Auditing in Petroleum Industries

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Contents

Introduction

Petroleum Industry

Risk Profile

Control Environment

Audit Procedure

Balances

References

Introduction

Audit is the unbiased evaluation of the final accounts of the organization. There are two types of audit which are internal or external. Internal auditors are less independent as compared to external (Audit, n.d.).Auditors represent true and fair view on the financial statements. We are newly appointed auditors in the Suncor Canada in year of 2013.

Petroleum Industry

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Crude oil is a central part of modern life and the world’s most important energy resource. We rely on it in many ways for the food we eat, the clothes we wear and the electronics we use at home and in the workplace. Without oil, we would not be able to continue to enjoy the same standard of living. But oil is also used to make medicines, plastics and cleaning products. In fact, modern life as we know it today would be impossible without oil and its products. Many of the everyday items people use are either made from oil or are dependent on oil for their production. Some of these products include heating oil, jet fuel, kerosene, dentures, diapers, fertilizers, lipstick, shampoo, deodorant, shaving cream, crayons, musical devices, cameras, computers, glue, contact lenses, toothpaste, synthetic fibers, tires, artificial hearts and even aspirin. So now you have an idea of how important oil is in our daily life.

The world’s first oil wells were drilled in China around the 4th century AD. The Chinese used simple bamboo poles to drill these wells. The dark, sticky material they extracted was then used primarily as a source of fuel. In later centuries, oil was found across Asia and Europe. Sometimes it accumulates in natural pools above the ground. Travelers and settlers use the mysterious black liquid for fuel, as well as for medical treatment. The modern oil industry began in the mid-19th century. On August 27, 1859, Colonel Edwin Drake discovered the first underground oil reservoir near Titusville, Pennsylvania (USA), after drilling a well only 21 meters (69 feet) deep. The oil flowed easily. It was also easy to work with and distil. This oil was known as a paraffin type of oil. Drake worked for the Pennsylvania Rock Oil Company which wanted to use the oil to light street lamps. Drake’s well initially produced 30 barrels of oil per day (b/d). (One barrel is equal to 159 liters or 42 US gallons). Its success marked the beginning of the modern oil industry. Oil soon began to receive more attention from the scientific community. After some research, a variety of products were eventually developed from crude oil. For example, kerosene for heating was one of the first products. Soon other products (like gasoline and diesel to run engines) were also on the market. In 1890, the mass production of automobiles began creating a huge demand for gasoline and pushing companies to find more oil fields. The way people live; work and travel all depend on oil. Oil is, in fact, the world’s most important transportation fuel. About 90% of all transportation fuels come from crude oil. It is also the raw material from which other important products are made, which have improved the quality of our lives over the past century and a half. It has been used to keep people’s houses warm during the winter for centuries.

Suncor is focusing on the world’s largest oil development project. The company is operating under the industry of crude oil production from Alberta. The company is using the advance technology to utilize the resources of oil efficiently and trying to reduce the environment of the footprints (Suncor, n.d.).

Risk Profile

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Audit risk is the centre of discussion in this part. Audit risk is the risk that an auditor expresses an inappropriate opinion on the financial statement. Audit risk is the combination of three risks which are inherent risk, control risk and detection risk. Inherent risk is the risk which arises due to the operations of the entity. These risks are industry specific and every industry has its own inherent risks. For example, in petroleum industry, estimation of assets may be wrong as they are related to future cash flows of business and there is risk that these assets may be overstated. Control risk is the risk which arises due to lack of control. This risk can be minimized with the help of effective control system. Detection risk is the risk that auditor may not be able to detect material misstatement in the financial statements. This risk can be minimized by using effective procedures and prior knowledge of client is also helpful in this regard. Following are the risks which are related to this entity.

Suncor management is attempting to raise finance, and the bank will use its financial statements as part of their lending decision. There is therefore pressure on management to present a favorable position. This may lead to bias in how balances and transactions are measured and presented. For example, there is a risk that earnings management techniques are used to overstate revenue and understate expenses in order to maximize the profit recognized.

Estimates included in the financial statements are also subject to higher risk. ISA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures states that auditors shall review the judgments and decisions made by management in the making of accounting estimates to identify whether there are indicators of management bias. Estimates are always prone to risk and chances of risk are higher in case of estimation because management can use them to make results favorable.

There is a significant risk that the requirements of IAS 38 Intangible Assets have not been followed. Research costs must be expensed and strict criteria must be applied to development expenditure to determine whether it should be capitalized and recognized as an intangible asset. Development costs are capitalized only after technical and commercial feasibility of the asset for sale or use have been established, and Suncor must demonstrate an intention and ability to complete the development and that it will generate future economic benefits. The risk is that research costs have been inappropriately classified as development costs and then capitalized, overstating assets and understating expenses. A specific risk relates to the drug which was being developed but in relation to which there have been side effects during the clinical trials. It is unlikely that the costs in relation to this product development continue to meet the criteria for capitalization, so there is a risk that they have not been written off, overstating assets and profit.

When an intangible asset has a finite useful life, it should be amortized systematically over that life. For a development asset, the amortization should correspond with the pattern of economic benefits generated from the sale of associated goods. The risk is that the amortization period has not been appropriately assessed. For example, if a competitor introduces a successful rival product which reduces the period over which Suncor’s product will generate economic benefit; this should be reflected in a reduction in the period over which that product is amortized, resulting in an increased amortization charge. The risk if this does not happen is that assets are overstated and expenses are understated.

The Group is a new client of our firm which may create detection risk as we have no previous experience with the client. However, thorough planning procedures which focus on obtaining a detailed knowledge and understanding of the Group and its activities will minimize this risk. We need to obtain an understanding of each of the subsidiaries and they are all significant components of the Group.

Company is operating in more than one country of the world and different currencies are involved in the transactions of the company. In case of foreign currency involved, there is always risk of misstatements because exchange rates change on daily basis and management of company might use incorrect exchange rate to record transactions in financial statements.

Control Environment

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ISA 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment, sets out the auditor’s responsibility to identify and assess the risks of material misstatement in the financial statements, through understanding the entity and its environment including the entity’s internal control. One of the five components of internal control is the control environment and it is recognized that the control environment within entities may be weaker which can lead to misstatements in financial statements. The control environment leads to the attitude of the company for the internal controls (Loughran, n.d.).

The five controls are as follows;

Senior management should exercises operational control over Suncor activities through the Executive Committee’s approval of investments and commitments for projects, based on defined thresholds. These projects are subject to prior vetting by the Risk Committee, whose assessments are presented to the Executive Committee. This control will enable management to perform in a better way. A report should be submitted to senior management on regular intervals.

Oil reserves should be reviewed by a committee of experts (the Reserves Committee), approved by Exploration & Production’s senior management and then confirmed by the Group’s senior management. Professionals should be hired for correct estimation of reserves and future potential assets of the company. This control is important because it is based upon core operations of the company and these reserves require proper evaluation.

There must be segregation of duties in the organization. A person should not be involved in more than one activity because chances of error and fraud in case many operations are performed by few individuals. It is one of the most effective controls in any organization.

The Information Technology Department is very important in the current era. It has developed and distributed governance and security rules that describe the recommended infrastructure, organization and procedures to maintain information systems that are appropriate to our needs and to limit information security risks. Systems of the organization can be interlinked with effective information technology department. This depart should work effectively to increase reliability in the organization.

Treasury department should be strong enough having all the control measures. The Treasury Department monitors and manages risks related to cash management activities and interest rate-related and foreign exchange-related financial instruments in accordance with strict rules defined by senior management. Cash and cash equivalents, financial positions and financial instruments are centralized by the Treasury Department.

Audit Procedure

There are two types of audit procedure; these are test of controls and analytical procedures. Analytical procedures are used to compare the data with last year and other measures which are used to check the accuracy of financial statements. Test of control are procedures which are used to confirm that there are effective controls in the organization to avoid any misstatement in financial statements. In this case, test of control procedures are used to test the controls of the company.

The biased management may be negligent in performing its duties. The management will try to increase the profitability as well as financial position to manipulate the financial statements. The procedures of the management bias are as follows;

  • Use questionnaire or checklist to confirm that all relevant tasks are performed by the senior management
  • Establish through discussion or questionnaire whether Suncor is a member of an auditing regulatory body, and the professional qualifications issued by that body.
  • Ascertain the quality control policies and procedures used by Suncor, both firm-wide and those applied to individual audit engagements.
  • Request any results of monitoring or inspection visits conducted by the regulatory authority under which Suncor operates.
  • Interview senior members of management to confirm that they have performed for which they are responsible

Oil reserves are very important for this business and it should be made sure that they are evaluated properly and there are enough controls to evaluate them. Following are the procedures which should be used to check the control on these reserves;

  • Discuss with management to confirm that they have hired professionals to evaluate reserves
  • Discuss with professional that the reserves are evaluated properly
  • Physically inspect the place of oil reserves
  • Obtain a detail of previous records and compare current records with those.

Segregation of duties is one of the essential controls for any organization. It always helps to minimize and reduce all types of risks. If a person is allowed to do more than one tasks, chances are higher that he may thinks to commit a fraud. Chances of error are also high if there is no one there to review the work properly. Audit procedures to test segregation of duties are listed below;

  • Observe segregation of duties is there in the organization
  • Enquire responsible persons that they are allowed only to do only one task
  • Discuss with management about their role in application of segregation of duties
  • Physically inspect the office location to confirm segregation of duties

Adequacy of information technology department is essential to run the business successfully. It should be reviewed properly to confirm that this department is working properly and it has significant portion in success of the organization. Following procedures should be used to test the adequacy of this department;

  • Discuss with the head of this department that how they are running this department
  • Higher an IT professional to check the operations of department
  • Physically inspect the site and confirm there is effective use of this department
  • Obtain detail of operations of department to understand it properly

Cash is considered as most risky thing for any business. So, effective controls in treasury department are critical for the business. Following are the audit procedures to verify the controls in this department;

  • Discuss with CFO about the effectiveness of this department
  • Enquire staff of this department to confirm how this department is working
  • Discuss with responsible person how cash is protected from unauthorized use
  • Obtain details and all relevant documents to confirm that cash is used properly
  • Identify the person with authority to use cash and interview him to confirm that there is proper effectiveness in the department

Balances

Following is the list of balances which should be tested;

  1. Inventory

Inventory is very important part of financial statements in case of Suncor Energy because prices are fluctuating and inventory should be recorded at lower of cost or NRV. There are four types of inventories which are part of financial statements which are; crude oil, refined products, materials and energy trading commodity inventories. Following are the audit procedures which should be performed to test the balance of inventory;

  • Physically inspect the place where inventories are maintained and make sure enough inventories are there.
  • Obtain details of all inventories in and out for whole year.
  • Enquire the people who are responsible for inventories maintenance.
  • Make sure crude oil is recorded at correct value which should be lower of cost or NRV
  • Confirm cut off is applied properly and inventory relates to only that year.
  1. Cash and Cash Equivalent

Cash and cash equivalent balance is always important for any business and it can be said as a most risky balance for any business because fraud is very easy for this asset as it can be stolen and manipulated easily. These are the procedures to test cash;

  • Verify bank balances to make sure that correct balances are included.
  • Confirm correct exchange rate was used in case of foreign transactions.
  • Bank reconciliation is essential to identify any inconsistency.
  1. Exploration and Evaluation Assets

This is a very major asset of this industry and it should be tested comprehensively to confirm that there is not any error in its valuation. There are several transactions related to this whole. Furthermore, amortization and impairment is applied in certain cases. Recently, IFRS 6 has been introduced for these assets. This is the list of procedures;

  • Confirm correct amount of amortization is included in financial statements.
  • Confirm there is not any impairment of assets if it is not included in financial statements.
  • Recalculate foreign exchange adjustments to confirm correct amount is part of asset.
  • Obtain details of all additions and disposals, and make sure they are recorded correctly.
  1. Goodwill and Other Intangible Assets

Intangible assets are covering a reasonable part of statement of financial position. These assets need annual evaluation and change in the value of assets should be incorporated in financial statements. Following are the procedures which should be performed for these assets;

  • Confirm no internally generated goodwill is part of financial statements.
  • Discuss with management regarding amortization of assets and make sure that reasonable basis is used for amortization of assets.
  • Confirm impairment loss is correctly included in financial statements.
  1. Provisions

In case of liabilities, provisions are major part of financial statements in this industry because there are many legal obligations for exploration businesses to level the land and other environmental liabilities. Correct estimation of these provisions is very important as they should not be understated. Audit procedures for provisions are;

  • Recalculate provision amount to confirm estimations of management are correct.
  • Discuss with management that which basis are used for calculations of provision.
  • Confirm any change in estimates is recorded properly.

References

Audit, n.d. Audit. [Online] Available at: http://www.investopedia.com/terms/a/audit.asp [Accessed 18 March 2015].

Loughran, M., n.d. How to Identify the Five Components of Internal Controls. [Online] Available at: http://www.dummies.com/how-to/content/how-to-identify-the-five-components-of-internal-co.html [Accessed 18 March 2015].

Managing operational risk, n.d. Managing operational risk. [Online] Available at: http://sustainability.suncor.com/2013/en/about/managing-operational-risk.aspx [Accessed 18 March 2015].

Oil Spills, n.d. Oil Spills. [Online] Available at: http://www.theguardian.com/environment/2015/jan/07/shell-announces-55m-payout-for-nigeria-oil-spills [Accessed 18 March 2015].

Suncor, n.d. Industry Leader. [Online] Available at: http://www.suncor.com/en/careers/564.aspx [Accessed 18 March 2015].