Northshore Inc. is an American oil producer with interests

Northshore Inc. is an American oil producer with interests in Latin America and West and Middle Africa. Its stocks are listed on Nasdaq and Toronto Stock Exchange.

In January 2007, after one year of negotiation, the company was awarded a new five-year concession (same as a license) by the central government of one Western African nation to explore for oil in a remote region. The concession was granted at a historical cost of US$15 million to Northshore (Northshore paid $15m to the government in January 2007). However, Northshore’s management had decided to recognize the concession at an estimated fair value of $30 million, arguing that the oil price has increased a lot from 2006 ($64 per barrel of crude oil in 2006 to $84 in mid-2007) and the fair value is more relevant here.

The most significant of Northshore’s tangible fixed assets are its 27 oil rigs as of September 30, 2007 (see picture 1 below). 22 rigs are now in 4 different African nations and 5 are in two Latin American nations. Each rig is composed of numerous components including a platform, buildings, and drilling equipment. The useful life of each platform is assessed annually on factors such as weather conditions and the period over which it is estimated that oil will be extracted. Platforms are depreciated on a straight-line basis over 15 to 40 years.

 In June 2007, two rigs in Latin America (one on land and one offshore) sustained severe hurricane damage. Northshore’s management believed the rigs were beyond economic recovery and that there would be no alternative but to abandon them where they were. This decision had brought angry protests from environmentalists and local government in Latin America for the concern of probable oil leakage into river and ocean. Provincial governor announced that it would sue Northshore in the near future and Earth’s Friend (a U.S.-based non-governmental organization, NGO) also claimed that it would sue the company in a U.S. court. 

You are the manager in charge of the 2007 audit of Northshore. Last year your firm qualified its auditors’ report due to a lack of evidence to support management’s schedule of proved oil reserves to be recoverable from known reserves. (tip: proved reserves are “estimated quantities of crude oil and natural gas which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years under existing economic and operating conditions).

 (1) Identify some key business risk factors in the Northshore case. Please give brief explanations.

 (2) List probable material misstatements in the financial statements of Northshore. Please give brief explanations.