Accounting Problems Inherent in Net Profits Interests

Accounting for net profits interests, when examined in isolation, presents problems that are no more difficult than those encountered in accounting for any other entity. While mining operations and the associated regulatory, tax and management reporting requirements probably present a greater challenge to the accountant than some other more standardized areas of business, financial statements and cost reports have been prepared for hundreds of years with no apparent difficulty.

The calculation of a net profits distribution is usually uncomplicated. From gross revenues are substracted all of the allowable deductions, as defined in the agreement, to arrive at net profits. If the agreement has a capital recovery provision, the portion of net profits to be used to reduce the investment account is calculated and subtracted from net profits. The net profits interest percent is applied to the remainder to arrive at the distribution to be made to the owner of the interest.

The accountant's difficulty with net profits interests stems from the fact that accounting records are maintained to reflect, as accurately as possible, the financial health of the venture, while a net profits agreement only describes a method to calculate a distribution. Definitions of costs under the two can be very different and the inclusion of a capital recovery provision will usually require a