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 has been reflected as noncontrolling interest. All intercompany transactions within the consolidated group have been eliminated in consolidation.

In December 2012, the Company acquired the noncontrolling interest in VAALCO International, Inc., for $26.2 million, with an effective date of October 1, 2012. Prior to the acquisition, the noncontrolling interest owned 9.99% of the issued and outstanding common stock of VAALCO International, Inc., a Delaware corporation of which VAALCO Gabon Etame, Inc. is the wholly owned subsidiary.

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 is classified as a current or non-current asset based on its designated purpose and time duration. Current amounts at December 31, 2013 each include an escrow amount representing the Company’s bank guarantees for customs clearance in Gabon ($2.4 million) and funds restricted to secure the Company’s drilling obligation in Block 5 in Angola ($10.0 million). Long term amounts at December 31, 2013 and 2012 each include the Company’s charter payment escrow for the Floating Production Storage and Offloading tanker (“FPSO”) in Gabon ($0.8 million) and 2012 includes the funds restricted to secure the Company’s drilling obligation in Block 5 in Angola ($10.0 million).

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:

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 recognized loss on foreign currency transactions of $0.1 million in 2013 and gains of $0.4 million, and $1.0 million in 2012 and 2011, 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., and VAALCO (USA), 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. The majority 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 2013 and 2012, the Company recorded a bad debt allowance of $1.6 million and $1.6 million, respectively, related to the uncertainty in collecting its joint venture receivable in Angola. The table below shows a rollforward analysis of the allowance against the partner accounts receivable balance: (in thousands)

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 for options is estimated using an option-pricing model which is consistent with the terms of the award. For restricted stock, grant date fair value is determined using the grant date price of the company’s shares. 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.

Fair Value – Fair value is defined as the price that would be received to sell an asset or the price paid to transfer a liability in an orderly transaction between market participants at the measurement date. Inputs used in determining fair value are characterized according to a hierarchy that prioritizes those inputs based on the degree to which they are observable. The three input levels of the fair-value hierarchy are as follows:

Level 1 – Inputs represent quoted prices in active markets for identical assets or liabilities (for example, exchange-traded commodity derivatives).

Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly (for example, quoted market prices for similar assets or liabilities in active markets or quoted market prices for identical assets or liabilities in markets not considered to be active, inputs other than quoted prices that are observable for the asset or liability, or market-corroborated inputs).

Level 3 – Inputs that are not observable from objective sources, such as the Company’s internally developed assumptions used in pricing an asset or liability (for example, an estimate of future cash flows used in the Company’s internally developed present value of future cash flows model that underlies the fair-value measurement).

Risks and Uncertainties - The Company’s interests are located overseas in onshore and offshore Gabon, offshore in Angola and Equatorial Guinea, and domestically in Texas, Montana, Alabama, South Dakota, and the Louisiana Gulf Coast area.

Substantially all of the Company’s oil and gas is sold at the well head at posted or indexed prices under short-term contracts, as is customary in the industry.

In Gabon, the Company sold oil under contracts with Mercuria Trading NV (“Mercuria”) beginning with the calendar year 2011. For the first quarter of 2014, the Company will also sell its oil under a contract with Mercuria. While the loss of Mercuria as a buyer might have material effect on the Company in the short term, management believes that the Company would be able to obtain other customers for its crude oil.

Domestic operated production in Texas is sold via two contracts, one for oil and one for gas and natural gas liquids. The Company has access to several alternative buyers for oil, gas, and natural gas liquids 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 consolidated 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 consolidated 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.

Asset Retirement Obligations (“ARO”) - The Company has significant obligations to remove tangible equipment and restore land or seabed at the end of oil and gas production operations. The Company’s removal and restoration obligations are primarily associated with plugging and abandoning wells, removing and disposing of all or a portion of offshore oil and gas platforms, and capping pipelines. Estimating the future restoration and removal costs is difficult and requires management to make estimates and judgments. Asset removal technologies and costs are constantly changing, as are regulatory, political, environmental, safety, and public relations considerations.

ARO associated with retiring tangible long-lived assets is recognized as a liability in the period in which the legal obligation is incurred and becomes determinable. The liability is offset by a corresponding increase in the underlying asset. The ARO liability reflects the estimated present value of the amount of dismantlement, removal, site reclamation, and similar activities associated with The Company’s oil and gas properties. The Company utilizes current retirement costs to estimate the expected cash outflows for retirement obligations. Inherent in the present value calculation are numerous assumptions and judgments including the ultimate settlement amounts, inflation factors, credit-adjusted discount rates, timing of settlement, and changes in the legal, regulatory, environmental, and political environments. To the extent future revisions to these assumptions impact the present value of the existing ARO liability, a corresponding adjustment is made to the oil and gas property balance. Accretion expense is recognized over time as the discounted liability is accreted to its expected settlement value.

Subsequent Events – In January 2014, the Company executed a loan agreement with the International Finance Corporation (IFC) for a $65.0 million reserve based loan facility (“RBL”) secured by the assets of the Company’s Gabon subsidiary.  The RBL provides for an availability period that expires on December 31, 2019. Borrowings under the loan agreement are limited to a borrowing base, initially established as $65.0 million ($50.0 million senior loan and a $15.0 million subordinate tranche) and scheduled to be re-determined every six months starting June 30, 2014.  RBL will bear interest at LIBOR plus 3.75% for the senior loan and LIBOR plus 5.75% for the subordinate tranche and is to be paid quarterly. The Company is also required to pay a commitment fee in respect of unutilized commitments, which is equal to 1.5% per annum on the senior loan and 2.3% per annum on the subordinate tranche. In addition, upon the signing of the RBL, the Company paid 2.5% in closing fees to the IFC. As of the date of these consolidated financial statements, the Company has no outstanding borrowings under the RBL.