Attached files
October
28, 2009
Mr.
Clayton Carter
President
and Chief Executive Officer
Freestone
Resources, Inc.
Republic
Center, Suite 1350
3225 N.
St. Paul St.
Dallas,
Texas 75201
Dear Mr.
Carter,
In
planning and the performance of our audit of the consolidated financial
statements of Freestone Resources, Inc. (the Company) as of and for the year
ended June 30, 2009 in accordance with the standards of the Public Company
Accounting Oversight Board (United States) (PCAOB), we considered Freestone
Resources, Inc.’s internal control over financial reporting (internal control)
as a basis for designing our audit procedures for the purpose of expressing our
opinion on the consolidated financial statements, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal
control. Accordingly, we do not express an opinion on the
effectiveness of the Company’s internal control.
Our
consideration of internal control was for the limited purpose described in the
preceding paragraph and would not necessarily identify all deficiencies in
internal control that might be significant deficiencies or material
weaknesses. However, as discussed below, we identified several
deficiencies in internal control related to the reporting process that we
consider to be significant deficiencies and, collectively, a material
weakness.
A control
deficiency exists when the design or operation control does not allow management
or employees, in the normal course of performing their assigned functions, to
prevent or detect misstatements on a timely basis. A significant
deficiency is a control deficiency, or combination of control deficiencies, that
adversely affects the entity’s ability to initiate, authorize, record, process,
or report financial data reliably in accordance with generally accepted
accounting principles of the United States of America (GAAP) such that there is
more than a remote likelihood that a misstatement of the entity’s financial
statements that is more than inconsequential will not be prevented or detected
by the entity’s internal control.
Mr.
Clayton Carter
President
and Chief Executive Officer
October
28, 2009
Page
2
These
conditions which we consider to be significant deficiencies in internal
controls, along with our recommendations, are as follows:
I. TRIAL BALANCE
AND ACCOUNTING
During
the planning and initial stages of our audit, accounting management did not
timely provide the trial balance for the Company’s subsidiary, Freestone
Technologies, LLC. Several versions of trial balances were provided to us during
our planning stage and as we began our audit procedures. In addition,
we noted incorrect accounting and adjusting entries related to several financial
statement areas which caused the financial statements to not be in accordance
with GAAP. As a result, we proposed twenty three audit adjustments
that were required in order for the consolidated financial statements to be
fairly stated. Some of the areas affected are described as
follows.
a.
Receivables - May
and June 2009 oil and gas revenues were not recorded as receivables at fiscal
year-end.
b. Inventory - Produced but unsold oil and
gas from the Byrd lease was not recorded as inventory but charged to
expense.
c. Long-lived
assets - Oil and
gas properties used in the Company’s research and development activities were
not considered for impairment during the fiscal year. Once impairment
was considered by management, an impairment charge of approximately $240,000
resulted.
d. Liabilities – There were several fiscal
year transactions not properly recorded as accrued expenses or accounts payable
at year end.
e. Note
payable -
Payments on an installment note payable were recorded by reducing the
principal balance by both the principal and interest portion of each
payment. This caused the outstanding balance of notes payable and
interest expense to be understated.
f. Stockholders’
equity -
The Company recorded its common stock issuance transactions net of a
share cancelation transaction rather than record each common stock transaction
separately. This resulted in a misstatement of stockholders’ equity
and an understatement of operating expenses.
Mr.
Clayton Carter
President
and Chief Executive Officer
October
28, 2009
Page
3
g. Income
and expenses - During the year,
the Company recorded approximately half of its oil and gas revenues net of the
related production and operating costs rather than recording gross production
revenues and the total production and operating costs.
II. DOCUMENTATION AND
SUPPORT FOR TRANSACTIONS
During
our audit, we noted that the Company was not able to timely produce the
supporting documentation for some of its equity transactions such as board of
director minutes and information to support the price per share used by
management for recording non-cash equity transactions. Although we
ultimately were provided documentation that allowed us to complete our audit of
stockholders’ equity transactions, it did not appear this documentation was
maintained in an organized manner.
The
Company has not retained adequate documentation supporting material loan
balances. During the year, related parties loaned the Company
approximately $276,000 for which there were no loan agreements.
The
Company does not maintain complete documentation to support amounts paid to
royalty interest owners. Although supporting documentation for
royalty payments must be filed with the Texas Railroad Commission and with the
respective counties, management should maintain complete documentation of all
royalty and working interest owners to insure compliance with all state and
regulatory requirements and this would facilitate processing and recording of
mineral interest conveyances. Such documentation should include
division orders, assignments and purchase agreements.
During
our review of the Company’s year-end bank reconciliation and our search for
unrecorded liabilities, we noted that there was a gap in the year ending and
subsequent year beginning check number sequence. The integrity of
check number sequences should be verified and maintained for all check runs to
insure unauthorized or unaccounted for transactions do not occur.
III. VALUATION OF
STOCK ISSUED FOR SERVICES AND DEBT
The
Company did not properly value the common stock shares issued in non-cash
transactions throughout the year. These improperly valued
transactions related to common stock issued for services and common stock issued
for forgiveness of a related party note payable. For example, management
incorrectly determined the value of the shares issued using the last trading
price of the Company’s stock, the average daily volume over a three month
period, arbitrarily determined discounts for restrictions placed on the stock
under SEC Rule 144 and the pink sheet status of the Company at the
time. The Company should have used the fair value of the shares using
the stock price as of the measurement date.
Mr.
Clayton Carter
President
and Chief Executive Officer
October
28, 2009
Page
4
IV. FINANCIAL
STATEMENT PREPARATION AND OVERSIGHT
Throughout
our audit, we noted numerous errors in the information provided for the audit
that could have been avoided if the Company had personnel with a more thorough
knowledge of GAAP and SEC disclosure requirements. As a result, additional time
was spent correcting the consolidated financial statements and redoing our work
papers for these financial statement changes. We recommend that
management train its personnel through appropriate continuing education courses
and/or seek additional expertise to insure they possess sufficient knowledge and
experience to correctly record the Company's transactions and to insure that the
Company’s financial statements are free of material misstatements and are
prepared in accordance with GAAP and SEC disclosure
requirements.
In
addition, management did not properly identify all of the items that should have
been disclosed in the financial statements or footnotes. We noted
that for these areas there were incorrect answers indicated on the financial
statement disclosure checklist that we provided accounting management to
complete. The areas for which there were missing disclosures included
non-cash transactions on the statements of cash flows, oil and gas receivables,
stock-based compensation, reclassifications, principles of consolidation, fair
value measurements, quarterly supplemental information, various income and
deferred tax disclosures, subsequent events, and commitments and
contingencies. We recommend that the Company carefully review the
financial statements and carefully prepare disclosure checklists to insure all
material disclosures are reflected in the financial statements and footnotes in
accordance with GAAP and SEC accounting and disclosure
rules. Additionally, the Company should complete an SEC filing
checklist in addition to having its SEC counsel review the filing.
Each of
these significant deficiencies was considered in our determination of the audit
tests applied to your financial statements. Collectively, we believe
these deficiencies represent a material weakness. A material weakness
is a significant deficiency, or combination of significant deficiencies, that
results in more than a remote likelihood that a material misstatement of the
annual or interim financial statements will not be prevented or
detected.
As a
result, the Company’s financial statements initially submitted to us for audit
contained significant reporting and disclosure deficiencies such that the
financial statements were materially misstated and omitted significant
disclosures required by GAAP and SEC accounting rules.
Mr.
Clayton Carter
President
and Chief Executive Officer
October
28, 2009
Page
5
This
communication is intended solely for the information and use of management and
the Board of Directors and is not intended to be and should not be used by
anyone other than these specified parties.
We would
be pleased to discuss these conditions and our recommendations with you at your
convenience. If we can assist you in any way please let us
know.
Thank you
for the opportunity to serve you.
Best
regards,
/s/
Turner, Stone & Company, LLP
Turner, Stone & Company, LLP
Certified
Public Accountants