Beyond the Wells: A Comprehensive Guide to Auditing Excellence in Nigeria's Energy Frontier

The Oil and Gas sector is a critical component of Nigeria's economy, and effective auditing is essential for ensuring transparency, compliance, and efficient operations.

The Oil and Gas sector, often called the Energy sector, presents unique challenges, such as pricing determination complexity and diverse royalties and taxes. However, by effectively addressing these challenges, auditors can contribute significantly to the accuracy of financial reporting, risk management, and the overall safety and sustainability of this vital sector.

This sector plays a fundamental role in the global economy, providing the primary sources of energy for various sectors, including transportation, manufacturing, and residential use. The sector is also divided into three major streams:

• Upstream: Exploration, Development, and production activities, e.g., prospecting, drilling and extraction, offshore drilling and mining
• Midstream: Transporting and processing extracted resources
• Downstream: Refining of the extracted raw materials

This article provides an overview of special considerations and best practices in oil and gas auditing for Nigerian companies.

Regulatory Environment

The Oil and Gas sector in Nigeria is a highly regulated sector. Essential government agencies to note are:

• Nigerian Upstream Petroleum Regulatory Commission (NUPRC), formerly the Department of Petroleum Resources (DPR) oversees exploration, production, and marketing, ensuring compliance with industry standards in Nigeria.

• The Nigerian National Petroleum Corporation (NNPC) manages state-owned assets and collaborates with international oil companies to boost the country’s economy.

• The Nigerian Content Development and Monitoring Board (NCDMB) promotes local participation and capacity development.

• The Petroleum Products Pricing Regulatory Agency (PPPRA) regulates product pricing and supply of petroleum products. Nigeria Midstream and Downstream Regulatory Authority which are responsible for technical and commercial regulation of the midstream operations in Nigeria.

• Federal Inland Revenue Service (FIRS) which is tasked with collecting taxes.

These and other agencies collectively ensure the sector operates efficiently, safely, and in accordance with local and international guidelines.

Specific Considerations for Auditors

1. Risk Assessment

The oil and gas industry in Nigeria is subject to various inherent risks. These risks arise from both internal factors within the industry and external factors beyond the control of the companies operating within it.

It is crucial that auditors assess this risk as they can pose a potential risk of material misstatement on the financial statements. They include but are not limited to:

• Commodity Price Risk: A significant drop in oil prices can impact the profitability of oil and gas companies, potentially leading to asset impairment, revenue reductions, and financial statement adjustments.

• Reserve Estimation Risk: Estimating oil and gas reserves is a critical aspect of financial reporting for oil and gas companies.

• Environmental and Regulatory Compliance Risk: Oil and gas operations are subject to environmental regulations. Failure to comply with these regulations can lead to fines and legal liabilities.

• Currency Exchange Rate Risk: Fluctuations in the exchange rate of the Nigerian Naira (NGN) can impact the financial statements of oil and gas companies, particularly in terms of translating foreign currency-denominated transactions.

• Government policies/involvement: licensing, subsidy removal, gas flaring, etc.

Audit Procedures for Risk Assessment

• Auditors should perform a thorough examination of the risk which includes obtaining the company’s risk register and reviewing how the company manages its associated risks related to fluctuating commodity prices, like oil.

• Assess the reasonableness of the basis of estimation of gas reserves.

• Evaluation of the company's compliance with laws and regulations including environmental rules.

• Analysing foreign currency transactions to ensure that the company follows accounting standards (IAS 21 – The Effects of Changes in Accounting Standards).

• Test the effectiveness of strategies the company uses to manage its risk.

• Assess the expertise of the company's management and consider bringing in specialists when necessary.

2. Revenue Recognition

The primary revenue sources for oil and gas companies operating in Nigeria encompass the sale of crude oil, natural gas, and petroleum products, with crude oil serving as a significant contributor.

Audit Procedures for Revenue Recognition

Conducting revenue audits in Nigeria's oil and gas sector necessitates a tailored approach. This audit encompasses three critical components: Contract Review, Internal Controls Evaluation, and Revenue Testing.

• The Contract Review involves a meticulous examination of crucial agreements, such as Production Sharing Contracts (PSCs) and Joint Venture Agreements (JVAs), to ensure compliance with local laws and that revenue recognition aligns with the contracts' economic substance.

• The Internal Controls Evaluation assesses the effectiveness of controls related to revenue recognition, pinpointing weaknesses and recommending improvements when necessary.

• Finally, Revenue Testing entails the selection of a representative sample of revenue transactions for verification, ensuring adherence to contractual terms and regulatory requirements, with particular focus on intricacies like Royalty and Production Entitlement calculations.

• Also, auditors need to consider any subsequent events, such as changes in pricing or contracts, that may affect the accuracy of revenue recognition.

This multifaceted audit approach is vital to ensure the accuracy and integrity of revenue reporting within the Nigerian Oil and Gas industry.

3. Reserves and Resources estimates

Reserves are the quantities of oil and gas that are known to exist with a high degree of certainty and can be extracted with current technology and economics.

Resources include both known reserves and potential future discoveries that may require further exploration. Reserves estimates are performed by geologists or petroleum reservoir engineers and these estimates are crucial for planning and decision-making in the oil and gas sector.

Audit Procedures for Reserves & Resources Estimates

• A comprehensive approach involves assessing the effectiveness of internal controls, control environment, data integrity, and documentation and approval processes in place for estimating reserves.

• Robust discussions with industry experts are always necessary to get it right.

• Review of Management expert’s work and assumptions is also crucial.

• Other procedures can also be carried out e.g data verification, testing assumptions, comparing current and prior estimates, reconciling with production data, sensitivity analysis, review of documentation, seeking expert opinions, benchmarking against industry peers, and ensuring compliance with regulatory standards.

• Ensure disclosure of key assumptions and key sources of estimation uncertainty as required by IAS 1- Presentation of Financial Statements.

These combined procedures help auditors evaluate the reliability and accuracy of reserve estimates, ensuring they align with industry best practices and regulatory requirements.

4. Depreciation, Depletion and Amortization

• Auditors must gain a comprehensive understanding of the company's depreciation and depletion policies.

• Thorough examination of asset registers, including assessments of useful lives and salvage values.

• Verification of the application of depreciation methods, scrutiny of assets disposals, and ensuring alignment with accounting standards are crucial for accuracy.

• Additionally, reconciling accumulated depreciation and assessing additions and retirements of assets is essential.

• Auditors should also evaluate the basis for depletion, confirm the use of reserves and production data in calculations, and assess the impact of changes in proved reserves on depletion.

• Finally, a meticulous review of supporting documentation, along with adherence to tax regulations, ensures a comprehensive audit of depreciation and depletion processes.

5. Joint Ventures, Production Sharing Contracts (PSCs) and other Specialized arrangements

Many oil and gas operations involve joint ventures with foreign partners. These can be highly complex, with multiple partners and revenue-sharing arrangements. Oil and gas companies utilize various specialized arrangements to manage their operations and investments, including Service Contracts. Service Contracts entail providing services for predetermined fees while Concession Agreements similar to PSCs, offer control over exploration and production in specified areas, often with royalties or taxes to governments.

Audit Procedures for Joint Ventures, Production Sharing Contracts (PSCs) and other Specialized arrangements

Verifying the accuracy and compliance of financial reporting related to these arrangements, ensuring that revenue recognition, cost allocation, and contractual obligations are properly accounted for, assessing the adequacy of risk disclosure and mitigation strategies to safeguard the company's interests and compliance with applicable regulations and industry standards.

6. IFRS 16 Consideration

The oil and gas industry is highly dependent on leased assets, so there is a need to carry out a review of the IFRS 16 assessment.

Audit procedures for IFRS 16 Assessment

• The auditor should review the lease contracts entered into by the oil and gas company to identify all the leases that fall within the scope of IFRS 16 - Leases. This may involve reviewing lease arrangements, communicating with management, and conducting interviews.

• Evaluating the judgement made by management in determining the lease term and independently verifying supporting documentation.

• The auditor needs to verify that the lease payments have been correctly identified and recorded in accordance with IFRS 16.

• Assessing the appropriateness of the discount rate used by management in calculating the lease liability and the corresponding right-of-use asset.

• Testing the completeness and accuracy of the lease disclosures on the financial statements to ensure compliance with IFRS 16.

7. Assets Retirement Obligation

This is a liability that the oil and gas companies in Nigeria incur for the eventual decommissioning and abandonment of exploration, production, and transportation facilities. This is very critical for oil and gas companies as it involves estimations.

Audit Procedures For Asset   Retirement Obligation (ARO)

• The auditor should gain proper understanding of the contractual obligations by reviewing the contracts agreements and other legal documents related to the assets to identify the specific asset retirement obligations.

• The auditor may need to engage technical experts or rely on internal technical personnel to assess accuracy and reasonableness of the company’s estimates for decommissioning, restoration, and abandonment costs.

• Evaluation of the reasonableness of assumptions used in estimation fair value of ARO, this can be done by reviewing the company’s discount rates, and other macro-economic assumptions.

• Verification of costs and commitments, and also carry out environmental compliance review given the significant environmental restoration and remediation requirements associated with ARO in the oil and gas industry.

8. Sustainability Reporting

Oil and gas companies must demonstrate commitment to environmental and social responsibility. Auditors should evaluate the company's compliance with environmental regulations and its corporate social responsibility initiatives.

With the requirements of IFRS Sustainability Standards S1 & S2 and the applicability on financial year end starting 1 January 2024, oil & gas companies and auditors must be up to date with these standards and ensure compliance considering Nigeria is an early adopter of the standard.

Conclusion

Auditing in the Oil and Gas sector is complex and requires a deep understanding of the industry's nuances and specific challenges.

From reserves estimation to revenue recognition, depreciation and depletion, specialized arrangements, and compliance with regulations, auditors play a significant role in the sustainability of this sector and must navigate a dynamic landscape while upholding the highest standards of transparency and adherence to regulatory frameworks.