1.     Summary of Significant Accounting Policies 

The accompanying unaudited consolidated financial statements and notes of Devon Energy Corporation ("Devon") have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission. Pursuant to such rules and regulations, certain disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The accompanying consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes included in Devon's 2010 Annual Report on Form 10-K.   

The unaudited interim consolidated financial statements furnished in this report reflect all adjustments that are, in the opinion of management, necessary to a fair statement of Devon's financial position as of March 31, 2011 and Devon's results of operations and cash flows for the three-month periods ended March 31, 2011 and 2010.

3.  Derivative Financial Instruments

Objectives and Strategies

Devon periodically enters into commodity and interest rate derivative financial instruments. These instruments are used to manage the inherent uncertainty of future revenues due to oil, gas and NGL price volatility and to manage exposure to interest rate volatility.  Devon does not hold or issue derivative financial instruments for speculative trading purposes and has elected not to designate any of its derivative instruments for hedge accounting treatment.

Devon's derivative financial instruments include financial price swaps, basis swaps, costless price collars and call options. Under the terms of the price swaps, Devon receives a fixed price for its production and pays a variable market price to the contract counterparty. For the basis swaps, Devon receives a fixed differential between two regional gas index prices and pays a variable differential on the same two index prices to the contract counterparty. The price collars set a floor and ceiling price for the hedged production. If the applicable monthly price indices are outside of the ranges set by the floor and ceiling prices in the various collars, Devon will cash-settle the difference with the counterparty to the collars. Under the terms of the call options, Devon sold to counterparties the right to purchase production at a predetermined price.

Devon periodically enters into interest rate swaps to manage its exposure to interest rate volatility. Devon's interest rate swaps include contracts in which Devon receives a fixed rate and pays a variable rate on a total notional amount. Devon also has forward starting swaps. Under the terms of the forward starting swaps, Devon will net settle these contracts in September 2011 or sooner should Devon elect. The net settlement amount will be based upon Devon paying a fixed rate and receiving a floating rate that is based upon the three-month LIBOR. The difference between the fixed and floating rate will be applied to the notional amount for the 30-year period from September 30, 2011 to September 30, 2041.

Counterparty Risk

By using derivative financial instruments to manage exposures to changes in commodity prices and interest rates, Devon exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. To mitigate this risk, the hedging instruments are placed with a number of counterparties whom Devon believes are minimal credit risks. It is Devon's policy to enter into derivative contracts only with investment grade rated counterparties deemed by management to be competent and competitive market makers. Additionally, Devon's derivative contracts generally require cash collateral to be posted if either its or the counterparty's credit rating falls below investment grade. The mark-to-market exposure threshold, above which collateral must be posted, decreases as the debt rating falls further below investment grade. Such thresholds generally range from zero to $50 million for the majority of Devon's contracts. As of March 31, 2011, the credit ratings of all Devon's counterparties were investment grade.

Commodity Derivatives

As of March 31, 2011, Devon had the following open oil derivative positions:

As of March 31, 2011, Devon had the following open natural gas derivative positions:

As of March 31, 2011, Devon had the following open NGL derivative positions:

Interest Rate Derivatives

As of March 31, 2011, Devon had the following open interest rate swap derivative positions:

Financial Statement Presentation

The following table presents the derivative fair values included in the accompanying consolidated balance sheets.

The following table presents the cash settlements and unrealized gains and losses on fair value changes included in the accompanying consolidated statements of operations associated with these derivative financial instruments.

4.     Other Current Assets

  The components of other current assets include the following: 

5.     Goodwill

During the first three months of 2011, Devon's Canadian goodwill increased $71 million entirely due to foreign currency translation.

7.     Asset Retirement Obligations

The schedule below summarizes changes in Devon's asset retirement obligations.

During the first quarter of 2010, Devon recognized a revision to its asset retirement obligations totaling $205 million. The increase was primarily due to an overall increase in abandonment cost estimates and a decrease in the discount rate used to calculate the present value of the obligations.

9.     Stockholders' Equity

Stock Repurchases

During the first quarter of 2011, Devon repurchased 8.1 million common shares under its $3.5 billion stock repurchase program announced in 2010 for $696 million, or $85.95 per share. Through the end of the first quarter of 2011, Devon had repurchased 26.4 million common shares for $1.9 billion, or $71.83 per share, under this program, which expires December 31, 2011.

Dividends

Devon paid common stock dividends of $68 million and $72 million (quarterly rates of $0.16 per share) in the first quarter of 2011 and 2010, respectively. In March 2011, Devon announced an increase of its quarterly cash dividend to $0.17 per share that will begin in the second quarter of 2011.

10.    Commitments and Contingencies

Devon is party to various legal actions arising in the normal course of business. Matters that are probable of unfavorable outcome to Devon and which can be reasonably estimated are accrued. Such accruals are based on information known about the matters, Devon's estimates of the outcomes of such matters and its experience in contesting, litigating and settling similar matters. None of the actions are believed by management to involve future amounts that would be material to Devon's financial position or results of operations after consideration of recorded accruals although actual amounts could differ materially from management's estimate.

Environmental Matters

Devon is subject to certain laws and regulations relating to environmental remediation activities associated with past operations, such as the Comprehensive Environmental Response, Compensation, and Liability Act and similar state statutes. In response to liabilities associated with these activities, loss accruals primarily consist of estimated uninsured costs associated with remediation. Devon's monetary exposure for environmental matters is not expected to be material.

Royalty Matters

Numerous natural gas producers and related parties, including Devon, have been named in various lawsuits alleging violation of the federal False Claims Act. The suits allege that the producers and related parties used below-market prices, improper deductions, improper measurement techniques and transactions with affiliates, which resulted in underpayment of royalties in connection with natural gas and NGLs produced and sold from federal and Indian owned or controlled lands. Devon does not currently believe that it is subject to material exposure with respect to such royalty matters.

Other Matters

Devon is involved in other various routine legal proceedings incidental to its business. However, to Devon's knowledge, there were no other material pending legal proceedings to which Devon is a party or to which any of its property is subject.

11.  Fair Value Measurements

Certain of Devon's assets and liabilities are reported at fair value in the accompanying consolidated balance sheets. Such assets and liabilities include amounts for both financial and non-financial instruments. The following tables provide carrying value and fair value measurement information for Devon's financial assets and liabilities.

The carrying values of cash and cash equivalents, accounts receivable, other current receivables, accounts payable and other current payables and accrued expenses included in the accompanying consolidated balance sheets approximated fair value at March 31, 2011 and December 31, 2010.  These assets and liabilities are not presented in the following table.

Devon's Level 3 fair value measurements included in the table above relate to certain long-term investments and a non-interest bearing promissory note. Included below is a summary of the changes in Devon's Level 3 fair value measurements during the first three months of 2011 and 2010.

12. Restructuring Costs 

In the fourth quarter of 2009, Devon announced plans to divest its offshore assets. As of March 31, 2011, Devon had divested all of its U.S. Offshore assets and a significant part of its International assets. Devon has entered into agreements to sell its remaining offshore assets in Brazil and Angola and is waiting for the respective governments to approve the divestitures.

Through the end of the first quarter of 2011, Devon had incurred $207 million of restructuring costs associated with these divestitures. This amount is comprised of $127 million of employee severance costs, $77 million associated with abandoned office leases and $3 million of other miscellaneous costs.

Financial Statement Presentation

The schedule below summarizes activity and balances associated with Devon's restructuring liabilities. There was no activity during the first quarter of 2010.

The schedule below summarizes the components of restructuring costs in the accompanying 2011 consolidated statement of operations. No restructuring costs were recorded in the three months ended March 31, 2010.

13.  Discontinued Operations

Revenues related to Devon's discontinued operations totaled $43 million and $212 million in the three months ended March 31, 2011 and March 31, 2010, respectively. Earnings from discontinued operations before income taxes totaled $30 million and $137 million in the three months ended March 31, 2011 and March 31, 2010, respectively.

The following table presents the main classes of assets and liabilities associated with Devon's discontinued operations.

14.  Earnings Per Share

The following table reconciles earnings from continuing operations and common shares outstanding used in the calculations of basic and diluted earnings per share.

15.   Segment Information

Devon manages its North American onshore operations through distinct operating segments, or divisions, which are defined primarily by geographic areas. For financial reporting purposes, Devon aggregates its United States divisions into one reporting segment due to the similar nature of the businesses. However, Devon's Canadian and International divisions are reported as separate reporting segments primarily due to significant differences in the respective regulatory environments.