1. Summary of Significant Accounting Policies

Description of the Business

        Berry Petroleum Company (the Company) is an independent energy company engaged in the production, development, exploitation and acquisition of crude oil and natural gas. The Company has invested in cogeneration facilities, which provide steam required for the extraction of heavy oil and which generate electricity for sale.

Basis of Presentation

        These statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). In addition, the Company has restated its historical financial statements for the years ended December 31, 2009 and 2008. See Notes 15 and 16 to the Financial Statements.

        Certain amounts in prior years' financial statements have been reclassified to conform to the 2010 financial statement presentation.

Assumptions, Judgments, and Estimates

        In the course of preparing the financial statements, management makes various assumptions, judgments and estimates to determine the reported amounts of assets, liabilities, revenues and expenses, and in the disclosures of commitments and contingencies. Changes in these assumptions, judgments, and estimates will occur as a result of the passage of time and the occurrence of future events and, accordingly, actual results could differ from amounts previously established.

        The more significant areas requiring the use of assumptions, judgments, and estimates include: (1) oil and natural gas reserves; (2) cash flow estimates used in impairment tests of long-lived assets; (3) depreciation, depletion and amortization; (4) asset retirement obligations; (5) assigning fair value and allocating purchase price in connection with business combinations; (6) income taxes; (7) valuation of derivative instruments; and (8) accrued revenue and related receivables. Although management believes these estimates are reasonable, actual results could differ from these estimates.

Cash and Cash Equivalents

        The Company considers all highly liquid investments purchased with a remaining maturity of three months or less to be cash equivalents. The Company's cash management process provides for the daily funding of checks as they are presented to the bank. Included in accounts payable at December 31, 2010 and 2009 is $16.3 million and $15.7 million, respectively, representing outstanding checks in excess of the bank balance (book overdraft).

Accounts Receivable

        Trade accounts receivable consist mainly of receivables from oil and gas purchasers and from joint interest owners on properties the Company operates. For receivables from joint interest owners, the Company typically has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, oil and gas receivables are collected within two months.

Allowance for Doubtful Accounts and Bad Debt Recovery

        The Company recognized $38.5 million in bad debt expense in the year ended December 31, 2008 related to the Flying J bankruptcy. On July 6, 2010, the Joint Plan of Reorganization of Flying J was confirmed under Chapter 11 of the United States Bankruptcy Code. Additionally, the United States Bankruptcy Court approved and confirmed the June 15, 2010 Stipulation and Agreed Order (the Stipulation) with Flying J regarding the resolution of the Company's claim in Flying J's pending bankruptcy. Pursuant to the Stipulation, Flying J agreed that the total amount owed to the Company by Flying J was $60.5 million and, as a result, the Company received $60.5 million in cash on July 23, 2010. In the quarter ended September 30, 2010, the Company recorded a settlement of the Company's Flying J bankruptcy clai m of $22.0 million and a bad debt recovery of $38.5 million.

Discontinued Operations

        In 2009, the Company sold its DJ assets, the results of operations of which are reported as discontinued operations in the 2009 Statements of Income. See Note 2 to the Financial Statements.

Income Taxes and Uncertain Income Tax Positions

        The Company recognizes deferred income tax liabilities and assets for the expected future income tax consequences of temporary differences between financial accounting bases and income tax bases of assets and liabilities. Deferred income taxes are measured by applying currently enacted income tax rates. The Company accounts for uncertainty in income taxes for income tax positions taken or expected to be taken in an income tax return. Only income tax positions that meet the more-likely-than-not recognition threshold will be recognized.

Derivative Instruments

        The Company enters into derivative contracts, primarily swaps and collars, to manage its exposure to commodity price risk. All derivative instruments, other than those that meet the "normal purchase normal sales" exclusion, are recorded on the balance sheet as either an asset or liability measured at fair value. The accounting for changes in the fair value of a derivative instrument depends on the intended use of the derivative and the resulting designation, which is established at the inception of a derivative. The Company is required to formally document, at the inception of a hedge, the hedging relationship and the risk management objective and strategy for undertaking the hedge, including identification of the hedging instrument, the hedged item or transaction, the nature of the risk being hedged, the method that will be used to assess effectiveness and the method that will be used to measure hedge ineffectiveness of derivative instruments that receive hedge accounting treatment. Effective January 1, 2010, the Company elected to discontinue all hedge accounting prospectively. As a result, subsequent to December 31, 2009, the Company records all derivative instruments as either assets or liabilities at fair value and recognizes all gains and losses from changes in derivative fair values immediately in earnings rather than deferring any such amounts in AOCL. See Note 8 to the Financial Statements. Cash flows from derivatives used to manage commodity price risk are classified in operating activities along with the cash flows of the underlying derivative transactions. The Company nets derivative assets and liabilities whenever it has a legally enforceable master netting agreement with the counterparty to a derivative contract. The Company uses these agreements to manage and reduce its potential counterparty credit risk. The Company does not enter int o derivative instruments for speculative or trading purposes.

Oil and Gas Properties, Buildings and Equipment

        In January 2010, the Financial Accounting Standards Board ("FASB") issued oil and gas reserve estimation and disclosure authoritative accounting guidance effective for reporting periods ending on or after December 31, 2009. This guidance was issued to align the accounting oil and gas reserve estimation and disclosure requirements with the requirements in the Securities and Exchange Commission's ("SEC") final rule, "Modernization of Oil and Gas Reporting", which was also effective for annual reports for fiscal years ending on or after December 31, 2009. These rules, among other things, changed pricing used to estimate oil and gas reserves, broadened the types of technologies that a company may use to establish oil and gas reserves estimates, and broadened the definition o f oil and gas producing activities. Accordingly, the Company adopted both the FASB's authoritative accounting guidance and the SEC's rule as of December 31, 2009.

        The Company accounts for its oil and gas exploration and development costs using the successful efforts method. Geological and geophysical costs are expensed as incurred. Exploratory well costs are capitalized pending further evaluation of whether economically recoverable reserves have been found. If economically recoverable reserves are not found, exploratory well costs are expensed as dry holes. All exploratory wells are evaluated for economic viability within one year of well completion, and the related capitalized costs are reviewed quarterly. Exploratory wells that discover potentially economic reserves in areas where a major capital expenditure would be required before production could begin and where the economic viability of that major capital expenditure depends upon the successful completion of further exploratory work in the area remain capitalized if the well fi nds a sufficient quantity of reserves to justify its completion as a producing well and the Company is making sufficient progress assessing the reserves and the economic and operating viability of the project. The costs of development wells are capitalized whether productive or nonproductive.

        The provision for depletion of oil and gas properties is calculated on a field-by-field basis using the unit-of-production method. If the estimates of total proved or proved developed reserves decline, the rate at which the Company records depreciation, depletion and amortization (DD&A) expense increases, which in turn reduces net earnings. Such a decline in reserves may result from lower commodity prices, which may make it uneconomic to drill for and produce higher cost fields. The Company is unable to predict changes in reserve quantity estimates as such quantities are dependent on the success of its development program, as well as future economic conditions. Changes in reserves are applied on a prospective basis.

        Buildings and equipment are recorded at cost. Depreciation is provided on a straight-line basis over estimated useful lives ranging from 5 to 30 years for buildings and improvements and 3 to 10 years for machinery and equipment.

        Acquisition costs of proved undeveloped and unproved properties qualify for interest capitalization during a period if interest cost is incurred and activities necessary to bring the properties into a productive state are in progress. As wells are drilled in a field with proved undeveloped reserves or unproved reserves, a portion of the acquisition costs are either re-designated as proved developed or expensed, as appropriate. In fields with multiple potential drilling sites, the Company determines the amount of the acquisition cost to re-designate or expense through a systematic and rational basis that considers the total expected wells to be drilled in that field.

        The Company reviews its proved oil and natural gas properties for impairment whenever events and circumstances indicate that a decline in the recoverability of their carrying value may have occurred. The Company estimates the expected future cash flows of its oil and natural gas properties and compares these undiscounted future cash flows to the carrying amount of the oil and natural gas properties to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, the Company will adjust the carrying amount of the oil and natural gas properties to fair value. The factors used to determine fair value include, but are not limited to, recent sales prices of comparable properties, the present value of future cash flows, net of estimated operating and development costs using estimates of reserves, future commodity pri cing, future production estimates, anticipated capital expenditures and various discount rates commensurate with the risk associated with realizing the projected cash flows.

        Unproved oil and natural gas properties are assessed periodically for impairment on a property-by-property basis based on remaining lease terms, drilling results, reservoir performance, commodity price outlooks or future plans to develop acreage and allocate capital. When the Company has allocated fair values to significant unproved property (probable reserves) as the result of a business combination or other purchase of proved and unproved properties, it uses a future cash flow analysis to assess the property for impairment. Probable reserves are defined in SEC Regulation S-X, Rule 4-10(a)(18) as those additional reserves that are less certain to be recovered than proved reserves but which, together with proved reserves, are as likely as not to be recovered.