Fall 2021 AFA 718 Group Term Paper (35 marks)
Marathon Oil Ltd.: Initial Audit
Engagement and Fraud Risk Case for a
Specialized Industry
INTRODUCTION
Over the years the cost of filling up at gas stations has generated negative publicity for the oil and gas
industry, and as a result the industry at times has been accused of price gouging and antitrust practices.
Turbulent gasoline prices have also become a political issue as the public blames the government for doing
nothing to control prices. One company in the center of the negative publicity is Marathon Oil Ltd., a major
publicly traded company that engages in upstream, midstream, and downstream development activities in
the oil and gas industry1. Marathon Oil‘s activities include exploration, production, and marketing of oil
and gas products. The company also seeks strategic alliances with local companies in the construction and
operation of oil pipelines and gas storage facilities. Marathon Oil’s vision and key objectives are to seek
undiscovered oil and gas reserves, to improve and expand production operations, to control costs, and to
partner with local businesses and oil and gas-related government agencies, all while maintaining a strong
balance sheet and maximizing shareholder value. Marathon Oil Ltd. recently filed its financial statements
with the Ontario Securities Commission (OSC) after its audit committee approved the hiring of Blake CPA,
LLP and the firing of its previous auditor, Big 4 CPA, LLP. Blake CPA is a second-tier international CPA
firm specializing in the oil and gas industry.
PART I: OVERVIEW OF Marathon Oil Ltd.
Formation and Location
Marathon Oil Ltd. is a Fortune 500 company that is also included in the TSX 500 indexes. The company
was started in 1953 in Lagos, West Africa by two petrochemical engineers. The following year, it was
incorporated in order to take advantage of emerging opportunities in the international oil and gas industry.
By 1960, Marathon Oil Ltd. went public and its securities began to trade on major stock exchanges in
Europe. Marathon Oil Ltd. has served its clients with various oil and gas products for over 50 years. Its
audited financial statements have portrayed the significant growth that the company has experienced over
the years. In particular, over the past decade its sales volume has consistently increased at a rate of 2 to 5
percent per year. In 2005, Marathon Oil Ltd. securities began to trade in stock exchanges in the Canada for
the first time after a series of acquisitions of related oil and gas businesses around the globe.
Marathon Oil Ltd. has four business units: exploration and production, marketing and sales of oil and gas
products, construction and operation of oil and gas pipelines and storage facilities, and barge and ship
building for oil and gas transportation across seas. Marathon Oil Ltd.’s oil and gas products are sold
through multiple sales channels, with the North American operations holding primary responsibility for the
marketing of these products. The exploration and production, construction and storage, and barge building
operations are located in the West African regions.
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The upstream portion encompasses activities related to exploration and development of crude oil and natural gas.
Midstream operations are defined as transportation links between oil production and end users, including pipelines,
barges, freighters, and storage terminals. Downstream operations consist of refineries and gas stations.
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Board of Directors
The Board of Directors at Marathon Oil Ltd. consists of 11 members. Six of the board members are
independent directors from outside the company, and one of these external members is an accounting
expert. The internal members include Mansa Khama, Chief Executive Officer, and four additional
representatives of various functional areas within the company. One independent member, Mazi Equiano,
is a community leader elected by the Marathon Oil Ltd. employees; each of the remaining directors is
elected by the shareholders at a general meeting. Usually, the board of directors nominates potential board
members to stand for election or reelection.
Each member of the board of directors is expected to have outstanding professional and personal ethics and
values, skills, experience, and diversity. In addition, members of the board are expected to attend at least 70
percent of the applicable committee meetings within their terms and should review materials for the
meetings in advance. Board members serve two-year terms and until their successor is named.
The board monitors various legal, environmental, and regulatory issues, as well as the integrity of the
company’s internal control programs. It also oversees management and is responsible for strategic and
business planning, development processes, and various aspects of capital spending. There are three
subcommittees of the board of directors: audit, compensation, and nominating and corporate governance.
The chairman of the audit committee is Bem Keita, an external board member who is a financial expert.
The meetings of the board of directors generally include discussions based upon reports received about new
business developments and contracts awarded, environmental impact studies, articulation agreements,
global ventures, and financial results.
Key members of Marathon Oil Ltd.’s management and Board of Directors include:
Name
Amir Fahad
Mansa Khama
Tau Theron
Peter Hani
Leliah Jonas
Edgar McCummis
Bem Keita
Mazi Equiano
Kizia Lindewea
Position
Chairman of the Board “external", former Chief Executive of Fahad Oil Co., Inc
Chief Executive Officer and board member
Chief Financial Officer and board member
Vice President of Legal Affairs and board member
Director of Human Resources and board member
Chief Operating Officer and board member
Board member !external" and audit committee chair
Board member !external" and coordinator of the contract Bid Committee
Controller
a Although
Ms. Lindewe is not a member of the board of directors, she regularly attends its meetings in order to present
and discuss financial information.
The majority of the shareholders are institutional investors, other investment companies, private equity
holders, and individual investors interested in financial opportunities for oil and gas products. In 2007,
there were over 250 million common shares outstanding.
Influence of the Industry
The oil and gas industry has seen an economic slump and a wave of mergers and acquisitions since the
mid-1980s. Although companies are currently making huge profits and apparently overcoming the slump,
there is no evidence of reinvestment of profits into expanded exploration and development activities.
Marathon Oil Ltd. has survived the decline through a combination of expansion and consolidation
strategies. At several points over the past 45 years, management has laid off employees in response to
reductions in the size and number of its business units. In 1960, there were 5,500 employees in ten business
units, whereas in 2007, there were 5,000 employees in four business units. Within the same general time
span, Marathon Oil Ltd. gradually acquired smaller oil and gas operations. The acquisitions have allowed
Marathon Oil Ltd.to build an asset base that provides the political clout needed to compete and expand
operations around the globe into the Canada, the Middle East, and South America.
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Recent increases in world oil prices have brought fortunes in increasing revenues to most sectors of the oil
and gas industry, and Marathon Oil Ltd. has been no exception. In 2007, Marathon Oil Ltd. earned total
revenues of $9 billion and operating income of $1.8 billion (see financial statements in Table 1). In 2005,
the year of its listing with the OSC., Marathon Oil Ltd’s total revenues were $5.7 billion while operating
income was just over $770 million. More than one-third of the 2007 revenues came from its U.S.
operations, while more than half came from its West African operations. According to Ed McCummis, the
growth in revenues has brought increases in new contracts for exploration and production materials and
supplies as well as property, plant, and equipment. In addition, Marathon Oil Ltd.’s success has introduced
new job opportunities in the surrounding communities. It is expected that the demand for oil and natural
gas will continue to grow in the future years; this means that oil and gas companies might expand their
pipeline networks to meet these demands. One of Marathon Oil Ltd.’s strategic goals is to take advantage
of these prospective opportunities.
Company Objectives/Strategies and Rationale for Change in Auditors
With achieving a strong balance sheet as one of its objectives, Marathon Oil’s management is particularly
aware that the company’s fortunes are tied to the prices of oil and gas commodities. Since listing with the
OSC, management has realized the profit and risk potential in the volatility of oil and gas prices, and has
gradually expanded its activities into the world of oil financial markets by hedging transactions to reduce
the risks taken.
KEY BUSINESS PROCESS FOR VINAND: BIDDING AND CONTRACTING
The company’s policies and procedures regarding bidding and contracting are documented within the MOL
Contract Policy Manual, which specifically states that Marathon Oil Ltd.’s procurement policies are fair
and are based on full and open competition. However, Marathon Oil Ltd. also strives to be a good corporate
citizen in the communities in which it operates. As a result, it awards some contracts to indigenous
companies. To this end, the company may bid each project separately or with a group of similar projects as
long as it meets the company’s risk portfolio of bids and contracts. Sometimes, the international host state
or local government may enforce certain articulation agreements whereby a specified number of projects
and contracts must be awarded to local vendors and contractors in order to boost the local economy.
Accordingly, Marathon Oil Ltd. has awarded contracts to build or lease boats and barges used in offshore
drilling and exploration activities" to local oil servicing companies.
If a contract for a specific project is $1.5 million or more, Marathon Oil Ltd. always requires sealed
competitive bids from reputable technical companies. As a general rule, contracts for developing,
engineering, or constructing oil and gas projects, such as contracts for oil pipelines and barge building,
must be awarded to a competent contractor with the lowest bid. Contractors intending to submit a bid are
required to first pass through a technical and commercial prequalification or screening process to ascertain
that all prospective bidders have the requisite technical competence for the proposed project. The technical
screening is handled by the Bid Committee, which consists of five members whose task is to review,
evaluate, and approve the selection of contracts in accordance with Marathon Oil Ltd.’s policies and
procedures. Three of the committee members are Marathon Oil’s own industry experts with significant
experience and favorable reputation in the oil and gas industry, one member is selected from the local
community, and one member is from the business community. The community members may or may not
have industry expertise. A majority vote of any three of the five committee members is needed to approve
bids obtained for any particular contract.
Depending on the project’s complexity, as many as seven contractors may apply for the initial screening
process. After the technical screening, this number is subsequently reduced to about three contractors, who
are then called upon to submit a commercial tender. Simply, a commercial tender includes a price quote on
the project and a statement of the contractor’s intention to accomplish the project. The lowest bid is then
selected for the contract award, as long as three of the five Bid Committee members vote to approve the
selection.
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MARATHON OIL LTD.CHANGES AUDITORS
As Marathon Oil Ltd. expanded into hedging transactions and other specialized areas, management
concluded that the Big 4 CPA firm was not keeping up with these new areas of business. Big 4 CPA
became increasingly slow to respond, and seemed to be out of touch with the general business climate in
the oil and gas industry. Marathon Oil Ltd. intended to do something about it at the appropriate time. The
opportunity came when Big 4 CPA proposed an increase in audit fees for the current year audit.
According to Marathon Oil Ltd.’s management, the change in auditor was a result of several factors. These
factors are summarized below:
 Big 4 CPA was becoming excessively slow in responding to Marathon Limited ’s new strategic
direction. The company viewed Big 4 CPA as being insufficiently proactive in delivering service,
likely due to the demands of recent regulations and the fact that Big 4 CPA has many other clients
facing these new regulatory requirements.
 Marathon Ltd.’s management had recently learned that the Big 4 engagement partner was being
promoted to another position in the firm and would no longer be available to service the
company’s account.
Although management at Marathon Oil Ltd. recognized that it is unusual for a growing company to make a
move to a smaller CPA firm, it believed that its Big 4 CPA firm no longer possessed the industry
specialization and extensive knowledge of the business that the company desired. Marathon Oil Ltd.
realized that the size of the audit firm was not as significant as it was historically so it took advantage of the
opportunity to engage the smaller, specialized audit firm. Its primary motivation for the change was the
superior industry expertise that it expected to find in its new engagement team from Blake CPA, LLP.
Blake CPA, a second-tier international specialty CPA firm, is Marathon Oil Ltd.’s newly hired auditor.
Larry Hyde is an audit manager at Blake CPA who has been assigned to lead the audit of Marathon Oil
Ltd. He is aware that Marathon Oil Ltd. recently fired Big 4 CPA, LLP, its auditor of the previous seven
years. Blake CPA is confident in its expertise in the oil and gas industry. In fact, the firm was established
30 years ago and specializes in auditing medium to large companies which are involved in oil and gas
exploration, drilling, processing, storage, marketing, and pipeline construction activities, and which are
listed with stock exchanges in the Canada. Its clients are located in oil and gas producing regions
throughout South America, the Middle East, Africa, and the Canada.
Blake CPA’S AUDIT OF Marathon Oil Ltd
Client Acceptance and Communication with Prior Auditor
Prior to bidding on the audit of Marathon Oil Ltd., Blake CPA thoroughly evaluated this prospective client.
As part of these client acceptance procedures, Blake CPA’s meeting with Big 4 CPA included completion
of the firm’s standard checklist addressing significant matters for initial audit engagements. This checklist
consists of a variety of inquiries regarding Big 4 CPA’s assessment of management integrity, and the
reasons for the change in auditor. At that meeting, Blake CPA learned that there were two significant
disagreements that appeared to contribute to the change. The first disagreement was Big 4 CPA’s proposed
increase in audit fees due to the additional internal control work required to comply with recent regulatory
requirements. Marathon Oil Ltd. rejected the proposed increase in audit fees because it was considered
excessive and added little value to the level of services being received from Big 4 CPA. The other area of
disagreement was Big 4 CPA’s complaint regarding overstatement of Marathon Oil Ltd.’s valuation of oil
and natural gas reserves. Big 4 CPA indicated without further explanation that these disagreements were
“the last straw.”
Assessment of Management Integrity
Based on the various interviews conducted by Blake CPA during the client acceptance phase, it has judged
Marathon Oil Ltd’s management to be of high integrity, committed to quality management, and reputable
in the community. Background checks of key individuals at Marathon Oil Ltd. and its board of directors
reveal no criminal convictions; however, two of the external board members have been involved in
regulatory investigations. Since those investigations did not pertain to their duties in connection with
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Marathon Oil Ltd. and since none of the investigations resulted in OSC sanctions or fines, Blake CPA has
maintained an overall favorable assessment of Marathon Oil Ltd.’s management.
Analytical Review of Financial Information
Marathon Oil Ltd. has experienced significant growth in revenues and profitability from 2005 to 2007,
which has significantly exceeded the industry averages and has resulted in a number of fluctuations in
account balances and financial statement line items. Blake CPA learned from the controller that the
increased business has lead to increases in payments to contractors and vendors for various projects and
supplies. The most recent balance sheets and income statements, with selected disclosures, are presented in
Table 1.
Assessment of Internal Controls
During its initial planning phase, Blake CPA evaluated Marathon Oil ’s internal controls
by performing the following procedures:
• Inquired of management regarding the company’s risk assessment processes and responsibilities for
monitoring internal controls;
• Reviewed documentation covering the company’s accounting information systems, including policies and
procedures manuals, system flowcharts, and job descriptions;
• Observed activities in each business unit, as well as within the accounting function;
• Inspected financial records and reports;
• Performed walk-throughs for all routine business processes; and
• Held a brainstorming session to consider how fraud might possibly be perpetrated and concealed.
Through these procedures, Blake CPA learned that there have been no significant changes in Marathon Oil
Ltd.’s control environment within the past year. Marathon Oil Ltd. uses COSO’s Enterprise Risk Model to
implement and maintain effective internal controls. In addition, its Controller, Kizia Lindewe, holds
monthly meetings with Peter Hani to monitor regulatory compliance and with Bem Keita to review
financial reporting issues and internal controls.
Despite its favorable impressions of Marathon Oil Ltd.’s management team and the overall control
consciousness of the company, Blake CPA is uneasy about the control environment and fraud risk
concerning the contract bidding processes. It appears that the contracts and contract bidding process are
somewhat inconsistent and secretive in nature. In particular, the auditors noted a lack of clarity regarding
the number and identification of contracts that are being awarded under the terms of articulation
agreements. In addition, it appears that very little information is being released to the public and to
prospective contract bidders. Upon inquiry of Marathon Oil Ltd. management concerning this anomaly,
Tau Theron explained that the company does not disclose certain contract bidding information due to
proprietary arrangements at the host state and local levels and for fear of providing too much confidential
information to competitors, thereby risking its competitive advantages. Blake CPA also noted that several
documented contractor bids contained handwritten markups. Tau Theron explained that certain contract
adjustments had been applied by the Bid Committee as deemed necessary to “level the playing field” so
that each contractor’s bid appropriately accounted for all relevant contract components. Blake CPA’s
interest in these issues and the potential for additional audit effort required to thoroughly investigate them
were noted.
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REQUIREMENTS FOR PART I
Engagement Risk and Client Acceptance Issues
You are a member of your firm’s quality assurance practice and you have been asked to assess the
engagement team’s client acceptance practices. The partner in charge of quality assurance has asked that
you provide some background on the client as well as an analysis of the client acceptance decision. Your
analysis should include the following.
a) What are the unique characteristics of the oil and gas industry that increase the risk to the
external auditor that there may be material misstatements in the financial statements? (5 marks)
The oil and gas industry consists of extensive operations that may be challenging to auditors. Some
processes take a long time to give out results such as oil exploration, thus limiting accountability of
resources and revenue. For instance, Marathon Oil Ltd has diversified operations under four categories.
Running of the four different operations creates room for fraudulent dealings among the management. The
management may thus push for misstatements to cover up losses.
On the other hand, the issuance of local contracts lacks adequate regulation hence the possibility of
corruption. The concerned bid body can collude with influential people and assign contacts to them. The
same management also has a significant influence in the industry hence appointing favoring themselves
during contracts.
As Tau Theron states concerning contract bidding, the company conceals some information to hinder
competitors from understanding its competitive advantages. This aspect leads to misstatements in the
financial statements.
Another loophole enabling misstatement of financial statements stems from the stock competitiveness
evident in the oil and gas industry. Different industries strive to qualify for listing on the stock markets.
This quest for listing prompts the overvaluation of financial statements—the result of the push for the
position results in the availing of wrong financial performance.
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b) Discuss various steps/procedures that Blake CPA should have carried out as part of their
assessment as to whether or not to accept this audit engagement. Do you agree with Blake CPA
decision to accept this Marathon Oil Ltd. as a client? If not provide your reasons. (6 marks)
Before accepting an audit engagement, an auditor ought to conduct due diligence concerning the client.
Areas of concern include an inquiry about the exit of the previous auditing company, the financial
performance of the client, and the management’s integrity, among others.
Question the Exit and Competence of the Previous Auditing Company
The new client should provide a practical reason for the exit of the previous auditing company. A client
may have fraudulent management intent to embezzle funds and conceal evidence through ‘cooking’ of
financial statements. Consequently, a competent and ‘uncooperative’ auditing company may lose the
contract to pave the way for fraudulent deals. Blake CPA should contact Big 4 CPA for detailed
information to have precise details on Marathon Oil Ltd. The meeting during agreement acceptance shows
inadequate disclosure of information. A private meeting, phone call, or email may result in the correct
information.
The previous audit company should also demonstrate high competence levels. According to its client base,
Big 4 CPA shows competence despite Marathon Oil Ltd raising issues to validate the end of their contract.
Assessing the Directors’ Integrity in the New Company
The integrity assessment shows a form of collaboration between the company’s external auditors and the
management. Blake CPA should solely evaluate to ensure they attain the correct information about the
company. Besides, considering the small size of Blake CPA, the management may easily influence their
decisions.
Assess Riskiness of Engaging such a Client
The responses that Big 4 CPA gives concerning Marathon Oil Ltd show a demanding client. They indicate
that the company had many problems concerning financial information with the previous auditor. Regular
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overvaluation of financials portrays a risky management team. Blake CPA should not be quick to engage
with Marathon Oil Ltd.
Investigate about Existence of any Limitations in the company
Some clients limit access to certain financial information. The auditor should, therefore, request access to
all information. In case the management hesitates, it can decline the agreement. The responses that Tau
Theron gives concerning the bidding process show non-disclosure of specific company information.
Ascertain the Suitability of the Client
Before engaging Marathon Oil Ltd, Blake should ensure it does the right business. Its financial
performance should also be favorable to finance the audit activity. Marathon Oil Ltd, having ended its
contract with Big 4 CPA due to failure of meeting their pay-rise, may have the same issues with the new
auditor. Blake 4 CPA should thus be careful when dealing with the new client.
c) Conduct analytical review on the financial statements and identify which accounts require follow-up and
why. Ensure you provide your support for your analysis.
(10 marks)
PART II: BLAKE CPA’S MONDAY MORNING SURPRISE
On a Monday morning in the early stages of the Marathon Oil Ltd. audit planning work, Larry Hyde is
about to assemble a team to begin developing the overall audit strategy and audit program. As he prepares
to meet Luci Byrd, the audit engagement partner, Larry decides to check his mailbox one more time for any
confirmation replies or other client communications. He discovers the following letter, signed with a
fictitious name of Nick Fraudus:
Dear Blake CPA, LLP,
I know that very soon, you will be auditing Marathon Oil Ltd. (MOL)., and I think you should be aware of a
serious issue concerning this company. Some contractors and vendors in the oil and gas industry have
accused MOL of running a fraudulent contracting process in which bid prices and the competence of
contractors are not fully considered when awarding contracts. I believe that many contracts are being
awarded fraudulently, without advertisement in the major dailies or without proper bidding processes, as
required by the MOL Contract Policy Manual pages 17 through 56.
Within the past 15 months, approximately eight new major contracts for carriers and several smaller project
contracts have been awarded to a select few contractors without any formal commercial tender or bidding
process. These contracts are worth millions (if not billions) of dollars and have been awarded at considerable
extra cost. Moreover, I have been privy to knowledge regarding a number of these recent contracts that were
approved by less than a majority of the Bid Committee, and I believe that similar practices have been going
on for at least five years. It is a mystery to many MOL employees as to what transpired between the
contractors and the awarders of these contracts, as this wrongful practice leaves too much room for
manipulation and no room for transparency. In fact, this practice fails to adhere to the requirements and
purpose for conducting the commercial evaluations in the first place. Let me provide a recent example of one
bidding process involving the supply of pipelines to Natural Gas Project No. 3. This project was widely
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advertised and at the end of the screening exercise, three national contractors were short-listed to submit
commercial tenders. The lowest bidder was a well-known company with a reputation for excellence; it has
been in business for over 30 years and has a powerful presence in various locations and regions. This
company also has equipment that could lay heavy and wide diameter pipes in a crowded environment or even
across the sea from any chosen spot. However, to the surprise of many in MOL and the industry at large, the
contract was awarded to another lesser-known company that quoted a higher bid. MOL has been unable to
justify its actions for awarding this contract. At a whim, MOL appears to be choosing a contactor that tickles
its fancy or that has bribed the company to award the contract. MOL has repeatedly committed wrongdoing
in its contractor selection process without anyone pointing out this glitch. This is because the rest of the
contractors are never expected to see the results of the process until the bidding is closed. It appears that the
committee is inflating figures to adjust for assumed omissions in the original bids of unsuccessful
contractors; however, the contractors are not notified of these adjustments. This tends to penalize competent
contractors, while colorful words are written about the favored contractor even if that contractor was the
highest bidder. When the outcome of the bidding process is later revealed, one begins to wonder how the
same class of contractors has been favored over and over again. With so many well-known national
shipbuilders and pipeline suppliers in the area, why the special interest in so few contractors?
I trust that you will give these matters careful consideration.
Sincerely,
Nick Fraudus
P.S. I worked as a production foreman at MOL for 10 years and was recently fired due to allegations of professional
misconduct. Those allegations are trumped-up charges; I was actually fired because I criticized the company’s fraudridden contract bidding processes. I am sure that your investigation will help to absolve me of these allegations of
wrongdoing.
As Larry reads this letter a second time, he realizes that his meeting with Luci Byrd cannot wait until later.
He decides to make an immediate appointment with her.
Larry takes a deep sigh and begins to recount the numerous audit procedures available to his engagement
team. He knows there are various regulatory pronouncements on fraud risk, illegal acts, internal controls,
and whistle-blowing. In addition, he recognizes the possibility of involving Blake CA’s legal department in
analyzing these matters, as well as communicating with Marathon Oil Ltd.’s audit committee, board of
directors, and attorneys. As Larry ponders these developments and considers how he might present them to
the engagement partner, his phone rings. It is Luci Byrd, who is ready for their meeting.
REQUIREMENTS FOR PART II
Assume the role of Larry and prepare a memo to the partner, Luci Byrd, that summarizes and analyzes the
allegations. In the memo, ensure you address the follow matters (Ensure you make reference to pertinent
case facts along with relevant handbook sections to support your analysis):
d) Your initial impression is that there is a high likelihood that Marathon Oil Ltd. has been committing
fraud in its contract awarding process? Cite specific case information that influenced your judgment.( 5
marks)
e) You are a forensic accountant and were hired to investigate whether fraud has been committed in the
contract awarding process. What procedures/evidence would you undertake to determine whether fraud
has occurred. ( 6 marks)
f) If Blake CPA discovers that a number of material contracts have been awarded in a fraudulent manner,
what would be the auditors’ responsibility for reporting the matter? Be specific regarding the persons or
groups to whom the communications should be targeted. ( 3 marks)
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TABLE 1
Marathon Oil Ltd. Balance Sheet December 31 (in 000’s)
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Marathon Oil Ltd. Income Statement for the years ended December 31 (in 000s)
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