Federal Research: Assessment of the Financial Audit for SEMATECH's Activities in 1988

Published by the Government Accountability Office on 1990-02-16.

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

                  United   States   General   Accounting   Office   l

GAO               Report to Congressional Requesters

February   1990
                  Assessment of the
                  Financial Audit for
                  Activities in 1988

                   United States
                   General Accounting Office
                   Washington, D.C. 20648

                   Resources, Community, and
                   Economic Development Division


                   February 16,199O

                   The Honorable Sam Nunn
                   Chairman, Committee on Armed Services
                   United States Senate

                   The Honorable Les Aspin
                   Chairman, Committee on Armed Services
                   House of Representatives

                   Section 274 of the National Defense Authorization Act for Fiscal Years
                   1988 and 1989 (P.L. 100-180) requires that we review the annual audits
                   of the financial statements of SEMATECH, Inc., a consortium of 14 U.S.
                   semiconductor manufacturers and the Department of Defense (DOD), and
                   provide comments to you on their accuracy and completeness. This
                   report reviews the audit conducted by Price Waterhouse, an indepen-
                   dent certified public accounting firm, of SEMATECH'S financial statements
                   for the year ending December 31, 1988.

                   The Price Waterhouse opinion, dated January 27, 1989, stated that
                   SEMATECH'S 1988 financial statements are fairly presented in all material
                   respects in conformance with generally accepted accounting principles.
                   In conformance with generally accepted government auditing standards,
                   Price Waterhouse also issued reports on SEMATECH'S internal accounting
                   controls and compliance with laws and regulations that did not disclose
                   any material internal control weaknesses or noncompliance with laws
                   and regulations. In addition, Price Waterhouse issued a management let-
                   ter making several recommendations that, although not material to the
                   financial statements, would improve SEMATECH'S management efficiency
                   and enhance its internal control structure.

Results in Brief
                   We found nothing during our review to indicate that the Price
                   Waterhouse opinion on the SEMATECH 1988 financial statements, or its
                   reports on internal accounting controls and on compliance with laws and
                   regulations, were inappropriate or could not be relied upon. However,
                   because SEMATECH receives a significant amount of federal and state
                   financial support, we believe SEMMTCH'S financial statements should
                   more fully disclose items that otherwise would not be considered mate-
                   rial or significant. In an August 1989 meeting, SEMATECH agreed to

                   Page 1                       GAO/‘ECEDW    SEMATECH   -   F’inancial   Audit for 1998

                 disclose in its financial statements for 1989 and thereafter the amount

             l federal contributions shown as revenue that were restricted because eli-
               gible costs had not yet been incurred;
             l unallowable costs, which under SEMATECH'S grant agreement with DOD
               have not been used for matching government funds; and
             . interest on federal fund advances collected and reimbursed to the U.S.

                 Price Waterhouse considered and documented in its working papers an
                 accounting position on each of these items. It did not consider these
                 items material or significant and did not take exception to SEMATECH'S
                 presentation of the items in the 1988 financial statements.

                 In addition, in response to our inquiries, SEMATECH'S Vice President for
                 Finance stated in November 1989 that the financial statements for 1989
                 and thereafter will recognize $34.3 million in contributions by the Uni-
                 versity of Texas for property, facilities, and furnishings by amortizing
                 the contributions on a straight-lin basis over SEMATEXH'S 20-year lease
                 with the University. While not an issue in the 1988 financial statements,
                 recognition of the University’s contribution will be relevant for the
                 duration of federal funding of SEMATECH. We believe that the value of the
                 University’s contribution, based on costs that the University incurred,
                 should be $48.2 million, rather than $34.3 million, thus providing a more
                 accurate basis for the allocation of funding between government and
                 SEMATECH'S member companies. We also believe that a portion of the con-
                 tribution-at    least $10.5 million for specialized equipment and office
                 furnishings-should      be amortized over a 5-year period rather than over
                 20 years. SEMATECH is depreciating similar assets that it had purchased
                 over a 5-year period, and this is the approximate useful life of such
                 equipment and furnishings.

                 SEhfATECH was incorporated    in Delaware in August 1987 as a nonprofit
Background       research and development corporation with the objective of advancing
                 semiconductor manufacturing technology. The National Defense Author-
                 ization Act for Fiscal Years 1988 and 1989, enacted in December 1987,
                 authorized the Secretary of Defense to make grants to SEMATECH to
                 defray research and development expenses. The act required the Secre-
                 tary of Defense to enter into a memorandum of understanding that pro-
                 vided, in part, that (1) the total amount of funds made available to
                 SEMATECH by federal, state, and local government agencies for any fiscal

                 Page 2                       GAO/RCEDM     SEMATECH   -   Financial   Audit   for 1988

year for the support of research and development activities may not
exceed 50 percent of the total cost of such activities and (2) an indepen-
dent, commercial auditor submit annual reports to the Secretary of
Defense, SEMATECH, and the Comptroller General on the extent to which
SEMATECH'S use of federal funds is consistent with the purposes of the
act and SEMATECH'S charter and annual operating plan. The Congress
appropriated $100 million annually in fiscal years 1988 through 1990

In April 1988 the Secretary of Defense delegated responsibility for over-
seeing SEMATECH to the Defense Advanced Research Projects Agency
(DARPA). DARPA has approved the consortium’s operating plans, and
DARPA'S program manager has served as a nonvoting member on
SEMATECH'S Board of Directors.’ In May 1988 DARPA entered into a memo-
randum of understanding with SEMATECH and signed a grant agreement.
DARPA delegated specific grant administration functions to the Office of
Naval Research’s resident office in Austin, Texas. The agreement pro-
vides that federal funds will be made available in increments to match
SEMATECH member companies’ contributions. In 1988 SEMATECH received
$78 million from its member companies and $77 million from DARPA.

SEMATECH selected Austin, Texas, as the consortium’s permanent location
in January 1988. To attract SEMATECH,    the State of Texas-through     the
University of Texas-contributed      $48.2 million consisting of (1) $10.2
million for the purchase of a 46-acre site in southeast Austin, including a
five-story office building and a warehouse, and (2) $38 million for reno-
vating and furnishing the office building, constructing a central utility
building, partially renovating the warehouse into a semiconductor fabri-
cation facility, issuing bonds to pay for the construction and improve-
ments, and paying first-year interest on the bonds. SEMATEXH paid the
additional costs for completing construction of the fabrication facility,
which was dedicated in November 1988.

In May 1988 the University of Texas and SEMMECH signed a lease for
SEMATECH'S use of land, facilities, and capital improvements over 20
years for a nominal amount. Under this operating lease arrangement,
the University of Texas retains title to the property with no option for
SEMATECH purchase. The lease became effective in January 1989, when
the certificate of substantial occupancy was issued for the fabrication

‘Our report, FederalResearch:The SEMATECHConsortiuxn’sStart-up Activities (GAO/RCED90-37.

Page 3                            GAO-             SEMATECH- Financial     Audit   for 1988

                       In an August 1989 meeting with SEMATECH'S Vice President of Finance
Agreements About       and Price Waterhouse audit staff, SEMATECH agreed to make additional
Future Disclosures     disclosures in its financial statements for 1989 and thereafter about the
                       amount of (1) federal contributions shown as revenue that were
                       restricted because eligible costs had not yet been incurred; (2) unallowa-
                       ble costs, which under the grant agreement with DOD would not be used
                       for matching government funds; and (3) interest on federal fund
                       advances collected and reimbursed to the U.S. Treasury.

Federal Contribution   SEMATECH recognizes contributions    from the federal government as reve-
                       nue when the funds are received, rather than when they are expended.
Revenue                The federal contribution is restricted to payment of eligible capital and
                       operating costs and the funds would have to be returned to the govem-
                       ment if not expended for this purpose. We noted that as of December 3 1,
                        1988, $19 million of the $77 million federal contribution were
                       unexpended and, therefore, restricted until the eligible capital and oper-
                       ating costs were incurred. SEMATECH did not consider the federal funds
                       restriction significant to the 1988 financial statements, given its commit-
                       ments to purchase about $39 million of machinery, equipment, and other
                       assets as of December 31, 1988. Price Waterhouse did not take exception
                       to .sEMATECH’s  financial statement presentation of revenue.

                       SEMATECH'S Vice President for Finance has agreed to disclose this restric-
                       tion on revenue recognition and federal funding in footnotes to its finan-
                       cial statements for 1989 and future years.

Unallowable Costs      The Office of Management and Budget’s Circular A-122, “Cost Principles
                       for Nonprofit Organizations,” establishes principles for determining
                       costs for federal grants and defines legally allowable and unallowable
                       costs. Unallowable costs include excessive compensation, charitable con-
                       tributions, entertainment, political advocacy (lobbying), and fund-rais-
                       ing. According to Price Waterhouse’s workpapers, SEMATECH classified
                       and segregated unallowable costs from allowable costs in its accounting
                       records to ensure proper matching and disclosed in its financial state-
                       ments that unallowable costs were excluded.

                       According to Price Waterhouse’s working papers, SEMATECH properly
                       excluded approximately $779,000 of unallowable costs from matching
                       government funds. SEMATECH'S 1988 financial statements did not disclose
                       the amount or nature of these unallowable costs, the most significant of
                       which were $500,000 for interest-free officer loans that were provided

                       Page 4                       GAO/‘RCED-90-36   SEMATECII   -   Financial   Audit for 1988

                       as employment incentives and about $198,000 classified as “consulting
                       fees-legal” that were determined to be lobbying costs. Price Waterhouse
                       did not take exception to SEMATECH'S financial statement disclosure.

                       Although SEMATECH is not a publicly-held corporation and, therefore, is
                       not required to disclose terms of loans to its officers, we believe that
                       disclosure of such items in the financial statements is appropriate. While
                       no public monies were involved in these unallowable items, substantial
                       federal funds were involved in support of other SEMATECH activities.
                       SEMATECH'S Vice President for Finance has agreed to disclose this infor-
                       mation in a footnote to the financial statements for 1989 and future

Interest Reimbursed    SEMATECH'S 1988 financial statements (1) disclosed that SEMATECH is
                       required to reimburse the US. Treasury on a quarterly basis for the
                       interest earned on grant funds received in advance of qualifying
                       expenditures and (2) recorded interest income net of such amounts,
                       SEMATECH considered the amount of reimbursed interest immaterial for
                       specific disclosure in the 1988 financial statements, and Price
                       Waterhouse did not take exception to this disclosure.

                       In 1988, $544,000 of interest was earned and was later reimbursed to
                       the U.S. Treasury. SEMATECH’S Vice President for Finance has agreed to
                       disclose this information in a footnote to the financial statements for
                       1989 and future years.

                       SEMATECH'S I988 financial statements disclosed in footnotes its 20-year
Recognition of State   lease with the University of Texas for property and facilities, but no
Contribution           value was ascribed for the property, facilities, and furnishings that the
                       University contributed. Price Waterhouse did not take exception to this

                       In a letter dated November 28,1989, SEMATECH'S Vice President for
                       Finance stated that the financial statements for 1989 and subsequent
                       years will recognize the University of Texas’ contribution of $34.3 mil-
                       lion over 20 years, or $1.7 million annually. We agree that it is appropri-
                       ate to begin amortizing the University’s contribution in 1989 because the
                       fabrication facility’s certificate of substantial occupancy was issued and
                       the lease became effective in January 1989. However, we calculated the
                       value of the University of Texas’ contribution, based on the costs that
                       the University incurred, to be $48.2 million. SEMATECH'S valuation of the

                       Page 6                       GAO/RCED@O-36   SEilUAlWCH   -   Financid   Audit   for 1986

University’s contribution is lower than ours because it did not include
(1) $3.7 million for bond issuance and debt service because these funds
did not provide any direct improvement to the facilities or operation of
SEMATECH and (2) $10.2 million for land and existing facilities because
the University has retained actual ownership and full value of this real
property. We believe that SJ3MAmHshould include these costs in its val-
uation of the University of Texas’ contribution because the costs were
incurred to attract SEMATECH to Austin.

SEMATECH    plans to amortize the University’s contribution on a straight-
line basis over its 20-year operating lease with the University. We
believe that it is appropriate for SEMATECH   to amortize the University’s
contribution of about $37.6 million for land and the structural compo-
nents of the facilities on a straight-line basis over the 20-year lease
beginning in January 1989. We believe, however, that at least $10.5 mil-
lion, including $8.8 million of specialized equipment for the fabrication
facility and $1.7 million of furniture and office equipment for the office
building, should be amortized over 5 years rather than 20 years.
SEMATECH is using a 5-year period to depreciate similar assets that it had
purchased, and this is the approximate useful life of such equipment
and furnishings. In addition, it is unclear that either member companies
or the federal government wilI support SEMATEXH      for the full 20-year
lease period. Member companies have agreed to participate in SEMATECH
through its first 5 years and will annually review continuing participa-
tion, and federal participation was initially proposed for 5 years.
SEMHECH    can terminate the lease should the consortium be dissolved. If
dissolution occurs after federal funding for SEMATECH     ceases, the prop-
erty and buildings, including the portion purchased with federal and
member matching funds, would revert to the University of Texas under
the terms of the lease.

Adding the University of Texas’ contribution to the federal share may
significantly affect SEMATECH’s  funding in 1989 and in the future years
that it receives substantial federal funds. The University’s contribution
from 1989 through 1993 would be valued at $4 million annually if $37.6
million is amortized over 20 years and $10.5 million is amortized over 5
years on a straight-line basis. From 1994 through the end of the lease,
the University’s contribution would drop to $1.9 million annually. To
comply with the requirement that member companies provide at least
50 percent of its funding, SEMATECH   will have to either reduce the federal
contribution each year or obtain additional member-company

Page f3                       GAO-          SJUUTECH - F’inanciai Audit for 1988
                  A draft of this report was sent to the Department of Defense and
Agency Comments   SEMATECH for comment. DOD did not provide written comments; however,
                  DOD officials we met with suggested that the report’s discussion of the
                  reversion of the property and buildings used by SEMATECH to the Univer-
                  sity of Texas should be clarified, noting that this would be the case only
                  if the SEMATECH consortium is dissolved after federal funding of
                  SEMATECH ceases. We incorporated this change.

                  SEMATECH, which coordinated its response with Price Waterhouse, pro-
                  vided two overall comments to the report (see app. I). First, SEMATECH
                  stated that our concern about the disclosure of the amount of restricted
                  federal contributions, unallowable costs, and interest on federal fund
                  advances in the financial statements represented a technical accounting
                  issue. We agree that our concern does not affect SEMATECH'S compliance
                  with generally accepted accounting principles. However, we continue to
                  believe that because the federal government and the State of Texas are
                  contributing almost 50 percent of SEMATECH’S   annual operating budget,
                  1~11disclosure of this kind of information in the financial statements is

                  Secondly, SEMATECH reiterated its position on the accounting treatment
                  for the University of Texas’ contribution and stated that it is consistent
                  with the terms and legislative history of SEMATM=H’S enabling legislation.
                  However, SEMATECH’S    enabling legislation does not specify the manner in
                  which the State of Texas’ contribution is to be calculated. We continue
                  to believe that the value of the University’s contribution should be $48.2
                  million, rather than $34.3 million because (1) capitalizing $3.7 million in
                  interest costs incurred during construction as part of the University’s
                  total acquisition cost is consistent with Financial Accounting Standards
                  Board Statement No. 34, “Capitalization of Interest Cost” and (2) the
                  University incurred $10.2 million for land and existing facilities specifi-
                  cally for SEMATECH   and is providing their exclusive use to SEMATECH
                  under the 20-year lease.

                  SEMATECH also suggested various changes to improve the presentation
                  and technical accuracy of the draft report. For example, SJZMATECH
                  pointed out that it depreciates, rather than amortizes, assets and noted
                  that the State of Texas-through     the University of Texas-invested,
                  rather than contributed, $48.2 million to attract SEMATECH. We incorpo-
                  rated these changes as appropriate.

                  Page7                        GAO,%CEDMS SEblMECH - F’handd      Audit   for 1998

                   This report is our first in response to the National Defense Authoriza-
Scopeand           tion Act’s requirement that we review the annual audits of SEMATECH'S
Methodology        financial statements. We conducted our review of the Price Waterhouse
                   auditors’ work from April 1989 to August 1989 in accordance with gen-
                   erally accepted government auditing standards. To determine the accu-
                   racy and completeness of this work, we

                . reviewed the auditors’ approach and planning of the audit;
                . evaluated the qualifications and independence of the audit staff;
                . reviewed the financial statements and auditors’ reports to evaluate com-
                  pliance with generally accepted accounting principles and generally
                  accepted government auditing standards; and
                . reviewed the auditors’ working papers to determine (1) the nature, tim-
                  ing, and extent of audit work performed; (2) the extent of audit quality
                  control methods the auditors used; (3) whether a study and evaluation
                  was conducted of SEMATECH’S internal accounting controls; (4) whether
                  the auditors tested transactions for compliance with applicable laws and
                  regulations; and (5) whether evidence in the working papers supported
                  the auditors’ opinion on the financial statements and internal accounting
                  control and compliance reports.

                   This report does not include the 1988 financial statements because they
                   contain proprietary information.

                   As agreed with your offices, we are sending copies of this report to the
                   Secretary of Defense, the Chairman of the Board of Directors of
                   SEMATECH, Price Waterhouse, and other interested parties. Copies also
                   will be made available to others upon request.

                   This report was prepared under the direction of John M. Ols, Jr., Direc-
                   tor, who may be contacted at (202) 275-6525. Other major contributors
                   to this report are listed in appendix II.

                    Assistant Comptroller   General

                   Page 8                       GAO/RCEDM     SEMKIECH   -   F’inancial   Audit for 1988
Page 9   GAO/lWEMNM   SEMATEcB   -   Finmdal   Audit   for 1988

Appendix I
Comments From           GAO Comments
Appendix II
Major Contributors to
This Report


                        DARPA    Defense Advanced Research Projects Agency
                        DOD      Department of Defense
                        GAO      General Accounting Office
                        SEMATECH SEmiconductor MAnufacturing TECHnology

                        Page 10                   GAO~90-36    SEMKFECH   -   Financial   Audit for 1988
Page 11   GAO/WED&%5   Sm   -   Financial   Audit   for 1988
Note: GAO comments
supplementing those In the
report text appear at the
end of this appendix

                                                    INNOVATION                fOR      AMERICA’S              flJTlJRt

                             January    5,   1990

                             Mr. John 01s
                             Director    of Housing and Community Development                   Issues
                             United States General Accounting    Office
                             441 G Street    NW (Room 4073)
                             Washington,    DC 20548

                             Dear Mr. 01s:

                                We appreciate the opportunity    to conrnent on the draft   GAO report,  dated                             December
                             22, 1989, which reviews  the accuracy and completeness     of the audit performed                             by Price
                             Waterhouse on SEHATECH's 1988 financial      statements.

                                 SEMATECH is a private,          non-profit       corporation      dedicated    to the highest     standards
                             of sound management and financial               accountability.         We have cooperated      fully  with our
                             independent    certified      public    accountant,        Price Waterhouse,       so that it could reach an
                             optnion that SEHATECH's financtal              statements       and internal    accounting   controls    conform
                             with generally       accepted    accounting       principles.

                                 We are pleased  that the draft   GAO report     does not question     the Price Waterhouse
                             opinion    nor find any deficiencies   with the Price Waterhouse        audit.    We, like you,
                             belleve   they have done a thorough   and professional     job.   We are further   pleased that
                             the GAO found the SEMATECH 1988 financial       statements    to be complete and accurate    and
                             the systems of internal     controls to be appropriate      and dependable.

                                 The draft    GAO report      does offer      two principal     comments, both of which are based on
                             technical     accounting       differences.         First,     the report     suggests  certain    additional
                             financial     disclosures       would be appropriate.              Second, the report       contends     that   a
                             different     amount should          be used for the amortized             value of the contribution          to
                             SEMATECH from the University              of Texas.        We have addressed     each of these counts         in
Seecomment     1.            the following       paragraphs       and have also attached         a list   of suggested wording changes
                             to make the report         factually      correct.

                             FOOTMOTE DIW                             FINANClAL        STAT-

                                 SEHATECH is coMtted        to making full     and accurate      accounting     disclosures        in its
                             financial  statements,    consistent   with industry    standards      and practices.        Further,    all
                             interested   parties   - investors     and the federal      government       - have broad access to
                             SEMATECH's financial     information,     despite   its sensitivity       or proprietary       nature.

                                 The issue raised      by the GAO questions                  is a technical         one of what aCCOUntin
                             information    is appropriate    for inclusion                in the financial        statements.      It is not a
                             question    of whether      SEMATECH is willing                  to disclose        financial     information   to

                                                    2706 Montopolis   Drive    - Austin.    Texas 76741 . (512) 356-3500

                                       Page 12                                        GAO/‘UCED-90-36       SEMATECH       -   Financial     Audit for 1968
             Appendix 1

Mr. John 01s
January 5, 1990
Page 2

appropriate    review    bodies.      Our books were completely             open to the GAO, and the GAO
did not identify      any concerns regarding    the availability,             appropriateness or accuracy
of SEHATECH financial        information.

    SEMATECH's 1988 financial            statements    were developed         in full      compliance     with the
strict     standards     of Generally       Accepted Accounting       Principles        (GAAP), which include
well-established         guidelines       for whether    any individual           item is material           to the
financial       statements     taken as a whole.          Considerable         time and effort         were spent
evaluating       and documenting      the appropriate      accounting      treatment       and the appropriate
financial        statement    disclosure       for  each of the items               questioned      by the GAO.
Ultimately,        SEHATECH and Price Waterhouse          concluded      that all items which should be
disclosed      in the financial       statements    were disclosed,       and were disclosed          properly    in
accordance       with GAAP.


     SEMATECH has explained    to the GAO in considerable    detail its accounting      treatment
of the contribution        by the University     of Texas.    This treatment    is based upon
recognizing    the funds which were made available        to SEMATECH by the University,         the
market value of the property        lease,   and the fact that the University     retained     full
title    to the land and property.

   We believe      this accounting       treatment     is a reasonable   and straightforward        approach
which meets the tests of generally               accepted   accounting   principles       and, perhaps even
more importantly,       is consistent       with the terms and legislative        history    of the SEMATECH
enabling    statute.      Further,    this treatment      has been acceptable       to both our investors
and the Department        of Defense.

    While it is certainly     possible     for accountants              to differ      on these   issues,    we
believe   the SEMATECH approach,     as endorsed by Price               Waterhouse,      is more appropriate
and consistent   with standard    accounting    principles.

   We appreciate      the courtesy     and cooperation    of GAO officials     in conducting    their    in-
depth review over the past 10 months.               Their suggestions      have been helpful      and have
contributed     constructively       to the presentation      of SEMATECH's financial        statements,
and we look forward         to continuing    to work with you in the future.


Robert N. Noyce
President and Chief         Execu tive    Officer

             Page 13                                   GAO/Em                SElWAlECH       -   Flnancid   Audit for 1983
               Appe*    I
               Cbmmentr From SFMATECH

               The following are   GAO’S   comments on SEMATECH'Sletter dated January 5,

               1. We have incorporated SEMATECH'S
                                                suggested changes as appropriate.
GAO Comments

               Page14                          GAO/BCTED90-35   SElUl’ECH   -   Financial   Audit for 1988
Appendix II

Major Contributors to This Report

                          Lowell Mininger, Assistant Director
Resources,                Richard P. Cheston, Assignment Manager
Community, and
Development Division,
Washington, D.C.

                          Roger R. Stoltz, Assistant Director, Financial Audit Group
Accounting and
Financial Management
Division, Washington,

                          Richard Kasdan, Assistant General Counsel
Office of the General
Counsel, Washington,

                          Joe D. Quicksall, Issue Area Manager
Dallas Regional Office,   Linda J. Libician, Evaluator-In-Charge
Dallas, Texas             John E. Clary, Evaluator

(005758)                  Page 16                      GAO/TtCED80-36 SEMATECH   -   Financial   Audit for 1988