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1. Nature of Operations:Seven Seas Petroleum Inc. (a Yukon Territory, Canada, corporation) was formed on February 3, 1995. Seven Seas Petroleum Inc. and its subsidiaries, Seven Seas Petroleum Holdings Inc., Seven Seas Petroleum Argentina Inc., Seven Seas Petroleum Australia Inc., Seven Seas Petroleum Colombia Inc., Seven Seas Petroleum Mediterranean Inc., Seven Seas Petroleum Turkey Inc., Seven Seas Petroleum PNG Inc., Seven Seas Petroleum U.S.A. Inc., GHK Company Colombia, Esmeralda LLC and Cimarrona LLC, are collectively referred to herein as "Seven Seas" or "the Company." The Company's business is to acquire, explore and develop interests in oil and gas projects worldwide.At December 31, 1996, the Company's unevaluated oil and gas interests were recently acquired and are in the initial stages of evaluation and development. Accordingly, the recoverability of such amounts is dependent upon the completion of exploration work, the discovery of oil and gas reserves in commercial quantities and the subsequent development, production and sales of these reserves. Recoverability is also dependent on the Company's ability to finance the exploration and development activities through operations or outside financing. 2. Business Combination:On June 29, 1995, the Supreme Court of British Columbia approved an amalgamation of Seven Seas and Rusty Lake Resources Ltd. Stockholders of Rusty Lake Resources Ltd. were issued one common share in Seven Seas, the new company after the amalgamation, for each 35 common shares held in Rusty Lake Resources Ltd. Additional shares of Seven Seas were issued in settlement of certain indebtedness of Rusty Lake Resources Ltd. This transaction has been reflected as an acquisition by Seven Seas using the purchase method of accounting. The net assets of Rusty Lake Resources Ltd. were recorded on the books of Seven Seas as follows:
 On July 26, 1996, the Company acquired 100 percent of the outstanding stock which represented 100 percent of the voting shares held in GHK Company Colombia and Esmeralda LLC. Additionally, on the same date, the Company acquired 62.963 percent of the outstanding shares and voting stock in Cimarrona LLC. This transaction has been reflected as an acquisition by Seven Seas using the purchase method of accounting. Seven Seas issued to the stockholders in GHK Company Colombia, Esmeralda LLC and Cimarrona LLC a combination of preferred shares and special warrants which are exchangeable into a total of 16,777,143 common shares upon the earlier of the receipting of a prospectus qualifying the exchange, or one year from the closing of the transaction. Of the 16,777,143 preferred shares and special warrants, 5,002,972 preferred shares were issued for all of the common shares in GHK Company Colombia, 4,469,028 special warrants were issued for all of the common shares in Esmeralda LLC and 7,305,143 special warrants were issued for 62.963 percent of the common shares in Cimarrona LLC. The remaining 37.037 percent interest in Cimarrona represents a minority interest which is reflected as such on the balance sheet. The 16,777,143 preferred shares and special warrants were recorded based on the closing stock price of Seven Seas on July 26, 1996, at $9.125, totaling $153,091,430. Net assets acquired include $153,122,523 assigned to oil and gas properties (which are subject to future evaluation based on further appraisal drilling) and other nominal net working capital, less amounts attributable to the minority interest in Cimarrona LLC. Any income and expenditures incurred by these three entities after July 26, 1996, are included in the current year's statement of operations and accumulated deficit. Of the 16,777,143 preferred shares and special warrants issued, 11,744,000 are held subject to an escrow agreement, whereby one-third of the Securities are released each year for three years. The Securities may be released earlier based upon a valuation of the Seven Seas interests in the contract areas. Collectively, the acquisition of these three companies resulted in the purchase of an additional 36.7 percent participating interest in the Dindal and Rio Seco Blocks in Colombia in which the Company previously held a 15 percent participating interest. All three entities were oil and gas exploration companies whose only material asset was the participating interest they held in the Dindal and Rio Seco Association contracts in Colombia. 3. Summary of Significant Accounting Policies:The Company follows accounting principles generally accepted in Canada. A summary of the Company's significant policies is set out below.ConsolidationThese consolidated financial statements include the accounts of Seven Seas Petroleum Inc. and its wholly owned subsidiaries named in Note 1.Cash and Cash EquivalentsCash and cash equivalents include bank deposits and short-term investments which, upon acquisition, have a maturity of three months or less.Marketable SecuritiesMarketable securities are recorded at the lower of cost or market value. Declines in market value below carrying value are written down through earnings. Marketable securities include $14,700 which is restricted until June 4, 1997.Oil and Gas InterestsThe Company follows the full-cost method of accounting for oil and natural gas operations, whereby all costs incurred for exploration and development of oil and natural gas properties are capitalized in country-by-country cost centers. Such costs include land acquisition costs, geological and geophysical costs, costs of drilling both productive and nonproductive wells, related plant and production equipment costs, carrying costs of nonproductive properties and that portion of administration costs applicable to exploration and development activities. Proceeds received from the disposal of properties are normally credited against accumulated costs. No gains or losses are recognized upon the disposition of oil and natural gas properties except under circumstances which result in a major disposal of reserves.The costs of acquiring and evaluating properties are initially excluded from depletion calculations. These properties are assessed periodically to ascertain whether impairment has occurred. When evaluated reserves are assigned or when the property is considered impaired, the cost of the property is added to the costs subject to depletion. Depletion is recorded on the unit-of-production basis. If the net capitalized costs of oil and gas properties (net of recorded deferred taxes and accumulated provision for site restoration and abandonment costs) in a cost center exceed an amount equal to the sum of the undiscounted estimated future net revenues from evaluated oil and gas reserves in the cost center (net of site restoration and abandonment costs, interest, production-related general and administrative costs) and the costs of properties not being amortized, both adjusted for income tax effects, such excess is charged to expense. Substantially all the Company's exploration and production activities are conducted jointly with others, and the accounts reflect only the Company's proportionate interest in such activities. Foreign Currency TranslationThe Company's reporting and functional currency is U.S. dollars. Foreign operations which generally are financially and operationally interdependent with the parent company are accounted for using the temporal method. Monetary items are translated using the exchange rate in effect at the balance sheet date; nonmonetary items are translated at historical exchange rates. Revenues and expenses are translated at the average rates in effect on the dates they occur. No material translation gains or losses were recorded during the period.Income TaxesThe deferral method of tax allocation is followed under which the income tax provision is based on the results of operations reported in the accounts. The difference between the income tax provision and taxes currently payable would be reflected as deferred income taxes. For the year ended December 31, 1996, the Company has recorded tax expense of $2,338. No deferred tax benefits have been recognized for 1996 or 1995 because the realization of these tax benefits cannot be reasonably assured.Fixed AssetsFixed assets are recorded at cost. Depreciation is provided on a straight-line basis over three to five years.Organization CostsOrganization costs represent the normal cost of incorporating the Company. In association with the amalgamation agreement with Rusty Lake Resources Ltd., organization costs of $87,481 were recorded to reflect the excess purchase price of Seven Seas common shares provided to Rusty Lake Resources Ltd. stockholders over and above the net asset value of Rusty Lake Resources Ltd. as of June 29, 1995. Organization costs are being amortized on a straight-line basis over two years.Earnings Per ShareBasic earnings (loss) per common share are calculated using the weighted average number of shares outstanding during the period. Fully diluted loss per share has not been presented as it is antidilutive.4. Cash And Cash Equivalents:
 The carrying value of short-term investments approximates fair value. 5. Investment In Oil And Gas Interests:
Exploration CostsThe Company has been involved in exploration activities in Colombia, Australia, Argentina, Turkey and Papua New Guinea and, also, the Company purchased an option for the right to participate in future exploration activities in North Africa, but the option was never exercised. Additionally, the Company acquired oil and gas properties in Columbia during 1996 totaling $153,122,523 and $57,624 of exploration costs were incurred also in 1996 which were reclassified as evaluated oil and gas interests. In the third and fourth quarters of 1996, the Company had oil and gas sales of $233,682 which pertained solely to production testing of two wells located in Colombia. During the period ending December 31, 1995, exploration costs incurred of $622,006 in Argentina and $500,800 for the option in North Africa were expensed.On May 16, 1995, the Company entered into an agreement whereby Seven Seas purchased an option for $500,000 to acquire a 5 percent participating interest in three exploration blocks in North Africa upon completion of the first exploration well drilled. The first exploration well was completed as a dry hole in July of 1995. After careful review, Seven Seas decided not to exercise its option. The cost of the well and the option, $500,000, plus additional costs of $800 incurred toward purchasing this option, were originally recorded as unevaluated oil and gas interests and were subsequently expensed. The El Catamarqueno X-1 test well on the Sur Rio Deseado Block in the San Jorge Basin, Argentina, was determined to be unsuccessful during January of 1996. The Company determined that further drilling on the block was not justified and, therefore, expensed exploration interests in Argentina of $622,006. Empresa Colombiana de Petroleos, the Colombian national oil company (Ecopetrol), has the right to back into Seven Seas Dindal and Rio Seco Association contracts in Colombia upon declaration of commerciality at an initial 50 percent participating interest. Ecopetrol's interest can increase based upon accumulated production levels. Ecopetrol will at the time of commerciality bear 50 percent of the future costs in the field and reimburse the other parties in these two blocks for 50 percent of previously incurred costs associated with successful exploratory and appraisal wells. The Company had capitalized exploration costs as follows, which included capitalized general and administrative costs of $140,628 as of December 31, 1996, and $130,866 as of December 31, 1995:
6. Income Taxes:The income tax benefit for the year ended December 31, 1996 and 1995, is calculated by applying Canadian federal and provincial statutory tax rates to pretax income with adjustments as set out in the following table:
7. Share Capital:
 The Company periodically issues incentive stock options to officers, directors and employees of the Company, exercisable at the approximate prevailing market prices at the time of issue. As of December 31, 1995, there were 990,000 options for common shares outstanding to directors, officers and employees of the Company under the 1995 stock option plan and, as of December 31, 1996, there were 1,164,667 options for common shares outstanding. Of the outstanding options at December 31, 1996, a total of 374,667 options have an exercise price of $.75 and 390,000 options have an exercise price of $7.125, while the remaining 400,000 options have an exercise price of $18.75. All options vest immediately and expire between March 2000 and November 2001. A brokered private placement involving the issuance of 2,000,000 special warrants at $2.75 per warrant for a net offering after commissions and expenses of $5,095,548 was completed in Canada on March 15, 1996. Each special warrant is convertible into one unit. Each unit consists of one share of common stock and a one-half common share purchase warrant at $3.50 per full share. The warrants are convertible at the earlier of (a) one year from date of issuance or (b) the date a receipt is issued for a prospectus qualifying the conversion in the appropriate jurisdictions (see Subsequent Events). A brokered private placement involving the issuance of 500,000 special warrants at $15.00 per warrant for a net offering after commissions and expenses of $7,013,370 was completed in Canada on October 16, 1996. Each special warrant is convertible into one unit. Each unit consists of one share of common stock and a one-half common share purchase warrant at $18.50 per full share. The warrants are convertible at the earlier of (a) one year from date of issuance or (b) the date a receipt is issued for a prospectus qualifying the conversion in the appropriate jurisdictions (see Subsequent Events). The proceeds of the March 15 and October 16, 1996, private placements will be used for additional drilling, seismic and production facilities on the Company's 51.7 percent participating interest in the Emerald Mountain, Colombia, oil discovery and for further exploration activities. See Note 2 for discussion of other securities issued. 8. Commitments And Contingencies:The Company is committed to make minimum payments under contracts for certain office facilities and equipment. Amounts due under these contracts as of December 31, 1996, are as follows: $63,799 for 1997, $54,902 for 1998, $25,138 for 1999 and none thereafter.Two wells estimated at a total cost of $7,600,000 are required to be drilled on the Company's Rio Seco and Dindal Blocks in Colombia by August and September 1997, respectively, to fulfill the Company's 1997 work commitment on these two blocks. The Company will be required to pay its proportionate share of the total cost of these two wells. 9. Subsequent Events:On March 5, 1997, the Company acquired 100 percent of the outstanding stock which represented 100 percent of the voting shares held in Petrolinson, S.A. The terms of the transaction were agreed to in a letter of intent dated November 22, 1996. The principal asset owned by Petrolinson, S.A., is a 6 percent participating interest in the Dindal and Rio Seco Association contracts. As consideration for the 6 percent interest in the Dindal and Rio Seco Association contracts, Seven Seas issued to the sole stockholder in Petrolinson, S.A., 1,000,000 common shares of Seven Seas Petroleum Inc. common stock. The common shares issued to Petrolinson, S.A., will be subject to an escrow agreement, the terms of which provide for a 120-day escrow of shares commencing from March 5, 1997. This 6 percent interest will be carried through exploration by the other 94 percent participating interest parties. This transaction will be reflected in 1997 as an acquisition by Seven Seas using the purchase method of accounting. The 1,000,000 shares will be recorded based on the average closing stock price of Seven Seas for the period beginning 30 days prior to and 30 days subsequent to November 22, 1996, or $18.55. This represents a transaction cost of $18,550,000. Net assets acquired include $18,537,321 assigned to oil and gas properties (which are subject to future evaluation based on further appraisal drilling) and other nominal net working capital.On February 6, 1997, approvals were granted by the Ontario Securities Commission, British Columbia Securities Commission and the Alberta Securities Commission receipting a prospectus filed to qualify 2,500,000 special warrants as common stock pertaining to the March and October 1996 financings. Additionally, the prospectus qualified 11,774,171 special warrants and 5,002,972 preferred shares as common stock which was issued in connection with the acquisition of a 36.7 percent participating interest in the Dindal and Rio Seco Association contracts in Colombia by the Company on July 26, 1996. 10. Differences In Generally Accepted Accounting Principles Between Canada And The United States:The consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) in Canada. No material modifications would be necessary to the financial statements to comply with generally accepted accounting principles in the United States.11. Supplemental Oil And Gas Information (Unaudited):Producing PropertiesProved reserves represent estimated quantities of crude oil which geological and engineering data demonstrate to be reasonably recoverable in the future from known reservoirs under existing economic and operating conditions. Estimates of proved developed oil reserves are subject to numerous uncertainties inherent in the process of developing the estimates including the estimation of the reserve quantities and estimated future rates of production and timing of development expenditures. The accuracy of any reserve estimate is a function of the quantity and quality of available data and of engineering and geological interpretation and judgment. Results of drilling, testing and production subsequent to the date of the estimate may justify revision of such estimate. Additionally, the estimated volumes to be commercially recoverable may fluctuate with changes in prices of oil. The proved reserves at December 31, 1996, are based only upon the results of the drilling of the El Segundo No. 1 well on the Dindal Block in Colombia.Estimates of future recoverable oil reserves and projected future net revenues were provided by Sproule International Limited. The Company's proved reserves were comprised entirely of crude oil in Colombia and are stated in barrels. Proved developed and undeveloped reserves (number of barrels at December 31, 1996):
 The following table presents the standardized measure of discounted future net cash flows relating to proved oil reserves. Future cash inflows and costs were computed using prices and costs in effect at the end of the applicable year without escalation. Crude oil prices at December 31, 1996, were $25.93 per barrel for West Texas Intermediate as compared to the average for the year of $22.13. Therefore, a crude price of $22.13 unescalated, less a $3.00 gravity adjustment, was used in calculating the standardized measure of discounted future net cash flows, as the December 1996 year-end price of $25.93 was not representative of current or future pricing. Future income taxes were computed by applying the appropriate statutory income tax rate to the pretax future net cash flows reduced by future tax deductions and net operating loss carryforwards. Standardized Measure of Discounted Future Net Cash Flows
 The standardized measure of discounted future net cash flows does not purport to present the fair market value of the Company's proved reserves. An estimate of fair value would also take into account, among other things, the recovery of reserves in excess of evaluated reserves, anticipated future changes in prices and costs and a discount factor more representative of the time value of money and the risks inherent in reserve estimates. |