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BDO – Contract Compliance Audits for Energy Companies

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Doing More With Less:

Contract Compliance Audits for Energy Companies

Dawn Williford / Frank Stafford

20 January 2016



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Biographies Contract Compliance


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BIOGRAPHY

Dawn Williford South Region Leader – Risk Advisory Services [email protected] Direct: +1-713-407-3867 Mobile: +1-832-721-3255 Drilling, Farm & Ranch, Oil & Gas Experience Summary Dawn has over 16 years of experience in delivering internal audit, compliance and consulting solutions to Fortune 500 and middle market companies. Dawn has managed, as the lead client service professional, construction audits, vendor audits, joint venture audits, and large scale multi-vendor audit programs that have identified millions of dollars in cost recoveries for her clients. Key Clients Oro Negro, Master Chemical, The King Ranch, Paragon Offshore Drilling, The Enthusiasts Network Magazine, Goodrich Petroleum.


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BIOGRAPHY

Frank Stafford Senior Manager – Risk Advisory Services [email protected] Direct: +1-713-407-3215 Mobile: +1-713-301-8885 Construction, E&P, Drilling Experience Summary

Frank has 17 years of audit and consulting experience. Frank has significant experience

in performing construction audits and has an additional 15 years of operational

upstream oil and gas financial reporting experience. Key Clients TOTAL E&P Canada, Paragon Offshore Drilling, Enterprise Products Partners, Alpha Energy Holdings.


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The Case for Audit

Why do it?

In today’s challenging economic and competitive environment, Owners are seeking

ways to control costs and streamline processes, particularly regarding major

construction projects and large service and material providers. Our vendor and

construction audits have resulted in millions of dollars in cost recoveries for our

clients by utilizing the following practices:

• A well proven and structured approach which allows for scalability and customization

• A team of audit professionals with past experience in performance of energy company

contract compliance audits for clients of all sizes and complexities

• Use of data mining and analytics to review large populations

• All resulting in typical identified recoveries in excess of 2-3% of total contract costs

Our joint venture expenditure and royalty audits authenticate joint account

transactions on behalf of the non-operator.


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Key Contract Provisions

All industries, around the globe

• A well drafted Contract will include definitions or provisions around:

- The preservation of records, book and accounts for a stipulated “look back” period

- The right to audit for a specified period of time

- The accounting and project-related records the provider (Contractor) is required to

generate, retain, and provide to the Owner

- The requirements that the provider have adequate internal controls to provide

assurance that financial management is effective and that claimed costs are reliable

and supported

- The specific costs that are subject to the audit, and specific limitations, if any

- The allowances for the Owner to recoup the cost of the audit if the audit detects

overcharges by the provider

• The Audit Provision must be included in the original contract


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Contract Audit Types

Energy

Contract Audit Types

Joint Venture Vendor Construction

Supplier Royalty Expenditure

Supplier Vendor

A & E CM

Sub



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Joint Venture Audit Contract Compliance


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Joint Venture Audit

Compliance with the Operating Agreement(s)

• Assist in the safeguarding of assets by verifying and authenticating joint

account transactions

• Ensure compliance with the provisions of the operating and other agreements

• Gain an understanding of the Drilling program to be reviewed, including a

review of the Joint Operating Agreement, Authorities For Expenditure, and

Joint Interest Billings

• Review of the various cost categories, such as Intangible Drilling Costs,

Tangible Drilling and Completion Costs, and Lease Operating Expenses


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Joint Venture Audit

Approach and Methodology

Scope Preliminary

Work

Audit Testing and Analysis

Elements Wrap-Up Deliverables

• Establish working

expectations

• Ascertain the

disposition of prior

audit exceptions

• Agreement

between the

parties as to the

definition of the

period open to the

audit

• Agree on dollar

limit of items to

be examined

• Identify Operators

for audit and

prepare

confirmation

letter

• Establish budget

and timeline

• Review Joint

Operating and Other

Agreements

• Review minutes of

Operating Meetings

• Obtain Operator’s

Joint Interest

Billings (JIB)

• Solicit input of

accounting, land,

and engineering

department

personnel

• Develop Audit

Program

• Accumulation and

review of Well and

Lease information

• Capital Expenditures

and Operating

Expenses review of

charges as to

location; date and

use; volume, cash or

trade discounts; and

compliance with the

Joint Operating

Agreement

• Investment Accounts

review, e.g.

Inventory

Adjustments,

disposal of surplus

equipment,

unitization

adjustments,

Insurance coverage's,

Taxes, etc.

• Other Unusual or

Special Items

• Summarize audit

exceptions

• Conduct closing

meeting with the

Operator and provide

detailed information

necessary for the

Operator to research

• Draft Audit Report

for issuance to

Operator and Audit

participants

• Include in report the

following: Cover

letter, Audit

Exception Summary,

Audit Exception

supported by

documentation and

exhibits to support

Exceptions. Include


necessary for the

Operator to research

and respond (if not

provided during the

closing meeting.


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Selected Case Studies

Joint Venture

Body text is Trebuchet MS 16pt in BDO grey.

Industry Situation Results Service

Public E&P Non-Operator BDO was approached

by the largest operator

(out of 3 non-

operators) to perform

a joint venture

expenditure audit for a

multi-year drilling

program for the three

separate operators

with wells in Alaska,

California, Wyoming

and Colorado. The

total reviewed spend

was approximately

$100MM.

Utilizing our

standardized operations

methodology, which is

based on the Council of

Petroleum Accountants

Society (“COPAS”)

protocol and guidelines,

BDO was able to

successfully identify

over $200k in credits

that were due to the

client.

Joint Venture

Expenditure (JIB) Audit


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Joint Venture



Private E&P Non-Operator BDO was approached

by the second largest

non-operator (out of 5

non-operators) to

perform a joint

venture expenditure

audit for a multi-year

drilling and drill site

program for a multi-

year program on the

Alaskan North-Slope.

The total reviewed

spend was

approximately

$66.5MM.

Utilizing our

standardized operations

methodology, which is

based on the Council of

Petroleum Accountants

Society (“COPAS”)

protocol and guidelines,

BDO was able to

successfully identify

over $1.3MM in credits

that were due to the

client.

Joint Venture

Expenditure (JIB) Audit


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Joint Venture



Oil & Gas Exploration

and Production

BDO was engaged by

the largest non-

operator partner, to

perform a partnership

audit for calendar year

2013 expenditures for

a significant oil sands

mining project. The

total reviewed was

$783.4 million out of a

total spend of

approximately $1.2

billion, or

approximately 65%.

BDO was able to

successfully identify over

$36 million in costs where

the non-operating partner

is awaiting support from

the operating partner for

final resolution. Costs

include capital costs,

labor, materials

management costs,

transportation, travel,

insurance, communication,

overhead, payroll and

allowances, asset disposal

and write-off, and prior

years adjustments.

Partnership

Expenditure Audit



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Royalty Audit Contract Compliance


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Royalty Audit

Compliance with terms of agreements

• Verification that all production and sales have been correctly measured,

accounted for and allocated

• Verification of fees related to production, handling, processing or otherwise

have been properly assessed

• Ensure compliance with the provisions of the operating and other agreements

• In addition to Energy or Energy related companies, compliance with terms of

agreements are similar in methodology for Franchise and Licencing agreements

across various other industries


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Royalty Audit


Scope Preliminary

Work

Audit Testing and Analysis

Elements Wrap-Up Deliverables


expectations

• Ascertain the

disposition of prior

audit exceptions

• Agreement

between the

parties as to the

definition of the

period open to the

audit

• Agree on dollar

limit of items to

be examined

• Identify Auditee

for audit and

prepare

confirmation

letter


and timeline

• Review Purchaser

contracts, sales

agreements and

ownership

percentages

• Review minutes of

Operating Meetings

• Obtain Purchasers

payment

information

• Solicit input of

accounting, land,

and engineering

department

personnel

• Develop Audit

Program

• Accumulation and

review of payment

documentation,

allocations, or other

similar information

• Prepare schedule of

volumes, quantities,

values, and pricing in

order to identify

possible nonpayment,

significant variances,

and comparison of

production versus

sales

• Verify pricing,

volumes, and values

• Other Unusual or

Special Items

• Summarize audit

exceptions

• Conduct closing

meeting with the

Auditee and provide


necessary for the

Auditee to research

• Draft Audit Report

for issuance to

Auditee and Audit

participants

• Include in report the

following: Cover

letter, Audit

Exception Summary,

Audit Exception

supported by

documentation and

exhibits to support

Exceptions. Include


necessary for the

Auditee to research

and respond (if not

provided during the

closing meeting.


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Royalty



Government, West

Africa

BDO performed a

series of audits

related to oil

production and sales

for an international

government. The

audits focused on

the Operators as

well as related

subcontractors. Our

work focused on the

review of production

sharing contracts

with three major oil

production

companies.

We utilized IDEA audit software to

analyze thousands of general

ledger entries and identified costs

not eligible for sharing with the

government, as well as for

compliance with various tax

regulations. Crude oil pricing

practices, foreign cost allocation

methodologies and compliance

with all applicable laws and

contracts were also analyzed.

Identified recoveries to the

Government were in excess of

$19MM.

Royalty and

Expenditure Audit


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Royalty



Electronic and print

Media

BDO conducted a 36 month

look-back royalty contract

audit of the royalty payments

made by the licensee to the

licensor, to determine

whether potential shortages

of royalty payments occurred.

Our work focused on the

review of licensor/licensee

agreements, and review of

royalty calculations and

payments in order to verify

compliance with the license

agreements. We reviewed

approximately $2.4 million in

royalty payments from the

licensee to the licensor.

We identified

approximately $310,000 in

underpayments of

royalties due the licensor

as a result of

contractually stipulated

dis-allowed charges taken

by the licensee in

connection with their

calculation of royalty

payments due the

licensor.

Royalty Audit



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Construction Audit Contract Compliance


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Construction Audit

Compliance with terms of all Owner agreements

• Verification of Contractor pay applications

• Identify and address contract non-compliance

• Identify and prevent fraud

• Gain an understanding of the Construction Program, including a review of the

Notice to Proceed and Schedule of Values

• Gain an understanding of billing procedures, including payment terms,

allowable expenses, retainage, etc.

• Review a sample of labor and materials costs billed by subcontractors to the

general contractor and passed through to the owner

• Evaluate change orders to supporting information to pay applications


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Construction Audit


Scope Risk Assessment Fieldwork Wrap-Up Deliverables


expectations

• Review contracts

for key terms and

create contract

summary

• Obtain listing of

all pay

applications/

invoices

• Obtain total spend

and breakdown by

contractor for the

project(s)

• Identify first tier

of contractors for

audit and prepare

audit notification

letters


and timeline

• Review key

procedures and

controls over the

processing of

payment

applications/

invoices

• Interview designated

process control

owners and evaluate

the adequacy of the

processes and

procedures

• Meet with

stakeholders

regarding specific

contractors to

discuss concerns

about quality of

service, challenges,

concerns, etc.

• Determine and

summarize material

internal control gaps

• Conduct interviews

with management

for selected

contractors

• Test sample of pay

applications/invoices

• Review additional

selected contract

terms for compliance

• Obtain support for

selected material

change orders

• Review

reconciliations of

accounting and

project management

records as applicable

• Test for additional

items, as

appropriate

(including Fraud)

• Prepare audit

findings

• Review final contract

documentation,

interview key

personnel to validate

that all construction

requirements have

been met prior to

release of retention

amounts

• Review final

certification and

agree to accounting

records

• Summarize audit

exceptions

• Tailored, regularly

recurring Status

Reports prepared for

project team and

management

• Report of initial

control gaps and

recommendations

• Deliver

recommendation on

cost recovery

opportunities

• Draft audit report,

including issues

requiring resolution

prior to payment of

retention

• Deliver

recommendation on

payment of

retention


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Construction



Leading North

American Supplier

of Oil & Gas

Midstream Services

This leading North American

supplier of O&G midstream

services requested BDO’s

assistance for real-time

construction audit services

for 4 separate projects over

a three-year construction

timeline. Total construction

spend was approximately

$2.3 Billion. BDO provided

ongoing services for audit of

contractual compliance

related to project invoices

and billing accuracy from

the supplier, contractor and

sub-contractors performing

the work.

Through key interviews

with internal

stakeholders and outside

service providers and,

via ongoing reviews

including but not limited

to billings, contracts and

construction change

orders, BDO was able to

identify substantial cost

recoveries available to

the client.

Construction Contract

Compliance


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Construction



Crude oil

transportation and

storage

BDO performed an audit on

behalf of the joint venture

partners for the construction

of a crude oil rail car loading

facility. The joint venture

partners were concerned

about large overruns

incurred related to several

key contractors and related

third-party contractors

utilized throughout the

project. BDO audited

several of the key

contractors and performed

an assessment of project

management, cost

management and project

reporting.

BDO identified

significant weaknesses in

the project management

and reporting as well as

numerous internal

control deficiencies that

led to the project

overruns. In addition,

BDO identified excess

inventory totaling

$250,000 and an unused

asset totaling $750,000

that could be sold to

help offset project

overruns.


Compliance


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Construction



Colocation Data

Centers

BDO performed an audit of

the general contractor and

selected major

subcontractors, and their

subcontractors, for a $50

million colocation data

center. Our procedures

included reviewing a sample

of labor and materials costs

billed by the subcontractors

to the general contractor

and passed through to the

owner. We also evaluated

change orders and

applications for payment

from the general contractor.

We identified substantial

recoveries available to

our client due to non-

compliance with

contractually stipulated

labor rates and mark-

ups, duplicated payment

applications, re-work

due to subcontractor

error, and payments for

additional work prior to

change order approval

and substantial

completion.


Compliance



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Vendor and Supplier Audits Contract Compliance


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Vendor and Supplier Audits

Compliance with specific Owner agreements

• Verify accuracy of data reported by suppliers

• Review of vendor’s contracts, billings and deliverables including pricing, cash

disbursement records, and other contractual terms

• Audit will cover Owner’s total spend with a vendor or supplier for a specific

period

• In addition to identifying cost recoveries, identify control improvements that

can be implemented by our clients


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Vendor and Supplier Audits


Planning Fieldwork Wrap-Up & Follow-Up

Deliverables


expectations

• Meet with mgmt/buyers

regarding the specific

vendor to discuss

concerns about quality

of service, challenges,

pricing, etc

• Review contract(s) for

key terms and create

contract summary

• Obtain electronic data

file of all transactions,

including line item

detail.

• Prepare audit

notification letters

• Prepare audit program,

budget and timeline

• Using ACL or IDEA audit

software, perform a

100% review of

payments to detect

duplicate or unusual

payments

• Select a sample from

the invoice data for

detailed testing.

Obtain original

invoices and trace

back to appropriate

supporting

documentation.

• Perform an analysis of

vendor’s receivables

and credit balances.

• Test for additional

items, as appropriate

• Prepare audit findings

• Conduct an exit

meeting with the

vendor to discuss

preliminary findings

• Discuss the following

with client:

--Results and audit

findings

--Issues exclusive to

the client

--Suspected vendor

fraud

• Review results with

vendor to confirm

understanding of

identified items

• Revise findings as

appropriate to reflect

changes from the

vendor/buyer.

• Finalize vendor audit

work papers.

• Review response from

vendor and prepared

rebuttal.

• Draft audit report

• Tailored, regularly

recurring Status Reports

prepared for project

team and management

• Report of initial issues

identified and

associated recoveries

• Deliver recommendation

on cost recovery

opportunities

• Final report, including

recoveries identified

and agreed with vendor

• Prepare and deliver

rebuttal to vendor

response, if required


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Vendor and Supplier



Interstate Natural Gas

Pipeline

BDO assisted a publically

traded natural gas

company with their

vendor audit program. In

total, BDO conducted

eight vendor audits, with

vendor spend totalling

$234 million. BDO was

the only provider from

that was asked to return

the following year to

perform five additional

audits with spend

totalling $109 million.

We identified recoveries

resulting from

overbillings related to

labor, transportation,

and other expenses. We

identified contractually

required discounts that

vendors had not provided

or had inaccurately

calculated. We assisted

our client with the

rebuttal and negotiation

with their vendors,

resulting in timely

recovery of claims.

Vendor Audit


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Vendor and Supplier



National Oil Company BDO assisted with the

entity’s Quality

Assurance Program by

analyzing pricing levels

charged by multiple

suppliers for parts

purchased by the entity

according to specific

“most favorable terms”

clauses outlined in the

contracts.

Using BDO’s custom

methodology for auditing

“most favorable terms”

pricing, BDO identified

overcharges related to

misclassification by the

vendors of “like” parts

and “like” customers.

Price Verification

Analysis


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Vendor and Supplier



Municipal Utility

District

BDO, on behalf of the

utility district,

conducted a review of

the third-party

Operator’s billing process

including a review of the

meter reading accuracy

associated with customer

billing input and final

invoicing.

Using data-mining

software, BDO analyzed

approximately 1,600

monthly meter reads and

associated billings for a

two year period. BDO

identified difference in

meter reads versus

billings, customers with

unusual usage patterns,

and differences in

contracted versus billed

rates.

Internal controls

review of third-party

meter reads and

billing processes



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Summary and Conclusion Contract Compliance


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Summary and Conclusion

Summary Conclusion

We have developed a standardized

operations methodology and approach

that is tailored to each individual client

based on its specific environment,

industry and contracts. We establish

timelines, milestones and provide

constant feedback to management

relative to issues and progress until final

completion of the audit.

Our objective is to assist our clients in

verifying joint account transactions, and

by controlling construction costs and

vendor spend. We approach each project

by first evaluating the effectiveness of the

controls over expenditures. We then focus

on control issues to help identify potential

overcharges and overpayments.

Contract compliance reviews will help assess

compliance with the client’s requirements

and improve their overall working

relationship with the provider. Our clients,

working closely with our professionals, have

been consistently successful in:

• Reimbursement from Overcharges Resulting in

Large Dollar Recoveries

• Improvement in Return on Investment

• Identification & Mitigation of Risks in Contracts

• Improvement in Internal Controls & Processes

• Standardization & Enhancement of Contracts

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