Royalty Compliance

During the past several years, the Department of the Interior has been collecting about $4 billion in royalties each year from oil and gas companies that hold mineral leases on federal or Indian lands. Although the Minerals Management Service (MMS) has substantially improved its strategy for auditing royalty payers, these audits still do not provide reasonable assurances that such royalty payments comply with applicable laws, rules, and regulations. The amount of royalties actually audited or verified is very small, increasing the likelihood that noncompliance will go undetected. In addition, the judgmental samples are not representative of all payers and leases; consequently, MMS cannot determine with any degree of confidence such things as the level of compliance by payers or the magnitude of underpayment--that is, the royalties at risk. MMS can, however, require payers to do the additional work needed to correct the system problems found by audits and to compute any additional royalties due. An MMS task force issued a report in June 1991 recommending major changes to improve MMS' strategy for auditing royalty payers, including the use of statistical sampling, a measure GAO supports.

GAO found that: (1) MMS did not develop a comprehensive audit strategy until 1988 because it concentrated on time-constrained nondiscretionary work, which it substantially completed in 1987; (2) the 1988 MMS audit strategy targeted over 90 percent of all royalties, and accelerated the completion of previous years' audits to make the audit cycle more current; (3) under the strategy, MMS reviewed each selected payor's financial and reporting systems for compliance, and then sampled leases and monthly reports for production and royalty payments; (4) if MMS found systemic problems, it required payors to correct the problems and compute additional royalties due on all comparable leases, which MMS auditors would then review for adequacy; (5) the strategy did not ensure compliance because the amount of actual royalties audited was significantly smaller than what was targeted, and the samples were not representative of all payors and leases; (6) many payors challenged the restructuring accounting requirement; and (7) MMS revised its strategy to increase audit effectiveness and improve estimates, and issued an action plan in 1991 to ensure compliance by balancing and integrating field and automated system audits. GAO also found that: (1) MMS has improved communication and coordination with state and tribal audit programs, but some problems remain; (2) MMS allocated funding to state and tribal programs through an inequitable formula, and funding levels were not sufficient or stable for the planned work loads; (3) MMS contracted with a private firm to assist with royalty audits, but it has yet to decide if it will continue using contract auditors; and (4) MMS and the state and tribal audit offices have internal control procedures to ensure the propriety and accuracy of audits.