oversight

Compact of Free Association: Single Audits Demonstrate Accountability Problems over Compact Funds

Published by the Government Accountability Office on 2003-10-07.

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

               United States General Accounting Office

GAO            Report to Congressional Requesters




October 2003
               COMPACT OF FREE
               ASSOCIATION
               Single Audits
               Demonstrate
               Accountability
               Problems over
               Compact Funds




GAO-04-7

               a

                                                October 2003


                                                COMPACT OF FREE ASSOCIATION

                                                Single Audits Demonstrate Accountability
Highlights of GAO-04-7, a report to             Problems over Compact Funds
congressional requesters




In 1986, the United States entered              GAO’s review of 30 single audit reports for the FSM, 4 FSM states, and the
into a Compact of Free Association              RMI for the years 1996 through 2000 identified pervasive and persistent
(Compact) that provided about                   noncompliance with Compact requirements and financial statement-related
 $2.1 billion in U.S. assistance from           audit findings. These single audit reports identified 458 audit findings
1987 through 2003 to the Pacific                relevant to the Compact. Significant numbers of these audit findings
Island nations of the Federated
States of Micronesia (FSM) and the
                                                occurred during each year of the 5-year period and at each of the auditees.
Republic of the Marshall Islands                In addition, successive single audits identified recurring audit findings over
(RMI). GAO has issued a number                  the 5-year period despite corrective action plans prepared by the auditees.
of reports raising concerns about               While none of the audit findings specifically discussed misuse of Compact
the effectiveness of this assistance.           funds, they did describe noncompliance with Compact requirements and
GAO was asked to review possible                financial management problems in areas that GAO considers highly
FSM and RMI misuse of Compact                   susceptible to misuse, such as poor control over cash and equipment. When
funds. We reviewed single audits                considered in conjunction with the qualified opinions or disclaimers of
for 1996 through 2000 and this                  opinion on the financial statements in all 30 reports and for 60 percent of the
report summarizes the audit                     Schedules of Expenditure of Federal Awards required by the Single Audit
results.                                        Act, the audit findings reveal one thing: overall poor accountability of
                                                Compact funds.

GAO recommends that the                         In responding to GAO’s previous reviews of the original Compact, Interior
Secretary of the Interior delegate              officials expressed concerns about the U.S. government’s limited ability to
responsibility to and hold the                  enforce accountability over Compact funds due to certain provisions of the
Office of Insular Affairs                       Compact and the related fiscal procedures agreement (FPA). Recently, an
accountable for monitoring and                  Interior official noted that departmental officials have been frustrated with
reporting on FSM and RMI actions                the lack of tools to administer or track federal assistance in a manner that
to address Compact-related single
                                                could reasonably ensure that such assistance is having its intended effect.
audit findings and initiating
appropriate actions when the FSM                GAO found that the amended Compacts and related FPAs, which are
or the RMI do not implement                     scheduled to become effective upon legislative approval in the three
appropriate and adequate actions                countries, include many strengthened reporting and monitoring measures
to correct Compact-related single               that could improve accountability, if diligently implemented. For example,
audit findings in a timely manner.              funds could be withheld for noncompliance with Compact terms and
                                                conditions. In addition, joint economic committees and an Interior oversight
In commenting on this report, the               team will focus on monitoring and overseeing Compact funds.
Office of Insular Affairs of the
Department of the Interior, FSM,
                                                Percentage of 1996 through 2000 Single Audit Findings That Recurred 3 or More Years
and RMI agreed with our findings
or conclusions and                                   FSM


recommendations. They also cited
the amended Compacts as                          Pohnpei


mechanisms that should result in
                                                     Yap
improved financial management
over Compact assistance.
                                                  Chuuk

www.gao.gov/cgi-bin/getrpt?GAO-04-7.
                                                  Kosrae
To view the full product, including the scope
and methodology, click on the link above.
For more information, contact McCoy                  RMI

Williams at (202) 512-6906 or                              0          10             20         30   40   50   60   70
                                                           Percentage of findings
williamsm1@gao.gov or Susan Westin at           Source: GAO analysis of single audit reports.
(202) 512-4128 or westins@gao.gov.
Contents




Letter
                                                                                                 1
                             Results in Brief 
                                                         3
                             Background                                                                 5

                             Objectives, Scope, and Methodology 
                                        7
                             Pervasive Audit Findings Demonstrate Poor Accountability over 

                               Compact Funds                                                            8
                             Amended Compact Agreements Contain Improved Accountability
                               Measures                                                                16
                             Conclusions                                                               19
                             Recommendations for Executive Action                                      19
                             Government and Agency Comments and Our Evaluation                         20


Appendixes
              Appendix I:    Comments from the Federated States of Micronesia                          22
             Appendix II:    Comments from the Republic of the Marshall Islands                        24
             Appendix III:   Comments from the Department of the Interior                              27
             Appendix IV:    GAO Contacts and Staff Acknowledgments                                    28
                             GAO Contacts                                                              28
                             Acknowledgments                                                           28


Figures                      Figure 1: Number of Audit Findings Reported Annually from 1996
                                       through 2000                                                     9
                             Figure 2: Auditee Findings as a Percentage of Total Findings              10
                             Figure 3: Percentage of Corrective Action Plans Developed for
                                       Audit Findings                                                  11
                             Figure 4: Percentage of 1996 through 2000 Single Audit Findings
                                       That Recurred 3 or More Years                                   12




                             Page i                                   GAO-04-7 Compact of Free Association
Contents




Abbreviations

CAP                   corrective action plan

FPA                   fiscal procedures agreement

FSM                   Federated States of Micronesia

OMB                   Office of Management and Budget

RMI                   Republic of the Marshall Islands

U.N.                  United Nations





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Page ii                                             GAO-04-7 Compact of Free Association
A

United States General Accounting Office
Washington, D.C. 20548



                                    October 7, 2003


                                    The Honorable Tom Lantos

                                    Ranking Minority Member

                                    Committee on International Relations

                                    House of Representatives


                                    The Honorable James A. Leach

                                    Chairman

                                    The Honorable Eni Faleomaveaga

                                    Ranking Minority Member

                                    Subcommittee on Asia and the Pacific

                                    Committee on International Relations

                                    House of Representatives


                                    The Honorable Doug Bereuter

                                    House of Representatives


                                    In 1986, the United States entered into a Compact of Free Association 

                                    (Compact) with the Pacific Island nations of the Federated States of 

                                    Micronesia (FSM) and the Republic of the Marshall Islands (RMI). Through 

                                    the Compact, the United States has provided about $2.1 billion in 

                                    assistance to these nations in the form of direct funding and federal 

                                    services and programs. Further, the Compact established U.S. defense 

                                    rights and obligations in the region and allowed for migration from both 

                                    nations to the United States. The Compact provisions that address 

                                    economic assistance were scheduled to expire in 2001; however, they 

                                    remained in effect while the United States negotiated amended Compacts 

                                    with each nation. 





                                    Page 1                                    GAO-04-7 Compact of Free Association
Over the last several years, we issued reports that raised concerns about
the effectiveness of the FSM and the RMI use of and accountability over
U.S. assistance provided under the Compact.1 In commenting on the
accountability issues raised in our 2000 report, officials at the Department
of the Interior, the agency responsible for overseeing the assistance
program, pointed out the limited ability of the United States to enforce
accountability over Compact funds because basic elements of federal grant
management were lacking. They also noted that additional personnel and
funding could have been committed to Compact oversight, but the United
States would still have had almost no ability to influence fiscal decisions
made by the FSM and the RMI. In recent testimony, an official from the
Office of Insular Affairs, Department of the Interior, noted that the
department was hampered by the fact that the Compact provided for large,
loosely defined grants with no express enforcement mechanisms to ensure
the efficient and effective expenditure of funds. This official also stated
that departmental officials “have been greatly frustrated with the lack of
tools to properly administer or track Federal assistance in a manner that
could reasonably ensure that such assistance is having its intended effect.”2

In conjunction with our monitoring and reporting on Compact
renegotiation efforts, you asked us to review possible FSM or RMI misuse
of Compact funds. The annual single audits of the FSM and the RMI, which
are required by the fiscal procedures agreement (FPA) for implementing
the Compact, are a potential source of this information.3 While the single
audit reports do not specifically use the phrase “misuse of Compact funds,”
many of the problems they identify are in areas that are susceptible to the
misuse of funds.




1
 U.S. General Accounting Office, Foreign Assistance: Effectiveness and Accountability
Problems Common in U.S. Programs to Assist Two Micronesian Nations, GAO-02-70
(Washington, D.C.: Jan. 22, 2002); Foreign Assistance: U.S. Funds to Two Micronesian
Nations Had Little Impact on Economic Development, GAO/NSIAD-00-216 (Washington,
D.C.: Sept. 22, 2000); and Foreign Relations: Better Accountability Needed Over U.S.
Assistance to Micronesia and the Marshall Islands, GAO/RCED-00-67 (Washington, D.C.:
May 31, 2000).
2
  Statement of David B. Cohen, Deputy Assistant Secretary of the Interior for Insular Affairs,
before the Subcommittee on Asia and the Pacific, House Committee on International
Relations, June 18, 2003.
3
  The FPA provides for a financial and compliance audit within the meaning of the Single
Audit Act. See 31 U.S.C. Chapter 75.




Page 2                                                GAO-04-7 Compact of Free Association
                    We obtained the 30 single audit reports for the years 1996 through 2000 for
                    the national government of the FSM; the FSM state governments of Chuuk,
                    Kosrae, Pohnpei, and Yap; and the national government of the RMI. We
                    reviewed and summarized the audit findings contained in these reports, the
                    most recently completed reports available at the start of our review, to
                    identify instances of possible misuse of Compact funds. On February 12,
                    March 12, and March 13, 2003, we briefed your staffs on our results. This
                    report summarizes our briefing results regarding the single audit reports.
                    In addition, it provides information on the enhanced accountability
                    measures that are built into the amended or renegotiated Compacts. The
                    amended Compacts4 and related FPAs, which are scheduled to become
                    effective upon legislative approval in the United States, the FSM, and the
                    RMI, include many strengthened reporting and monitoring measures that
                    could improve accountability, if diligently implemented.5 (Further details
                    on our scope and methodology are provided later in this report.)



Results in Brief	   Single audits are intended to promote sound financial management,
                    including effective internal control over federal awards. Our review of 30
                    single audit reports for the FSM, the four FSM states, and the RMI for the
                    years 1996 through 2000 identified pervasive and persistent compliance-
                    and financial statement-related audit findings. More specifically, the audit
                    reports contained about 90 audit findings for each year of the 5-year period
                    that we reviewed and a significant number of audit findings for each of the
                    auditees. In total, they contained 458 audit findings. Further, these reports
                    showed recurring audit findings over the 5-year period despite the fact that
                    the corrective action plans prepared by the FSM, the four FSM states, and
                    the RMI indicated more timely completion of actions to address these
                    findings.




                    4
                      According to a Department of State official, while the original Compact was one document
                    that applied to both the FSM and the RMI, an amended Compact has been prepared for each
                    nation.
                    5
                      Although the three governments have signed the amended Compacts, the Compacts have
                    not been approved by the legislature of any country. Therefore, in this report, we describe
                    the amended Compacts’ requirements and potential impact conditionally, recognizing that
                    the Compacts have not yet been enacted. The total possible cost to renew expiring
                    assistance in fiscal year 2004 U.S. dollars would be $3.8 billion on the basis of the
                    Congressional Budget Office’s forecasted inflation rate.




                    Page 3                                               GAO-04-7 Compact of Free Association
None of the audit report discussions of the 458 audit findings specifically
cited misuse of Compact funds. However, they did discuss noncompliance
with Compact requirements and financial management problems in areas
that we consider highly susceptible to such misuse. For example, one
finding noted that differences between the cash balance shown in the
entity’s financial records and the bank records amounted to over $150,000.
Further, the independent auditors issued qualified opinions or disclaimers
of opinion on the entitywide financial statements in all 30 reports and for
about 60 percent of the Schedules of Expenditures of Federal Awards
required by the Single Audit Act.6 These opinions were frequently issued
because the audited entity did not provide the auditor with all required
financial reports and/or other financial records. Taken together, the audit
findings of and the financial statement opinions rendered by the auditors
demonstrate that the FSM, the 4 FSM states, and the RMI did not provide
reasonable accountability over Compact funds and assurance that these
funds were used as intended.

The amended Compacts and related FPAs, which are scheduled to become
effective upon legislative approval in all three countries, include many
accountability provisions that would strengthen reporting and monitoring,
if diligently implemented. If so implemented, they would address most of
the recommendations that we made in past reports regarding assistance
accountability, fiscal control and accounting procedures, and standards for
financial management systems. For example, under the amended
Compacts, the annual reporting and consultation requirements would be
expanded; funds could be withheld for noncompliance with Compact terms
and conditions; and the FPAs call for the establishment of a joint economic
management committee for each nation. These committees will consist of
three members appointed by the United States, including the chairman, and
two members appointed by FSM or RMI and will have significant oversight
and monitoring responsibilities. In addition, Interior officials have stated
that they are in the process of assembling a Compact oversight team of full-
time employees that will focus exclusively on monitoring and oversight of
Compact financial assistance. The successful implementation of these
strengthened reporting and monitoring measures will require a sustained
commitment and appropriate resources from the United States, the FSM
and the RMI.



6
 An audit of these schedules as part of the single audit is required by the Single Audit Act, as
amended, 31 U.S.C. 7502(e)(2).




Page 4                                                 GAO-04-7 Compact of Free Association
              To help promote compliance with Compact requirements and sound
              financial management, we are recommending that the Secretary of the
              Interior delegate this responsibility to the Office of Insular Affairs and hold
              appropriate officials in that office accountable for (1) ensuring the
              adequacy of staff dedicated to Compact oversight and monitoring
              activities, (2) monitoring FSM and RMI progress in correcting Compact-
              related single audit report findings, (3) reporting on the FSM and the RMI
              actions to address Compact-related compliance and financial statement
              findings identified in single audit reports to the Secretary of the Interior or
              other appropriate high-level Interior official, (4) initiating appropriate
              actions if the FSM or the RMI do not implement timely and adequate
              actions to correct Compact-related single audit findings, and
              (5) investigating single audit findings that indicate possible violations of
              grant conditions or misuse of funds and taking appropriate actions when
              such problems are verified.

              The Department of the Interior and the RMI concurred with the findings
              cited. The FSM noted that the report was constructive and useful as it
              continues to prepare for the implementation of the amended Compact and
              its related agreements. The FSM and RMI also provided technical
              comments and other information on current actions to address the
              financial management issues that the report raised.



Background	   In 1947, the United Nations (U.N.) created the Trust Territory of the Pacific
              Islands. The United States entered into a trusteeship with the U.N. Security
              Council and became the administering authority of the current islands of
              the FSM and the RMI. The United States administered the islands under
              this trusteeship until 1986, when it entered into a Compact of Free
              Association with the FSM and the RMI, both of which are located in the
              Pacific Ocean.

              The original Compact represented both a continuation of U.S. rights and
              obligations first embodied in the U.N. trusteeship agreement and a new
              phase in the unique and special relationship that had existed between the
              United States and these island nations. It also provided a framework for
              the United States to work toward achieving its three main goals of
              (1) securing self-government for the FSM and the RMI,7 (2) assisting the

              7
                The FSM and RMI are now independent nations and are members of international
              organizations such as the U.N.




              Page 5                                            GAO-04-7 Compact of Free Association
FSM and the RMI in their efforts to advance economic development and
self-sufficiency, and (3) ensuring certain national security rights for all of
the parties.

The Department of the Interior’s Office of Insular Affairs was responsible
for disbursing and monitoring Compact funds. For the 15-year period from
1987 through 2001, it provided funding at levels that decreased every 5
years. For 2002 and 2003, while negotiations to renew the expiring
Compact provisions were ongoing, funding levels increased to equal an
average of the funding provided during the previous 15 years. For 1987
through 2003, total U.S. assistance to the FSM and the RMI to support
economic development is estimated, based on Interior data, to be about
$2.1 billion.

In addition, the Compact identified several services that U.S. agencies
would supply to the FSM and the RMI and further stated that these
agencies could provide direct program assistance as authorized by the
Congress. This assistance included grants, loans, and technical assistance
that, for fiscal years 1987 through 2001, totaled about $700 million from 19
U.S. agencies. The Department of the Interior was responsible for
supervising, coordinating, and monitoring program assistance, while the
Department of State was responsible for directing and coordinating all U.S.
government employees in foreign countries, except those under the
command of U.S. area military commanders.

In 2000, we reported that one tool that should be used for ensuring
accountability over Compact assistance was the annual audits required by
the Compact. FPAs for implementing the Compact required that financial
and compliance audits be conducted in accordance with the provisions of
the Single Audit Act.8 This act is intended to, among other things, promote
sound financial management, including effective internal controls, with
respect to the use of federal awards. Entities that expend $300,000 or more
in federal awards in a year are required to comply with act’s requirements.
Further, the act requires entities to (1) maintain internal control over
federal programs, (2) comply with laws, regulations, and the provisions of
contracts or grant agreements, (3) prepare appropriate financial
statements, including a Schedule of Expenditures of Federal Awards,
(4) ensure that the required audits are properly performed and submitted


8
  The Single Audit Act of 1984 was substantially amended by the Single Audit Act
Amendments of 1996, which is codified in Chapter 75 of Title 31, United States Code.




Page 6                                              GAO-04-7 Compact of Free Association
                         when due, and (5) follow up and take corrective actions on audit findings.
                         Deloitte Touche Tohmatsu, an independent public accounting firm,
                         conducted the 30 single audits that we reviewed for the FSM; the 4 FSM
                         states of Chuuk, Kosrae, Pohnpei, and Yap; and the RMI.



Objectives, Scope, and   Our objective was to review possible FSM and RMI misuse of Compact
                         funds. One source of this type of information is the annual single audits
Methodology              that the fiscal procedures agreement for the implementation of the
                         Compact requires the FSM and the RMI to obtain.

                         We obtained the single audit reports for the years 1996 through 2000, the
                         most recent single audit reports available at the time of our review, for the
                         national government of the FSM; the FSM state governments of Chuuk,
                         Kosrae, Pohnpei and Yap; and the national government of the RMI. In total,
                         this amounted to 30 single audit reports representing 5 years, a period that
                         we considered sufficient for identifying misuse of funds and common or
                         persistent compliance and financial management problems involving
                         Compact funds. While these reports did not specifically identify any
                         findings as instances of misuse of Compact funds, they did identify
                         problems that could leave Compact funds susceptible to misuse, including
                         poor control over cash and equipment.

                         We reviewed each report to identify and categorize the audit findings
                         relevant to the Compact, paying particular attention to those involving
                         assets or other financial accounts (i.e., cash and equipment) that we
                         considered particularly susceptible to misuse. (We did not independently
                         assess the quality of these audits or the reliability of the audit finding
                         information. However, based on the fact that the audited entities
                         developed corrective action plans for about 93 percent of the findings
                         contained in the audit reports, we concluded that the audit findings provide
                         an accurate representation of the problems reported.) We also reviewed
                         the reports to identify auditee responses to the audit findings and their
                         corrective action plans. These plans indicate auditee agreement or
                         disagreement with the audit findings and the actions they planned to take
                         or had taken to fix the findings. In addition, we reviewed the audit findings
                         to determine if they recurred in successive single audits over the 5-year
                         period. We completed our review of each single audit report by identifying
                         and categorizing the auditor’s opinions on the financial statements and the
                         Schedules of Expenditures of Federal Awards.




                         Page 7                                      GAO-04-7 Compact of Free Association
                       In responding to our previous review of the Compact program, Interior
                       officials expressed concerns about the U.S. government’s limited ability to
                       enforce accountability over Compact funds due to certain provisions of the
                       original Compact and the related FPA. In light of these concerns, we
                       reviewed the amended Compacts and related FPAs to determine if they
                       included measures that could increase accountability over Compact funds.
                       In addition, we supplemented our review of these documents with a
                       discussion about the amended Compacts with Interior officials to
                       determine if the new provisions addressed their prior concerns about
                       limited actions available to them for holding the FSM and the RMI
                       accountable.

                       Interior’s Compact-related expenditures represented about 80 percent of
                       the total expenditures of U.S. assistance made by the FSM, the 4 FSM
                       states, and the RMI during the 5-year period. Because of the relatively
                       small amount of funding from other federal agencies at these recipients, we
                       did not discuss finding resolution with representatives of those agencies.

                       We conducted our audit from August 2002 through May 2003 in accordance
                       with generally accepted government auditing standards. We requested
                       written comments on a draft of this report from the governments of the
                       FSM and the RMI and the Secretary of the Interior. Their comments are
                       discussed in the section entitled Government and Agency Comments and
                       Our Evaluation and are reprinted in appendixes I, II, and III. Further, we
                       considered all comments and made changes to the report, as appropriate.



Pervasive Audit        Single audits of the FSM, the four FSM states, and the RMI identified
                       pervasive audit findings involving noncompliance with Compact
Findings Demonstrate   requirements and financial statement problems in areas that we consider
Poor Accountability    highly susceptible to misuse. In addition, the independent auditor
                       performing the single audits issued qualified opinions or disclaimers of
over Compact Funds     opinion on the financial statements in all 30 single audit reports reviewed
                       and for 60 percent of the Schedules of Expenditures of Federal Awards.
                       Taken together, these findings and opinions demonstrate that the FSM, the
                       four FSM states, and the RMI did not provide reasonable accountability
                       over Compact funds and assurance that these funds were used for their
                       intended purposes.




                       Page 8                                     GAO-04-7 Compact of Free Association
Single Audit Reports         The 30 single audit reports that we examined contained about 90 audit
Identify Pervasive Audit     findings for each year of the 5-year period covered by our review. In total,
                             they contained 458 audit findings relevant to Compact funds and significant
Findings Involving Compact   numbers of findings for each of the auditees for which we reviewed single
Funds                        audit reports. Further, successive single audits during the 5-year period
                             contained recurring audit findings despite corrective action time frames
                             established by the auditees and our conclusion that few of the findings
                             involved significant issues, such as implementing an accounting system,
                             that could be expected to require more than 2 years to correct.

                             Figure 1 shows the number of audit findings reported annually from 1996
                             through 2000. It demonstrates that the auditors performing the 30 single
                             audits in our review identified a significant number of audit findings both in
                             total and in each year of the 5-year period of our review.



                             Figure 1: Number of Audit Findings Reported Annually from 1996 through 2000
                             120 Number of findings



                             100



                              80



                              60



                              40



                              20



                                0
                                    1996                      1997           1998           1999              2000
                             Source: GAO analysis of single audit reports.



                             In addition, the 30 audit reports identified a significant number of audit
                             findings for each of the auditees. Figure 2 shows the percentages of the 458
                             audit findings related to Compact funds for each auditee.




                             Page 9                                                 GAO-04-7 Compact of Free Association
Figure 2: Auditee Findings as a Percentage of Total Findings


                                       28%        RMI
                      11%
                                                  FSM

             14%                                  Kosrae




                                                  Pohnpei
          13%

                                            18%   Yap

                           16                     Chuuk

Source: GAO analysis of single audit reports.



Office of Management and Budget (OMB) Circular No. A-133, Audits of
States, Local Governments, and Non-Profit Organizations, establishes
policies for federal agency use in implementing the Single Audit Act, as
amended, and provides an administrative foundation for consistent and
uniform audit requirements for nonfederal entities that administer federal
awards. In part, the circular requires the auditee to follow up and take
corrective actions on audit findings identified by the single audits. It
clarifies this requirement by stating that, at the completion of the single
audit, the auditee shall prepare a corrective action plan (CAP) to address
each audit finding included in the current year auditor’s report. If the
auditee does not agree with the audit findings or believes corrective action
is not required, the CAP is to include an explanation of and justification for
this position. Based on our review of the audit reports, the FSM, the four
FSM states, and the RMI generally fulfilled their responsibility to either
prepare a CAP or indicate their disagreement with the audit finding and
provide reasons for their disagreement. As figure 3 shows, they prepared
CAPs for 93 percent of the audit findings identified by the single audits in
our review and indicated their disagreement and reasons for this
disagreement for 5 percent of the findings.




Page 10                                            GAO-04-7 Compact of Free Association
Figure 3: Percentage of Corrective Action Plans Developed for Audit Findings
                              1%                   Corrected finding
                               1%
                                                   No CAP prepared


                        5%
                                                   Disagree with finding

                                          93%      CAP prepared




Source: GAO analysis of single audit reports.



Our review of these CAPs showed that about 33 percent (138) included
anticipated completion dates, and, of these plans, only 4 percent (16)
indicated that the planned corrective actions would require more than 2
years to complete. Based on a review of the CAPs that did not include
anticipated completion dates (287), we concluded that, with a few
exceptions,9 the problems addressed by these plans could be corrected
within a year. For example, Financial Status Reports submitted to the
grantor agencies for fiscal year 2000 were not available during the single
audit of the RMI. The auditors recommended that an adequate filing
system, including the maintenance of Financial Status Reports, be
maintained for all federal awards. The CAP called for the Ministry of
Finance to ensure that an adequate filing system was in place and to review
status reports periodically.

Further analysis of the findings revealed that successive single audits
identified recurring audit findings over the 5-year period despite the time
frames identified in the auditee-prepared CAPs or our estimate of the


9
  We identified 11 CAPs that we believe could require significant amounts of time to correct.
For example, 3 CAPs called for accounting system upgrades and another 2 called for
accounting systems. In another 2 instances, FSM states prepared plans that required legal
opinions from the FSM national government in order to resolve the problems.




Page 11                                               GAO-04-7 Compact of Free Association
                           amount of time corrective action should take. As figure 4 shows, many
                           audit findings that were identified in more than one single audit report
                           recurred in 3 or more years over the 5-year period. The percentage of each
                           auditee’s single audit findings that recurred 3 or more years over the 5-year
                           period of our review ranged from RMI’s high of 69 percent to a low of 17
                           percent for the FSM.



                           Figure 4: Percentage of 1996 through 2000 Single Audit Findings That Recurred 3 or
                           More Years

                                FSM




                            Pohnpei




                                Yap




                             Chuuk




                             Kosrae




                                RMI

                                      0          10             20         30   40       50         60        70
                                      Percentage of findings
                           Source: GAO analysis of single audit reports.




Compliance and Financial   The auditors categorized the audit findings related to the Compact into
Statement Problems         three areas—federal award findings, local findings, and financial statement
                           findings. Upon further review, we determined that 117 audit findings that
Persisted over Compact
                           the auditors categorized as federal award findings or local findings
Funds                      discussed problems related to compliance with Compact requirements, and
                           the remaining 341 discussed financial statement problems. The auditors
                           who performed these single audits qualified or disclaimed their opinion on
                           all of the financial statements and about 60 percent of the Schedules of
                           Expenditures of Federal Awards generally because the auditees did not
                           provide them with all needed financial statements or documentation to



                           Page 12                                              GAO-04-7 Compact of Free Association
support transactions recorded in their books. Taken together, the
compliance and financial statement findings and audit opinions
demonstrate poor accountability over Compact funds and an inability on
the part of the entities involved to provide assurances that all program
funds are used as intended. They highlight the need for a stronger control
environment and greater efforts to implement control activities that
strengthen accountability and help ensure that Compact funds are used for
program purposes.

Compliance requirements for federal assistance set forth what is to be
done, who is to do it, the purpose to be achieved, the population to be
served, and how much can be spent in certain areas. OMB’s Single Audit
Act guidance includes 15 compliance categories10 used by auditors to
report on compliance-related findings. Our analysis of the compliance
categories the auditors cited for the Compact-related audit findings showed
that over half of the audit findings related to two categories—allowable
costs/cost principles and equipment and real property management. The
first category, allowable costs/cost principles, specifies the allowability of
costs under federal awards. For example, expenditures for 17 types of
projects or activities were allowable under the original Compact capital
account, including construction or major repair of capital infrastructure,
public and private sector projects, training activities, and debt service.
The second category, equipment and real property management, specifies
how federal award recipients should use, manage, and dispose of
equipment and real property.

The following examples illustrate the types of audit findings that the
auditors categorized into the 15 areas.

•	 Kosrae advanced $93,000 in Compact Health and Medical Program funds
   to off-island health providers for medical referrals. The advances were
   immediately expensed without reference to the specific medical
   expenses actually incurred. This is an example of a compliance finding
   related to allowable costs/cost principles.



10
   The 15 areas are (1) activities allowed or unallowed, (2) allowable costs/cost principles,
(3) cash management, (4) Davis-Bacon Act, (5) eligibility, (6) equipment and real property
management, (7) matching, level of effort, and earmarking, (8) period of availability of
federal funds, (9) procurement, (10) program income, (11) real property acquisition and
relocation assistance, (12) reporting, (13) subrecipient monitoring, (14) special tests and
provisions, and (15) none.




Page 13                                                GAO-04-7 Compact of Free Association
•	 Kosrae incurred over $274,000 in expenditures of Compact Capital funds
   that lacked proper supporting vendor’s invoices. This is an example of a
   compliance finding related to allowable costs/cost principles.

•	 Chuuk transferred about $169,000 in Compact Capital funds to entities
   (subrecipients) that have not been audited or reviewed for compliance
   with Compact requirements. This is an example of a compliance finding
   related to subrecipient monitoring.

As mentioned earlier, the auditors performing the single audits also
categorized findings as financial statement findings. The audit findings for
this category related to the reliability of financial reporting and involved
recording, processing, summarizing, and reporting financial data. Unlike
the findings that related to compliance with Compact requirements, the
auditors did not tie the financial statement findings to the categories
contained in the Single Audit Act guidance. Our review of these findings
identified 101 financial statement findings involving problems with assets
or accounts that we consider susceptible to misuse. The following
examples illustrate financial statement findings related to assets or
accounts that we consider susceptible to misuse.

•	 Yap’s three major bank accounts (general checking, savings, and
   payroll) were not reconciled to bank records at the end of fiscal year
   1999. Differences between the amounts shown for these cash accounts
   in Yap’s books and the bank records amounted to over $150,000. The
   auditors identified this lack of bank reconciliations as an internal
   control weakness in Yap’s single audit reports for the years 1995 through
   1999. A record being out of balance is a risk factor auditors use to
   identify the possibility of fraud. This is an example of a cash problem.

•	 The RMI had not conducted a physical inventory or updated property
   records for equipment and real property. As of September 30, 2000, RMI
   reported that its equipment was worth about $11 million, but the auditor
   could not substantiate this amount due to inadequate records. The
   auditor identified a lack of updated property records for the General
   Fixed Asset Group in single audit reports for the years 1988 through
   2000. Missing documents, such as the property records for equipment in
   this example, are a risk factor used by auditors to identify the possibility
   of fraud. This is an example of an equipment problem.

The 30 single audit reports included auditor opinions or disclaimers of
opinion on the financial statements and Schedules of Expenditures of



Page 14                                       GAO-04-7 Compact of Free Association
Federal Awards for the FSM, the four FSM states, and the RMI. The
financial statements reflect a federal award recipient’s financial position,
results of operations or changes in net assets, and, where appropriate, cash
flows for the year. The Schedules of Expenditures of Federal Awards show
the amount of expenditures for each federal award program during the
year. If the auditors are not able to perform all of the procedures necessary
to complete an audit, they consider the audit scope to be limited or
restricted. Scope limitations may result from the timing of the audit work,
the inability to obtain sufficient evidence, or inadequate accounting
records. If the audit scope is limited, the auditors must make a
professional judgment about whether to qualify or disclaim an opinion. A
qualified opinion states that, except for the matter to which the
qualification relates, the financial statements are fairly presented in
accordance with generally accepted accounting principles. In a disclaimer
of opinion, the scope limitation is serious enough that the auditor does not
express an opinion.

The auditor’s opinions on the financial statements and Schedules of
Expenditures of Federal Awards for the 30 single audits in our review
reveal overall poor financial management. The auditors performing these
single audits qualified or disclaimed their opinions on all of the financial
statements and about 60 percent of the Schedules of Expenditures of
Federal Awards generally because they were unable to obtain sufficient
evidence or adequate accounting records. For example, the auditor
qualified its opinion on the FSM’s financial statements for the year 2000
because of the auditor’s inability to ensure the propriety of receivables
from other governments and missing financial statements for a component
unit. In another example, the auditor did not express an opinion on
Chuuk’s financial statements for the year 1999 because of inadequacies in
the accounting records and internal controls, incomplete financial
statements for component units, and its inability to obtain audited financial
statements supporting investments.

The significant number of audit findings involving FSM and RMI
noncompliance with Compact requirements and weaknesses in their
financial management systems, along with auditor qualified opinions or
disclaimers of opinion on financial statements, echo the control and
accountability issues that we identified in our earlier reports on Compact
assistance. Further, the pervasive and recurring nature of the compliance
and financial statement problems highlights (1) the need for stronger
control environments that will help ensure that Compact funds are used for
program purposes and (2) the limited progress made during the 5-year



Page 15                                     GAO-04-7 Compact of Free Association
                     period of our review in establishing accountability in the FSM, the four
                     FSM states, and the RMI that would provide reasonable assurance that
                     Compact funds are used for their intended purposes.



Amended Compact      In responding to our previous reviews of the original Compact program,
                     Interior officials expressed concerns about the U.S. government’s limited
Agreements Contain   ability to enforce accountability over Compact funds due to certain
Improved             provisions of the original Compact and the related FPA. According to these
                     officials, administrators have been reluctant to commit oversight resources
Accountability       to the Compact when no enforcement mechanisms exist due to these
Measures             provisions. The United States and the FSM signed an amended Compact in
                     May 2003. The United States and the RMI signed an amended Compact in
                     April 2003. These amended Compacts are awaiting legislative approval in
                     the United States, the FSM, and the RMI. They contain strengthened
                     reporting and monitoring measures over the original Compact that could
                     improve accountability over Compact assistance, if diligently implemented.

                     According to Interior officials, the FPA in effect during the period of our
                     review created a financial management regimen unique in federal practice.
                     They explained that it was negotiated to give the FSM and the RMI
                     governments clear control over Compact funding and to limit the U.S.
                     government’s authority to intervene in spending decisions and, most
                     important, to withhold payments if the terms and conditions of funding
                     were violated. More specifically, these officials explained that the expiring
                     FPAs lacked basic elements of federal grant management practice similar
                     to those in OMB Circular A-102, Grants and Cooperative Agreements with
                     State and Local Governments, which requires standard procurement
                     practices and cost principles. They elaborated that, when coupled with the
                     full faith and credit provisions of the Compact,11 this lack of standards
                     limited the U.S. government’s response to mismanagement. In summing
                     up, they stated that while additional personnel and funding could have
                     been committed to Compact oversight, the United States would still have
                     had almost no ability to influence fiscal decisions made by the FSM or the
                     RMI.


                     11
                        “Except as otherwise provided, approval of the Compact by the Government of the United
                     States shall constitute a pledge of the full faith and credit of the United States for the full
                     payment of the sums and amounts specified in Articles I and III of this Title. The obligations
                     of the United States under Article I and III of this Title shall be enforceable in the United
                     States Claims Court.” Compact of Free Association, section 236 (Jan. 14, 1986).




                     Page 16                                                GAO-04-7 Compact of Free Association
The amended Compacts could potentially cost the U.S. government about
$6.6 billion in new assistance. Of this amount, $3.5 billion would cover
payments over a 20-year period (2004-23), while $3.1 billion represents
payments for U.S. military access to the Kwajalein Atoll in the RMI for the
years 2024 through 2086. The amended Compacts contain strengthened
reporting and monitoring measures that could improve accountability over
Compact assistance, if diligently implemented. In addition, the Department
of the Interior has taken actions to increase resources dedicated to
monitoring and oversight of Compact funds.

The following are amended Compact and related FPA measures that
represent changes from the prior Compact and FPAs.

•	 In 2000, we reported that Compact funds were placed in a general
   government fund and commingled with other revenues and, therefore,
   could not be further tracked. In addition, some Compact assistance was
   only traced at a high level with few details readily available regarding
   final use. The amended Compacts and FPAs include requirements that
   should address these accountability concerns. Specifically, they require
   fiscal control and accounting procedures sufficient to permit
   (1) preparation of required reports and (2) tracing of funds to a level of
   expenditures adequate to establish that such funds have been used in
   compliance with applicable requirements. Further, the amended
   Compacts specify standards for the financial management systems used
   by the FSM and the RMI. For example, these systems should maintain
   effective controls to safeguard assets and ensure that they are used
   solely for authorized purposes.

•	 The new FPAs would establish a joint economic management
   committee for the FSM and the RMI that would meet at least once a
   year. The committee would be composed of three U.S. appointed
   members, including the chairman, and two members appointed, as
   appropriate, by either the FSM or the RMI. The committee’s duties
   would include (1) reviewing planning documents and evaluating island
   government progress to foster economic advancement and budgetary
   self-reliance, (2) consulting with program and service providers and
   other bilateral and multilateral partners to coordinate or monitor the
   use of development assistance, (3) reviewing audits, (4) reviewing
   performance outcomes in relation to the previous year’s grant funding
   level, terms, and conditions, and (5) reviewing and approving grant
   allocations (which would be binding) and performance objectives for
   the upcoming year.



Page 17                                     GAO-04-7 Compact of Free Association
•	 Grant conditions normally applicable to U.S. state and local
   governments would apply to each grant. General terms and conditions
   for the grants would include conformance to plans, strategies, budgets,
   project specifications, architectural and engineering specifications, and
   performance standards. Specific postaward requirements address
   financial administration by establishing, for example, (1) improved
   financial reporting, accounting records, internal controls, and budget
   controls, (2) appropriate use of real property and equipment, and
   (3) competitive and well-documented procurement.

•	 The United States could withhold payments if either the FSM or the RMI
   fails to comply with grant terms and conditions. The amount withheld
   would be proportional to the breach of the term or condition. In
   addition, funds could be withheld if the FSM or RMI governments do not
   cooperate in U.S. investigations of whether Compact funds have been
   used for purposes other than those set forth in the amended Compacts.

•	 The new FPAs include numerous reporting requirements for the two
   countries. For example, each country must prepare strategic planning
   documents that are updated regularly, annual budgets that propose
   sector expenditures and performance measures, annual reports to the
   U.S. President regarding the use of assistance, quarterly and annual
   financial reports, and quarterly grant performance reports.

The successful implementation of the new accountability provisions will
require a sustained commitment by the three governments to fulfilling their
new roles and responsibilities. Appropriate resources from the United
States, the FSM, and the RMI represent one form of this commitment.
While the amended Compacts do not address staffing issues, officials from
Interior’s Office of Insular Affairs have informed us that they intend to post
six staff in a new Honolulu office: a health grant specialist, an education
grant specialist, an accountant, an economist, an auditor, and an office
assistant. Interior can also contract with the Army Corps of Engineers for
engineering assistance, when necessary. These Honolulu-based staff may
spend about half of their time in the FSM and the RMI. Further, an Interior
official noted that his office has brought one new staff member on board in
Washington, D.C. and intends to post one person to work in the RMI (one
staff member already works in the FSM). We have not conducted an
assessment of Interior’s staffing plan and rationale and cannot comment on
the adequacy of the plan or whether it represents sufficient resources in the
right locations.




Page 18                                      GAO-04-7 Compact of Free Association
Conclusions	          The 30 single audit reports demonstrate a lack of or poor accountability
                      over U.S. Compact assistance that has totaled an estimated $2.1 billion
                      since 1987. The large number and recurring nature of the findings involving
                      noncompliance with Compact requirements or financial management
                      weaknesses, along with the preponderance of auditor’s qualified opinions
                      or disclaimers of opinion on FSM and RMI financial statements, clearly
                      indicate the need for improved FSM and RMI management of U.S.
                      assistance and greater U.S. oversight and monitoring of the use of this
                      assistance. Changes are needed especially considering the fact that the
                      amended Compacts with these nations could potentially cost the U.S.
                      government about $3.5 billion in new assistance over the next 20 years.

                      Under the original Compact, the Department of the Interior was
                      responsible for supervising, coordinating, and monitoring the program
                      assistance provided. Interior officials expressed frustration with the lack
                      of tools available to them to administer or track this assistance in a manner
                      that could reasonably ensure that such assistance was having its intended
                      effect. The amended Compacts strengthen reporting and monitoring
                      measures that could improve accountability over assistance, if diligently
                      implemented. These measures include strengthened fiscal control and
                      accounting procedures requirements, expanded annual reporting and
                      consultation requirements, and the ability to withhold funds for
                      noncompliance with grant terms and conditions. The successful
                      implementation of the new accountability provisions will require
                      appropriate resources and sustained commitment from the United States,
                      the FSM, and the RMI. The joint economic committees called for in the
                      Compact with each nation and Interior’s planned increase in staff
                      associated with Compact oversight and monitoring functions should play
                      key roles in improving accountability over Compact funds.



Recommendations for   To help promote compliance with Compact requirements and sound
                      financial management, the Secretary of the Interior should delegate
Executive Action      responsibility to the Office of Insular Affairs and hold appropriate officials
                      in that office accountable for

                      •	 ensuring the adequacy of staff dedicated to Compact oversight and
                         monitoring,

                      •	 monitoring FSM and RMI progress in addressing Compact-related single
                         audit report findings,



                      Page 19                                      GAO-04-7 Compact of Free Association
                      •	 reporting on the FSM and RMI actions to correct Compact-related
                         compliance and financial management findings identified in single audit
                         reports to the Secretary of the Interior or other appropriate high-level
                         Interior official,

                      •	 initiating appropriate actions when the FSM or the RMI do not
                         undertake adequate actions to address Compact-related single audit
                         findings in a timely manner, and

                      •	 investigating single audit findings that indicate possible violations of
                         grant conditions or misuse of funds and taking appropriate actions
                         when such problems are verified.



Government and        In commenting on this report, the Office of Insular Affairs of the
                      Department of the Interior, FSM, and RMI agreed with our findings or
Agency Comments and   conclusions and recommendations. They also cited the amended
Our Evaluation        Compacts as mechanisms that should result in improved financial
                      management over Compact assistance. The FSM and RMI also provided
                      technical comments and information on current actions to address
                      financial management issues. We considered all comments and made
                      changes to the report, as appropriate.

                      The FSM comments noted that it found the report constructive and useful
                      as it continues to prepare for the implementation of the amended Compact
                      and its related agreements. The comments (reprinted in app. I) recognized
                      that, although FSM has worked hard to develop a consistent approach to
                      satisfy the Compact and FPA requirements, significant work remains to be
                      done to improve and strengthen accountability in all aspects throughout
                      the nation. Further, FSM agreed that it must continue to improve internal
                      financial control through upgrading the current financial management
                      system, providing for capacity building, and retaining its most productive
                      and experienced employees. Finally, it noted that the amended Compact
                      and related fiscal procedures agreement include requirements that will
                      address all of the accountability concerns expressed in the report.

                      RMI’s comments (reprinted in app. II) stated that it concurred with the
                      report’s findings and noted that the report will be useful since it gives a
                      summary of the financial and management situation of the RMI between
                      1996 and 2000. RMI noted that its problems stem partly from the fact that it
                      has not had a global system for following up on audits that would apply
                      throughout all ministries of the government as well as other entities that



                      Page 20                                      GAO-04-7 Compact of Free Association
receive Compact grant assistance. RMI stated that it has made progress
recently by upgrading its information system and strengthening its internal
control procedures and noted that it will add personnel to the budget,
procurement, and supply areas.

In its comments (reprinted in app. III), the Office of Insular Affairs of the
Department of the Interior agreed with the conclusions and
recommendations in the report. The Office also noted that it looks forward
to discharging its responsibilities under the amended Compacts and that it
is confident that it will now have the tools needed to properly protect the
American taxpayer’s investment in the freely associated states.


As agreed with your offices, unless you publicly announce its contents 

earlier, we will not distribute this report until 30 days after its date. At that 

time, we will send copies to the Secretary of the Interior, the President of 

the Federated States of Micronesia, the President of the Republic of the 

Marshall Islands, and appropriate congressional committees. Copies will 

also be made available to others on request. This report will also be 

available at no charge on GAO’s Web site at http://www.gao.gov. 


For future contacts regarding this report, please call McCoy Williams at 

(202) 512-6906 or Susan S. Westin at (202) 512-4128. Staff contacts and 

other key contributors to this report are listed in appendix IV. 





McCoy Williams

Director

Financial Management and Assurance





Susan S. Westin

Managing Director

International Affairs and Trade





Page 21                                        GAO-04-7 Compact of Free Association
Appendix I

Comments from the Federated States of
Micronesia




              Page 22         GAO-04-7 Compact of Free Association
Appendix I

Comments from the Federated States of 

Micronesia





Page 23                                   GAO-04-7 Compact of Free Association
Appendix II

Comments from the Republic of the Marshall
Islands




              Page 24          GAO-04-7 Compact of Free Association
Appendix II

Comments from the Republic of the Marshall 

Islands





Page 25                                        GAO-04-7 Compact of Free Association
Appendix II

Comments from the Republic of the Marshall 

Islands





Page 26                                        GAO-04-7 Compact of Free Association
Appendix III

Comments from the Department of the
Interior




               Page 27        GAO-04-7 Compact of Free Association
Appendix IV

GAO Contacts and Staff Acknowledgments




GAO Contacts	      Tom Broderick, (202) 512-8705 or broderickt@gao.gov
                   Emil Friberg, Jr., (202) 512-8990 or friberge@gao.gov



Acknowledgments	   In addition to the contacts named above, Perry Datwyler and Leslie Holen
                   made key contributions to this report.




(195008)           Page 28                                   GAO-04-7 Compact of Free Association
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