M&A Due Diligence Checklist

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                       INTERNAL AUDIT WORK PROGRAM

AUDIT PROCEDURE                                                        INITIALS   DATE   W/P

  I. General
      A. What is the status and location of well, revenue, joint
      interest billing, production, contract, and other files
      maintained by the seller.
      B. Are computer tapes of all accounting files and data
      available, or can these files downloaded into the buyers
      C. How long has the seller owned the properties and how
      far back due accounting records go?
      D. Will any employees be laid off as a result of the sale
      and would they be available to the buyer?

  II. Interest Verification
       A. Well Interests - verity Seller represented interest to the
            1. Revenue checks
            2. Joint Interest Billings
            3. Division of Interest
            4. Joint Operating Agreements
            5. Payout Statements
            6. Gas Balancing Statements
            7. Ad Valorem Tax Bills
            8. Any other documents denoting ownership
       B. Revenue Checks
            1. Review the following and note discrepancies
                 a. Tie revenue amounts appearing on checks to
                 the Lease Operating Statement
                 b. Tie volumes to the Lease Operating
                 Statement. State Production reports,
                    Independent production History and gas
                    Balancing Statements
                 c. Tie price received to applicable contracts. run
                 tickets or invoices
                 d. Review for applicable severance tax rates
                 e. Review other deductions for applicability to
                 contracts or agreements
       C. Expenditures
            1. Tie Joint Interest Billings to Lease Operating

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           2. Review Joint Interest Billings for unusual or
           significant charges
      D. Lease Operating Statement
           1. Review for differences between source
           2. Determine impact of accruals, non-billable
           expenses or special overhead
      E. Investigate any Discrepancies noted above

III. Processing and Recording of Revenues and Revenue
      A. Purchasers and Remitters
          1. Obtain Major Purchasers list
          2. Obtain a list of the difficult purchasers to deal
          with and which ones pay slow?
          3. Are sales remitted at the wellhead or some other
          4. Are there any funds being held by purchasers or
      B. Check Processing and Revenue Distribution
          1. Is a purchaser cross reference sheet available?
          2. Are there any checks that are not processed to a
          division of interest and instead coded to some type
          of holding account awaiting further instructions?
          3. Are checks filed by well, purchaser, batch. or
          some other method?
          4. Are distribution made on unreceived revenues or
          out of pocket royalties required?
          5. Are revenues disbursed on check stubs or run
      C. Severance Taxes
          1. What wells is the seller responsible for reporting
          severance taxes on?
          2. When was the last severance tax audit done by
          each state?
          3. Are Severance Tax Payments current?
      D. Transportation. Marketing, and other deducts

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AUDIT PROCEDURE                                                   INITIALS   DATE   W/P

          1. Are there any deducts from purchaser/remitter
          checks other than severance taxes and are they
          evidenced by a contract or agreement?
          2. Are there any deducts that the seller makes prior
          to the distribution of revenues and are they
          evidenced by a contract or agreement?
      E. Suspended Revenues Payable
          1. Review Suspense run by well for significant or
          negative items
      F. Other items
          1. Are there any other unusual revenue procedures or
          allocations required on a regular basis not discussed
          2. Are there any special royalty provisions
          concerning payment timing, volume, or price?

 IV. Oil and Gas Contracts/Marketing Arrangements
     A. Are contracts filed by well, purchaser, or some other
     B. Is there a master listing of contracts and contract
     C. What are the terms including price, required volumes,
     and contract duration for the major wells?
     D. Are there any wells in which gas must be nominated
     E. Do any pooling arrangements exist'?
     F. Are there any contracts existing with gas plants or
     processing facilities?

  V. Processing and Recording of Expenses
      A. Vendors
          1. What payment time frame is generally utilized for
          2. Which vendors require deposits?
          3. Are vendor invoices filed by well. batch, vendor.
          or some other method?
          4. Are there any vendor liens on wells?

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AUDIT PROCEDURE                                                     INITIALS   DATE   W/P

           5. Are there any vendor invoices unpaid as a result of
      B. Joint Interest Billings
           1. How are Joint Interest Billings filed?
           2. Do operating agreements exist on all wells?
           3. How are operated divisions of interest set up?
           4. Are there any outside operated wells that require
           seller to re-bill?
           5. What are the recent divisions of interest utilized?
           6. Who are the most difficult owners/operators to
           deal with?
      C. Company Labor. Field Offices, and Vehicles
           1. What are the terms of field offices and other
           leases, if applicable?
           2. Are there any field labor, office, vehicle or other
           costs not being recouped through joint interest

VI. Other Assets - If other assets are being acquired. detail
concerning these assets should be requested. Such details
might include specific questions and requests concerning
physical location, types of equipment, values. Serial
numbers. Evidence of title, etc. Questions should be asked
concerning the impact of these assets to the joint account.
      A. Well Inventory
      B. Tubular Goods
      C. Pipelines
      D. Gas Plants
      E. Facilities ( SWD. Compressors. Dehydrators.etc.)
      F. Vehicles
      G. Buildings/Offices
      H. Furniture and Equipment
      I. Prepaid Drilling Cost
      J. Deposits
      K. Accounts Receivable (See Section VI)
      L. Any Other assets

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AUDIT PROCEDURE                                                     INITIALS   DATE   W/P

VII. Accounts Receivable
      A. Are there any pre-effective date receivables being
      B. Are there any credit balances being assumed?
      C. Is there proper documentation concerning these
      D. Are aging schedules available?
      E. Which owners does the seller net joint interest billings
      against revenue?
      F. Which operators currently net sellers joint interest
      billings against revenue?
      G. Is the netting contractual or due to slow or non-
      H. What steps has the seller taken to collect past due
       I. Is correspondence and documentation concerning past
          due collection attempts available?

VIII. Contingencies
      A. Gas Balancing
           1. Do well imbalances exist?
           2. Do pipeline imbalances exist?
           3. Are there gas balancing agreements on wells with
           4. Have current balancing statements been prepared
           for all balanced wells?
           5. Are there any disagreements or disputes between
           owners concerning imbalance amounts?
           6. Are there any settlement offers outstanding?
           7. What wells have imbalances that will significantly
           affect future revenues?
           8. What is the current nomination status on these
      B. Plugging Liabilities
           1. Which wells are currently in a negative cash flow
           status or have reserves that have significantly
           2. Approximately how much money are negative

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AUDIT PROCEDURE                                                   INITIALS   DATE   W/P

             cash flow wells losing on a monthly basis?
          3. Is there any plans for reworks on these wells?
          4. Is there a list of wells proposed for plugging?
          5. Have any plugging or reworks be requested by
          other owners
          6. What are the estimated costs of plugging wells?
      C. Advance Payments
          1. What is the sellers policy concerning advance
          payment requests?
          2. Are there any balances in the advance payment
          account currently?
          3. Are there any owners in which advance payments
             have been requested, but refused to pay?
          4. When will balances in the advance account be
      D. Take or Pay/Production Payments
          1. Do any Take or Pay or production arrangements
          2. What is there current status?
      E. Payouts
          1. What wells do payout reversions exist on?
          2. Of these, which are likely to payout?
          3. Are payouts statements available on all wells with
          reversionary Interests?
          4. If not. can estimates be generated?
          5. What is the impact of reversions to future cash
      F. Accounts Payable
          1. Are there any accounts payable being assumed?
          2. If so, have they already been billed out through
          joint interest billing?
          3. Are there any disputed payables?

      G. Capital Expenditures/ Drilling Commitments
          1. Are there any outstanding drilling commitments?
          2. Have any capital expenditures been incurred after
          the effective date?

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AUDIT PROCEDURE                                                        INITIALS   DATE   W/P

            3. If so, were these expenditures reflected in
            engineering studies?
            4. Obtain a copy of the open AFE's including
                  a. Activity report
                  b. Date work started
                  c. Last activity
                  d. drilling reports showing work done and cost
       H. Revenue and Joint Interest Audits?
            1. Are there any open or unresolved audits?
            2. Have all wells drilled in the last two years had
            audits performed?
       I. Environmental
            1. Have any environmental audits been performed on
            wells in the past?
            2. If so, are copies available?
            3. What are the dollar estimates required in order to
            bring locations into compliance with environmental
            recommendations and regulations?
       J. Litigation
            1. Is there any litigation or dispute, either threatened
            or pending of which the seller is aware?
            2. If so, are any settlements proposed or imminent?
            3. Are there any tax liens filed against the

IX. Other Reporting
      A. MMS
          1. What MMS reporting is required?
      B. Partnerships and Joint Ventures
          1. What wells are part of a special tax partnership or
          joint venture?
          2. Is there any financial statement. tax return. or
          other records that must be prepared by the seller on
          these partnerships?
          3. Must independent audits be performed on these
          partnerships or joint ventures?
          4. Can the buyer elect out of the partnerships?

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AUDIT PROCEDURE                                                     INITIALS   DATE   W/P

X. Land
      A. General
          1. Discuss the control of confidential information
          with the Division Landman and the landmen in the
          Division. Consider the safeguards in effect to avoid
          employee conflict of interest. Determine the
          safeguards in effect for the control of maps.
          2. Follow through on any violations reported and
          evaluate the resolution and significance.
      B. Scouting
          1. Ascertain methods or procedures employed for
          securing timely information relative to leasing and
          drilling activities in the area. If the information is
          obtained through scouting activities by company
          employees, consider the following:

           2. Do scouts regularly report acreage (federal and
           state) being released by others in the state?
           3. Is scouting information pooled with other
           companies through scout check meetings or other
           4. Do scouts currently report land play drilling
           activities of others?
           5. Are scouts restricted access to other confidential
           6. Determine if the availability and desirability of
           contract scouting has been considered. If the method
           used to obtain information on the leasing and drilling
           activities is not by company employees, review and
           evaluate method used.
       C. Lease Acquisitions
           1. Trace selected Lease Acquisitions to Leasehold
           Agreements and verify the
           2. Each purchase was covered by a properly
           approved AFE.
           3. Leasehold records contain the required detail;

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AUDIT PROCEDURE                                                       INITIALS   DATE   W/P

           such as legally recorded leases,
              assignments where applicable, evidence of lease
              cost, description, acreage, rent date and amounts,
              and accurate cost allocation of individual leases.
           4. Leasehold recording and processing procedure is
           on a current basis.
                a. Controls are in effect for billing partners with
                their share of lease acquisition costs.
                b. Verify all obligations on the lease agreement
                are being compiled with;
                    i.e., obligations to drill, etc.
                c. Review the procedure followed in
                ascertaining the price per acre to be paid for
                leases in any given prospect.
                d. Determine the "going rate" and compare with
                actual acreage cost and brokerage commission
                on leases purchased "going rate" can be
                determined through examining lease submittals
                made to the company and transactions of a
                similar nature.
                e. Is there evidence in the leasehold file to show
                that the purchase of a lease was recommended
                by a geologist?
                f. Review the procedures for controlling top
                price per acre to be paid by brokers and
                landmen. -
                g. Determine the following regarding
                commission payments:
                h. Leasehold records clearly indicate amounts
                paid to brokers for services rendered.
                i. Lease was purchased by broker to whom
                commission was paid.
                j. Commission acres agree with leased acres.
                k. No duplicate payments were made; i.e., per
                acre and per them payments not made for same
                l. Where expenses are paid in addition to

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AUDIT PROCEDURE                                                     INITIALS   DATE   W/P

                commissions, check for receipts supporting the
                broker's statement.
               m. The memorandums of agreements between
               landmen and Brokers relative to basis of payment
               for services are on file. If payment is made
               contrary to the agreed basis, insure that an
               adequate and acceptable explanation is given.
               n. Determine how the broker's commission rates
               were arrived at and by whom.
               o. If lease purchase funds were advanced,
               determine that:
               p. Advances were covered by a properly
               approved AFE.
               q. Proper accounting is made for funds advanced
                   and that the funds were returned promptly
                   when it is determined that they are no longer
               q. Do duplicate credits were made against funds
               r. File contain acknowledgement by broker of
               funds advanced.
          5. Determine that deposits on bids are properly
          6. Examine files on trades which fail. Verify the
             propriety of the documents supporting payments to
             brokers where leases were not obtained. If no
             payment was made, inquire as to the reason.
          7. Insure that commitments for purchase of non-
          producing leases are reported.
          8. Examine acquisition costs of lease renewals.
          9. Determine if procedures provide that personnel
          authorized to sign lease purchase checks have the
          supporting papers at hand for verification purposes at
          time checks are issued.
         10. Trace a selection of leases from the most recent
         inventory run to the leasehold agreement files to verify
         that leases on inventory are active. Note particularly

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AUDIT PROCEDURE                                                      INITIALS   DATE   W/P

          any unsupported lease cost appearing in inventory and
          determine that control is exercised over these items for
          proper clearance.
          11. Select leases from a prior quarterly inventory run
          (one year if possible) and review to determine if still
          active. If production was obtained, insure that the
          lease was properly transferred to production.
          12. Check for safekeeping of revenue stamps.
          13. Determine if the Land Department refers 'proposed
          acquisition agreements requiring a guaranteed payment
          or an oil payment to the tax department for review
          prior to execution.
          1. Review procedures following in reviewing rental
          recommendations to ascertain that the geological unit
          recommends rental payment and relinquishments.
          2. Trace rental payments from the rental
          recommendations to the lease Purchase report and the
          Lease Agreement. Determine that the rental payments
          and relinquishments are properly approved.
          Determine if any leases were forfeited due to non-
      E. FARMOUTS - Review the files covering farmout
         agreements and perform the following:
          1. Determine that the farmout agreements are reviewed
          by the Legal Department and properly approved.
          2. Determine that follow-up is made if assignee's
          performance of obligations and that controls preclude
          the loss of a lease.
          3. Follow through on farmout agreements to determine
          that subsequent agreements were not made without
          proper approvals; such as the payment of dry hole or
          bottom hole contributions.
          4. Check procedures and controls for billing rentals to
          assignee on farmed-out acreage.
          5. Verify compliance with existing instructions relative
          to completion of the Initial Production Report, when

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AUDIT PROCEDURE                                                       INITIALS   DATE   W/P

          production is obtained on farmed-out acreage.
          1. Review the procedures followed in preparing,
          executing, and distributing agreements covering Joint
          2. Verify that agreements are properly approved.
          3. Examine methods to assure recovery of payments by
          participating parties in the Joint Agreement.
          1. Review the accounting Procedures for Acreage
          2. Determine the status of all trades. If acreage is
          owed to the company, examine the length of time
          acreage has been owed and documentation supporting
          the trade.

XI. Properties Department
     A. General
         1. Review and identify the system supporting the Land
         records Department.
            Obtain the numbers, names, and distribution of all
            reports and other output generated by the system. It
            is necessary to be familiar with the overall
            functioning of the system.
         2. Review and evaluate the internal controls to assure
         the integrity and reliability of data relating to the land
         record system.
         3. What controls exist to verify accuracy and
         completeness of machine generated Accounting
         entries, invoices, and checks.
         4. Discuss the importance and ease of replacement of
         source files with the Properties Management. Could
         the Department continue to operate if the files were
     B. Calendars
         1. Determine the types of "calendars" that exist.
         2. Ascertain if a calendar is prepared every month for
         each general ledger company or Operating Division

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AUDIT PROCEDURE                                                    INITIALS   DATE   W/P

         and who is responsible for approving those calendars.
         3. Select a sample of calendars for two months and
         perform the following tests:
         4. Trace items shown on the calendar to the original
         documents (acquisition
         5. Verify that the recommendations made on the
         calendar to "pay" or "defer" is carried out by the
      C. Disbursements and Billings
         1. Verify correct payment to the landowners by
         reviewing the return receipt copy of the checks.
         2. Trace payments to the check register and check
         3. Verify correct amount billed on any inter-company
         invoices by tracing amounts to the invoice register and
         invoice summary.
         4. Check procedures and controls for billing rentals to
         assignee on farmed-out-acreage.
         5. Verify correct working interest percentages on the
            billings to the property lease files.

         6. For any inter-company and partner invoices, verify
         with the appropriate accounting office that the
         accounts receivable is recorded in the General Ledger.
     D. Checks
         1. Verify that blank checks are stored in a locked
         cabinet or vault.
         2. Verify the withdrawal of blank stock is properly
         3. Examine a sample of computer generated and
         manually prepared checks to determine if checks are
         modified in any way. If so, examine for correct
         procedures and support.
         4. Review manual checks for the reason they were
         prepared manually. Determine if manual checks are
         included on the "delay rental check error list" and the
         reason why.

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AUDIT PROCEDURE                                                       INITIALS   DATE   W/P

     E. Property Lease Files
          1. Select a number of files and review to insure that all
          data has been correctly put into the land System.
          Question and investigate any discrepancies or missing
          2. Determine that updates are maintained in the files,
          and that they have a sequential number assigned to
          assure continuity for historical purposes.
     F. Suspense List
          1. Review the latest monthly calendar for suspense
          2. Select a sample of properties and review the reasons
          they are on the suspense list. Determine what
          conclusive actions have been taken.
     G. Bank Account Review
          1. Request signature authorizations from Banks.
          Obtain copy of authorized signatures from Treasury
          Department and compare.
          2. Verify that Bank Accounts are reconciled in a timely
          fashion by an independent group.
     H. Surrendered Properties
          1. Examine procedures for Managerial approvals of
          properties to be surrendered.
          2. Evaluate the controls considering the following:
                a. Timely notification to management of
                properties subject to surrender.
                b. Positive confirmation by an authorized
                employee of properties to be held and
                surrendered to avoid any unintentional
                c. Insure the reason for surrender is shown on the
                surrender report.
                d. Are potential surrenders included in the budget
                e. Is there a formal report generated of properties
          3. Select a sample of properties from the "Expiration

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AUDIT PROCEDURE                                                       INITIALS   DATE   W/P

          Calendars" and trace disposition of properties to verify
          that properties were handled as management
          4. Determine if well cards, Title Opinions, and lease
          records are submitted to the Division Order and
          Royalty Department on a timely basis upon completion
          of the well.
          5. Determine if some type of documentary stamp tax is
          levied on oil and gas leases, mineral deeds, and royalty
          assignments. Check for safekeeping of the revenue
          stamps and compliance with the existing state laws.

     A. Prepare a schedule of sales of producing properties for
     the audit period. Obtain the files or documentation
     supporting each sale and generally discuss the procedures
     followed by Management in handling these transactions.
     Review each of the sales and determine the following:
     B. Are recommendations solicited from key personnel prior
     to a possible sale of producing properties? Is there
     unanimous agreement among key personnel before the final
     decision to sell is made?
     C. Does a property section employee review the applicable
     agreements to determine if Joint Partners have preferential
     rights or whether the property is subject to a production
     payment? Have the required approvals been obtained from
     any partners?
     D. Are bid letters sent to all parties or organizations on the
     Divisions bid list? Does the Division Production Manager
     select the Purchaser? If not, determine final responsibility
     of the decision.
     E. Was an AFE prepared to document the sale? Does the
     AFE reflect the monetary amount of the sale? Is the AFE
     routed to the appropriate Division and Joint Partner
     personnel for approval? Review the timing between the
     preparation of the AFE and the actual date of sale.
     F. Has the Division conducted an inventory of equipment
     on location? Were all items included in the sale agreement?

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     G. Have all necessary State and Federal forms been
     properly prepared to transfer properties? Are invoices for
     prorated taxes prepared and presented to the purchaser for
     payment? Is the sale subject to Federal or local sales taxes
     and have they been assessed accurately?
     H. Has the sales price been adjusted for any revenue of
     expense realized after the date of sale?
      I. Has the payment been made by certified check or band
      order? If not, review method of payment.
      J. Have all appropriate departments been advised of the

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