2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation—The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The portion of the income and net assets applicable to the non-controlling interest in the majority-owned operations of the Company's Gabon subsidiary is reflected as noncontrolling interest. All transactions within the consolidated group have been eliminated in consolidation.

Cash and Cash Equivalents—For purposes of the statements of consolidated cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash and cash equivalents.

Restricted Cash—Restricted cash includes cash that is contractually restricted. Restricted cash and cash equivalents are classified as a current or non-current asset based on their designated purpose. Current amounts at December 31, 2011 include an escrow account representing the Company's bank guarantees for customs clearance in Gabon ($1.3 million). Long term amounts at December 31, 2011 include the Company's charter payment escrow for the Floating Production Storage and Offloading tanker ("FPSO") in Gabon ($0.8 million), funds restricted to secure the Company's drilling obligation in Block 5 in Angola ($10.0 million), and funds restricted for the abandonment of certain Gulf of Mexico properties ($44,000).

Amounts in restricted cash at December 31, 2010 included an escrow account representing the Company's bank guarantees for customs clearance in Gabon ($4.9 million), as well as funds restricted to secure the Company's drilling obligation in Block 5 in Angola ($10.0 million). Long term amounts at December 31, 2010 included the Company's charter payment escrow for the Floating Production Storage and Offloading tanker ("FPSO") in Gabon ($0.8 million) and for the abandonment of certain Gulf of Mexico properties ($44,000).

The Company invests restricted and excess cash in certificates of deposit and commercial paper issued by banks with maturities typically not exceeding 90 days.

Inventory—Materials and supplies are valued at the lower of cost, determined by the weighted-average method, or market. Crude oil inventories are carried at the lower of cost or market and represent the Company's share of crude oil produced and stored on the FPSO, but unsold. Inventory cost represents the production expenses including depletion.

Income Taxes—VAALCO accounts for income taxes under an asset and liability approach that recognizes deferred income tax assets and liabilities for the estimated future tax consequences of differences between the financial statements and tax bases of assets and liabilities. Valuation allowances are provided against deferred tax assets that are not likely to be realized.

 

Property and Equipment—The Company follows the successful efforts method of accounting for exploration and development costs. Under this method, exploration costs, other than the cost of exploratory wells, are charged to expense as incurred. Exploratory well costs are initially capitalized until a determination as to whether proved reserves have been discovered. If an exploratory well is deemed to not have found proved reserves, the associated costs are expensed at that time. Other exploration costs, including geological and geophysical expenses applicable to undeveloped leasehold, leasehold expiration costs and delay rentals are expensed as incurred. All development costs, including developmental dry hole costs, are capitalized.

The Company records the fair value of a liability for an asset retirement obligation in the period in which it is incurred by capitalizing the corresponding cost as part of the carrying amount of the long-lived assets.

The Company reviews its oil and gas properties for impairment whenever events or changes in circumstances indicate that the carrying amount of such properties may not be recoverable. When it is determined that an oil and gas property's estimated future net cash flows will not be sufficient to recover its carrying amount, an impairment charge must be recorded to reduce the carrying amount of the asset to its estimated fair value. Provisions for impairment of undeveloped oil and gas leases are based on periodic evaluations and other factors.

Depletion of wells, platforms, and other production facilities are calculated on a field basis under the unit-of-production method based upon estimates of proved developed producing reserves. Depletion of developed leasehold acquisition costs are provided on a field basis under the unit-of-production method based upon estimates of proved reserves. Undeveloped leasehold acquisition costs are not subject to depletion, but are subject to impairment testing. Provision for depreciation of other property is made primarily on a straight-line basis over the estimated useful life of the property. The annual rates of depreciation are as follows:

Office and miscellaneous equipment:			3-5 years
Leasehold improvements:			8-12 years

Foreign Exchange Transactions—For financial reporting purposes, the subsidiaries use the United States Dollar as their functional currency. Gains and losses on foreign currency transactions are included in income currently. The Company incurred gains on foreign currency transactions of $1.0 million, losses of $0.6 million and losses of $0.5 million in 2011, 2010 and 2009, respectively.

Accounts With Partners—Accounts with partners represent cash calls due or excess cash calls paid by the partners for exploration, development and production expenditures made by VAALCO Gabon (Etame), Inc. and VAALCO Angola (Kwanza), Inc.

Bad Debt—On a quarterly basis, the Company evaluates its accounts receivable balances to confirm collectability. Where collectability is in doubt, the Company records an allowance against the accounts receivable balance with a corresponding charge to net income as bad debt expense. Nearly all of the Company's accounts receivable balances are with its joint venture partners and purchasers of its oil, natural gas and natural gas liquids. Collection efforts, including remedies provided for in the contracts, are pursued to collect overdue amounts owed to the Company.

During 2011, the Company recorded a bad debt provision of $4.4 million related to the uncertainty in collecting its joint venture receivable in Angola.

Revenue Recognition—The Company recognizes revenues from crude oil and natural gas sales upon delivery to the buyer.

 

Stock Based Compensation—The Company measures the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the date of the grant. Grant date fair value is estimated using either an option-pricing model which is consistent with the terms of the award or a market observed price, if such a price exists. Such cost is recognized over the period during which an employee is required to provide service in exchange for the award (which is usually the vesting period). The Company estimates the number of instruments that will ultimately be issued, rather than accounting for forfeitures as they occur.

Fair Value of Financial Instruments—The Company's financial instruments consist primarily of cash, restricted cash, trade receivables and trade payables. The book values of cash, restricted cash, trade receivables, and trade payables are representative of their respective fair values due to the short-term maturity of these instruments.

Risks and Uncertainties—The Company's interests are located overseas in certain onshore and offshore areas in Gabon, offshore in Angola and the British North Sea and in Texas, Montana, Alabama, and the Louisiana Gulf Coast area.

Substantially all of the Company's crude oil and natural gas is sold at posted or index prices under short-term contracts, as is customary in the industry.

In Gabon, the Company sold crude oil under a contract with Mercuria Trading NV ("Mercuria"), which ran through calendar year 2011. For the 2012 calendar year, the Company will also sell its oil under a new contract with Mercuria. In 2010, Vitol S.A., and in 2009, Total Oil Trading S.A., were the crude oil buyers in Gabon and accounted for all of the Company's revenues in Gabon for those years. While the loss of the Company's buyer might have a material effect on the Company in the near term, management believes that the Company would be able to obtain other customers for its crude oil. Domestic operated production is sold under two contracts, one for oil and one for gas/liquids. The Company has access to several alternative buyers for oil and gas sales domestically.

Use of Estimates in Financial Statement Preparation—The preparation of financial statements in conformity with generally accepted accounting principles requires estimates and assumptions that affect the reported amounts of assets and liabilities as well as certain disclosures. The Company's financial statements include amounts that are based on management's best estimates and judgments. Actual results could differ from those estimates.

Estimates of oil and gas reserves used in the financial statements to estimate depletion expense and impairment charges require extensive judgments and are generally less precise than other estimates made in connection with financial disclosures. The Company considers its estimates to be reasonable; however, due to inherent uncertainties and the limited nature of data, estimates are imprecise and subject to change over time as additional information become available.

Subsequent Events—The Company has evaluated subsequent events through the date the financial statements were issued.