You are an audit manager in the Calgary offices of Rowlands, Marcellin, and Khan, LLP. Since you specialize in the oil sector, you have heard of Western Energy Recovery Ltd (WER), but, as it is a private company, you have not had any solid information about WER. Today, you are meeting with Elaine To, CFO, and Darrell Haines, CEO. Darrell Haines is tall and broad shouldered, made taller by his western-style boots. The offices of WER are simply, yet tastefully, furnished in wood panelling and pictures of the trains so important in the history of the Canadian west. Nice to meet you, says Darrell, Maybe we can start with a little about me so you know where Im coming from. When I was seventeen, I was a top hockey player in major junior with Swift Current. A bad fall into the boards ended my NHL dream. In truth, though, a lot of guys who I thought were much better players never made it either, so, really, my dream was just an illusion. The timing turned out to be perfect. I went home to Olds, concentrated on school, got my diploma, then a chemical engineering degree out of Lethbridge where I got on the honour roll for the first time in my life. I had a couple of jobs in the oil patch while paying for school, and joined full time after graduation. But I got lured by the dot-com boom in the nineties, did my MBA at UofT and went into the venture capital business. The v-cap business in Toronto is all about software, web services, and pharmaceuticals. Anything else is radioactive. Trust me. I tried, but there was no interest in the extractive or manufacturing parts of the economy. Everything was fast in and fast out. The 2008 real estate collapse made the firm go nova. A few of us decided to go out on our own but I insisted on looking at a wider selection of targets. I convinced one of the senior players to buy into some small players in the oil and gas sector. In 2011 we were riding high on record oil prices. Shale oil was still coming onstream and we were players there too so we thought we were protected. I did a lot of travelling throughout Alberta getting to know all the players. In 2014, prices tanked. The lead partner wanted out and we worked out a deal where I took ownership, and he had debt convertible to a 20% equity stake. He hasnt converted yet. In 2018, we bought a small producer, Fields Oil Company. We bought the assets and liabilities and left the company shell for the old owner. After the merger, as is common, we let most

everyone go except those we needed to keep the bills paid. Elaine was accounting manager there. I quickly came to rely on her and in 2019 made her our companys first CFO. So what do we do? We buy old oil fields and old producers. You know about the orphan well problem in Alberta? We target those. In a lot of cases, the wells do not produce enough to carry a high corporate overhead, but still produce. The hole is drilled, the pump is in place, the pipe is connected to the system, so all of the capital expenditure is done. All that is left is maintenance. And do not underestimate maintenance. Most of these older wells leak gas like a sieve. When we take them over, we immediately upgrade everything. Rather than let the gas leak or get burned off, we recover it. People dont realize that there is no such thing as an oil well. They are always oil and gas wells. You cannot have one without the other. Everything gets inspected at least once per year. We connect a system to each well to compress any gas into an onsite tank. Since most oil derricks already have electricity, it costs very little to add a compressor. Then, we monitor the tank. Right now, we job out the collection of gas from the tank if there is no connection to gas lines, but we are looking at having our own fleet of tankers to do the collection and also inspect and service the well head at every visit. And that brings us to the costs of decommissioning. Often, we buy these sites virtually for free. Capping the well essentially pouring concrete down the bore hole and removing the equipment is about $100,000 depending on how remote the site is. Cleaning up the ground is the big one. At a minimum, it is $150,000, and it can go into the millions. Every producer pays into an Orphan Well Fund, because some companies just abandon the wells and declare bankruptcy rather than do what our moms taught us and clean up after ourselves. The equipment is usually fully depreciated when we buy the wells. So all we are doing is buying the production license, less cost to clean up, and we have a revenue generating asset. Elaine will walk you through the accounting. Thank you, Darrell, says Elaine. When we buy an oil well, we set up the production asset at fair market value, and the offsetting liability for the decommissioning costs. We retire the debt by paying into a trust fund based on the expected date of last production, discounted at 6%. The initial refurbish extends the life of the asset. We capitalize that as a leasehold improvement, depreciated at five percent double-declining. After that, maintenance is expensed. We track each well using standardized oil and gas prices to estimate the date of last profitable production. In 2020, we bought a dormant listing on the TSX, TAL Software. Our lawyers are going through the process of merging the two companies, after which we will rename the listing to WER. We will then raise more money for more wells through a secondary offering. It also allows the debt-holder to liquidate their investment. We expect them to convert the debt and hold the shares when we go public and that would be a huge increase in equity. We have never had an audit before and, obviously, before we file a prospectus for the secondary offering, we need one. Except for the convertible debt, Darrell owns everything. After we go public senior employees will be paid in share options as well as salary. That should allow us to attract and retain talent. Darrell cant be out in the oil fields and run the company all by himself.

Required

b) (8 marks) Perform a preliminary analysis of the financial information, meaning booth vertical

and horizontal analysis.

c) (6 marks) Write a few sentences expanding on the needs of the key users of these financial

statements.

d) (2 marks) What type of engagement would you recommend?

e) (4 marks) Calculate materiality based on the information youve been given and justify your

calculation.

f) (8 marks) Identify four areas of inherent risk that might affect your audit planning. Would you

say these are high risks or low?

g) (2 marks) Would you recommend RMK accept this assignment?

Wester Energy Recovery Limited Income Statement For the year ending December 31 2020 Projected] 2020 (Unaudited) 2019 (Unudited 2018 Unudited $ 53,593,680 $ 23,925,750 $ 4,843, 801 4,800,086 48,749,879 $ 19,125,664 S 25,520,800 $ 21,692,680 4,320,737 2,937,485 21,200,063 S 18.255,195 $ Sales less royalties Cost of production Gross Margin Amortization of oil properties Production maintenance Decommissioning expense Income from Production 17,653,032 3,200,644 5,497,485 $ 22,398,718 18 14,593,032 3,151,130 9,162,475 7.780.973) S 9,493,032 2,137,189 5,497,485 4,072,357 $ 6,433,032 1,386,565 1.832.495 9,103,103 Administrative and other Earnings before interest and taxes 390,451 22,008,267 377,092 8,158,065) S 353,121 3,719,2365 346,758 8.756.345 $ Interest expense Net Income before taxes $ $ 12,100,000 10,700,000 $ 9.908,267 S 18,858,065) S 3,700,000 $ 19.236 S 3,000,000 5.756,345 Tax expense Net income $ $ 4,260,555 S 8,108,961) 5,647,712 10.749,092 $ 3.271 2.475,228 10,965 S 3.281 117 Activate Windows Gotha * Sales revenue net of royalty payable to Alberta Bowerment Anet Desember 31 2016/dited 2012/United 2016(ed 2015 ASSETS Cash and equivalents Accounts receivable net Taxes recoverable Inventory Total current assets $ 4,646,092 $ 4,344,717 5,442405 1.667.45 $ 18,100,2593 7,508,418 5 3,466,257 9,702,960 4,831 25,009, 2385 8,386,214 $48,728,664 3.827,388 2,929,94 1,593,992 1,602,263 140002 2.67250 17,307,522 55.03 AGO Land leases Leasehold improvements Production equipment Office equipment Totalfixed assets $ 8,467,387 S 7,349,644 S 5,171,901 $ 3,894,150 184,552,653 157,727,819 104,027,985 72,203,151 113,779,753 97,875,162 65,545,971 46,941,500 103,152 100.00 101,038 100,145 S306,902,25 3263,054 860 $ 175,141205 121, 119,037 Equity investments TOTAL ASSETS 2.000.000 5 2.000.000 $ 327,001,204 $ 290,064 098192,454,417 $ 179,077, 497 $ 685,727 S 1,846,527 LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable Royalties payable Taxes payable Current portion of decommissioning Total current liabilities 691,972 S 4,021,005 4,260,555 638,113 9,6,7055 517.2485 2,211,102 21 199,330 25.951 S 4194661 1,587,151 2,475,224 3 649429 3,18118) 5 6151 Comwertible debe Long term det Decommissioning obligation Total low-teem intilities TOTAL LIABILITIES S 50,000,000 550,000,000 $ 50.300,000 $50,000,000 130,000,000 110,000,000 10.000.000 50869,152 46,000,950 3744 224,779 520692525206.00 97093432778 5.740, 40105258209 1916 52100,83 RS3710 SHAREHOLDERS' EQUITY Common shares Retained in TOTAL SHAREHOLDERS'EQUITY 50,000,000 HO,000,000 500.000.000 6,120.14 72.415 12 SOAS HOLZ2415 91215 11.ndows TOTAL UABILITIES AND SHAREHOLDERS' EQUITY $ 27,003, 2045 20.044,096 192.454.4175 179.077407 Wester Energy Recovery Limited Income Statement For the year ending December 31 2020 Projected] 2020 (Unaudited) 2019 (Unudited 2018 Unudited $ 53,593,680 $ 23,925,750 $ 4,843, 801 4,800,086 48,749,879 $ 19,125,664 S 25,520,800 $ 21,692,680 4,320,737 2,937,485 21,200,063 S 18.255,195 $ Sales less royalties Cost of production Gross Margin Amortization of oil properties Production maintenance Decommissioning expense Income from Production 17,653,032 3,200,644 5,497,485 $ 22,398,718 18 14,593,032 3,151,130 9,162,475 7.780.973) S 9,493,032 2,137,189 5,497,485 4,072,357 $ 6,433,032 1,386,565 1.832.495 9,103,103 Administrative and other Earnings before interest and taxes 390,451 22,008,267 377,092 8,158,065) S 353,121 3,719,2365 346,758 8.756.345 $ Interest expense Net Income before taxes $ $ 12,100,000 10,700,000 $ 9.908,267 S 18,858,065) S 3,700,000 $ 19.236 S 3,000,000 5.756,345 Tax expense Net income $ $ 4,260,555 S 8,108,961) 5,647,712 10.749,092 $ 3.271 2.475,228 10,965 S 3.281 117 Activate Windows Gotha * Sales revenue net of royalty payable to Alberta Bowerment Anet Desember 31 2016/dited 2012/United 2016(ed 2015 ASSETS Cash and equivalents Accounts receivable net Taxes recoverable Inventory Total current assets $ 4,646,092 $ 4,344,717 5,442405 1.667.45 $ 18,100,2593 7,508,418 5 3,466,257 9,702,960 4,831 25,009, 2385 8,386,214 $48,728,664 3.827,388 2,929,94 1,593,992 1,602,263 140002 2.67250 17,307,522 55.03 AGO Land leases Leasehold improvements Production equipment Office equipment Totalfixed assets $ 8,467,387 S 7,349,644 S 5,171,901 $ 3,894,150 184,552,653 157,727,819 104,027,985 72,203,151 113,779,753 97,875,162 65,545,971 46,941,500 103,152 100.00 101,038 100,145 S306,902,25 3263,054 860 $ 175,141205 121, 119,037 Equity investments TOTAL ASSETS 2.000.000 5 2.000.000 $ 327,001,204 $ 290,064 098192,454,417 $ 179,077, 497 $ 685,727 S 1,846,527 LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable Royalties payable Taxes payable Current portion of decommissioning Total current liabilities 691,972 S 4,021,005 4,260,555 638,113 9,6,7055 517.2485 2,211,102 21 199,330 25.951 S 4194661 1,587,151 2,475,224 3 649429 3,18118) 5 6151 Comwertible debe Long term det Decommissioning obligation Total low-teem intilities TOTAL LIABILITIES S 50,000,000 550,000,000 $ 50.300,000 $50,000,000 130,000,000 110,000,000 10.000.000 50869,152 46,000,950 3744 224,779 520692525206.00 97093432778 5.740, 40105258209 1916 52100,83 RS3710 SHAREHOLDERS' EQUITY Common shares Retained in TOTAL SHAREHOLDERS'EQUITY 50,000,000 HO,000,000 500.000.000 6,120.14 72.415 12 SOAS HOLZ2415 91215 11.ndows TOTAL UABILITIES AND SHAREHOLDERS' EQUITY $ 27,003, 2045 20.044,096 192.454.4175 179.077407