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A royalty audit is essentially a revenue audit, but often with one hand tied behind your back.
Royalty owners are typically the federal government, various states, Indian tribes, farmers, ranchers, and their descendants. There are also overriding royalty owners, who may have received an interest carved out of a federal lease transaction or as a landman or geologist who helped put a prospect together. This article will not deal with governmental or Indian royalty audits - those entities typically have a substantial procedures and regulatory rulebook to follow regarding audits.
First, a couple of caveats: I am not a lawyer. If there is anything that sounds like legal advice, it is not. If you have legal questions, talk to your own lawyer.
Secondly, let me clarify the use of the term "audit." In Texas, the state Board of Accountancy has essentially trademarked the terms "auditor" and "accountant" (and their derivatives) for the exclusive use of CPAs who are licensed in Texas. When I am in Texas I do not do "audits" - I do "royalty compliance reviews" or some other label which avoids use of the banned terms; but for the purpose of this article, due to habit and industry practice, the term "audit" will be used.
My experience deals almost entirely with private royalty owners and overriding royalty owners, so that will be the primary thrust of this article, and I will generally refer to both as "royalty owners".
Purpose and Need for an Audit
There are some textbook statements of purpose for an audit:
* Assist in the safeguarding of assets by verifying that all production and sales have been correctly measured, accounted for and allocated,
* Ensure compliance with the provisions of the lease, and
* Verify that any fees related to production, handling, processing or otherwise have been properly assessed.
But the bottom-line layman's reason is: Make sure you are getting paid correctly.
The decision of whether, or which properties to audit will primarily be driven by the economic potential of an audit. Typically, it would not make sense to spend, say $ 10,000 to audit a well with a maximum potential recovery of $200. How does one know what the potential recoveries are? Barring some of the most egregious...