oversight

Farmers Home Administration Procedures and Policies on the Use of Independent Auditors Should Be Strengthened

Published by the Government Accountability Office on 1971-01-22.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

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                                         LM095740




      Department of Agriculture




      BY THE COMPTROLLER GENERAL
      OF THE UNITED STATES
                                    -        -
                    COMPTROLLER         GENERAL     OF   THE      UNITED   STATES
                                    WASHINGTON.      D.C.      20548




      B-170874




      To the     President      of the Senate      and the
i
 I-   Speaker      of the    House    of Representatives

               This is our report        pointing     out that Farmers          Home          22 ”
      Administration,         Department        of Agriculture,      procedures      and
      policies      on the use of independent           auditors    should    be
      strengthened.         Our review      was made pursuant           to the Budget
      and Accounting         Act,   1921 (31 U.S.C.         53), and the Accounting
      and Auditing        Act of 1950 (31 U.S.C.           67).

                Copies   of this    report         are being   sent to the Director,
      Office     of Management         and        Budget,   and to the Secretary     of
      Agriculture.




                                                                Comptroller         General
                                                                of the United       States
I
             Cbr4PTROLLER
                        GENERAL'S                         FARMERSHOMEADMINISTRATION PROCEDURES  AND
             REPORTTO THE CONGRFJSS                       POLICIES ON THE USE OF INDEPENDENTAUDITORS
I                                                         SHOULDBE STRENGTHENED
                                                          Department of Agriculture  B-170874
I
I

,            DIGEST
             ------

I            WHYTHE REVIEW WASMADE

                ( The Farmers Home Administration        (FHA) makes loans to rural public and pri-
                  vate nonprofit      associations   and organizations  to finance various under-
                  takings, such as the development of water and sewer facilities,           recre-
                  ational facilities,       and rural housing projects.    Loans outstanding for
                  these and other purposes totaled $942 million         to 7,375 borrowers as of
                  January 1, 1970. FHA uses reports of independent auditors in administer-
                  ing these loans.

                    The General Accounting       Office    (GAO) undertook   its   review of the use of
                                                                                            +re.v-iews-"of...EHA
                                                                                        d.i.to.rs..were..*_
                                                                                                         not
                                                                                                           . being

                    GAO expanded its review to include the Rural Electrification   Administration
                    because it is the other principal  agency in the Department of Agriculture
                    that uses reports of independent auditors in administering   loan programs.

    I
    I        FINDINGS AND CONCLUSIONS
    I
    II
                    The Rural Electrification     Administration has established a sound program
                    for using independent auditors , including    a means of assuring that only
                    professionally     qualified accountants are selected to make audits.   FHA
                    needs to strengthen its procedures and practices for using independent
                    auditors.      (See p. 9.)

                    Auditors'   qualifications

                    FHA has not provided clear guidelines  to its field staff for determining
                    whether the auditors engaged by its borrowers possess the independence and
                    professional  qualifications essential to the conduct of audits and prepara-
                    tion of required reports in accordance with generally accepted auditing
                    standards.   FHA generally does not advise or assist borrowers in the selec-
                    tion of auditors or otherwise determine that the auditors are qualified.
        II          (See p. 9.)
                    Guidance for Federal departments and agencies concerning qualifications  of
                    public accountants' making audits of federally  chartered, financed or regu-
                    lated private organizations  was provided September 15, 1970, by the
         I
         I
             Tear Sheet
                    .l in a ieir;tr   to ~y~t-tcy heads.
                                                   The Comptro ller  General
recommended that Federal deparimenxs and agencies require that audits be
conducted in accordance with generally accepted auditing standards by in-
dependent certified  public accountants, or by independent licensed public
accountants who are certified  or licensed by a regulatory authority   of a
State on or before December 37, 1970. Certain exceptions to that require-
ment were allowed.   (See ps 11.)

In effect the language recommended by the Comptroller General provides that
all audits after December 31, 1975, be made by certified     public accountants
except for those licensed public accountants who receive their licenses on
or before December 31, 1970. This provision provides for a terminating
class of public accountants who will continue to be eligible      for such au-
dit work throughout their active careers.    (See app. III.)

QuaZity of audits
FHA has not properly defined or effectively  communicated its auditing         and
reporting requirements to borrowers and their independent auditors.

GAO's examination of 79 audit reports prepared for FHA borrowers in Colo-
rado and Idaho showed that 43 reports did not contain the required audi-
tors' opinions on the financial   statements.    Of the 43 reports,   19 in-
cluded a statement that the financial    statements were prepared from the
borrower's records without audit.     Only five of the 79 reports were sub-
stantially  responsive to FHA's reporting requirements.      (See pp. 16 and 17.)

FHA supervision

Instructions     have not been developed on how FHA personnel are to review
and use audit reports prepared by independent auditors.       As a result,
agency officials     (1) have accepted audit reports that did not meet FHA
minimum requirements and (2) have not taken action to obtain audit re-
ports from borrowers who failed to furnish the reports to FHA. (See
p. 19.>

FHA instructions   relating   to the use of independent auditors were prepared
by personnel responsible for association      loan program operations without
the advice or assistance of professionally        qualified    accountants or audi-
tors.   GAO concluded that technically     qualified     personnel should develop
or assist headquarters'     program personnel in developing such instructions.
(See p. 21.)

ConcZusion

Audit reports prepared by qualified       independent auditors can be useful to
FHA in supervising   its borrowers, particularly      from the standpoint of
isolating  and analyzing problem areas and evaluating the financial       posi-
tion and results   of borrowers'  operations.

Because of the potential value of properly prepared audit reports3 it          is
important for FHA to ensure that audit reports prepared for borrowers          by

                                      2
         independent   auditors             meet         generally  accepted                 auditing    standards  and that
         they are effectively               used         in the administration                    of its loan programs.


 RECOMMENDATIONS
               OR SUGGESTIONS

         The Administrator            of    FHA should:

             --Establish       the qualifications                      of independent      auditors       in         line       with   the
                language     recommended        in             the    Comptroller     General's     letter.

             --Define      FHA's     role      in      the      selection       of     auditors        engaged     by borrowers.

             --Define     auditing     and reporting     requirements    with respect                                to (1) the
                auditing     and reporting     standards      for making an audit     and                              for preparing
                the report       and (2) the required       minimum scope of audit,                                  including     any
                procedures       to be used in tailoring         reports to meet FHA's                                 specific    needs.

             --Require    that       borrowers                and auditors    be furnished      FHA requirements                       which
                the auditors         must meet                in the performance      of audits    and preparation                        of
                audit  reports.

             --Provide    FHA personnel                 with         guidance    for      the      review    and use of the            in-
                dependent   auditors'                reports.

        The Administrator           should   also see that qualified          personnel     are assigned
        to functions       relating       to the use of independent         auditors      and that   the
        county    supervisors        are given    training     and assistance        as they may require
        in the review        and use of audit         reports.     (See p. 24.)

        GAO made no recommendations                            or suggestions           to   the     Rural    Electrification
        Administration.


AGENCYACTIONS AND UNRESOLVEDISSUES

        The Administrator,         FHA, stated  (see app. I) that    FHA's instructions       are
        being revised      generally    in line  with GAO's recommendations       and that    standards
        would be established         by which borrowers   can select   an independent      audi-
        tor acceptable      to FHA.

        Although   the Administrator        stated     that    FHA would not participate       directly
        in the selection     of auditors       by borrowers,          FHA officials    advised GAO in
        further  discussions      that   appropriate        action     would be taken in those      in-
        stances  where reviews       of independent         auditors'      reports  evidenced  noncom-
        pliance  with    FHA established       requirements.

        The Administrator             stated           that      FHA's      professional   staff  at the national      head-
        quarters   and at          certain          field        offices       would be increased    to ensure    that

Tear Sheet




                                                                     3
   functions   relating     to the use of independent   auditors   are performed by
   qualified   individuals.

   GAO believes that FHA's planned actions are responsive          to its recommenda-
   tions and should result in upgrading and strengthening          materially the use-
   fulness of independent auditors'  reports.


MATTERS
      FORCONSIDERATION
                    BY THECONGRESS
   GAO is bringing this matter to the attention       of the Congress because of
   (1) the significance      of the FHA and Rural Electrification  Administration
                     reliance is placed on the work of independent auditors and
                     congressional interest   in the development of sound programs
                     independent auditors in the administration    of Federal pro-




                                       4
                           Contents
                                                                     Page

DIGEST                                                                 1

CHAPTER

  1       INTRODUCTION                                                 5
              FHA organization    and      administrative     re-
                quirements for use         of independent
                auditors
              REA organization    and     administrative      re-
                quirements    for use     of independent
                auditors

  2       FHA SHOULD STRENGTHENPROCEDURESAND
          PRACTICES RELATING TO ITS USE OF INDEPEN-
          DENT AUDITORS                                               9
              FHA should clearly         define the minimum
                 professional      qualifications       of in-
                 dependent auditors         and its role in
                 the selection      of such auditors                  9
                    REA procedures for selection             and
                         approval of independent auditors            12
              Auditing     and reporting        requirements
                 should be properly         defined and com-
                municated by FHA to borrowers and
                 independent auditors                                14
                    REA auditing      and reporting       require-
                       ments                                         17
              Procedures for review and use of audit
                 reports by FHA should be developed                  19
                    REA procedures for review and use
                       of audit reports                              20
              Instructions      relating      to use of inde-
                 pendent auditors        should be developed
                 by qualified      FHA personnel                     21
                    REA organization        relating    to use of
                       independent auditors                          21

  3       RECENT INTERNAL AUDIT WORKRELATING TO FHA'S
          USE OF REPORTSBY INDEPENDENTAUDITORS                       23
                                                                      Page
CHAPTER
   4             CONCLUSIONS, RECOMMENDATIONS,AND AGENCY
                 COMMENTS                                              24
                    Conclusions                                        24
                    Recommendations to the Administrator,
                      FHA                                              24
                    FHA comments                                       25
                    REA comments                                       26
   5             SCOPE OF REVIEW                                       27

APPENDIX

        I        Letter dated August 10, 1970, from the Ad-
                   ministrator,  Farmers Home Administration,
                   to the General Accounting Office                   31

   II            Letter dated June 15, 1970, from the Admin-
                    istrator,Rural     Electrification   Adminis-
                   tration,      to the General Accounting Office     33

 III             Letter     dated September 15, 1970, from the
                    Comptroller      General to heads of Federal
                    departments and agencies,        concerning
                    qualifications      of public accountants
                   making audits of federally          chartered,
                    financed,      or regulated  private    organi-
                    zations                                           35

   IV           Principal      officials    of the Department of
                   Agriculture       responsible  for administra-
                   tion of the matters discussed in this
                   report                                             37

                                 ABBREVIATIONS

FHA         Farmers Home Administration
GAO         General Accounting Office
OIG         Office of the Inspector     General
REA         Rural Electrification    Administration
COMPTROLLER
          GENERAL'S                 FARMERSHOMEADMINISTRATION PROCEDURES  AND
REPORT
     TO THE CONGRESS                POLICIES ON THE USE OF INDEPENDENTAUDITORS
                                    SHOULDBE STRENGTHENED
                                    Department of Agriculture  B-170874


DIGEST
------

WHYTHEREVIEWWASMADE
    T!re Farmers Home Administration       (FHA) makes loans to rural public and pri-
    vate nonprofit      associations   and organizations  to finance various under-
    takings,  such as the development of water and sewer facilities,          recre-
    ational facilities,       and rural housing projects.    Loans outstanding for
    these and other purposes totaled $942 million         to 7,375 borrowers as of
    January 1, 1970. FHA uses reports of independent auditors in administer-
    ing these loans.

    The General Accounting Office (GAO) undertook its review of the use of
    independent auditors because of indications  from earlier reviews of FHA
    operations that the reports prepared by independent auditors were not being
    used and--in many instances--did  not meet FHA's needs.

    GAO expanded its review to include the Rural Electrification    Administration
    because it is the other principal  agency in the Department of Agriculture
    that uses reports of independent auditors in administering   loan programs.


FINDINGSANDCONCLUSIONS
    The Rural Electrification     Administration   has established  a sound program
    for using independent auditors,      including  a means of assuring that only
    professionally     qualified accountants are selected to make audits.      FHA
    needs to strengthen its procedures and practices for using independent
    auditors.      (See p. 9.)

    Auditors'   qualifications
    FHA has not provided clear guidelines  to its field staff for determining
    whether the auditors engaged by its borrowers possess the independence and
    professional  qualifications essential to the conduct of audits and prepara-
    tion of required reports in accordance with generally accepted auditing
    standards.   FHA generally does not advise or assist borrowers in the selec-
    tion of auditors or otherwise deter-m ne that the auditors are qualified.
    (See p. 9.)

    Guidance for Federal departments and agencies concerning qualifications  of
    public accountants'  making audits of federally chartered, financed or regu-
    lated private organizations  was prov ded September 15, 1970, by the
Comptroller  General in a letter   to agency heads. The Comptroller General
recommended that Federal departments and agencies require that audits be
conducted in accordance with generally accepted auditing standards by in-
dependent certified  public accountants,    or by independent licensed public
accountants who are certified    or licensed by a regulatory  authority of a
State on or before December 31, 1970. Certain exceptions to that require-
ment were allowed.    (See p. 11.)

In effect the language recommended by the Comptroller General provides that
all audits after December 31, 1975, be made by certified    public accountants
except for those licensed public accountants who receive their licenses on
or before December 31, 1970. This provision   provides for a terminating
class of public accountants who will continue to be eligible     for such au-
dit work throughout their active careers.   (See app. III.)


FHA has not properly defined or effectively  communicated its auditing        and
reporting requirements to borrowers and their independent auditors.

GAO's examination of 79 audit reports prepared for FHA borrowers in Colo-
rado and Idaho showed that $3 reports did not contain the required audi-
tors' opinions on the financial   statements.      Of the 43 reports9 19 in-
cluded a statement that the financial    statements were prepared from the
borrower's records without audit.     Only five of the 79 reports were sub-
stantially  responsive to FHA's reporting     requirements.    (See pp. 16 and 17.)



Instructions     have not been developed on how FHA personnel are to review
and use audit reports prepared by independent auditors.       As a result,
agency officials     (1) have accepted audit reports that did not meet FHA
minimum requirements and (2) have not taken action to obtain audit re-
ports from borrowers who failed to furnish the reports to FHA. (See
p. 19.)

FHA instructions  relating   to the use of independent auditors were prepared
by personnel responsible for association     loan program operations without
the advice or assistance of professionally       qualified    accountants or audi-
tors * GAO concluded that technically     qualified     personnel should develop
or assist headquarters'    program personnel in developing such instructions.
(See p. 21.)

ConcZusion

Audit reports prepared by qualified  independent auditors can be useful to
FHA in supervising  its borrowers, particularly  from the standpoint of
isolating and analyzing problem areas and evaluating    the financial posi-
tion and results of borrowers' operations.

Because of the potential value of properly prepared audit reports,  it        is
important for FHA to ensure that audit reports prepared for borrowers         by

                                   2
    independent auditors       meet generally accepted auditing standards and that
    they are effectively       used in the administration of its loan programs.


RECOMifENDATIONS
             ORSUGGESTIONS
   The Administrator     of FHA should:

      --Establish  the qualifications of independent auditors in line           with   the
         language recommended in the Comptroller General's letter.

      --Define    FHA's role    in the selection   of auditors   engaged by borrowers.

      --Define auditing and reporting     requirements with respect to (1) the
         auditing and reporting  standards for making an audit and for preparing
         the report and (2) the required minimum scope of audit, including     any
         procedures to be used in tailoring     reports to meet FHA's specific needs.

      --Require that borrowers and auditors be furnished FHA requirements which
         the auditors must meet in the performance of audits and preparation of
         audit reports.

      --Provide    FHA personnel     with guidance for the review and use of the in-
        dependent auditors'        reports.

    The Administrator   should also see that qualified     personnel are assigned
    to functions relatinq    to the use of independent auditors and that the
    county supervisors    are given training  and ass istance as they may require
    in the review and use of audit reports.      (See p. 24.)

    GAO made no recommendations        or suggestions   to the Rural Electrif   i cati on
    Administration.


AGENCY
     ACTIONSANDUNRESOLVED
                       ISSUES
    The Administrator,   FHA, stated (see app. I) that FHA's instructions are
    being revised generally in line with GAO's recommendations and that standards
    would be established   by which borrowers can select an independent audi-
    tor acceptable to FHA.

    Al though the Administrator   stated that FHA would not participate   directly
    in the selection   of auditors by borrowers, FHA officials    advised GAO in
    further discussions    that appropriate action would be taken in those in-
    stances where reviews of independent auditors'     reports evidenced noncom-
    pliance with FHA established requirements.

    The Administrator stated that        FHA's professional  staff at the national head-
    quarters and at certain field        offices would be increased to ensure that




                                           3
    functions   relating     to the use of independent   auditors   are performed   by
    qualified   individuals.

    GAO believes that FHA's planned actions are responsive          to its recommenda-
    tions and should result in upgrading and strengthening          materially the use-
    fulness of independent auditors'  reports.


Ki'TER9 FORCONSDERATION
                      BY THE CONGRESS
    GAO is bringing this matter to the attention       of the Congress because of
     (1) the significance     of the FHA and Rural Electrification  Administration
    programs where reliance is placed on the work of independent auditors and
    (2) increasing     congressional  interest in the development of sound programs
    for the use of independent auditors in the administration       of Federal pro-
    grams.




                                       4
                                 CWTER      1

                               INTRODUCTION

        The General Accounting      Office reviewed how independent
auditors     are used by the Farmers Hone Administration          and the
Rural Electrification        Administration     (REA), Department of
Agriculture,      in  administering     their loan  programs.    The
matters discussed in this report should not be considered
typical     of the manner in which either        agency administers
other aspects of its loan programs.             The scope of our re-
view is described on page 27 of this report,

      Principal    officials    of the Department of Agriculture
responsible     for administration    of the matters discussed              in
this report are listed       in appendix IV.

FHA QRCANIZATION AND ADMINISTRATIVE
REQUIREMENTSFOR USE QF INDEPENDENT
AUDITORS

       FHA was established        on November 1, 1946, pursuant to
the Farmers Home Administration               Act of 1946 (60 Stat. 1062),
to simplify      and improve credit          services    available    to farmers
and to promote farm ownership.                FHA makes direct       and insured
loans to public and private           nonprofit       associations      and orga-
nizations     for (11 the development of water and se-wer systems,
 (2) land conservation        practices        such as the construction        of
 soil and water conserving          facilities       and shifts     in land
uses9 (3) the development of rural recreational                     projects,
 (4) the development of rural housing projects--primarily
 for' senior citizens       and farm labor, and (5) the creation               of
 cooperatives     providing    essential        processing,     purchasing,    or
marketing     services,     supplies     or facilities       to predominantly
 low-income rural families.            The loans are made pursuant to
 the Consolidated       Farmers Home Administration             Act of 1961,
 as amended (7 U.S.C. 1926); the Watershed Protection                      and
 Flood Prevention       Act of 1954, as amended (16 U.S.C. 1006a);
 Title V of the Housing Act of 1949, as amended (42 U.S.C.
 1471); and the Economic Opportunity                Act of 1964, as amended
  (42 U.S.C. 2852).
       FHA maintains   41 State offices--which            serve the 50
States,   the District   of Columbia, Ruerto           Rico, and the

                                        5
Virgin     Islands--and    about 1,700 county offices.         Each FHA
State office       is headed by an FHA State director        who is re-
sponsible      for all program operations      within    his territorial
jurisdiction.         The FHA county offices,     each under the super-
vision of an FHA county supervisor,           are located throughout
the country to serve all agricultural            counties.    Applications
for all loans are made to the county offices.               County office
operations      are subject to review by FHA district          supervisors
and other FHA State office         officials.

       Under FRA instructions,      a borrower,    after receiving     a
loan, is provided with FHA supervision          necessary to accom-
plish the objectives       of the loan,    Methods of supervision
include organizational       and development planning;      construe-
tionconferences;     long-term,   annual, and other periodic        plan-
ning; accounts and records inspection;          facility  inspections.;
attendance    at membership and governing body meetings;           and
analysis    of accounting    and audit reports.

       With respect to audit reports,     FHA instructions         require
each borrower to submit an annual audit report within                60
days after    the close of the borrower's    fiscal    year.       The
instructions     also provide that:

      --When a borrower!s    total outstanding indebtedness     to
         F'HA exceeds $25,000 or the loan is delinquent,     an
        audit report will be prepared by a qualified      inde-
        pendent auditor.

      --When a borrower‘s  total  outstanding     indebtedness
         to FRA is $25,000 or less and the loan is current,
         the audit may be made by a committee of the member-
        ship not to include any officer,      director,   or em-
        ployee of the borrower.

        The number and total     dollar    volume of association       and
organization    loans made by FHA has increased substantially
in recent years,        At January 1, 1964, loans of about $54
million    had been made to 750 borrowers,           of which about $47
million    was outstanding    to 649 borrowers.         By January 1,
1970, cumulative      loans of about $1 billion         had been made to
7,720 borrowers,     of which about $942 million           was outstand-
ing to 7,375 borrowers.        As  of   that   date,   1,508  borrowers,
or 20 percent,     were delinquent      about $13 million      on their

                                    6
outstanding   loans.    The percentage of borrowers delinquent
ranged from a low of 4 percent for watershed loans to a
high of 43 percent for loans to economic opportunity       coop-
c--a~i-&s B FHA ad-;Esed us that by April 30, 1970, the over-
all delinquency    rate had decreased to 10 percent.

       The status at January 1, 1970, of the various   types of
organization    and association loans made by F'HA is shown in
the following    schedule.

                   Number of borrowers
                                   De-         Percent
                              linquent           o$ berm
                    Having    on their        rowers de-
                      out-       out-          linquent         De-
   nTe of          standing   standing         on their      linquent
    loan              1OEQlS     loans           loans       amounts

Association           4,745             843       18       $10,381,419
Watershed                399             17        4            494,392
Mousing               1,014             143       14            932,224
Renewal and
  resource
  conservation
  development            65               7       11            34,665
Economic
  opportunity
  cooperative         1,152             498      -43         1,774,686

    Total             7,375           1,508      E
                                                  20       $13,617,386

        At January 1, 1970, cumulative    loans of about $62 mil-
lion had been made to 443 borrowers in Colorado and Idaho--
the two States where we made our review--of        which about $57
million    was outstanding   to 374 borrowers.    As of that date,
92 borrowers,     or 25 percent,  were delinquent   about $977,000.

       FHAvs program planning data for fiscal         year 1970-74
indicate   that the total     dollar volume of loans to associa-
tion and organization     borrowers will continue to grow at a
rapid pace,     ?.%Aestimates     that loans totaling     $1.2 bil-
lion will be made during the 5-year period.            In addition
to being authorized     to make loans for established         programs,
ERA is authorized    under section 524 of the Housing Act of

                                  7
1949, as amended (42 U.S.C. 1490d), to make loans to public
or private   nonprofit     organizations      for the acquisition  and
development of landas building           sites to be subdivided   and
sold to eligible     applicants.

REA ORGANIZATION AND ADMINISTRATIVE
REQUIREHENTS FOR USE OF INDEPENDENT AUDITORS

      REA was established        on May 11, 1935, by Executive
Order 7037. Pursuant to the Rural Electrification           Act of
1936, as amended (7 U.S.C. 9011, REA makes loans to (1) pri-
vate companies and cooperatives          for the extension of elec-
tric and telephone service to rural areas and for the im-
provement of existing        telephone service to rural areas and
(2) cooperative   associations        and public bodies for neces-
sary additional   facilities        to meet the increasing need for
power on existing    rural electric        systems.

      REA requires   its borrowers to have their accounts and
supporting   records audited annually by independent certified
public accountants     (CPAs) selected by the borrowers and ap-
proved by REX. Specific      auditing   and reporting requirements
are published    in an REA bulletin   for use by the borrowers
and WAS.

      At January 1, 1970, REA had made loans totaling        $8.8 bil-
lion to 1,963 borrowers,      of which about $5.2 billion    was out-
standing   to 1,828 borrowers.     Of these borrowers,    11 were
delinquent   about $2 million.
                                CHAPTER 2

      .FHA SHOULD STRENGTHENPROCEDURESAND PRACTICES

         RELATING TO ITS USE OF INDEPENDENT AUDITORS

      On the basis of our review, we concluded that (1) FHA
should strengthen  its procedures and practices       relating   to
the use of independent auditors    in administering      its loan
programs and (2) REA has established       a sound program for the
use of independent auditors.     Specifically,    FHA should:

     --Clearly    define the minimum professional         qualifica-
        tions of independent auditors    and its       role in the
        selection   of such auditors.

     --Properly   define auditing  and reporting    requirements
        and communicate such requirements     to all borrowers
        and their  independent auditors.

     --Develop     procedures   for   the review   and use of audit
        reports.

     --Ensure that functions   relating        to the use of inde-
        pendent auditors  are performed        or supervised by
        qualified personnel.

      The following sections of this chapter discuss the
areas where improvements should be made by FHA and describe
the procedures and practices   being followed by REA in each
of these areas.

FHA SHOULD CLEARLY DEFINE THE MINIMUM
PROFESSIONAL QUALIFICATIONS OF
INDEPENDENT AUDITORS AND ITS ROLE
IN THE SELECTION OF SUCH AUDITORS

      FHA has not provided any clear guidelines   to its field
personnel for determining  whether auditors   engaged by its
borrowers possess independence and professional     qualifica-
tions essential  to the conduct of audits and preparation      of
required    reports  in accordance      with   generally     accepted      au-
diting   standards.1

        FHA's only written    instructions      concerning     auditors'
qualifications     state that:

      'I*** the audit report will be prepared by a qual-
      ified   independent auditor.      The State Director
      may require,    in any particular    case, that the au-
      ditor   be a Certified  Public Accountant."

      The instructions      do not:

      --Describe    any minimum professional    qualifications      in
         terms of technical    training,  experience,      independence,
         or recognition   which would be acceptable        to FHA in ,
         those cases where the State director       does not require
         that the auditor    be a CPA.

      --Require  FHA personnel to advise          or assist     borrowers
         in the selection  of auditors.

       We discussed with 18 FHA county supervisors      in Colorado
and Idaho their    involvement  in the selection    of auditors.
The supervisors    informed us that generally    they did not (1)
provide advice and assistance       to borrowers in the selection
of auditors    or (2) determine that the persons selected        by
the borrowers were qualified      to conduct audits and prepare
reports.                                            .

       We selected for examination    79 of 125 audit reports
prepared for FHA borrowers     in Colorado and Idaho in calendar
years 1968 and 1969.     Generally  our selection    included audit
reports   for all borrowers having outstanding     loan balances
of $100,000 or more at January 1, 1969.        Our examination
showed that


1Those standards which have been adopted by the accounting
 profession   to apply to audits of accounts,  financial trans-
 actions,   and financial statements of an organization.
      --55 reports were prepared by accountants    who were cez-
         tified and licensed by a regulating  authority  of a
         State and

      --24 reports were prepared by persons who were not
         certified   and licensed to practice as independent
         auditors  by the States and whose qualifications     were
         not otherwise   determinable from the reports    or FHA
         records.

       Although the majority    of the audit reports were pre-
pared by accountants     who were certified    and licensed,    most
of the reports did not contain all the information           required
by FHA instructions     or indicate   that the 'audit met generally
accepted auditing    standards.     This problem is discussed in
detail    beginning on page 16 of this report.

        In a letter     to heads of Federal departments           and agen-
cies dated September 15, 1970 (see app. III),               the Comptrol-
ler General discussed the qualifications              which public ac-
countants making audits of federally             chartered,     financed,,
or regulated      private   organizations     should have.        The Comp-
troller    General recommended that the following             language be
included in regulations         issue.d by departments      and agensies
prescribing     the qualifications        of public accountants        se-
lected to audit programs administered              by .the depart:iznts    and
agencies.

              "Such audits shall be conducted in accor-
      dance with generally          accepted auditing       standards
      by independent certified           public accountants         or
      by independent licensed           public accountants,         li-
      censed on or before December 31, 1970, who are
      certified     or licensed      by a regulatory       authority
      of a State or other political             subdivision     of the
      United States:         Except that independent public
      accountants      licensed to practice        by such regu-
      latory    authority     after December 31, 1970, and
      persons who, although not so certified                or li-
      censed, meet, in the opinion of the Secretary,
      standards of education and experience               represen-
      tative    of the highest prescribed          by the licensing
      authorities      of the several States which provide
      for the continuing         licensing    of public accoun-
      tants and which are prescribed             by the Secretary
                                      11
      in appropriate   regulations      may perform such audits
      until  December 31, 1975:       Provided,    that if the
      Secretary   deems it necessary in the public            inter-
      est, he may prescribe      by regulation     higher stan-
      dards than those required       for the practice        of
      public accountancy by the regulatory           authorities
      of the States."

      In effect   the language recommended by the Comptroller
General provides      for all audits after       December 31, 1975, to
be made by CPAs except for those licensed             public accountants
who receive their       licenses    on or before December 31, 1970.
This provision    provides      for a terminating     class of public
accountants    who will     continue   to be eligible     for such audit
work throughout     their     active careers.


REX procedures  for selection     and
approval of independent    auditors

      REA has established     the following      procedures  relating
to its participation     in the selection       and approval of inde-
pendent auditors.

      1.   Upon notification      from R,JU to engage an independent
           CPA to audit its records,         the borrowerss   board of
           directors     is responsible    for selecting    a CPA subject
           to REX approval.       Although REA policy      does not re-
           quire the accountant       selected   by the borrower to be
           a CPA of the State in which the borrbwer            is located,
           he must be licensed       by a State or territory      or the
           District    of Columbia.

      2.   In selecting    the CPA, the borrower's      board of di-
           rectors    is to consider the qualifications      of avail-
           able accountants     with emphasis on their     experience
           in performing     audits of utilities    and on their    abil-
           ity to complete the audit and submit the report
           within   the required    time limit.

      3.   After  selection of the CPA, the borrower is required
           to advise REA by letter  of its selection   and to sub-
           mit a certified  copy of the resolution   adopted by
  the    board of directors    covering such action.    If
  the    borrower's  selection   of a CPA is not satisfac-
  tory    to REA, the borrower is advised prior      to the
. date    the audit is to begin.




                            13
AUDITING AND REPORTING REQUIREMiNTS SHOULD
BE PROPERLYDEFINED AND COMtfUNICATED BY FHA
TO BORROWERSAND INDEPENDENT AUDITORS

       ??HAhas not properly    defined and generally      has not com-
municated its auditing      and reporting   requirements     to bor-
rowers and their    independent auditors.       Such  action   is
needed to provide assurance to F'HA that audits will           provide
the information    needed for an evaluation      of the borrowers'
financial   status and results     of their operations.

      FHA instructions    state that audit reports will                              be dated
as of the close of the fiscal       year and will include                            at
least the folloT&ng    information.

          '#I   The auditor's    opinion regarding  the extent to
                IJfiich the audit report represents    the finan-
                cial position    of the borrower.

     "II        The auditor?s comments and recommendations
                on items such as:

                A   Adequacy of accounts .and records including
                    suggestions for improvement,   if any.

                B   Adequacy of managerial  practices,                    including
                    suggestions for improvement,    if                  any.

   “III         The name, address, and date of expiration                           of
                the term of directors and officers.   .'

     "Iv        Balance      Sheet showing         at least        the following:

                A   Assets        and other   debits.

                B   Liabilities        and other        credits,      including
                    reserves.

                C Pkmber or stockholder                 equities      or sur-
                  pluses.

                D Fund balances.



                                              14
.



          "V   A Statement'of  Income and Expenses showing
               sources of income and major categories  of
               expenses for the year.

         "VI   A list   of accounts receivable showing the
               n69e, amount, and whether the accounts are
               delinquent.

        'W-I   Other   appropriate       information   such as:

               A   Amount   of property insurance, liability
                   insurance,   and workman's compensation
                   insurance.

               B   Status    of taxes,     if   any.

      "VIII    Any unusual     items."

            The instructions     do not contain any statement regard-
    ing the auditing       and reporting      standards   to be followed    in
    making the audit and in preparing             the report and the mini-
    mum scope of audit required           that would give consideration
    to any audit procedures which the auditor               should follow   in
    tailoring     the audit report to meet specific           needs of FHA.
    F'HA's instructions      do not require       the auditor    to (1) com-
    ment on a borrower's       compliance with requirements          of F'J3A
    loan agreements or (2) provide special analyses of a bor-
    rower's operations       which could be useful to FHA in super-
    vising a borrower's       activities.

           For example FHA loan agreements require           that certain
    cash reserves be established         and maintained    by borrowers,
    but-the   instructions    do not require     the auditor     to comment
    on the extent of a borrower's         compliance with this require-
    ment.    Special analyses which we believe could be useful to
    FHA include (1) evaluations        of internal    controls     and finan-
    cial policies      and (2) contrasts    of borrowers'      actual finan-
    cial progress with loan objectives          and annual operating
    budgets.

           In our view, because FHA is operating           nationwide   loan
    programs, an improved statement of auditing             and reporting
    requirements   would
                                                                                                         .



          --promote           uniformity          in audit       reports,

          --help      to ensure         that       sufficient         information         is pro-
             vided      for     an   evaluation            of   a borrower's        financial
             status       and results             of operations,            and

          --provide  assurance-- in those cases where audits are
             made by other than CPAs- -that such audits meet gen-
             erally accepted auditing   and reporting  standards.

        FHA instructions     also do not contain any statement
that F'HA county or State officials         are to communicate FHAvs
requirements      to borrowers and their independent      auditors.
Fifteen    of 18 county supervisors      contacted  by us indicated
that they did not normally         communicate the requirements     to
borrowers or their       auditors.

      Audit reports    received by FHA in the two States in-
cluded in our review,        for the most part, did not meet many
of the requirements       established      by FHA. For example our
examination   of 79 audit reports          showed that 43 reports    did
not contain the required         auditors'    opinions on the financial
statements.    Of the 43 reports,          19 included a statement    that
the financial   statements       were prepared from the borrowers'
records without    audit.       Only five of the 79 reports were
substantially   responsive       to FHA's reporting    requirements.

       The tabulation   below shows the extent to which the 79
audit reports     did not meet FHA's minimum reporting require-
ments.
                                                                      Mot meeting      Percent not
                                                   Fleeting FXA             E-HA       meeting     FHA
           FXA requirement                         requirement        requirement      requirement

Auditor's        opinion      on borrower's
    financial       position                               36                  43               54
Auditor's        comments on adequacy
   of records                                              18                  61               77
Auditor's        comments on adquacy
   of managerial           practices                       11                  68               86
List of directors             and officers                 17                  62               78
Balance       sheet                                        71                   8               10
Statement       of income and expenses                     69                  10               13
List of accounts            receivable                     25                  54               68
Information         on:
       Insurance       coverage                            15                  64               81
       Status of taxes                                     15                  64               81


                                                      16
      The following two cases illustrate      the need for FHA to
communicate its auditing   and reporting    requirements   to al'i
borrowers and their independent auditors        in order to have
some assurance that adequate audits are conducted and that
the reports provide required   information.
      1. Borrower A, a grazing association               in Colorado,      ob-
         tained an initial         loan from FHA in 1966.           The asso-
         ciation    owed FHA about $1.7 million            and was delin-
         quent about $31,000 at January 1, 1969.                  For the
         borrower!s     fiscal    year ended November 1968, the
         borrower's     auditor,      a certified    public accountant,
         indicated    in his report that the financial               state-
         ments were "unaudited."'            The auditor    clearly     stated
         in his report that a complete examination                  was not
         made and that,        for this reason, he was not express-
         ing an opinion on the financial             statements.        The
         auditor's    report included a balance sheet and state-
         ment of income and expenses.
          At the time of our fieldwork,    the county supervisor
          informed us that FYI-U's requirements    for audits and
          reports had not been communicated to the borrower or
          the borrower's  auditor,  and that the county office
          had accepted whatever the auditor     provided in the
          way of an audit report.
      2. Borrower B, a recreation       organization     in Idaho, owed
         FHA about $114,000 and was delinquent          about $24,000
         at January 1, 1969.      Financial     statements    received
         by FHA from this borrower for the borrower's             year
         ended June 30, 1969, contained a comment by the CPA
         firm to the effect    that the financial        statements
         were prepared without     independent verification.
         The county supervisor     informed us that he had not
         communicated ?XAs auditing         and reporting     require-
         ments to the borrower or the auditor.
RELAauditing    and reporting      requirements
        REA has established      comprehensive auditing        and report-
ing requirements      which are furnished       to both borrowers and
independent auditors       in an REA bulletin.         According to the
bulletin,     RJIA has found--in    administering      a national     loan
program-- that the qualify        of auditreportsvaries         considera-
bly.      Because of this,   REA auditing      and reporting      require-
ments were established        to

                                      17
      --promote    uniformity   in audit    reports,

      --ensure audit reports     provide sufficient    information
         for a comprehensive evaluation      of borrowers'   finan-
         cial status and results     of operations,   and

      --give   some assurance     that   adequate      audit   procedures
         are followed.

       In general the minimum audit acceptable           to RIZA is one
performed in accordance with auditing         standards equivalent
to those established      by the American Institute        of Certified
Public Accountants.       Also REX requires    performance of cer-
tain audit procedures which it deems necessary to an evalu-
ation of borrowers'     financial   status and compliance with
REA loan agreement requirements.         REA's bulletin      specifi-
cally points out that RJZA's requirements          are considered      the
minimum and are not intended to limit        the auditor's       judgment
concerning   additional    work necessary to make a proper audit
and prepare an adequate and appropriate          report.

      MA requires    the CPA, upon completion          of the audit to
submit an audit report containing         certain    financial   state-
ments and supplementary      analyses,    comments on the financial
statements,    and an opinion of the fairness          with which the
statements   present the financial       position    of the borrower
and the fairness    of the supplementary        analyses and balance
sheet comments.     FXA's bulletin     includes     sample forms, for-
mats, and comments for use by CPAs in preparing , acceptable
audit reports.

       Our review of 29 audit reports     submitted     to REA by bor-
rowers in Colorado and Wyoming showed that the reports             sub-
stantially    conformed with FLEAauditing      and reporting   re-
quirements.     In three of the reports,     the CPAs did not
present the subdivisions     of detailed    account balances on the
balance sheet and income statements       in the format required
by MU.      PEA pointed out the specific     deviations    in audit
review letters     to the concerned borrowers and the CPAs who
performed the audits.
PROCEDURESFOR REVIEN AND USE OF
AUDIT FW?ORTSBY FXA SHOULD BE DEVELOPED

       FHA has not developed any instructions        concerning     the
review and use by FHA personnel of audit reports            prepared
by independent    auditors.     In the absence of any instructions
to reject   inadequate reports,     FHA personnel have accepted
audit reports    which did not contain the minimum information
which IWA considered      essential   to constitute   satisfactory
audit reports,     Also, in instances      where borrowers did not
furnish   audit reports,    FHA personnel did not take follow-
up action to obtain the required        reports.

       As previously    pointed out on page 16;of the 79 audit
reports   we examined, only five were substantially        responsive
to FHA's minimum requirements.         Also, in the two  States    in-
cluded in our review,       38 borrowers had not furnished     re-
quired audit reports for the most recent fiscal         year.     FHA
State officials      were aware that action to obtain required
reports   was not taken.

      In our discussions      with FHA county supervisors          and FHA
State officials,      they indicated     that detailed     analyses of
audit reports      to determine whether such reports          complied
with FHA's minimum reporting         requirements     generally    were
not made. From these discussions,            we concluded that county
supervisors,     the primary FHA officials        responsible    for re-
view of audit reports       and supervision     of borrowers:

      --Did not have a clear understanding          of the signifi-
         cance of audits,    audit reports,     auditors'     opinions
         on financial   statements,   and   financial     statement
         analysis,

      --Were not using audit reports   in evaluating    the bor-
         rower's financial position  and results   of its oper-
         ations.

A January 1970 audit report     issued by the Office of the In-
spector General (OIG), Department of Agriculture,         on FHAss
association   recreation  loan program included a statement
that county supervisors     had advised OIG that they were not
bookkeepers,    that they did not understand   financial    manage-
ment o and that they had never received     any financial

                                    19
training   from the State offices       in the financial    management
of associations.    (See p. 23.)

       In our opinion,   the fact that county supervisors    gen-
erally    do not have formal training    and experience in finan-
cial management increases      the importance of clear,   complete
instructions    on the review and use of audit reports.

RXA procedures  for review
and use of audit reports

      REA's bulletin     states that, upon receipt     of the audit
report by a borrower,       the board of directors    and management
should carefully     review the report    and should take correc-
tive action to eliminate       any unsound practices.

      Copies of the audit report         submitted to REA are re-
viewed for information     relating     to the borrower's  operations
and financial   status and for conformance with REA*s auditing
and reporting   requirements.       After its review of the report,
REA furnishes   the borrower and the CPA with any comments or
recommendations    it may have.

       Also REA field    accountants    evaluate   the adequacy of
the audit of the borrower's        records.     REA's Borrowers‘    Au-
dit Standards Staff examines selected audit work papers of
CPAs to determine the conformance with REAss minimum stan-
dards for audit.      This review function       is performed to pro-
vide assurance that the reports         submitted    are based on ex-
aminations   carried   out in accordance with acceptable         stan-
dards.

      As previously discussed on page 18, audit reports       re-
ceived by REA substantially    conform with REA requirements.
In those instances  where a report did not conform, REA
pointed our the deviations   to the borrower and to ,the CPA.




                                   20
INSTRUCTIONS RELATING TO USE OF
INDEPENDENT AUDITORS SHOULD BE
DEVELOPEDBY QUALIFIED FHA PERSONNEL

       Because the problems previously          discussed in this re-
port stemmed to a large extent from the lack of adequate
and completeagencyinstructions          relating      to audits by in-
dependent auditors,       we inquired   as to the placement of re-
sponsibility     in FHA for the preparation         of such instructions.
We were advised that the instructions            had been prepared by
personnel    responsible     for association     loan program opera-
tions in FHA's Washington headquarters             without    the advice
or assistance      of professionally    qualified       accountants  or
auditors.

       In our opinion,     FHA, to derive maximum benefit          from
the reports    prepared by independent      auditors,      should have
technically    qualified    personnel develop or assist         the head-
quarters'   program personnel      in developing     instructions      which
can be used as a basis for correcting          the problems found in
our review.     Also we believe      that, once the instructions         are
developed,   FHA will have to provide the county supervisors
with the assistance      that they need in the review and use of
audit reports.

REA organization     relating    to use
of independent     auditors

       REA's Borrowers'     Financial   Management Division    admin-
isters   activities     concerned with borrowers'    accounting   and
audits of borrowers'       records.    The Division  has a Borrowers'
Audit Standards Staff,        a Technical Accounting   Staff,   and a
Borrowers'     Accounting    Branch,

        The Borrowers'   Audit Standards Staff      develops proposed
policies,    procedures,   and standards   for the use of CPAs and
for agency examination      programs.    The Staff develops also
criteria    and techniques    for the review by REA of audit re-
ports prepared by CPAs. This Staff         is responsible     for the
examination     of CPA workpapers,    as necessary,    to determine
conformance with REA's minimum standards         for audits.




                                    21
       The Technical    Accounting  Staff is responsible           for de-
veloping    and evaluating    broad and basic accounting           policies,
systems, and procedures      with respect to borrowers'            accounting
operations.

      The Borrowers'     Accounting        Branch:

      --Appraises  borrowers' accounting systems and proce-
         dures and recommends changes as necessary.

      --Provides      advice and assistance   to borrowers    in the
         installation      and operation  of accounting   systems.

      --Examines borrowers'     records        to ensure   that   loan,funds
         are expended properly.

      --Conducts    regular financial         audits   of borrowers    not
         audited   by CPAs.

      --Identifies      deficiencies     which tend to delay the bor-
         rowers'   attainment      of program objectives   and recom-
         mends plans for remedial action.

The Branch is responsible            for the review of audit reports      by
CPAs to determine          conformance with acceptable      accounting
practices,      procedures,      and standards,   and compliance with
RE.A's requirements.           In cases of nonconformance     or noncompli-
ance, the 3ranch is responsible             for determining   that appro-
priate     action is taken.        In addition,   the Branch approves the
borrower's       selection     of a CPA.




                                      22
                             WAFTER 3

                    RECENT INTERNAL AUDIT WORK

               RELATING TO FHA'S USE OF REPORTS

                     BY INDEPENDENT AUDITORS

        OIG issued a report in January 1970 dealing with F'HA's
recreation     association  loan program in 14 States,   including
the two States where we made our review.         The OIG report,
which covered 107 associations,        pointed out, among other
things,    that the associations    did not have proper audits.

     With respect    to 90 associations  required to have audits
by an independent    auditor, the OIG report pointed out that

     --43 associations     had submitted  audit reports which did
        not comply with FHA's reporting     requirements--$  of
        these associations    had audit reports which were not
        prepared by independent auditors,

     --24 associations    had not submitted     audit   reports   to
        FHA, and

     --23 associations     had submitted   audit reports which
        complied with F%IAss reporting     requirements    but con-
        tained the auditors'    qualifying    statements   that the
        borrower's   records did not adequately      support certain
        balance sheet or income account transactions.

       The 0% report recommended that the Administrator,          FHA,
revise the agency's instructions        to require  that associa-
tions enter into agreement with a qualified         accountant   be-
fore loan closing      to (1) set up an accounting     system,
(2) train and supervise       the person who is to maintain    the
records,     and (3) furnish    an adequate audit of the books when
required,      OIG recommended also that FHA State offices       re-
view and approve the borrowers'        accounting  systems and con-
tracts    with accountants.

     In March 1970 we were advised by an OIG official            that
FHA had promised to make procedural  changes in line          with the
recommendations  contained in the OIG report.

                                 23
                                CHAPTER4

      CONCLUSIONS, RECOMMENDATIONS,AND AGENCY COMfaENTS

CONCLUSIONS

       Audit reports prepared by qualified          independent au-
ditors   can be useful to FHA in supervising           organization-
type borrowers,     p articularly     from the standpoint      of iso-
lating   and analyzing problem areas and evaluating              the fi-
nancial position      and results     of borrowers'    operations.       Be-
cause of the potential         value of properly    prepared audit re-
ports,   it is important       for FIiA to ensure that audit reports
prepared for borrowers by independent auditors              meet gener-
ally accepted auditing         standards and that they are effec-
tively   used in the administration        of its loan programs.

RECOMMEZNDATIONS
              TO THE ADMINISTRATOR, FDA

       We recommend that the Administrator,           FHA, have agency
instructions   for the use of independent           auditors revised to:

      --Establish   the qualifications     of independent  auditors
         in line with the language recommended in the Comp-
         troller  General's   September 15, 1970, letter    to heads
         of Federal departments      and agencies.   (See app. III.)

      --Define  FHA's role in the selection           of auditors    en-
         gaged by borrowers.

      --Define   auditing   and reporting   requirements      with re-
         spect to (I) the auditing      and reporting     standards
         for making an audit and for preparing        the report      and
         (2) the required    minimum scope of audit,       including
         any procedures   to be used in tailoring       reports    to
         meet FRA'S specific     needs,

      --Require    that borrowers and auditors   be furnished  FHA
         requirements   which the auditors   must meet in the
         performance of audits and preparation     of audit re-
         ports.




                                    24
     --Provide  FHA personnel with          guidance     for the review
        and use of the independent          auditors'      reports.

       In the event that the Administrator              requires  outside
assistance    and advice in the development             of improved pro-
cedures and requirements,      we suggest that           he call upon OIG
and WA.      Also the American Institute     of         Certified  Public
Accountants9     Committee on Relations   with          Federal Government
Agencies is available      to provide Federal           agencies with ad-
vice and assistance      in such matters.

       We recommend also      that the Administrator     take steps
to ensure that functions          relating to the use of independent
auditors    are performed     by qualified   personnel and that the
county supervisors     are    given training    and assistance   that
they may require     in the     review and use of audit reports.



       The Administrator,   FHA, advised us by letter        dated
August 10, 1970 (see appe I), that FHA was revising             its
supervision   and servicing    instructions      and that the revised
instructions   would include an exhibit        which would be pro-
vided to FHAls borrowers      and their     accountants.    He stated
that the exhibit     would define:

      --The minimum professional    qualifications of independent
         auditors in line with the language recommended in
         the Comptroller  General's  September 15, 1970, letter.

      --Auditing     and reporting      requirements      with respect to
          (a) scope, (b) the auditing          and reporting      standards
         to be followed     in making the audit and in preparing
         the report,    and (c) the audit procedures            to be used
         by the auditor     in tailoring       the report to the needs
         of FHA. The auditing         requirements      for the various
         types of loans are to be detailed             separately     and will
         include requirements       for nonprofit       organizations,
         public bodies, recreation          associations,      grazing as-
         sociations,    watershed and irrigation           associations,
         economic opportunity       cooperatives,       labor and rental
         housing organizations,        and individuals.


                                    25
        The Administrator     stated also that (1) the revised in-
structions    would include detailed          requirements     for the re-
view and use of independent          auditors1      reports by FIiA field
personnel    and (2) F'HA would increase its professional                 staff
at the national      headquarters     office      and certain    field   of-
fices to ensure that functions            relating     to the use of in-
dependent auditors        are performed by qualified          personnel.,

        The Administrator      stated the belief     that FHA field
personnel      should not assist borrowers       in the selection        of
their    auditors,      He did state, however9 that FHA would es-
tablish    standards by which borrowers        can select an indepen-             '
dent auditor       acceptable   to FHA. In further       discussions,
FHA officials       stated that appropriate      action would be taken
in those instances        where reviews of independent auditorIs
reports    evidenced noncompliance with FHA established               require-
ments.

        We believe that the actions planned by FHA are fully
responsive     to our recommendations   and should result in ma-
terially    upgrading and strengthening    the usefulness of in-
dependent auditors'      reports.

REA COMMENTS

       The Administrator,      REA, advised us by letter       dated
June 15, 1970 (see app. II),         that he was pleased that we
found REA's procedures        and practices    relating   to its use of
independent    auditors    sound,    He also stated that REA would
be willing   to provide assistance        to FHA in the development
of its procedures       and requirements    relating    to independent
auditors.



       OIG officials    advised us that the Department of Agri-
culture    would issue regulations      prescribing    the qualifica-
tions of public      accountants   selected to audit programs ad-
ministered    by Federal departments       and agencies along the
lines recommended by the Comptroller           General in his Septem-
ber 15, 1970, letter.




                                        26
                                  CHAPTER 5

                               SCOPE OF REVIEW

      Our review was made at the FHA and the REA headquarters
offices    in Washington,    D.C.; at the FHA Finance Office    in
St. Louis, Missouri;      at FHA State Offices    in Denver, Colo-
rado,   and  Boise,  Idaho;   at  10 FHA  county offices in Colorado
and eight county offices       in Idaho; and at the REA Field Ac-
countant's    office   in Brighton,   Colorado.

      We reviewed the pertinent    provisions of applicable    leg-
islation    and the procedures and practices   *followed by FHA
and REA in the use of independent auditors.         We examined
audit reports     and agency records of 79 FHA borrowers located
in Colorado and Idaho, and 29 REA borrowers        located in Colo-
rado and 'EJyoming.

         We also   discussed   various   matters   with   FHA and REA offi-
cials.




                                         27
             -.
             ..
APPENDIXES




  29
; ‘,
                                                                                     APPENDIX I
                                                                                         Page b
                 UNITED   SYAYES      DEPARTMENY             OF      AGRICULTURE

                           FARMERS      HOME     ADNIINISTRATION

                                   WASHINGTON.        D.C.   20250




PLr. Victor L. Lowe                                                          AUG 10 1970
Associate Director
U, S. General Accounting Office
Civil Division
Washington, D. C. 20548
Dear Mr. Lowe:
Thank you for sending me copies of your draft report to the Congress
on the review of the use of independent auditors by the Farmers Home
Adi&xistration (ERA) and the Rural Electrification Administration (REX).
On page three of your report you commenton the delinquent association
borrowers of FRA as at January 1, 1969. We feel that if you are going
to include these figures you should show more detail, because over 36
percent of the delinquencies reported are Economic Opportunity Coopera-
tive borrowers. These are high risk loans to low income rural residents.
Also loan repayments from public bodies are due on January 1 and their
fiscal agents, in some instances, issue checks to FHA on or after
January 1.
We have detailed the number of delinquent loans by type at January 1,
April 30, end June 30 for both 1969 and 1970 on Exhibit A. A further
breakdown by loan catagory is detailed on Mbit     B for January 1,
January 31, and April 30, 1970, which indicates the percentage of
delinquent association loans, other than the Economic Opportunity
Cooperatives, is 16, 9, and 8, respectively.   [see GAO note.:
Mbit     C details the dollar mounts of outstanding loans and the
amounts reported delinquent at Jenuary 1, 1970 by loan types. Exhibit
D details the cumulative amounts advanced for Organization and
Association Loans Nationally and for Colorado and Idaho, and the amount
of such loans  outstanding January 1, 1970. This information was
requested in your letter of May 28, 1970.
You mention that REAhas made 1,963 loans in the past 35 years and that
it has published specific auditing and reporting requirements for

GAOnote:     The detailed information on delinquencies by loan
             program furnished by FRA is shown on page 7 of
             this report.   Therefore, the exhibits to FEA's
             letter are not included.



                                                 31
APPENDIX I
    Page 2

 borrowers. FHA has made about '7,CCCloans (representing less than
 one percent of all loans nade) to organization and association
 borrowers in the past six years. F'KA has recently added an accountant
 to its Community Services Division staff to develop the auditing and
 reporting requirements for organization and association bc,.-owers.
 We are presently rewriting our supervision and servicing instructions
 and we will include an exhibit that will be given to borrowers and
 their accountants which will:
       I, Define the minimum professional qualifications  of independent
 auditors in line with the language recommendedin the Comptrollers
 General's May 12, 1970 letter B-J@lU.    ;See G-40 r::,te.-
      2.  Define the auditing and reporting requirements with respect to
 (a) scope, (b) the auditing and reporting standards to be followed in
 making the audit and preparing the report and, (c) the audit procedures
 to be used by the auditor in tailoring the report to the needs of FHA.
 Auditing requirements for the various types of loans will be detailed
 separately.   These will include: Nonprofit organizations; public
 bodies; recreation associations; grazing associations; watershed end
 irrigation  associations; economic opportunity cooperatives; labor and
 rental housing organizations and individuals.
 Cur revised instructions will include detailed requiraents for the
 review and use of independent auditors' reports by F'HAfield personnel.
We do r,rjt believe that FHA personnel should assist borrowers in the
selecti>-n and approval of auditors. We have never followed this practice
with ether professionals such as attorneys, engineers and planners. To
do so wxild put the agency in a position of determining whether particular
individuals qualify for the position.    F'HAwill, however, establish
standards by which borrowers may select an independent auditor acceptable
to the agency.
In order to ensure that functions relating to the use of independent
audttors are performed by qualified personnel, we intend to increase
our professional staff p the National Office and certain field offices.
Sincerely,




 GAO note:     In a letter    to the heads of Federal departments             and
               agencies dated September 15, 1970, the Comptroller
               General recommended somewhat different            language
               than that recommended in the May 12, 1970, letter
               referred    to by FHA. (See app. III.>           FHA officials
               advised us    that  the   September    15 letter   will   be
               used in rewriting      its instructions.


                                        32
                                                                                               APPENDIX II
                                                                                                    Page 1
            UNITED       STATES      DEPARTMENT               OF     AGRICULTURE

                     RURAL   ELECTRIFICATION              ADMINISTRATIDN

                                  WASHINGTON.      D.C.      20250

                                                              Jun          1.5, 1970




Mr. Victor L. Lowe
Associate Director, Civil Division
U. S. General Accounting Office
Washington, D. C. 20548

Dear Mr. Lowe:

We t'nank you for the opportunity.to   review ttc Ax-art of -,;:e
proposed report to tne Congress on the use of independent auditors
by the Farmers Home Administration   and the Rural Electrification
Administration,  Department of Agriculture.

We are pleased that you found REA's procedures                                and practices       sound
for its use of independent auditors.

In accordance with your request,                  we offer            the following        comments
for your consideration:

     1. Page 4 - Line 12 - We suggest that this statement be
broadened to show that tne electrification    loans are made pri~ariiy
to cooperative associations   and public bodies and that telephone
loans are made to both private companies and cooperatives,      As of
January 1, 1970, there were loans outstanding to 1,82E borrowers
as follows:

      Ty-pe of Organization                        Electric                        Telephone

        Cooperatives                                                                 232
        Public Sodies
        Private Companies                                                            6;o
                                                                                     Q


     2. Page 17 - Last Line - Suggest this sentence be modified
to read:  "In addition,  the Branch approves CPA's to perform au&it
services for borrowers."




                                                   33
APPE!dDIX 11
     Page 2




               34
                                                                                        APPENDIXIII
                                                                                             Page 1

                  COMI=‘TROLL.ER     GENEFZAL        OF      THE      UNITED   STATES
                                   WASHINGTON.        D.C.         20548




B-148144

                                                                               September 15, 1970


HEADS OF FEDERAL DEPARTMENTS
                           AND AGENCIES

Subject:   Qualifications   of public accountants making
           audits of federally   chartered, financed, or
           regulated private organizations


       By our circular letter of May 12, 1970, (B-148144) we advised you
of a change in our position regarding the qualifications      of those who
may be selected to audit federally    chartered, financed or regulated
private organizations.     The major change from our previously announced
position was that after December 31, 1975, only certified      public
accountants should be selected to make such audits.

       Since announcing this revised position we have received information
and have had consultations    which convinced us of the desirability   of
making a further revision in our position.     Instead of limiting   such
audits to only certified    public accountants after December 31, 1975,
we believe it equitable that those licensed public accountants who
received their licenses on or before December 31, 1970, also be per-
mitted to perform such audits after the December 31, 1975, cut off
date. This has the effect of creating a terminating      class of public
accountants who throughout their active careers     will continue to be
eligible    for such work.

       In accordance with this revised position,  we recommended to the
House Coaznittee on Education and Labor, in lieu of our previous pro-
posal, the inclusion    of the following language in a bill it is con-
sidering,

             "Such audits shall be conducted in accordance with
     generally accepted auditing standards by independent
     certified    public accountants or by independent licensed
     public accountants, licensed on or before December 31, 1970,
     who are certified    or licensed by a regulatory authority   of
     a State or other political     subdivision of the United States:
     Except that independent public accountants licensed to




                                                35
APPENDIX      III
         Page       2

       practice      by such regulatory           authority      after      December 31, 1970,
       and persons       who, although         not so certified           or licensed,         meet,
       in the opinion          of the Secretary,          standards       of education         and
       experience      representative          of the highest          prescribed        by the
        licensing     authorities        of the several         States      which provide
       for the continuing           licensing      of public       accountants         and which
       are prescribed          by the Secretary         in appropriate           regulations
       may perform       such audits        until    December 31, 1975:               Provided,
       that     if the Secretary         deems it necessary            in the public         in-
       terest,     he may prescribe           by regulation        higher      standards       than
       those required          for the practice         of public        accountancy        by the
       regulatory      authorities        of the States.”

         We recommend       that the position     expressed    in the above language,
 rather      than that    proposed   in our Fiiy 12, 1970 letter,         be incorporated
 in regulations        issued    by departments     and agencies    prescribing      the
 qualifications        of public    accountants     selected   to audit     programs admin-
 istered       by the departments      and agencies.




                                                                    Comptroller   General
                                                                    of the United   States




                                                  36
                                                  APPENDIX IV


                  PRINCIPAL OFFICIALS OF

               THE DEPARTMZNTOF AGRICULTURE

        RESPONSIBLE FOR ADMINISTRATION OF THE MATTERS

                  DISCUSSED IN THIS REPORT


                                      Tenure of office --
                                      From            -To

SECRETARYOF AGRICULTURE:
   Clifford  M. Hardin             Jan.    1969   Present
   Orville  L. Freeman             Jan.    1961   Jan.    1969

ASSISTANT SECRETARYOF AGRICULTURE
  FOR RURAL DEVELOPMENTAND CON-
  SERVATION:
    Thomas K. Cowden              Apr.     1969   Present
    John A. Baker                 Mar.     1961   Jan.    1969

ADMINISTRATOR, FARMERSHOME
  ADMINISTRATION:
    James V. Smith                 Jan.    1969   Present
    Howard Bertsch                 Apr.    1961   Jan.    1969

ADMINISTRATOR, RURAL ELECTRIFI-
  CATION ADMINISTRATION:
    David A. Hamil                 Jan.    1969   Present
    Norman M. Clapp                Mar.    1961   Jan.    1969




                              37