related to the prior periods (increase (decrease) to the impairment of $7.0 million attributable to the year ended December 31, 2014, $(3.1) million attributable to the three months ended March 31, 2015 and $0.6 million attributable to the three months ended June 30, 2015). The related impact on depletion was $0.4 million and $0.5 million attributable to the three months ended March 31, 2015 and June 30, 2015.  In total, the net loss for the three months ended September 30, 2015 reflects an additional net charge of $3.6 million (increase (decrease) to the impairment of $7.0 million attributable to the year ended December 31, 2014, $(3.5) million attributable to the three months ended March 31, 2015 and $0.1 million attributable to the three months ended June 30, 2015).  This resulted in an 11% increase in the net loss for the three months ended September 30, 2015. For the nine months ended September 30, 2015, the impact of correcting the error was $7.0 million related entirely to impairment and to the year ended December 31, 2014 period.  This resulted in a 9% increase in the net loss for the period.  

Allowance for Bad Debts

Quarterly, we evaluate our accounts receivable balances to confirm collectability.  When collectability is in doubt, we record an allowance against the accounts receivable and corresponding income charge for bad debts which appears in the Other costs and expenses line of the condensed consolidated statement of operations.  In the three months ended September 30, 2015 and 2014, we recorded an allowance of $2.8 million and $1.8 million related to Value Added Tax (“VAT”) which the government of Gabon has not reimbursed. These were the only allowances recorded during the nine months ended September 30, 2015 and 2014. The remaining amount receivable is being reported as a long-term item in the Value added tax receivable line of the September 30, 2015 balance sheet.