[Special Report on the External Quality Control Review of the Audit Divisions, Minerals Management Service]
[From the U.S. Government Printing Office, www.gpo.gov]

Report No. 98-I-398

Title: Special Report on the External Quality Control Review of the
       Audit Divisions, Minerals Management Service


  
     Date:  April 2, 1998
  

  
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     U.S. Department of the Interior         
     Office of Inspector General                              

     SPECIAL REPORT

     EXTERNAL QUALITY CONTROL REVIEW OF THE AUDIT DIVISIONS,
     MINERALS MANAGEMENT SERVICE         

     REPORT NO. 98-I-398
     APRIL 1998 
  
  
  
     MEMORANDUM
  
     TO:  The Secretary
  
     FROM:  Robert J. Williams
            Acting Inspector General
  
     SUBJECT SUMMARY:  Final Special Report for Your Information -
                       "External Quality Control Review of the Audit
                       Divisions, Minerals Management Service" (No. 98-I-398)
  

     Attached for your information is a copy of the subject final
     special report. The Minerals Management Service requested this
     review to be in compliance with the "Government Auditing
     Standards," issued by the Comptroller General of the United
     States, which requires organizations conducting audits in
     accordance with these standards to undergo an external quality
     control review every 3 years.
  
     This is the second report we are issuing on the Service's Audit
     Divisions. The first report contained the results of our audit
     of the Service's work regarding alleged underpricing of
     California crude oil. Because the Service's work on the
     underpricing of California crude oil was conducted under
     different controls, including methodology and performance
     procedures, the conclusions in that report do not relate to the
     Service's audit work covered by our external quality control
     review.
  
     Based on our review of the 19 audits, we concluded that the audit
     work performed by the Audit Divisions was generally in
     compliance with the "Standards" and the Service's Audit
     Procedures Manual. Specifically, the audits were conducted in a
     professional manner; audit conclusions were adequately supported
     by the working papers; and, with few exceptions, auditors were
     current in their continuing education requirements. Although we
     found minor weaknesses in the areas of compliance with laws and
     regulations, internal quality controls, audit supervision,
     timeliness of report products, and working paper quality, we
     also found that the validity of each audit finding and
     conclusion was not adversely affected. The report contained no
     recommendations.
  
     If you have any questions concerning this matter, please contact
     me at (202) 208-5745.
  
     Attachment
  
  
  
  
     SPECIAL REPORT
  
     Memorandum
  
     To:  Associate Director for Royalty Management,
          Minerals Management Service
     
     From:  Robert J. Williams
            Acting Inspector General
  
     Subject:  Special Report on the External Quality Control Review of
     the Audit Divisions, Minerals Management Service (No. 98-I-398)
  
  


     INTRODUCTION
  
     This report presents the results of our external quality control
     review of the Audit Divisions of the Minerals Management
     Service. The Service requested this review to be in compliance
     with the "Government Auditing Standards," issued by the
     Comptroller General of the United States, which requires
     organizations conducting audits in accordance with these
     standards to undergo an external quality control review every 3
     years.
  
     This is the second report we are issuing on the Service's Audit
     Divisions. The first report contained the results of our audit
     of the Minerals Management Service's work regarding alleged
     underpricing of California crude oil. Because the Service's work
     on the underpricing of California crude oil was conducted under
     different controls, including methodology and performance
     procedures, the conclusions in that report do not relate to the
     Service's audit work covered by our external quality control
     review.
  
     BACKGROUND
  
     The Minerals Management Service is responsible for managing
     royalties relating to minerals produced from most Federal and
     Indian lands.  Specifically, the Service collects about $4.4
     billion annually in rents, royalties, and other payments;
     maintains necessary accounting records; prepares royalty
     liability determinations; and conducts audits of royalty
     payments to ensure that royalties received represent fair and
     equitable value. To help accomplish its responsibilities, the
     Service has established financial and production accounting
     verification systems, compliance and enforcement programs, and
     an overall audit strategy.
  
     The Audit Divisions are responsible for conducting audits of
     royalty payors to ensure that the correct amount of royalties is
     reported and received. The Divisions are guided by a 5-year
     audit strategy and an audit plan that is updated annually. The
     strategy provides for a wide range of audits that cover specific
     companies and special issues or projects such as processing
     allowances pertaining to gas plants, production allocations
     specified by unit agreements, contract settlements, and royalty
     payments made from individual Indian leases. These audits are
     performed by residency teams permanently stationed at the 11
     largest royalty payor companies (see Appendix 1) and by mobile
     teams that visit smaller companies selected for review.
  
     The Audit Divisions consist of a headquarters office in
     Washington, D.C., and compliance divisions located in Lakewood,
     Colorado, and Dallas and Houston, Texas. The Dallas Compliance
     Division also has compliance offices located in Oklahoma City
     and Tulsa, Oklahoma. The Audit Divisions have a total of
     approximately 190 auditors.
  
     OBJECTIVE AND SCOPE
  
     The objective of our review was to provide reasonable assurance
     that audit work of the Audit Divisions was performed in
     accordance with the "Government Auditing Standards" and with
     policies and procedures contained in the Service's Audit
     Procedures Manual. To accomplish the objective, we judgmentally
     selected for review 19 audits, consisting of 6 audits each from
     the Lakewood and the Houston Compliance Divisions and 7 audits
     from the Dallas Compliance Division. The sample for the Dallas
     Compliance Division included two audits from the Oklahoma City
     Compliance Office and one audit from the Tulsa Compliance
     Office. Our sample was taken from summary lists prepared by the
     Service and reportedly represented all audits performed by the
     Service for the October 1, 1995, through May 1, 1997 period (see
     Appendix 2). Our review did not include any other work performed
     by the Audit Divisions during this time period and did not
     evaluate the economy or efficiency of the Audit Divisions
     operations. In addition, we did not evaluate the adequacy of the
     Audit Divisions overall audit strategy. The audits reviewed
     represented a cross section of audit activities, audit teams,
     and supervisory officials. We examined audit reports and other
     audit report products such as issue letters (formal
     notifications of royalty underpayments), orders to perform
     (demands for companies to recompute additional royalties owed),
     orders to pay additional royalties, and audit closure letters;
     the supporting working paper files; and employee training
     records.
  
     The review was performed at the Service's Royalty Management
     Program offices in Lakewood and at Compliance Division offices
     in Lakewood, Dallas, and Houston. We also visited the Service's
     audit residency offices located at Chevron Oil Company in
     Concord, California, and Texaco, Incorporated, in Houston. Our
     review was made in accordance with the discussion draft titled
     "Guide for Conducting External Quality Control Reviews of the
     Audit Operations of Offices of Inspector General," dated
     December 1996, and issued by the President's Council on
     Integrity and Efficiency. This draft discussion guide provides
     the standards and detailed guidance for conducting external
     quality control reviews required by the quality control standard
     in the "Government Auditing Standards."
  
     PRIOR REVIEW
  
     The last external quality control review of the Audit Divisions
     was conducted by the Office of Inspector General in February and
     March 1991. The resultant May 1991 report concluded that, with
     only minor weaknesses in the areas of individual job planning,
     legal and regulatory requirements, internal controls, audit
     evidence, supervision, and reporting, the Royalty Compliance
     Division (which became the Audit Divisions in a 1992
     reorganization) was in compliance with the "Government Auditing
     Standards." The report contained no recommendations.
  
     During our current review, we noted that the Service was not
     timely with its request for an external quality control review,
     as the prior review was completed about 5 years before the
     Service requested the current review. Accordingly, we believe
     that the Service should ensure that it complies with the
     requirement (Paragraph 3.33) of the "Government Auditing
     Standards" by undergoing an external quality control review at
     least once every 3 years.
  
     DISCUSSION
  
     Based on our review of the 19 audits, we concluded that the audit
     work performed by the Audit Divisions was generally in
     compliance with the "Government Auditing Standards" and the
     Service's Audit Procedures Manual. Specifically, the audits were
     conducted in a professional manner; audit conclusions were
     adequately supported by the working papers; and, with few
     exceptions, auditors were current in their continuing education
     requirements. Although we found minor weaknesses in the areas of
     compliance with laws and regulations, internal quality controls,
     audit supervision, timeliness of report products, and working
     paper quality, we also found that the validity of each audit
     finding and conclusion was not adversely affected, as described
     in the following paragraphs.
  
     Compliance With Laws and Regulations
  
     The working paper files for the 19 audits that we reviewed did
     not indicate that the Service had conducted a risk assessment to
     aid in detecting significant illegal acts. The "Government
     Auditing Standards" (Paragraph 6.28) states that a risk
     assessment should be performed so that specific audit procedures
     can be designed to provide reasonable assurance of detecting
     significant illegal acts. Because the royalty payment process
     for Federal and Indian mineral leases is complex and frequently
     involves large monetary amounts, we believe that auditors should
     be more cognizant of their responsibility to detect fraud and
     other illegal acts.
  
     Internal Quality Controls
  
     The Service established an internal quality control system, as
     required by the "Government Auditing Standards" (Paragraph
     3.31), which we believe provided reasonable assurance that the
     Service's Audit Procedures Manual was complied with and that
     audits were generally conducted in accordance with the
     "Government Auditing Standards." However, we also concluded that
     the system could be strengthened as follows:
  
     - Internal Quality Control Review Program. We found that the
     internal quality control review program which the Service
     initiated in 1996 generally operated efficiently and
     effectively. The program ensured that individual audit offices
     were evaluated on a regular and uniform basis, the internal
     reviews were completed timely, weaknesses identified in the
     internal review reports were balanced with noteworthy
     accomplishments of the offices, and appropriate officials were
     briefed on the results of the internal reviews. However, as
     currently designed, the internal quality control review program
     does not include tests for:
  
     -- Compliance with the general standards covering staff
     qualifications, independence, and due professional care. The
     "Government Auditing Standards" (Paragraph 3.32) requires that
     an internal quality control review program be designed to
     evaluate compliance with all applicable standards. Accordingly,
     the scope of the program should be expanded to include testing
     of the general standards.
  
     -- Determining whether a risk assessment for compliance with laws
     and regulations was performed, as required by the fieldwork
     standards of the "Government Auditing Standards" (Paragraph
     6.28). Accordingly, the program should include this step to
     verify that the auditors assessed the risks that significant
     illegal acts could occur and, as necessary, that the auditors
     designed and performed procedures to provide reasonable
     assurance of detecting significant illegal acts, as discussed in
     the prior section ("Compliance With Laws and Regulations").
  
     - Other Quality Control Matters. During our review, two issues
     that related to ensuring the accuracy of report products were
     disclosed as follows:
  
     -- Five of the 19 audits reviewed did not have an independent
     verification of computations. Although neither the "Government
     Auditing Standards" nor the Audit Procedures Manual specifically
     requires an independent verification, this procedure helps to
     satisfy the "Government Auditing Standards" requirement
     (Paragraph 7.50) that findings should be presented accurately in
     reports.
  
     -- The Audit Divisions were considering a significant policy
     change concerning the referencing process for final audit report
     products. Specifically, report referencing may become an
     optional rather than a mandatory procedure. In our opinion, the
     referencing process is an important tool that helps ensure the
     accuracy and overall quality of the report product. Accordingly,
     we strongly encourage the Audit Divisions to reconsider this
     policy change and to continue the existing requirements for
     report referencing.
  
     Audit Supervision
  
     We found that all audits were supervised but that the supervision
     was not always accomplished in a timely manner. The "Government
     Auditing Standards" (Paragraph 6.64) states that working papers
     should contain evidence of supervisory review of the work
     performed. Further, the Audit Procedures Manual (Section 7.6)
     requires supervisors to review the working papers "after
     segments of the work are completed." However, for 12 of the 19
     audits, the supervisory review of many working papers ranged
     from 3 to more than 12 months after the documents had been
     prepared. Additionally, for 5 of the 12 audits, the report
     product was issued, even though working papers had no indication
     that a supervisory review had been performed. The "Government
     Auditing Standards" (Paragraphs 6.22 and 6.23) requires staff to
     be properly supervised. Timely supervision of the working papers
     will reduce the risk that undetected errors or unsound
     conclusions could be included in the Service's report products.
  
     Timeliness of Report Products
  
     We found that report products for 2 of the 19 audits could have
     been issued more timely. Specifically, two orders to pay
     additional royalties relating to an audit of an oil company were
     issued at least 6 months after the draft orders had been
     prepared, and an order to pay additional royalties relating to
     the audit of a second oil company was issued about 2 years after
     the underpayments were identified. The "Government Auditing
     Standards" (Paragraph 7.6) states that reports should be issued
     "to make the information available for timely use."
  
     Working Paper Quality
  
     The supporting audit working papers were generally prepared in
     accordance with the Audit Procedures Manual (Section 7).
     However, some of the working papers and files for 13 of the 19
     audits did not have one or more of the following items: the
     required source, purpose, and conclusion; a table of contents;
     indexing (specifically, page numbers); adequate cross-indexing
     to the supporting working papers; the preparer's name; and a
     heading describing the working paper contents. Also, some
     records were not permanently attached to the files. In our
     opinion, these deficiencies did not adversely impact the overall
     quality of the audit working papers. However, we believe that
     the quality of working papers could be improved with more timely
     supervisory reviews.
  
     A response to this report is not required. However, if you have
     any questions regarding this report, please call Mr. Alan Klein,
     Director of Performance Audits, at (303) 236-9243.
  
     We appreciate the assistance of Minerals Management Service
     officials in the conduct of our review.           AUDIT
     RESIDENCY OFFICES       MINERALS MANAGEMENT SERVICE
  
  
          Office Location          Company Name
  
     Dallas Compliance Division Dallas, Texas                   Mobil
  
     Dallas, Texas                   ARCO
  
     Ponca City, Oklahoma                Conoco
  
     Tulsa, Oklahoma                Amoco
  
     Bartlesville, Oklahoma                    Phillips
  
     Houston Compliance Division Houston, Texas         
     Exxon
  
     Houston, Texas                   Shell
  
     Houston, Texas                   Texaco
  
     Houston, Texas                   Unocal
  
     Lakewood Compliance Division Concord, California      
     Chevron
  
     Findlay, Ohio                   Marathon           AUDIT SAMPLE
     SELECTION
  
      Office    Company      Case Location     Name      Number
     Type of Audit
  
     Dallas Compliance Division
  
     Dallas      ARCO      9340001    Residency*  Dallas
     Thriftway      5-40222    Company**  Dallas      Sunwest
     Petroleum  9540229    Special issue***  Dallas      Meridian
     9240205    Special issue  Oklahoma City  Jenex Petroleum
     9665511    Special issue  Oklahoma City  Merrico       6
     -65507.000     Company          (TriPower Resources) through .006
     Tulsa      Yates      5-40215.005,    Special issues        
     .011, and .014
  
     Houston Compliance Division
  
     Houston     Badger Oil        9520008    Company               
     and special issue  Houston     CNG Producing    9320081
     Special issue  Houston     Enron Oil & Gas     8820055
     Special issue  Houston     UMC Petroleum    9420030    Special
     issue  Houston     Shell          2-22708.017     Residency         
     and .022  Houston     Texaco       3-20069    Residency
  
  
  
     *Residency audits are comprehensive royalty reviews of the 11
     largest royalty payor companies that are conducted by audit
     staff stationed at the companies (see Appendix 1).
  
     **Company audits are comprehensive royalty reviews of the next
     largest 115 royalty payors, as well as randomly selected smaller
     companies, that are conducted by mobile audit teams.
  
     ***Special issues cover a variety of royalty verification
     activities, including audits of gas processing plants, the
     companies' royalty accounting systems, lease inspections
     performed by the Bureau of Land Management, individual leases,
     contract settlements, and royalty settlements. These audits are
     conducted by mobile audit teams.        
  
      Office    Company      Case Location     Name      Number
     Type of Audit
  
     Lakewood Compliance Division
  
     Lakewood     Chevron       3-30001.033     Residency        
     6-30503.000                  6-30501.022                  5-30238.000  
     Lakewood     Axem Resources    3-30094    Special issue
     Lakewood     Energy Minerals   4-30057    Special issue Lakewood
     Questar          3-30004    Company Lakewood     Mayo Foundation
     5-30212    Company Lakewood     Pan Canadian Petroleum  5-30206
     Special issue
     



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