Financial Audit: Auditing Use of OMB's Credit Subsidy Model

Published by the Government Accountability Office on 1997-08-29.

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

            United States
            General Accounting Office
i- T        Washington, D.C. 20548

            Accomtjng and Information
            Management Division


            August 29, 1997

            Inspectors General

            Subject:    Financial Audit: Atiditinrr Use of OMB’s Credit Subsidy Model

            Federal agencies use the Office of Management and Budget’s (OMB) Credit
            Subsidy Node1 (CSM) to calculate credit subsidies for federal direct loan and
            loan guarantee programs. With outstanding balances for federal credit
            programs approaching a reported $1 trillion, accountants and auditors preparing
            and auditing agency financial statements, as well as CSM users, need to have
            assurance that the CSM calculates a reliable subsidy cost in compliance with
            applicable legislation and accounting standards.

            In order to provide such assurance on a governmentwide basis, we undertook a
            review and are issuing the results today in a report to the Director of OMB,
            Credit Reform: Review of OMB’s Credit Subsidv Model (GAO/AIMD-97-145). As
            a result of this work, certain issues surfaced related to the use of the CSM that
            need to be addressed as part of the financial statement audits of user agencies.
            Thus, with assistance from the Federal Audit Executive Council, credit agencies’
            inspectors general, representatives of the Governmentwide Credit Reform
            Subgroup, and OMB’s credit reform staff, we prepared a list of supplemental
            audit procedures to help provide assurance that federal credit agencies are
            using the CSM properly. These audit procedures, included as the enclosure to
            this letter, should be used in conjunction with more comprehensive guidance on
            auditing credit reform subsidy estimates found in PreDaring and Auditing Direct
            draft issue paper prepared by the Governmentwide Credit Reform Subgroup,
            which is expected to be issued during fiscal year 1998.

            The collaborative approach used to develop the CSM audit procedures is similar
            to the process that we used recently to prepare our letter to you, Financial
            Audit: Reconciliation of Fund Balances with Treasurv (GAONMD-97-104R,
            June 24, 1997). In both instances, the process worked well and we appreciate
            the assistance we received. As other audit issues surface during the audit of
            the Consolidated Financial Statements of the U.S. Government,.we plan to
            follow the same approach in obtaining input from the inspector general
            community before finalizing any material.

                            GAOKTMD-97-155R Auditing Use of OMB’s Credit Subsidy Model
Copies of the report on the CSM, including the supplemental audit procedures,
have been sent to the Office of Management and Budget and the chief financial
officers at federal credit agencies. If you have any questions regarding the
information in this letter or the enclosure, please contact me at (202) 512-2600,
Linda Calbom, Director, Civil Audits, at (202) 51243341,or McCoy Williams,
Assistant Director, at (202) 512-6906.

Assistant Comptroller General


2              GAO/AI&ID-97-155R Auditing Use of OMB’s Credit Subsidy Model

The Honorable Jeffrey Rush, Jr.
Inspector General
Agency for International Development

The Honorable Roger C. Viadero
Inspector General
Department of Agriculture

The Honorable Frank D. DeGeorge
Inspector General
Department of Commerce

The Honorable Eleanor Hill
Inspector General
Department of Defense

The Honorable Thomas R. Bloom
Inspector General
Department of Education

The Honorable John C. Layton
Inspector General
Department of Energy

Nikki L. Tinsely
Acting Inspector General
Environmental Protection Agency

The Honorable George J. Opfer
Inspector General
Federal Emergency Management Agency

The Honorable William R. Barton
Inspector General
General Services Administration

The Honorable June Gibbs Brown
Inspector General
Department of Health and Human Services

3             GAO/AIMD-97-155R Auditing Use of OMB’s Credit Subsidy Model
The Honorable Susan Gafhey
Inspector General
Department of Housing and Urban Development

The Honorable Wilma A. Lewis
Inspector General
Department of Interior

The Honorable Michael R. Bromwich
Inspector General
Department of Justice

The Honorable Charles C. Masten
Inspector General
Department of Labor

The Honorable Roberta L. Gross
Inspector General
National Aeronautics and Space Administration

Linda G. Sundro
Inspector General
National Science Foundation

The Honorable Hubert T. Bell
Inspector General
Nuclear Regulatory Commission

The Honorable Patrick E. McFarland
Inspector General
Office of Personnel Management

The Honorable James F. Hoobler
Inspector General
Small Business Administration

 The Honorable David C. Williams
-Inspector General
 Social Security Administration

The Honorable Jacquelyn Will.iams-Bridgers
Inspector General
Department of State

4             GAO/AIMD-97-155R Auditing Use of OMB’s Credit Subsidy Model
The. Honorable Kenneth M. Mead
Inspector General
Department of Transportation

The Honorable Valerie Lau
hspector General
Department of the Treasury

William T. Merxinmn
Deputy Inspector General
Department of Veterans A&h

             GAO/AJMD-97-155R Auditing Use of OMB’s Credit Subsidy Model

ENCLOSURE                                                                   ENCLOSURE
                         OF THJ.3CREDIT SUBSIDY MODEL

Proper use of the Office of Management and Budget’s (OMB) Credit Subsidy Model (CSM)
requires that user agencies correctly install the appropriate CSM version, make correct
choices from available CSM options and commands to accurately reflect specific credit
program characteristics, control access to the CSM, and understand the CSM’s capabilities
and limitations.

With the assistance of the Federal Audit Executive Council, credit agencies’inspectors
general, representatives of the Governmentwide Credit Reform Subgroup, and OMB’s
credit reform staff, we identified the following audit procedures that should be performed
to ensure proper use of the CSM. Comprehensive guidance on auditing credit reform
subsidy estimates is included in Prenaring and Auditing Direct Loan and Loan Guarantee
Subsidies Under the Federal Credit Reform Act, a draft issue paper prepared by the
Governmentwide Credit Reform Subgroup, which is expected to be issued during fiscal
year 1998. Audit procedures discussed below should be used in conjunction with those
presented in the issue paper. Additionally, these procedures are intended to provide audit
guidance that may or may not be applicable in all situations. The auditors should use .
professional judgment in determinin g which are applicable to the agency they are

Ensure Use of an ADDroDriate and
Unmodified Version of the CSM

Since 1990, OMB has periodically revised the CSM to add enhancements, make
methodology changes, and otherwise improve its operation. Different versions of the
CSM may produce slightly different subsidy rates. As of July 1997, the current version of
the CSM was Version r.9, dated August 1, 1994. We expect that OMB will, on occasion,
release new versions of the CSM. In addition, although it may be unlikely, the agency’s
computer file of the CSM may become modified intentionally or accidentally. Therefore,
the auditor should obtain the appropriate version of the CSM for the fiscal year under
audit by contacting the agency’s OMB budget examiner.l This version should be
compared with the version used by the agency in its subsidy calculations. To verify that
the agency’s version of the CSM is unmodified, the auditor should use the “file compare”
feature of desktop operating software to compare the agency’s version with the OMB
official, approved version. Tf the two versions are the same, the auditor can conclude that
the agency’s version is unmodified. If they differ, the auditor should bring this to the

‘The auditor may also wish to obtain from the OMB budget examiner information on past
errors in agency use of the CSM and a copy of the most recent or appropriate version of
the CSM User’s Guide.

6                        GAO/A.TMD-97-155RAuditing Use of OMB’s Credit Subsidy Model
ENCLOSURE                                                                     ENCLOSURE
attention of agency management and the OMB budget examiner and obtain an explanation
for the differences. Einally, as the ultimate check, the auditor can calculate the subsidy
rate using the agency’s cash flows, the agency’s version of the CSM, and OMB’s version of
the CSM and compare the results.

Verifv That .\DDroVed Cash Flow Data Are the Same
Data Used bv the CSM to Calculate the Subsidv Rate

The user agency should provide the auditor with the approved cash flow data that
support its credit program subsidy rate for each of the credit programs selected for
internal control and substantive testing. (Cash flow data will be available from electronic
spreadsheet files in a format prescribed by the CSM User’s Guide.) The auditor should
verify that these data were, in fact, the same data used by the CSM to calculate the
applicable subsidy rate. The spreadsheet file name, the range name, and the date and
time the spreadsheet was last changed are included in the printed CSM output. The
auditor can check this information against the named spreadsheet tie provided by the
agency to veri@ the cash flow data used in the CSM’s subsidy calculation. However, if
the spreadsheet file provided by the agency was changed after the subsidy calculation, the
date and time stamp on the spreadsheet file will not match what is on the CSM output.
In this case, the CSM output will not provide sufficient information to verify the cash flow
data used by the CSM. Therefore, the auditor wih need to use other methods. One
method is to recalculate the subsidy rate using the cash flow data provided by the agency
and the auditor’s copy of the appropriate version of the CSM obtained from the applicable
agency’s OMB budget examiner. If the recalculated subsidy rate is the same as the
subsidy rate under audit, the auditor should be able to conclude that the cash flow data
provided by the user agency was the same data used by the CSM. If the recalculated
subsidy rate is different, the auditor should bring this to the attention of agency
management and the OMB budget examiner and obtain an explanation for the difference.

Follow UD on Error Messages

Prior to calculating a subsidy rate, the CSM performs several edits on agency-generated
cash flows to help ensure that cash flow data do not contain obvious errors. If the CSM
edit process identifies a serious error, the CSM will issue an error message and terminate
its operation without calculating a subsidy. However, if the CSM edit process determines
an error to be less serious, it will issue a “warning” but will not terminate the program.
Warnings will be listed with the subsidy rate calculation on CSM output sent to a printer.
The auditor should review CSM output to iden- whether any warning messages are
listed and follow up with agency management to determine why the situation causing the
warning message was not resolved and whether not eliminating the error could have any
impact on the subsidy rate calculation.

In addition, the CSM provides options for the user to suppress certain warning messages.
For example, when cumulative scheduled principal payments do not equal disbursements,

7                       GAO/AlMD-97-155R Auditing Use of OMB’s Credit Subsidy Model
ENCLOSURE                                                                   ENCLOSURE
a warning message is normally issued. If the agency has suppressed this warning,
auditors should determine whether ibis suppression is appropriate. This concern ‘applies
to other warning messages as well. Specifically, the auditor should check the agency’s
cash flow spreadsheet to determine whether the “‘suppress warnings” command was used.
If so, the auditor should request that the agency explain why warning messages were
suppressed and, if certain warning messages are suppressed, whether conditions exist
that would cause those messages to be generated, and whether the warning indicates a
material problem in the cash flows.

Ensure That Ontions Chosen Prone& Reflect Sneciiic
Characteristics of Each Credit Program

Proper use of the CSM requires that the agencies select the appropriate options from
those available (see Chapter RI of the CSM User’s Guide, Version r.9) and use the
appropriate Treasury rate to discount cash flows to net present value. Pticular care
should be used in reviewing the choice of timing options for the principal and interest
payments in direct loan programs. When a row of cash flows for scheduled principal or
interest payments is prepared using standard financial formulas (which assume
disbursements at the beginning of the period and payments at the end of the period), the
“simple annual” option should be used. In contrast, when estimates of interest and      *
principal payments are based on the assumption that these payments occur continuously
throughout the year, the timing option row of cash flows should be “continuous.” When
the wrong timing option is used for scheduled principal or interest payments, the
financing subsidy may be materially distorted. The auditor may also want to review the
choice of timing options for payments and receipts other than principal and interest,
although the effects of these distortions are generally smaller.

Care should also be exercised when reviewing cash flows for loan guarantee programs
that guarantee less than 100 percent of the face value. As indicated in the User’s Guide,
the amount in the cash flow row for disbursement of loans by private lenders” is the
total amount disbursed by the lenders, regardless of how much is guaranteed by the
credit agency. The amount of disbursed loans guaranteed by the government is included
in the row of the cash flow representing the estimate of claims made against the
government. For example, if an agency has a program that guarantees 75 percent of
loans disbursed, and the lenders disburse $100,000 in loans that immediately default, the
agency should put $100,000 in the disbursement by private lenders cash flow row and
$75,000in the cash flow row for defaults.

Ensure Proper Scale Has Been Used
in Cash Flow S-oreadsheets

OMB’s assertions state, “The model rounds cash flows to three decimal places when read
from spreadsheet files. Because of the rounding, and particularly in programs that have
disbursements over several years, the calculated subsidy can change slightly with the

8                       GAO/AIMD-97-155R Auditing Use of OMB’s Credit Subsidy Model
ENCLOSURE                                                                    ENCLOSURE
scale of the program. This effect is most pronounced when many of the cash flow items
are very small after rounding (.005 or .Oll, for instance). Small values are especially
sensitive to the hazards of rounding.” Therefore, agency controls should be in place to
ensure that rounding to three decimal places has no significant effect on the spreadsheet
values and, in turn, the calculated subsidy. For example, if a series of underlying values,
in millions of dollars, are 0.0054, 0.0054, 0.0054, the CSM will round each to 0.005-losing
0.0004 in each case, which could be significant. In this situation, the agency should
express values in thousands of dollars so that the underlying values are 5.400, 5.400,
5.400-losing nothing in the rounding-in order to obtain a more precise subsidy rate
calculation. The auditor should COTT&ITII   that management controls are adequate to ensure
that the cash flows contain the proper scale and that rounding has no significant effect on
the subsidy calculation. If these controls are not adequate, the auditor should review the
cash flow spreadsheet to ensure that the scale used is appropriate. The auditor should
also bring the situation to the attention of agency management.

Determine Whether Cash Flows Are BeDared
at AunroDriate Level of Detail

The CSM permits spreadsheet cash flow data to be prepared on a disbursement year basis
or a cohort basis. (A disbursement year cons&s of all loans from a given cohort that are
disbursed in a given fiscal year.) For the special case in which all disbursements occur
during a single fiscal year, the disbursement year includes the entire cohort and these
bases do not differ. However, for loan programs with cohorts that disburse over more
than one year, the disbursement year includes just part of the cohort. For such programs,
the cash flows for each disbursement year of a given cohort are necessary to precisely
calculate subsidies at the time of disbursement. Because agencies cannot always provide
such detail, the CSM permits less detailed cohort level data-combinations of 2 or more
disbursement years-to be used as an approximation. But the use of cohort level data can
introduce distortions. For example, a loan program can be expected to have a zero
financing (interest rate) subsidy if the borrower rate is the same as the discount rate.
However, if a program disburses loans over 2 or more years, cohort rather than
disbursement year cash flows are used, and the discount rates are not held constant in all
disbursement years, the CSM will calculate a non-zero subsidy.

Therefore, whenever a loan program has substantial disbursements in 2 or more years
and the agency has prepared cash flows using cohort level rather than disbursement year
data, the auditor should determine why disbursement year cash flows were not used.
Specifically, if there are reasons why disbursement year cash flows cannot be prepared,
these reasons should be documented. On the other hand, if disbursement year cash flows
are available, the auditor should determine whether the use of cohort level cash flows has
had a material effect on the subsidy calculation. A determination that an effect is
material should take into account the size of the difference in absolute terms and relative
to the subsidy, the effect on the level of loans supported by the subsidy, and other factors
the auditor may consider important. If the auditor determines that the effect is material,

9                        GAO/AIMD-97-155R Auditing Use of OMB’s Credit Subsidy Model
ENCLOSURE                                                                  ENCLOSURE
the auditor should recommend that the agency prepare cash flows on a disbursement year
basis to eliminate the problem. If the agency is unable to do this, the auditor should
exercise professional judgment to determine whether there is a potential for material
misstatement and whether this situation would affect the ability to conclude on the
fairness of the amounts in related accounts.

CornDare Cash Flow Sbreadsheet and
Related Subsidv Rate With Prior Years

Credit reform and the CSM require credit agencies to develop spreadsheets of projected
cash flows, which must be presented in a prescribed format and require the spreadsheet
preparer to choose among various commands and options that properly characterize each
credit program. Once an auditor has determined that a spreadsheet contains the proper
format, commands, options, etc. for the credit program, then the auditor can have some
assurance about future years’cash flows with the same formats, commands, options, etc.
If changes in formats or commands on the cash flow spreadsheets have been made,
auditors should discuss with agency officials why such changes were made, including
what the changes are intended to accomplish. An auditor may wish to use analytical
procedures each year to confkrn that any changes to the credit program are properly
reflected in the spreadsheet and that changes to the spreadsheet and associated subsidy
rate, including components, are reasonable. For example, if an agency’s fee structure has
not changed, the auditor should expect the subsidy rate component attributable to fees to
remain the same.

Evaluate Agencv Securitv Controls
Over CSM Access

OMB’s assertions state that agencies are responsible for ensuring that the CSM has not
been corrupted or otherwise inappropriately changed. Such assurance requires that
agencies have procedures in place to limit access to the CSM to authorized personnel
only.” For example, the auditor might expect to find procedures to ensure password
protection on the desktop workstation where the CSM resides. The auditor should review
these procedures and determine if they adequately protect the CSM from unauthorized
use and corruption.


2Agency access controls should be implemented for the CSM copy that is used to produce
the agency’s official subsidy rate calculations.

10                       GAO/ADD97-155R Auditing Use of OMB’s Credit Subsidy Model
                                        ._ .

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