10. Begin working on your schedules well in advance of the audit. And remember, if you have questions, your auditor is just a phone call or email away. 

 9. Keep track of issues you struggled with during the year and communicate those to your auditor. It will help the auditor key in on important areas at the beginning of the audit and prevent surprises down the road. 

 8. Get the confirmations back to the auditors quickly! The more time there is to send these out the better chance we have of getting them back. Every confirmation that’s not returned creates more work for everyone. 

7. Communicate your schedule to the auditors. We understand that your normal responsibilities don’t go away during the audit, and we’ll do everything we can to work around your schedule. 

 6. Post all adjustments to your trial balance before you provide it to the auditor. 

 5. Those schedules we talked about earlier – make sure they tie to the final trial balance you just provided to the auditor. 

 4. Make requested documentation easy to access and provide it to the auditors as soon as possible. 

 3. Be available! Set aside some time on your calendar to answer questions and prepare information requested during the audit. 

 2. Maintain good processes and controls. The more checks & balances you have, the less likely it is that your auditors will find errors. 

 1. Don’t do anything fraudulent or misleading during the year (always a plus). 

The key to success is communication and preparedness. If you apply these steps you should see a reduction in the amount of friction an audit can cause.

• Review your joint interest agreement and the accounting procedure.  While many of the agreements are standard, ensure you are aware of the audit provisions and other pertinent facts such as the allowed overhead allocation method. The more complexities in the agreement, the more likely there could be errors.
• Consider the size of the interest and amounts at stake.  A joint interest audit will likely produce some results for all wells, but only certain wells would be worth the cost.
• Contact other nonoperating joint owners to share the costs.  Unfortunately for the initiator of the joint audit, you don’t receive all the reward for being diligent on your investment. When an error is found in a joint interest audit, the error is corrected and all affected parties receive remedy even if they didn’t help foot the bill for the audit. This should not necessarily prevent you from pursuing the audit assuming you followed the previous two steps.
• Utilize a professional. The individuals who perform a joint interest audit need to have appropriate training and experience resolving the issues typically uncovered in an audit. Many of the large oil and gas companies have a joint interest audit department and conduct most, if not all, of the procedures themselves. If you do not have those resources or lack the expereince to perform a joint interest audit, engaging an independent auditor may be appropriate. 
• Consider the timing of the audit. Attempting a joint interest audit during the first three months of the year may lead to higher fees, less cooperative staff at the operator, and less timely completion of the audit. When beginning the audit process under any timing, you should prepare for an extended timeline due to the various communications between the auditor and the operator from initial testing all the way down the road to multiple discussions over the reported findings before resolution. 
• Open up communications with other nonoperators and the professional performing the audit. You should consult with the other nonoperators, whether they are participating in the audit or not, about specific concerns related to their joint interest billings. You should communicate their concerns and your own to the professional when engaging them to perform the audit. 

We enjoy partnering with our oil and gas clients in all facets of their business needs. We would be happy to discuss joint interest audits or other accounting services with you.

Fraud is a hot topic. If you don’t think so ask someone who used to work for Enron or invested in Madoff’s investment company - they might change your mind. Because of instances like these, people often think of fraud in large terms, and the mention of the word carries a lot of weight. But fraud can occur in all sizes and forms.

Who is likely to commit fraud? Most people use what is commonly known as the fraud triangle to identify areas where one can commit fraud. The three criteria are Pressure/Incentive, Opportunity, and Rationalization.

The pressure/incentive trait is common with performance based jobs where there is motivation for employees to record false sales to meet sales/performance quotas or up their commission, or other incentive pay.

Opportunity rears its ugly head when an individual has too much control over one key process in a business. Let’s say a cashier at a bank did not have to reconcile the cash drawer at the end of the day. The “opportunity” is there for cash to be stolen without any knowledge of it being gone.

A big one in today’s economy is rationalization. This is commonly referred to as the “I deserve this” mentality. An individual develops a frame of mind where they can justify their actions and commit the fraud even though it is outside their typical ethical guidelines. For example, the company is generating large revenue streams, but an employee needs money to pay for his kid’s summer baseball league; this employee could find themselves thinking “They won’t miss this money, and I can’t say no to my child.”

Now let’s not confuse fraud with honest mistakes, errors, or plain ignorance; there is a difference. Fraud is defined as “intentional” deception…intentional being the key word.

Stay tuned as we post methods to identify and address fraud and help you to minimize the risk of fraud in your business.

Over the last few years we’ve worked with several clients who outsourced various accounting functions, such as joint interest billing, revenue processing, or accounts payable.  Others have gone a step further and outsourced their entire accounting department, including the controller function.

Some of these arrangements work really well, but some others we’ve seen created huge problems.

If you’re considering outsourcing or trying to evaluate your current arrangement, here are some things you might consider from our experience.

Remember you’re not their only client. You hired the outsourcer in part because they serve lots of companies in your industry.  That means they also serve other companies with the same reporting deadlines that you have. Before you engage an outsourcer, establish a monthly accounting calendar that details all of the reporting deadlines, and make sure they agree to meet those deadlines.  Most importantly, don’t miss your deadlines.  You will have to provide information to the outsourcer throughout the year, and every delay on your end could result in delays by the outsourcer.

Make sure you control the general ledger.  Some companies outsource the responsibility for recording transactions so that every entry is recorded by their outsourcer in an accounting system maintained by the outsourcer.  In those situations, you lose a significant amount of control over the efficiency of the accounting process and your ability to generate financial reports on a timely basis.  And what if they get some entries wrong and they have to be corrected?  Now, you’ve delayed the process even more.  Finally, what happens if you decide the arrangement isn’t working and you want to change service providers or take the accounting in-house?  If you don’t own the software and control the general ledger, you’ve got problems.

Hire a knowledgable and experienced controller. You need someone who lives in and experiences your business everyday to effectively oversee your accounting and financial reporting processes.  You need someone in-house who understands the accounting and tax implications of the operational decisions you make every day and can offer proactive advice.  An outsourcer who thinks about your company on a part-time basis when it’s time to close the books just can’t offer that service.

The decision to outsource has huge impications for your company.  If you’ll invest the time early on to set expectations, you can structure an arrangement that works very effectively.  If we can help, just let us know.

A tax partnership is a tool used in certain drilling arrangements to ensure that the working interest owner who bears the cost of drilling a well also gets the tax benefits related to those costs.

Consider the following example.  A working interest owner who doesn’t have the cash to drill and develop his property strikes a deal with a third party operator to fund all of the drilling costs in exchange for a working interest in the property.  Even though the operator will incur all of the costs to drill that well, he can only deduct IDC in proportion to his ultimate working interest percentage.  The remaining IDC is treated as additional leasehold cost and is depleted (deducted) over time.  As a result, tax deductions for IDC paid in one year are not realized for tax purposes until later years. 

Here’s where a tax partnership  can be a huge benefit to the operator.  By establishing a tax partnership and contributing all of the property and the costs of drilling and development to that partnership, all of the costs incurred (and resulting tax benefits) can be allocated to the operator regardless of the ultimate working interest percentages.

Using a tax partnership is not without its hassles.  The biggest headache is the administrative burden of accounting for the activity of the partnership and the requirement to file a federal partnership tax return each year.  Therefore, you should carefully consider the tax implications before deciding to use a tax partnership.

If you have questions about whether you might benefit from using a tax partnership, we can help.

As a result, the FASB has deferred the effective date of FIN 48 to annual financial statements for fiscal years beginning after December 15, 2008.  The deferral applies to most nonpublic entities with certain exceptions.

If an entity elects to defer adoption of the Interpretation, the entity must disclose its election, as well as its accounting policy for evaluating uncertain tax positions for each set of financial statements were the deferral applies.

Schedule B (Other Information) was previously a half-page, list of 12 “yes or no” questions whose repsonses could easily be carried forward from the prior year. The new Schedule B (still labeled Other Information) now spans a page and a half! This makes the Form 1065 five pages instead of four.

New reporting requirements ask that you state any corporation, partnership, or trust that “directly or indirectly owns more than 50% of the profit, loss or capital of the partnership”. A separate section asks about individuals or estates that “directly or indirectly owns more than 50% of the profit, loss or capital of the partnership”. The key word that I think definitely has to be focused on is INDIRECTLY; that word alone will require a taxpayer to do some mapping of ownership amongst its partners.

Another question in Schedule B asks about the partnerships ownership of other entities. It requires you list any corporation or partnership directly with at least 20% or own “directly or indirectly 50% or more of the voting power”. Again, the term “indirectly” pops out to makes us think a little harder beyond just the entity filing the return and its partners.

So, as information is beginning to be gathered and you prepare to file your return or have it filed by your trusted tax professional, do yourself (and them) a favor and get this new information together as well. If you want to review all the new questions and required information, check out the IRS website to view a copy of the form.

Many deals, especially those financed by investment funds, have a tiered or waterfall structure for allocating income and distributions.  It is normal for the partners who are putting the deal together and who will run the day-to-day operations to have a relatively small ownership percentage on the front end since most of the capital will come from an investment fund.

Over time, based on the entity’s performance and the increase in value of the enterprise, these “operations partners” may increase their ownership percentage in the income and profits of the partnership.  This will usually occur once certain return hurdles are met for the “investment partners.”  Unless provided for in the partnership agreement, this switch in sharing percentages will result in the “investment partners” being allocated more income and therefore more distributions over time that the parties intend.

Although there are several options, the best way to make sure all partners end up being allocated the income and distributions everyone intends each party to receive over time, is to handle income allocation and distribution provisions independently in the partnership agreement.

Working interests and royalty interests are considered interests in real estate. As a result, not only can you exchange a working interest for another working interest and take advantage of deferring tax on the gain, you can exchange oil and gas interests with other types of real estate as well.

To qualify for Like-kind Exchange treatment, there are some limitations:

1. The property relinquished and the replacement property must be trade or business property or be property held for investment.
2. Upon the sale of the relinquished property, you have 45 days to specifically identify the replacement property. There are additional limitations if you identify more than three replacement properties.
3. You must close on the purchase of the replacement property within 180 days of the sale of the relinquished property.
4. The exchange must take place using a qualified intermediary.

For additional information on using 1031 Exchanges for oil and gas properties, see this article from 1031 Corporation.

• Do you account for oil and gas properties under the full cost method?  You may not be allowed to under IFRS.
• Is your accounting staff sufficient to understand the changes and the impact on your business, and if not, how do I accomplish this? You may be able to hire an accounting firm to consult and evaluate your current accounting compared to IFRS.
• When will this possible conversion be required? By most reports, the switch to IFRS could be as early as 2013.

International standards would have a significant affect particularly on oil and gas companies.

Under current International Financial Reporting Standards (IFRS), oil and gas companies would need to make drastic changes in their accounting methods. In their current form, IFRS does not have specific standards for any individual industries. Based on the conceptual framework, the current standards would not allow full cost accounting for oil and gas properties. The framework allows capitalization of assets when you are able to predict the probable future economic benefits as a consequence of the investment, which may be difficult in exploration when you consider the amount of unproved assets.

The International Accounting Standards Board (IASB) is currently working on a project to better address the complexities of oil and gas. The project is also addressing issues of fair value reporting of reserves on the balance sheet. This project may address the asset issue, but ultimately not address issues such as joint ownership arrangements, which are also integral to oil and gas property accounting.

Check back for periodic updates.