Callon Petroleum Company Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Summary of Significant Accounting Policies (Policies)

Summary of Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2012

The preparation of financial statements in conformity with United States generally accepted accounting principles (“US GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.

Receivable

Accounts Receivable

Accounts receivable consists primarily of accrued crude oil and natural gas production receivables. The balance in the reserve for doubtful accounts netted within accounts receivable was $34 and $36 at December 31, 2012 and 2011, respectively. During 2012, 2011, and 2010 the Company recorded $0, $(281) and $281, respectively of bad debt expense in general and administrative expenses. The negative bad debt expense in 2011 relates to the collection of an amount charged to bad debt expense during 2010.

Revenue Recognition and Natural Gas Balancing

The Company recognizes revenue under the entitlement method of accounting. Under this method, revenue is deferred for deliveries in excess of the Company’s net revenue interest, while revenue is accrued for the undelivered volumes. Production imbalances are generally recorded at the lower of cost or market. The revenue we receive from the sale of natural gas liquids is included in natural gas sales.

Oil and Natural Gas Properties

Crude Oil and Natural Gas Properties

The Company uses the full-cost method of accounting for its exploration and development activities. Under this method of accounting, the cost of both successful and unsuccessful exploration and development activities are capitalized as property and equipment. Such amounts include the cost of drilling and equipping productive wells, dry hole costs, lease acquisition costs, delay rentals, interest capitalized on unevaluated leases, other costs related to exploration and development activities, and site restoration, dismantlement and abandonment costs capitalized in accordance with asset retirement obligation accounting guidance. Costs capitalized also include any internal costs that are directly related to exploration and development activities, including salaries and benefits, but do not include any costs related to production, general corporate overhead or similar activities. The Company capitalized $13,331, $11,857 and $11,829 of these internal costs during 2012, 2011 and 2010, respectively.

When applicable, proceeds from the sale or disposition of crude oil and natural gas properties are accounted for as a reduction to capitalized costs unless the sale would significantly alter the relationship between capitalized costs and proved reserves, in which case a gain or loss is recognized in income.

Costs of crude oil and natural gas properties, including future development costs, which have proved reserves and properties which have been determined to be worthless, are depleted using the unit-of-production method based on proved reserves. Excluded from this amortization are costs associated with unevaluated properties, including capitalized interest on such costs. Unevaluated property costs are transferred to evaluated property costs at such time as wells are completed on the properties or management determines that these costs have been impaired.

Under the SEC's full cost accounting rules, we review the carrying value of our crude oil and natural gas properties each quarter. Under these rules, we compare the present value, discounted at 10%, of estimated future net cash flows from proved crude oil and natural gas reserves to the capitalized costs of crude oil and natural gas properties (net of accumulated depreciation, depletion and amortization and related deferred income taxes) which may not exceed a “ceiling”.

These rules generally require that we price our future crude oil and natural gas production at the twelve-month average of the first-day-of-the-month reference prices as adjusted for location and quality differentials. Our reference prices are the West Texas Intermediate, or WTI, for crude oil and the Henry Hub spot price for natural gas. Such prices are utilized except where different prices are fixed and determinable from applicable contracts for the remaining term of those contracts. The reserve estimates exclude the effect of any derivatives we have in place. The rules require an impairment if our capitalized costs exceed this “ceiling”. See Notes 12 and 14 for additional information regarding the Company’s crude oil and natural gas properties.

Upon the acquisition or discovery of crude oil and natural gas properties, the Company estimates by using available geological, engineering and regulatory data the future net costs to dismantle, abandon and restore the property. Such cost estimates are periodically updated for changes in conditions and requirements. In accordance with asset retirement obligation guidance issued by the FASB, such costs are capitalized to the full-cost pool when the related liabilities are incurred. In accordance with SEC's rules, assets recorded in connection with the recognition of an asset retirement obligation are included as part of the costs subject to the full-cost ceiling limitation. The future cash outflows associated with settling the recorded asset retirement obligations are excluded from the computation of the present value of estimated future net revenues used in determining the full-cost ceiling amount.

Other Property and Equipment

The Company depreciates its other property and equipment of $6,424 and $3,998 at December 31, 2012 and 2011, respectively, using the straight-line method over estimated useful lives of three to 20 years. Depreciation expense of $760, $645 and $446 relating to other property and equipment was included in general and administrative expenses in the Company’s consolidated statements of operations for the years ended December 31, 2012, 2011 and 2010, respectively. The accumulated depreciation on other property and equipment was $13,238 and $12,688 as of December 31, 2012 and 2011, respectively. Included within the Company's other property and equipment, and excluded from depreciation, are certain assets held for sale, which were valued at $3,634 and $6,514 as of December 31, 2012 and 2011, respectively. The Company reviews its other property and equipment for impairment when indicators of impairment exist.

Asset Retirement Obligations

The Company is required to record its estimate of the fair value of liabilities for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Interest is accreted on the present value of the asset retirement obligations and reported as accretion expense within operating expenses in the consolidated statements of operations.

Derivatives

The Company’s derivative contracts executed prior to 2012 were designated as cash flow hedges, and were recorded at fair market value with the changes in fair value recorded net of tax through other comprehensive income (loss) (“OCI”) in stockholders’ equity. Ineffective derivative contracts or portions of contract designated as cash flow hedges are recognized as derivative expense (income). The last of the Company's derivative contracts designated as cash flow hedges expired on December 31, 2012. Derivative contracts executed during 2012 and outstanding as of December 31, 2012 are not designated as accounting hedges, and are also carried on the balance sheet at their fair market value. Changes in the fair value of derivative contracts not designated as accounting hedges are reflected in earnings as a gain or loss on derivative contracts.

Income Taxes

Provisions for income taxes include deferred taxes resulting primarily from temporary differences due to different reporting methods for crude oil and natural gas properties for financial reporting purposes and income tax purposes. US GAAP requires the recognition of a deferred tax asset for net operating loss carryforwards, statutory depletion carryforward and tax credit carryforwards, net of a valuation allowance. A valuation allowance is provided for that portion of the asset for which it is deemed more likely than not will not be realized.

Share-based Compensation

Share-Based Compensation

The Company grants to directors and employees stock options, restricted stock awards ("RS awards"), and restricted stock unit awards ("RSU awards") that may be settled in cash or common stock at the option of the Company and RSU awards that may only be settled in cash (“Cash-settleable RSU awards”).

Stock Options. For stock options the Company expects to settle in common stock, share-based compensation expense is based on the grant-date fair value and recognized straight-line over the vesting period (generally three years).

RS awards, RSU awards and Cash-settleable RSU awards. For RS and RSU awards that the Company expects to settle in common stock, share-based compensation expense is based on the grant-date fair value and recognized straight-line over the vesting period (generally three years). For Cash-settleable RSU awards that the Company expects or is required to settle in cash, share-based compensation expense is based on the fair value remeasured at each reporting period, recognized over the vesting period (generally three years) and classified as Accounts payable and accrued liabilities for the portion of the awards that are vested or are expected to vest within the next 12 months, with the remainder classified as Other long-term liabilities.

Off-Balance Sheet Investment in Medusa Spar LLC

The Company holds a 10% ownership interest in Medusa Spar LLC (“LLC”), which is accounted for under the equity method of accounting for investments. The LLC owns a 75% undivided ownership interest in the deepwater spar production facilities at the Company’s Medusa field in the Gulf of Mexico. The LLC earns a tariff based upon production volume throughput from the Medusa area. Callon is obligated to process through the spar production facilities its share of production from the Medusa field and any future discoveries in the area. The balance of Medusa Spar LLC is owned by Oceaneering International, Inc. and Murphy Oil Corporation.

Consolidation of Variable Interest Entities

In June 2009, the FASB issued an accounting standard which became effective for the Company on January 1, 2010, and which amended US GAAP as follows:


•	to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a Variable Interest Entity (“VIE”), identifying the primary beneficiary of a VIE;


•	to require ongoing reassessment of whether an enterprise is the primary beneficiary of a VIE, rather than only when specific events occur;


•	to eliminate the quantitative approach previously required for determining the primary beneficiary of a VIE;


•	to amend certain guidance for determining whether an entity is a VIE;


•	to add an additional reconsideration event when changes in facts and circumstances pertinent to a VIE occur;


•	to eliminate the exception for troubled debt restructuring regarding VIE reconsideration; and


•	to require advanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a VIE.

The Company adopted the pronouncement for consolidation of variable interest entities on January 1, 2010. Upon adoption, and as discussed in Note 3, the Company reevaluated its interest in its subsidiary, Callon Entrada. Based on the evaluation performed, management concluded that a VIE reconsideration event had taken place resulting in the determination that Callon Entrada is a VIE, for which the Company is not the primary beneficiary. Therefore, effective January 1, 2010, Callon Entrada was deconsolidated from the consolidated financial statements of the Company. During the second quarter of 2011 and through the formal execution of a wind-down agreement with its former joint interest partner in the Entrada deepwater project, the Company became the primary beneficiary of Callon Entrada. Consequently, effective April 29, 2011, Callon Entrada was reconsolidated in the Company's financial statements.

Earnings per Share (EPS)

Earnings per Share ("EPS")

The Company’s basic EPS amounts have been computed based on the weighted-average number of shares of common stock outstanding for the period. Diluted EPS reflects the potential dilution, using the treasury-stock method, which assumes that options were exercised and restricted stock was fully vested. Diluted EPS also includes the impact of unvested share appreciation plans. For awards in which the share price goals have already been achieved, shares are included in diluted EPS using the treasury-stock method. For those awards in which the share price goals have not been achieved, the number of contingently issuable shares included in the diluted EPS is based on the number of shares, if any, using the treasury-stock method, that would be issuable if the market price of the Company’s stock at the end of the reporting period exceeded the share price goals under the terms of the plan.

Treasury Stock

The Company applies the weighted-average-cost method of accounting for treasury stock transactions and held 29 treasury shares as of December 31, 2012.

Recent Accounting Pronouncements


	Recent Accounting Pronouncements

From time to time, new accounting pronouncements are issued by FASB that are adopted by the Company as of the specified effective date. If not discussed, management believes that the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company’s financial statements upon adoption.