Audit Method: Oil & Gas Industry

The Oil & Gas Industry comprises of three sectors:

The Upstream sector: This is also called the exploration and production sector (E&P). It involves the search for potential underground or underwater crude oil and natural gas.

The Midstream sector: This sector involves the transportation, storage and marketing of petroleum products.

The Downstream sector: this sector is involved in the refining of crude petroleum products and processing and purification of the raw natural gas.

Accounting for oil and gas companies is a bit complicated because it has to reflect the company’s principal assets; the oil and gas reserves, with ownership rights often based on contractual relationships between the oil and gas producing entities and the owners of the mineral rights. 

Some of the specific accounting issues which arise in the Oil and gas sector are as follows: 

• Joint Arrangements: It is a common term for oil & gas companies to share the risks and costs of exploration and production activities. A separate Joint Venture Account statement is prepared which shows the advances received from working interest owners and how the amount is spent.
• Revenue recognition: The revenue arising from each transaction is recognized based on the terms of the underlying sales agreement.
• Exploration & Evaluation Assets and Development Assets: IFRS 6 - Exploration for and Evaluation of Mineral Resources explain the complete accounting for these assets.
• Depletion, depreciation and amortization (DD&A): The unit of production method is most commonly used to deplete upstream oil and gas assets.
• Impairment of non-financial assets: IFRS 6 relaxed the rules of annual impairment testing for exploration and evaluation (E&E) assets. IFRS 6 requires these assets to be tested for impairment only when the facts and circumstances suggest that the carrying amount may exceed its recoverable amount and on the transfer of E&E asset to development assets. 
• Reserves Reporting: The purpose of reserve reporting is to make available information about the oil and gas reserves which are controlled by the company. This information helps to assess the companies’ current performance and future prospects.
• Provisions for Decommissioning Costs: Due to exploration and evaluation activities oil and gas companies often are required to create a provision for meeting the costs of site restoration, decommissioning and dismantling of assets. It is covered by IAS 37.

Practice

While conducting the audit of oil & gas companies, the auditor should gain thorough and deep understanding of the industry and the practices followed by the oil & gas companies. Audit requirements may vary depending on whether the company is operating in an upstream, midstream or downstream sector. Moreover audit procedures in upstream sector also vary depending on whether the company is an operator or non-operator of and oil or gas well or lease. 

Audit Method: Telecom, Media and Entertainment

Media and Entertainment business include companies for movie studios, TV station groups, Cable distribution companies, Radio broadcasting companies, Advertising companies, Interactive gaming companies, Book publishing companies, Newspaper publishing companies and Internet companies. Media and Entertainment businesses live or die based on how well they identify and manage trends.

Telecommunications is a general term and include a vast array of technologies that transmit and receive voice, data, and video information over varying distances through electronic means. Telecommunications is a huge industry, comprising companies that make hardware, produce software and provide communication services.

The main area of concern for auditors while conducting the audit of a telecom media or entertainment company is to verify their revenue. Telecom operators continue to lose billions of dollars every year due to revenue and fraud leakage. Most telecom companies principally obtain revenue from providing the following telecommunication services: access charges, airtime usage, messaging, interconnect fees, data services and information provision, connection fees and equipment sales. Products and services may be sold separately or in bundled packages. The fast pace of change and intense commercial competition increase the likelihood of mistakes. There is significant complexity in determining the combined effect of interacting systems and processes; and the high-volume, low-value nature of transactions amplifies the financial implications of "small" errors.

Another area of concern for auditor is to verify the license fee paid by media and telecom companies to the government and compliance of companies with the regulations imposed under the provisions of these licenses by the government.

Fixed assets verification particularly in telecom service provider companies is also an area which requires auditor’s significant attention. Telecommunications is a very capital-intensive industry, with the fixed assets of network infrastructure forming a large part of a telecom company’s balance sheet whether it is a fixed line, mobile or fiber network. Fixed assets management remains an important competitive differentiator as it presents significant operational and internal control challenges. Auditor should be diligent in reviewing asset lives manually, as well as in a more sophisticated manner with the use of client integrated ERP systems generated reports.

Additional Thoughts

While conducting the audit of a telecom media or entertainment sector company; the principal rules remain the same for the auditor. The auditor should understand the entity and its environment, in which it is operating and identify and assess the risks of material misstatement. On the basis of this understanding the auditor should frame audit procedures to minimize the audit risk to an acceptable level. 

Audit Method: Audit Approach

Audit planning is one of the most interesting steps in the audit process. It requires to apply audit specific knowledge, business skills, understanding of the own resources and velocity of their usage.

In this post I am going to make the brief overview of some audit approaches and their applicability in real life.

Audit Process

The audit process could be depicted very simply, but work done and time spent on each stage of audit process have crucial effect on audit efficiency and effectiveness (audit risk). The illustration demonstrates that basically we have two types of approach: business risk approach with controls testing and substantive approach.

Audit Process

The approach in strategy should not be confused with approach in tactics regarding the concrete account connected with business process. In any case, we have to detect most risky and material areas of clients’ financial statements, i.e. substantive testing of all accounts is not reasonable.
         The second step is to identify our tactic regarding concrete type of account and assertion. For example, account is “fixed assets” (FA) and assertion is “valuation”. The process which is reflected by these two elements is “FA purchases” process. So at this point we might decide to test value of FA items substantively or do some preliminary purchases tests of controls to reduce substantive work in later stages. 

To test or not to test?

The outcome of control testing should be combined risk assessment of financial statement risk and audit risk, i.e. the result per well-known models:

         Audit Risk = Inherent Risk x Control Risk x Detection Risk (1);

Audit Risk = Financial Statement Risk x Detection Risk (2).

The audit firms try to formalize risk assessments (low, moderate, high) and spot the point at which it would be reasonable to reduce substantive procedures. However, there is still a problem: test of controls is time and money spent on procedures. And how do we know whether we should even start testing controls? What if after extensive control testing they proved to be ineffective? The mistakes might lead to inefficient audit, harming auditors’ profit margin. Unfortunately, I might say in majority cases the decision is made based on common sense and subjective opinion, i.e. there is no 100% proven scientific way to figure this out. Admittedly, to facilitate a right decision auditors should understand client’s business process, document suggested controls, and do process walk-through. There are also some rules of thumb, e.g. if there are lots of small routine transaction, then tests of controls are likely to be the right option.

Additional factors

The audit with accurate planning stage, through understanding of business processes and risk detection would require highly proficient audit team. However, we live in a real world and we do not always have access to the best dream audit teams J . The point is that the audit approach should be understandable by team members and fit their abilities: for someone it would be easier (time/budget factor) to vouch 1000 transaction than make decision based analytical job of connecting facts from process narrative, walk-through, initial strategy, and audit methodology. I mean, that process need not be overcomplicated. I would suggest following basic principles for establishing strategy:

1. Efficiency (budget);
2. Effectiveness (prudence, audit risk);
3. Complexity/easiness to bring about;
4. Understandability (and acceptability) for all members of team: from partner to audit staff.

In the future blog posts, it would be interesting to elaborate each of the above principles.

Conclusions

This is only outline of audit approaches. The topic is enormous and I will try to cover most arguable areas. Your comments are welcome as usual.

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