SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation. The consolidated financial statements include the accounts of Unit Corporation and its subsidiaries. Our investment in limited partnerships is accounted for on the proportionate consolidation method, whereby our share of the partnerships’ assets, liabilities, revenues, and expenses are included in the appropriate classification in the accompanying consolidated financial statements.

Certain amounts in the accompanying consolidated financial statements for prior periods have been reclassified to conform to current year presentation. Certain financial statement captions were expanded or combined with no impact to consolidated net income or shareholders' equity.

Accounting Estimates. The preparation of financial statements in conformity with generally accepted accounting principles (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.

Drilling Contracts. We recognize revenues and expenses generated from “daywork” drilling contracts as the services are performed, since we do not bear the risk of completion of the well. Under “footage” and “turnkey” contracts, we bear the risk of completion of the well; therefore, revenues and expenses are recognized when the well is substantially completed. Under this method, substantial completion is determined when the well bore reaches the negotiated depth as stated in the contract. The entire amount of a loss, if any, is recorded when the loss is determinable. The costs of uncompleted drilling contracts include expenses incurred to date on “footage” or “turnkey” contracts, which are still in process at the end of the period, and are included in other current assets. Typically, any one of these three types of contracts can be used for the drilling of one well which can take from 10 to 90 days. At December 31, 2017, all of our contracts were daywork contracts of which nine were multi-well and had durations which ranged from six months to two years, eight of which expire in 2018 and one expiring in 2019. These longer term contracts may contain a fixed rate for the duration of the contract or provide for the periodic renegotiation of the rate within a specific range from the existing rate.

Cash Equivalents and Book Overdrafts. We include as cash equivalents all investments with maturities at date of purchase of three months or less which are readily convertible into known amounts of cash. Book overdrafts are checks that have been issued before the end of the period, but not presented to our bank for payment before the end of the period. At December 31, 2017 and 2016, book overdrafts were $12.4 million and $17.3 million, respectively.

Accounts Receivable. Accounts receivable are carried on a gross basis, with no discounting, less an allowance for doubtful accounts. We estimate the allowance for doubtful accounts based on existing economic conditions, the financial condition of our customers, and the amount and age of past due accounts. Receivables are considered past due if full payment is not received by the contractual due date. Past due accounts are generally written off against the allowance for doubtful accounts only after all collection attempts have been unsuccessful.

Financial Instruments and Concentrations of Credit Risk and Non-performance Risk. Financial instruments, which potentially subject us to concentrations of credit risk, consist primarily of trade receivables with a variety of oil and natural gas companies. We do not generally require collateral related to receivables. Our credit risk is considered to be limited due to the large number of customers comprising our customer base. Below are the third-party customers that accounted for more than 10% of our segment’s revenues:



	2017		2016		2015
Oil and Natural Gas:
Sunoco Logistics Partners L.P.	10	%	24	%	19	%
Valero Energy Corporation	9	%	11	%	15	%
Drilling:
QEP Resources, Inc.	26	%	28	%	25	%
Whiting Petroleum Corp. (formerly Kodiak Oil and Gas Corp.)	7	%	18	%	7	%
Mid-Stream:
ONEOK, Inc.	36	%	30	%	29	%
Range Resources Corporation	9	%	10	%	5	%
Koch Energy Services, LLC	8	%	11	%	9	%
Tenaska Resources, LLC	6	%	10	%	18	%
Laclede Group, Inc.	1	%	9	%	12	%

We had a concentration of cash of $11.4 million and $8.3 million at December 31, 2017 and 2016, respectively with one bank.

The use of derivative transactions also involves the risk that the counterparties will be unable to meet the financial terms of the transactions. We considered this non-performance risk with regard to our counterparties and our own non-performance risk in our derivative valuation at December 31, 2017 and determined there was no material risk at that time. At December 31, 2017, the fair values of the net assets (liabilities) we had with each of the counterparties with respect to all of our commodity derivative transactions are listed in the table below:



	December 31, 2017
	(In millions)
Canadian Imperial Bank of Commerce	$	0.7
Bank of America Merrill Lynch	(2.5		)
Bank of Montreal	(5.3		)
Total assets (liabilities)	$	(7.1	)

Property and Equipment. Drilling equipment, transportation equipment, gas gathering and processing systems, and other property and equipment are carried at cost less accumulated depreciation. Renewals and enhancements are capitalized while repairs and maintenance are expensed. Depreciation of drilling equipment is recorded using the units-of-production method based on estimated useful lives starting at 15 years, including a minimum provision of 20% of the active rate when the equipment is idle. We use the composite method of depreciation for drill pipe and collars and calculate the depreciation by footage actually drilled compared to total estimated remaining footage. Depreciation on our corporate building is computed using the straight-line method over the estimated useful life of the asset for 39 years. Depreciation of other property and equipment is computed using the straight-line method over the estimated useful lives of the assets ranging from 3 to 15 years.

We review the carrying amounts of long-lived assets for potential impairment annually, typically during the fourth quarter, or when events occur or changes in circumstances suggest that these carrying amounts may not be recoverable. Changes that could prompt such an assessment may include equipment obsolescence, changes in the market demand for a specific asset, changes in commodity prices, periods of relatively low drilling rig utilization, declining revenue per day, declining cash margin per day, or overall changes in general market conditions. Assets are determined to be impaired if a forecast of undiscounted estimated future net operating cash flows directly related to the asset, including disposal value if any, is less than the carrying amount of the asset. If any asset is determined to be impaired, the loss is measured as the amount by which the carrying amount of the asset exceeds its fair value. The estimate of fair value is based on the best information available, including prices for similar assets. Changes in these estimates could cause us to reduce the carrying value of property and equipment. Asset impairment evaluations are, by nature, highly subjective. They involve expectations about future cash flows generated by our assets and reflect management’s assumptions and judgments regarding future industry conditions and their effect on future utilization levels, dayrates, and costs. The use of different estimates and assumptions could cause materially different carrying values of our assets.

On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type. The components comprising inactive rigs are evaluated, and those components with continuing utility to the Company’s other marketed rigs are transferred to other rigs or to its yards to be used as spare equipment. The remaining components of these rigs are retired. During 2015, we recorded a write-down on 31 of our drilling rigs and related equipment of approximately $8.3 million pre-tax based on the estimated market value for similar equipment from auctions sales. We then sold all 31 of these drilling rigs and some other drilling equipment to unaffiliated third parties. The proceeds from the sale of those assets, less costs to sell, was less than the $11.3 million net book value resulting in a loss of $7.3 million pre-tax. When property and equipment components are disposed of, the cost and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is generally reflected in operations. Our contract drilling segment had no impairments in either 2016 or 2017. For dispositions of drill pipe and drill collars, an average cost for the appropriate feet of drill pipe and drill collars is removed from the asset account and charged to accumulated depreciation and proceeds, if any, are credited to accumulated depreciation.

In 2015, our mid-stream segment incurred a $27.0 million, pre-tax write-down of three of its systems, Bruceton Mills, Midwell, and Spring Creek due to anticipated future cash flow and future development around these systems not being sufficient to support their carrying value. The estimated future cash flows were less than the carrying value on these systems. Our mid-stream segment had no impairments in either 2016 or 2017.

We record an asset and a liability equal to the present value of the expected future ARO associated with our oil and gas properties. The ARO asset is depreciated in a manner consistent with the depreciation of the underlying physical asset. We measure changes in the liability due to passage of time by accreting an interest charge. This amount is recognized as an increase in the carrying amount of the liability and as a corresponding accretion expense.

Capitalized Interest. During 2017, 2016, and 2015, interest of approximately $15.9 million, $15.3 million, and $21.7 million, respectively, was capitalized based on the net book value associated with unproved properties not being amortized, the construction of additional drilling rigs, and the construction of gas gathering systems. Interest is being capitalized using a weighted average interest rate based on our outstanding borrowings.

Goodwill. Goodwill represents the excess of the cost of acquisitions over the fair value of the net assets acquired. Goodwill is not amortized, but an impairment test is performed at least annually to determine whether the fair value has decreased and is performed additionally when events indicate an impairment may have occurred. For impairment testing, goodwill is evaluated at the reporting unit level. Our goodwill is all related to our contract drilling segment, and, the impairment test is generally based on the estimated discounted future net cash flows of our drilling segment, utilizing discount rates and other factors in determining the fair value of our drilling segment. Inputs in our estimated discounted future net cash flows include drilling rig utilization, day rates, gross margin percentages, and terminal value. No goodwill impairment was recorded for the years ended December 31, 2017, 2016, or 2015. There were no additions to goodwill in 2017, 2016, or 2015. Based on our impairment test performed as of December 31, 2017, the fair value of our drilling segment exceeded its carrying value by 41%. Goodwill of $0.7 million is deductible for tax purposes.

Oil and Natural Gas Operations. We account for our oil and natural gas exploration and development activities using the full cost method of accounting prescribed by the SEC. Accordingly, all productive and non-productive costs incurred in connection with the acquisition, exploration and development of our oil, NGLs, and natural gas reserves, including directly related overhead costs and related asset retirement costs, are capitalized and amortized on a units-of-production method based on proved oil and natural gas reserves. Directly related overhead costs of $14.8 million, $15.4 million, and $19.2 million were capitalized in 2017, 2016, and 2015, respectively. Independent petroleum engineers annually audit our internal evaluation of our reserves. The average rates used for DD&A were $6.00, $6.24, and $12.30 per Boe in 2017, 2016, and 2015, respectively. The calculation of DD&A includes all capitalized costs, estimated future expenditures to be incurred in developing proved reserves and estimated dismantlement and abandonment costs, net of estimated salvage values less accumulated amortization, unproved properties, and equipment not placed in service. Our unproved properties and wells in progress totaling $296.8 million are excluded from the DD&A calculation.

No gains or losses are recognized on the sale, conveyance, or other disposition of oil and natural gas properties unless a significant reserve amount to our total reserves is involved.

Revenue from the sale of oil and natural gas is recognized when title passes, net of royalties.

Under the full cost rules, at the end of each quarter, we review the carrying value of our oil and natural gas properties. The full cost ceiling is based principally on the estimated future discounted net cash flows from our oil and natural gas properties discounted at 10%. We use the unweighted arithmetic average of the commodity prices existing on the first day of each of the 12 months before the end of the reporting period to calculate discounted future revenues, unless prices were otherwise determined under contractual arrangements. In the event the unamortized cost of oil and natural gas properties being amortized exceeds the full cost ceiling, as defined by the SEC, the excess is charged to expense in the period during which such excess occurs. Once incurred, a write-down of oil and natural gas properties is not reversible.

We determined the value of certain unproved oil and gas properties were diminished (in part or in whole) based on an impairment evaluation and our anticipated future exploration plans. Those determinations resulted in $114.4 million, $7.6 million, and $10.5 million in 2015, 2016, and 2017, respectively of costs being added to the total of our capitalized costs being amortized. In 2015, we incurred non-cash ceiling test write-downs of our oil and natural gas properties of $1.6 billion pre-tax ($1.0 billion net of tax) primarily due to the reduction of the 12-month average commodity prices during the year. In 2016, we incurred non-cash ceiling test write-downs of our oil and natural gas properties of $161.6 million pre-tax ($100.6 million net of tax) due to the reduction of the 12-month average commodity prices during the first three quarters of the year. We had no non-cash ceiling test write-downs during 2017.

Our contract drilling segment provides drilling services for our exploration and production segment. Depending on the timing of the drilling services performed on our properties those services may be deemed, for financial reporting purposes, to be associated with the acquisition of an ownership interest in the property. Revenues and expenses for these services are eliminated in our statement of operations, with any profit recognized reducing our investment in our oil and natural gas properties. The contracts for these services are issued under the similar terms and rates as the contracts entered into with unrelated third parties. By providing drilling services for the oil and natural gas segment, we eliminated revenue of $13.4 million and $22.1 million during 2017 and 2015, respectively, from our contract drilling segment and eliminated the associated operating expense of $11.8 million and $18.3 million during 2017 and 2015, respectively, yielding $1.6 million and $3.8 million during 2017 and 2015, respectively, as a reduction to the carrying value of our oil and natural gas properties. We eliminated no revenue or expenses in our contract drilling segment during 2016.

ARO. We record the fair value of liabilities associated with the future plugging and abandonment of wells. In our case, when the reserves in each of our oil or gas wells deplete or otherwise become uneconomical, we must incur costs to plug and abandon the wells. These costs are recorded in the period in which the liability is incurred (at the time the wells are drilled or acquired). We have no assets restricted to settle these ARO liabilities. Our engineering staff uses historical experience to determine the estimated plugging costs considering the type of well (either oil or natural gas), the depth of the well, the physical location of the well, and the ultimate productive life to determine the estimated plugging costs. A risk-adjusted discount rate and an inflation factor are used on these estimated costs to determine the current present value of this obligation. To the extent any change in these assumptions affect future revisions and impact the present value of the existing ARO, a corresponding adjustment is made to the full cost pool.

Gas Gathering and Processing Revenue. Our gathering and processing segment recognizes revenue from the gathering and processing of natural gas and NGLs in the period the service is provided based on contractual terms.

Insurance. We are self-insured for certain losses relating to workers’ compensation, control of well and employee medical benefits. Insured policies for other coverage contain deductibles or retentions per occurrence that range from zero to $1.0 million. We have purchased stop-loss coverage in order to limit, to the extent feasible, per occurrence and aggregate exposure to certain types of claims. There is no assurance that the insurance coverages we have will adequately protect us against liability from all potential consequences. If insurance coverage becomes more expensive, we may choose to self-insure, decrease our limits, raise our deductibles, or any combination of these rather than pay higher premiums.

Derivative Activities. All derivatives are recognized on the balance sheet and measured at fair value with the exception of normal purchase and normal sales which are expected to result in physical delivery. Any changes in our derivatives' fair value occurring before their maturity (i.e., temporary fluctuations in value) are reported in gain (loss) on derivatives in our Consolidated Statements of Operations.

We document our risk management strategy and do not engage in derivative transactions for speculative purposes.

Limited Partnerships. Unit Petroleum Company is a general partner in 13 oil and natural gas limited partnerships sold privately and publicly. Some of our officers, directors, and employees own the interests in most of these partnerships. We share in each partnership’s revenues and costs in accordance with formulas set out in each of the limited partnership agreement. The partnerships also reimburse us for certain administrative costs incurred on behalf of the partnerships.

Income Taxes. During the fourth quarter of 2017, the U.S. government enacted the Tax Act. Among other provisions, the Tax Act reduces the federal corporate tax rate from the existing maximum rate of 35% to 21%, effective January 1, 2018. The change in tax law required the Company to remeasure existing net deferred tax liabilities using the lower rate in the period of enactment resulting in the Company recording a tax benefit of $81.3 million in 2017 due to a revaluation of our net deferred tax liability. Measurement of net deferred tax liabilities is based on provisions of enacted tax law (including the Tax Act); the effects of future changes in tax laws or rates are not included in the measurement. Valuation allowances are established where necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable for the year and the change during that year in deferred tax assets and liabilities.

The accounting for uncertainty in income taxes prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a return. Guidance is also provided on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

Natural Gas Balancing. We use the sales method for recording natural gas sales. This method allows for recognition of revenue, which may be more or less than its share of pro-rata production from certain wells. We estimate our December 31, 2017 balancing position to be approximately 3.7 Bcf on under-produced properties and approximately 3.8 Bcf on over-produced properties. We have recorded a receivable of $2.4 million on certain wells where we estimate that insufficient reserves are available for us to recover the under-production from future production volumes. We have also recorded a liability of $3.3 million on certain properties where we believe there are insufficient reserves available to allow the under-produced owners to recover their under-production from future production volumes. Our policy is to expense the pro-rata share of lease operating costs from all wells as incurred. Such expenses relating to the balancing position on wells in which we have imbalances are not material.

Employee and Director Stock Based Compensation. We recognize in our financial statements the cost of employee services received in exchange for awards of equity instruments based on the grant date fair value of those awards. The amount of our equity compensation cost relating to employees directly involved in exploration activities of our oil and natural gas segment is capitalized to our oil and natural gas properties. Amounts not capitalized to our oil and natural gas properties are recognized in general and administrative expense and operating costs of our business segments. We utilize the Black-Scholes option pricing model to measure the fair value of stock options and SARs. The value of our restricted stock grants is based on the closing stock price on the date of the grants.

New Accounting Standards

Compensation—Stock Compensation. The FASB issued ASU 2017-09, to clarify and reduce both (i) diversity in practice and (ii) cost and complexity when applying its guidance to changes in the terms of a share-based payment award. The amendment is effective for reporting periods beginning after December 15, 2017. This amendment will not have a material impact on our financial statements.

Intangibles—Goodwill and Other: Simplifying the Test for Goodwill Impairment. The FASB issued ASU 2017-04, to simplify the measurement of goodwill. The amendment eliminates Step 2 from the goodwill impairment test. The amendment will be effective prospectively for reporting periods beginning after December 15, 2019, and early adoption is permitted. This amendment will not have a material impact on our financial statements.

Business Combinations; Clarifying the Definition of a Business. The FASB issued ASU 2017-01, clarifying the definition of a business. The amendment should help companies and other organizations evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. For public companies, the amendment is effective for annual periods beginning after December 15, 2017. This amendment will not have a material impact on our financial statements.

Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. The FASB issued ASU 2016-15, to address diversity in how certain transactions are presented and classified in the statement of cash flows. The amendment will be effective retrospectively for reporting periods beginning after December 31, 2017, and early adoption is permitted. This amendment will not have a material impact on our financial statements.

Leases. The FASB has issued ASU 2016-02. The amendment will require lessees to recognize at the commencement date a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee's right to use a specified asset for the lease term. Lessor accounting is largely unchanged. For public companies, the amendment is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods. The standard will not apply to leases of mineral rights. We are evaluating the impact this amendment will have on our financial statements and currently evaluating a plan for implementation.

Revenue from Contracts with Customers. The FASB has issued ASU 2014-09. This standard affects any entity using U.S. GAAP that either contracts with customers to transfer goods or services or enters into contracts for transferring nonfinancial assets unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). The core principle of the amendments is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 has been amended several times pre-issuance, which is codified in the new Topic 606, effective January 1, 2018. The guidance in this update supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. We adopted this standard January 1, 2018 using the modified retrospective approach, which resulted in a cumulative effect adjustment upon adoption for our mid-stream segment. This adjustment related to the timing of revenue on certain demand fees which was not material to the company. Both our oil and natural gas and contract drilling segments had no retained earnings adjustment.

The application of Topic 606 will not have a material effect on our statement of operations or our balance sheet, as the timing of revenue recognized will not be materially modified, but additional footnote disclosures are required with respect to revenue. In our oil and natural gas segment, the classification of certain costs as either a deduction from revenue or an expense will be determined based on when control of the commodity transfers to the customer, which would impact total revenue recognized, but will not affect gross profit.

Part of our review included evaluation of these issues:

•

Based on an analysis of whether the transportation of gas is a performance obligation that occurs at a point in time or over time, the timing of when we recognize certain revenue elements will change. Specifically related to our mid-stream segment, certain fees collectible during a contract will be recognized over the life of the contract because these fees are part of the single performance obligation associated with the contract.

•

Certain of our contracts include promises to deliver a minimum volume of commodity to the customer over a defined period. If we do not meet this commitment, a deficiency fee is payable to the customer. Topic 606 requires these arrangements represent variable consideration related to the sale of the commodity, and requires that we include an estimate of any deficiency fees expected within revenue, rather than as operating costs. In addition, we will also be required to analyze fees that are billable for deficiencies in minimum volume commitments from customers for our mid-stream segment. In these instances, we will assess the likelihood of earning these fees each reporting period based on the customer’s performance and recognize variable revenue when it is not expected to be subject to a significant reversal.

Our internal control framework did not materially change, but the existing internal controls have been modified to consider our new revenue recognition policy effective January 1, 2018. As we implement the new standard, we have added internal controls to ensure that we adequately evaluate new contracts under the five-step model under ASU 2014-09.

Adopted Standards

Income Taxes: Balance Sheet Classification of Deferred Taxes. The FASB has issued ASU 2015-17. This changes how deferred taxes are classified on organizations' balance sheets. Organizations must classify all deferred tax assets and liabilities as noncurrent. The amendments apply to all organizations that present a classified balance sheet. For public companies, the amendments were effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The amendment requires current deferred tax assets to be combined with noncurrent deferred tax assets. We have adopted this ASU during the first quarter of 2017 on a prospective basis. Previously, we had a net current deferred tax asset now netted with our noncurrent deferred tax liability. Prior periods were not retrospectively adjusted.

Compensation—Stock Compensation: Improvements to Employee Share-Based Payment Accounting. The FASB has issued ASU 2016-09. The amendment should improve the accounting for employee share-based payments and affect all organizations that issue share-based payment awards to their employees. Several aspects of the accounting for share-based payment award transactions are simplified, including: (a) income tax consequences; (b) classification of awards as either equity or liabilities; and (c) classification on the statement of cash flows. For public companies, the amendment was effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The amendment primarily affects classification within the statement of cash flows between financial and operating activities. This did not have a material impact on our financial statements.

Revision to Previously Reported Financial Information

We have revised our consolidated statement of cash flows to correct an error. In the course of preparing or consolidated financial statements for the quarter ended June 30, 2018, we identified an accounting error as of December 31, 2017, of approximately $13.6 million within the operating activities and the investing activities sections of the statement of cash flows. The Company has evaluated the materiality of the error and concluded it was not material to the previously issued consolidated financial statements. However, the Company has elected to revise it's consolidated cash flow statement for the period ending December 31, 2017 to correct the error. The following table presents the effect of the revision on the selected line items previously reported in the consolidated cash flows statement for the year ended December 31, 2017:



	Year Ended December 31,
	2017
	As Reported			Adjustment			As Revised
	(In thousands)
OPERATING ACTIVITIES:
Changes in operating assets and liabilities increasing (decreasing) cash:
Accounts payable	$	21,824		$	(13,632	)	$	8,192
Net cash provided by operating activities	279,588			(13,632		)	265,956

INVESTING ACTIVITIES:
Capital expenditures	(269,185		)	13,632			(255,553		)
Net cash used in investing activities	(306,998		)	13,632			(293,366		)

Supplemental disclosure of cash flow information:
Changes in accounts payable and accrued liabilities related to purchases of property, plant, and equipment	$	(6,942	)	$	(13,632	)	$	(20,574	)

There were no impacts to net cash provided by financing activities within our consolidated statements of cash flows and there was no impact to the net increase (decrease) in cash and cash equivalents resulting from the revision.

The impacts of the revisions have been reflected throughout these financial statements as appropriate.