Why Do Companies Report Their Estimate Revisions?
U.S. accounting standards require companies to report errors and adjustments to their prior estimates of AROs. For example, in 2015 Chevron increased its prior year’s ARO estimate by $804 million, stating that, “the revisions in estimated cash flows generally reflect increased cost estimates to abandon wells, equipment and facilities and accelerated timing of abandonment.”
Accounting Standards Codification section 410-20-50-1(c)(4) requires companies to annually disclose “revisions in estimated cash flows,” which is another way of saying companies must disclose corrections to their prior ARO estimates. Let us say this again. Each year companies are required to self-report the amount by which their prior ARO estimates were wrong. For example, when an oil company spends $1 million to decommission an asset with an estimated ARO of $100,000, the company must disclose the $900,000 estimate revision.
This means you can test the reliability of current estimates by checking to see how reliable estimates have been in the past. If oil companies are failing to accurately estimate their AROs, this will become apparent in the form of large and frequent “revisions in estimated cash flows,” as assets near retirement and companies begin to settle these obligations.