The difference between net income and profits adjusted for current cost of supply comes down to the way inventories are accounted for. The net income figure is calculated according to IFRS standards in Europe which demand ‘first-in first-out’ (FIFO) methodology for accounting inventory. Most US companies however produce based on ‘last-in first-out’ (LIFO) accounting.

Shell’s current cost of supply (CCS), however, are neither FIFO nor LIFO compliant. This means that Shell’s CCS figure are not recognized by US GAAP or IFRS.They are an industry measure only provided for in quarterly results for the benefit of investors.

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Instead of the FIFO method, Shell uses a weighted cost pricing methodology for the reporting period. In other words, Oil Products and Chemicals cost of sales sold during the period is based on the cost of supplies during the same period after making allowance for the estimated tax effect. The latter means that Shell also accounts for tax adjustments based on the new inventory value and one-time provision.However, earnings calculated on an estimated current cost of supplies basis does not reflect drawdown? effect the same way LIFO methodology would. But, as Shell mentions in their 3rd Quarter Results, this basis provides a better understanding of underlying business performance. This is because it provides useful information concerning the effect of changes in the cost of supplies on Shell’s result of operations and is a measure to manage the performance of the Downstream segment but is not a measure of financial performance under IFRS.CCS can be best compared to LIFO, especially in a quarterly period when inventories do not change much. Because prices of oil and gas changes every day, CCS figures outperform their historical cost.

That is why it is important to know that the Earnings Per Share (EPS) is calculated on the basis of the net-income figure arrived at via FIFO inventory accounting. In periods of inflation, companies on FIFO report higher gross margins and EPS than companies on LIFO since less costs impact the income statement.Overall inventory on the balance sheet is also higher for a company on FIFO than a company on LIFO in inflationary periods. The reverse holds for deflationary periods. In other words: in an environment where prices are declining, CCS figures outperform their historical records. Condensed Consolidated Balance Sheet| Current assets:| $ million| | 3rd Quarter 2009| 3rd Quarter 2010| Inventories| 25,420| 28,922| Accounts receivable| 66,966| 62,769| Cash and cash equivalents| 14,275| 11,282|Downstream| Quarter| $ million| Q3 2009| Q3 2010| %| | 6,121| 6,385| + 4| Oil Products sales volumes (thousand b/d)| 4,723| 5,333| + 13| Chemical sales volumes (thousand tonnes)| If we take a look at the inventories and actual volumes sold during the 3rd quarter of 2010, we see increasing sales volumes and corresponding build up in inventory. Oil Products sales volumes were 4% higher than in the third quarter of 2009. Chemical Product sales volumes in the third quarter of 2010 increased by 13% compared to the third quarter of 2009.

The latter may be due to an increase in Chemicals manufacturing plant availability in 2010 compared to 2009. Overall, Shell’s total oil-production sales rose in the period to 6,385 (thousand b/d) vs. 6,121 in the previous quarter. As for the actual crude volumes sales achieved, however, we don’t know as Shell does not provide an exact figure. Shell’s inventory value rose too. However, if inventory continues to grow, the cost of inventory will eventually have to spill through ever more severely into future profits – especially so if prices fall. Drawdown: a decline in the value of an investment, below its all-time high.

Marketable securities Depreciation Method Depreciation and depletion Property, plant and equipment related to hydrocarbon production activities are depreciated on a unit-of-production basis over the proved developed reserves of the field concerned (proven and probable minable reserves in respect of oil sands extraction facilities), except in the case of assets whose useful life is shorter than the lifetime of the field, in which case the straight-line method is applied.Rights and concessions are depleted on the unit-of-production basis over the total proved reserves of the relevant area. Where individually insignificant, unproved properties may be grouped and amortized based on factors such as the average concession term and past experience of recognizing proved reserves.Other property, plant and equipment are depreciated on a straight-line basis over their estimated useful lives, which is generally 30 years for upgraders, 20 years for refineries and chemical plants and 15 years for retail service station facilities, and major inspection costs are amortized over the estimated period before the next planned major inspection (three to five years). Property, plant and equipment held under finance leases are depreciated over the lease term.


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