oversight

Chapter 3 - HUD Multifamily Housing Programs

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-07-01.

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

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                       CHAPTER *3.* HUD Multifamily Housing Programs


3-1.    Background. This chapter contains the U.S. Department of Housing and Urban
        Development’s (HUD) requirements for conducting the compliance portion of the annual
        financial audits of profit-motivated and limited-distribution entities participating in HUD’s
        Federal Housing Administration (FHA) multifamily housing programs *except for
        hospitals, which are covered by chapter 4 of this guide.*

        *For audits performed under this chapter, which include many different types of projects,
        the required compliance testing must be done for each project on an individual basis except
        when the project is owned and/or managed by an entity that owns and/or manages multiple
        HUD/FHA-assisted projects. When this condition exists, audit guide compliance sections,
        paragraph 3-5.J, Tenant Application, Eligibility, and Recertification; paragraph 3-5.L,
        Tenant Security Deposits; and paragraph 3-5.M, Management Functions, can be audited on
        an individual project basis or can be sampled using a group project-basis sample (defined
        later in this section) if

       A.   The same system is used by management for the compliance section for all projects
            selected for inclusion in this group project-based sample.

       B.   For the projects that are to be included in the population and sample, the compliance
            section has the same supervisor for all projects, the procedures followed are identical,
            and the test of internal controls did not disclose any weaknesses.

       C.   The owner(s) agrees to the project-based sample method.

       D.   The auditor fully documents in the work papers the above information upon which the
            determination was made, including the owner’s signed agreement.

        All other compliance sections except for the three cited above must be performed on each
        project.

        When a condition or weakness is found during the testing that is required to be reported, it
        must be reported in the audit report for each project in the population. Reference should be
        made to each report that contains that type finding. If dollars are involved, only the dollars
        belonging to that specific project should be included in that project’s audit finding. For
        example, significant deficiencies found or findings developed must be included in the audit
        report for all projects that were grouped for the group project-based population. The*




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  *following illustrates wording that can be used. “This internal control problem applies to
  and is reported in 15 audit reports, 5 for projects owned by companies related to the X
  Housing Cooperation and 10 projects owned by two unrelated owners. The total disallowed
  cost is $450,000, of which $100,000 applies to this project, and $200,000 applies to the
  other 4 projects owned by companies related to the X Housing Cooperation and $150,000
  applies to the 10 projects owned by the two unrelated owners.” Additionally, nonmaterial
  instances of noncompliance must be reported in a management letter or other written
  correspondence for each project in the population (reporting requirements are included in
  paragraph 3-8 of this chapter).

  A group project-based sample must include at least 20 percent of the projects with no less
  than a minimum of four projects to be reviewed each year for compliance with audit steps
  contained in sections 3-5J, 3-5L, and 3-5M. This will result in each project in the
  population being reviewed at least every five years or less for those compliance sections.
  The following examples illustrate this point:

                 Example 1. An auditor has 50 projects in the population that are to be
                 audited, and the conditions permit the auditor to use group project-based
                 sampling. The auditor would test 20 percent or 10 projects since this amount
                 is greater than four.

                 Example 2. An auditor has 10 projects in the population that are to be
                 audited, and the conditions permit the auditor to use group project-based
                 sampling. The auditor would test the minimum of four projects since 20
                 percent would only be two projects.

  Specific projects from the population may be added to the sample based on a risk analysis
  or for any other reason. However, any specific project shall not be counted as a part of the
  20 percent or minimum sample of four for that year.

  If the auditor elects to use the project-based sampling method, the sampling schedule and
  system for selecting must be included in the work papers so auditors can later ensure that all
  projects in the population will continue to be audited systematically.

  The auditor’s opinion on compliance is to be provided for each individual project, and the
  compliance testing must support the opinion for each individual project and not the group
  as a whole.

  Practitioners with nonprofit projects as clients, who participate in HUD/FHA multifamily
  housing programs covered by the Single Audit Act, are to conduct audits in accordance
  with Office of Management and Budget (OMB) Circular A-133, Audits of States, Local*




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       *Governments and Non-Profit Organizations, and with the requirements contained in OMB
       Circular A-133’s, Compliance Supplement, which can be found on the OMB Web site

                      http://www.whitehouse.gov/omb/grants/grants_circulars.html.

       This chapter is not intended to be a program-specific audit guide for compliance with the
       A-133 requirements. If the Compliance Supplement includes the program that is being
       audited, the guidance in the supplement is to be used. If the Compliance Supplement does
       not include the program that is being audited, part 7 of the supplement provides guidance
       on how to identify the applicable compliance requirements to test. Paragraph 1d of part 7
       states “If there is an audit guidance issued by the Federal agency’s Office of Inspector
       General (OIG), the auditor may wish to consider this guidance in identifying the program
       objectives, program procedures, and compliance requirements.” This guide should be used
       only for that purpose.

3-2.   Reference Material. The following is the reference material that was in effect at the time
       this audit guide was issued. It is the auditor’s responsibility to use the procedures that were
       in effect during the period covered by the audit.

       The audit procedures that are established in this guide are based on the procedures that were
       in effect when the guide was written. The auditor must determine the procedures that were
       in effect during the audit period which their client was to follow. The auditor must conform
       those procedures to the audit steps in this guide. Changes, as found necessary, must be
       made to the audit steps.

       Throughout this chapter, reference is made to handbooks, using the base handbook number
       without the revision number (i.e., REV-1, REV-6, etc.). This will enable periodic updates
       to paragraph 3-2 should any of the material referenced below be revised, causing a change
       to documents’ revision number, rather than revising the entire handbook/chapter, since the
       base handbook number would not change. Also, the auditor should ensure that the updated
       reference, listed in this paragraph, is used for performing the audit. The versions listed
       below were those in effect at the time this audit guide was issued. If reference to a
       handbook is needed in the audit report, the auditor should ensure that the entire updated
       reference, including the current revision number, is used.

                Document                                            Title
          HUD Handbook 4370.2,         Financial Operations and Accounting Procedures for Insured
          REV-1                         Multifamily Projects*




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          *HUD Handbook               Occupancy Requirements of Subsidized Multifamily Housing
           4350.3, REV-1              Programs
          HUD Handbook 4370.1,
          REV-2                       Reviewing Annual and Monthly Financial Statements

          HUD Handbook 4381.5,
          REV-2, CHG-2                The Management Agent Handbook

          HUD Handbook 4350.1         Multifamily Asset Management and Project Servicing
                                      M2M Program Operating Procedures Guide
          Not numbered                Located at Web site:
                                      http://www.hud.gov/offices/hsg/omhar/readingrm/opglinks.cfm

       Reference material may be obtained by accessing HUD’s Client Information and Policy
       System (HUDCLIPS) at the following Web site:
                                http://www.hudclips.org/

       Reference material may also be ordered from HUD’s direct distribution system by
       telephone, (800) 767-7468; in a letter addressed to HUD, Customer Service Center, Room
       B-100, 451 Seventh St., SW, Washington, DC 20410; or by fax, (202) 708-2313.*


3-3.   Reporting Requirements. The regulatory agreement for the project requires the owner to
       submit audited financial statements, prepared in accordance with the requirements of the
       Secretary, within 90 days after the end of the fiscal year. *Although most regulatory
       agreements may indicate a required submission date of 60 days after the end of the fiscal
       year, 24 CFR [Code of Federal Regulations] 5.801, Uniform Financial Reporting Standards
       (UFRS), supersedes this requirement by giving projects 90 days to submit their financial
       statements*. In addition to issuing an opinion, the basic financial statements, and
       supplemental (supporting) data, the auditor is required to issue, at a minimum, a report on
       the internal control structure and a report on compliance. The owner must certify to the
       completeness and accuracy of the financial statements. The management agent, if
       applicable, must certify to the management of the project. *The owner and management
       agent certifications are to be made in accordance with the requirements of HUD Handbook
       4370.2, paragraphs 3-7 and 3-8. When circumstances prohibit the specified number of
       partners’ or officers’ certifying signatures, explanatory information should be provided with
       the audit report.
       The auditor’s role is to conduct and report the results of the audit in accordance with
       auditing standards generally accepted in the United States of America (GAAS) as issued by
       the American Institute of Certified Public Accountants (AICPA) and the standards*




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      *applicable to financial audits contained in the generally accepted government auditing
      standards (GAGAS) issued by the Comptroller General of the United States. It is the
      owner’s responsibility to file an accurate electronic submission with the Real Estate
      Assessment Center (REAC). In that regard, the independent auditor shall*

      A. Issue an independent auditor’s report (refer to chapter 2, example A) on the ownership
         entity’s basic financial statements. This report should cover the following items:
                   •   Balance sheet.
                   •   *Statement of profit and loss.*
                   •   Statement of changes in partner’s capital. 1
                   •   Statement of cash flows.
                   •   Footnotes to the basic financial statements, including descriptions of
                       accounting policies.
      B. Issue an independent auditor’s report (refer to chapter 2, example A) on the
         supplemental information. A paragraph may be added to the auditor’s report on the
         basic financial statements, or a full report may be issued separately. 2 *Supplemental
         information includes the REAC financial data templates, which essentially include
         support and detail for specific accounts included in the basic financial statement data
         and certain other information as required by HUD Handbook 4370.2, chapter 3, and as
         further described in REAC’s Guidelines on Reporting and Attestation Requirements of
         Uniform Financial Reporting Standards (UFRS) located on REAC’s Web site. The
         Web address is
                             http://www.hud.gov/offices/reac/products/fass/mf_doc.cfm.
           Use of the guidelines is mandatory for all engagements covered under UFRS.

           The financial data templates are further defined in the appendixes of the Industry User
           Guide for Financial Assessment Subsystem – Multifamily Housing (FASSUB). The
           Industry User Guide is available at the following Web address:
                          http://www.hud.gov/offices/reac/products/fass/fassmf_guide.cfm.
                                                                                                                       *



1
 Or similarly titled report based on the type of participating ownership entity. For example, if a limited liability
company owns the property, “statement of changes in members’ equity” should be discussed.

2
    Refer to AICPA Professional Standards, Volume 1, U.S. Auditing Standards, AU §551.06e.




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       C. Issue any additional reports described in chapter 2.


3-4.   *Sample Selection. According to the Government Auditing Standards, published by the
       Government Accountability Office (GAO), the third fieldwork standard for financial audits
       states:

                  The auditor must obtain sufficient appropriate audit evidence by
                  performing audit procedures to afford a reasonable basis for an
                  opinion regarding the financial statements under audit.

       Audit sampling, when properly applied, can provide sufficient appropriate evidence to
       support the audit opinion.

       Audit sampling is defined as the application of an audit procedure to less than 100 percent
       of the items within an account balance or class of transactions for the purpose of evaluating
       some characteristic of the balance or class. There are two general approaches to audit
       sampling: nonstatistical and statistical. Both approaches require the auditor to use
       professional judgment in planning, performing, and evaluating a sample and in relating the
       audit evidence produced by the sample to other audit evidence when forming a conclusion
       about the related account balance or class of transactions.

       It is important that the sample selected be representative of the population. The size of a
       sample necessary to provide sufficient audit evidence depends on both the objectives and
       the efficiency of the sample. Because of the previous inconsistency in the application of the
       sampling process in auditing HUD programs, OIG convened a panel consisting of
       representatives from OIG, HUD REAC, AICPA, and several auditing firms with significant
       HUD experience to discuss the issue and potential solutions. Based on the feedback from
       that panel, OIG decided and all participants agreed that attribute sampling 3 is the
       appropriate sampling methodology for use in auditing programs using this chapter to
       provide consistency and to assure adequate coverage to support the audit opinions rendered.

       The attribute sampling method of selecting a sample is to be used anytime in this chapter a
       statement is made that a sample is to be selected. If the auditor is of the opinion that
       another sampling method should be used for a particular audit; for example, when the
       objective is to sample transaction dollar values for purposes of statistically estimating
       over/understatements (variable sampling methodology), the working papers must contain
       justification for the methodology used. Appendix A to this chapter provides additional*

   3
    Until such time as OIG decides to extend this approach to other chapters, attribute sampling will only apply to
   audits performed using chapter 3.




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       *information on attribute sampling. The sample sizes stated in appendix A are to be the
       minimum sample sizes to be used regardless of the methodology the auditor uses in lieu of
       attribute sampling.


3-5.   Compliance Requirements and Audit Areas. The following sections contain suggested
       audit procedures that HUD believes should be performed. If an auditor determines that the
       stated procedures to be inappropriate and/or other audit procedures should be performed,
       the deviation from the stated procedures must be justified and documented in the auditor’s
       working papers.*

          A. Federal Financial Reports.

              1. Compliance Requirement. Projects are required to ensure that financial status
                 reports contain reliable financial data and are presented in accordance with the
                 terms of applicable agreements between the project and HUD. The individual
                 agreements contain the specific reporting requirements that the project must
                 follow. *HUD will usually require monthly reports whenever annual financial
                 reviews, on-site reviews, or other information indicates that the project is
                 experiencing financial or management difficulties or the owner/agent is
                 suspected of noncompliance (HUD Handbook 4370.1, chapter 3). The type of
                 annual statements can vary by program. HUD Handbooks 4370.2 and 4350.1
                 provide detailed guidance as to which owners must submit financial statements
                 and the types of statements that are required.*

              2. Suggested Audit Procedures.

                     a. Identify all required financial reports by inquiry of the
                        owner/management agent and review of agreements and correspondence
                        with HUD. Request a copy of auditee submissions to HUD during the
                        period under audit.

                     b. Obtain an understanding of the owner/management agent’s procedures
                        for preparing and reviewing the financial reports.

                     c. Select a sample of financial reports, other than those included in the
                        annual financial statements, and determine whether the reports selected
                        are prepared in accordance with HUD instructions.




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               d. For the sample selected, determine whether significant data reported are
                  accurate. Report all material differences between financial reports and
                  project records.

               e. *Determine whether the project complied with HUD’s reporting
                  requirements.*

  B. Fair Housing and Nondiscrimination.

          1. Compliance Requirement. Owners and management agents are prohibited
             from discriminatory practices in accepting applications, renting units, and
             designating units or sections of a project for renting to prohibited bases in
             accordance with the Fair Housing Act and the provisions of the regulatory
             agreement.

          2. Suggested Audit Procedures.

               a. Obtain a copy of the project’s approved affirmative fair housing
                  marketing plan, if applicable. Review the marketing plan for compliance
                  with appropriate statutes and the regulatory agreement. Section 232
                  projects will not have an affirmative fair housing marketing plan but
                  have a regulatory obligation not to discriminate.

               b. Obtain an understanding of the owner/management agent’s policies and
                  procedures relating to marketing of the units; processing, approving, and
                  rejecting applications; and providing reasonable accommodation to
                  applicants and tenants with disabilities in accordance with the
                  requirements of applicable federal civil rights laws *and the Americans
                  with Disabilities Act.*

               c. *Obtain a copy of the project’s tenant selection plan as required by HUD
                  Handbook 4350.3. Review the plan for compliance with the handbook
                  and perform the following steps:

                          (1) Determine whether there are indications of any
                              discriminatory practices such as prohibited screening
                              practices based on

                              i. Race, color, religion, sex, national origin, age, family
                                 status, or disability;*




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                          ii. *Segments of population, e.g., welfare recipients, single-
                              parent household;

                         iii. Income;

                         iv. Lack of rental history; or

                          v. Other civil rights and nondiscrimination requirements
                             listed in Handbook 4350.3.

                      (2) Determine whether the plan is updated every five years.*

            d. Determine whether procedures were placed in operation as established
               by the owner/management agent through inquiry and physical
               examination of documentary evidence. Documentation can vary based
               on the procedures established.

            e. Review a sample of the correspondence chronology files for the period
               under audit for correspondence evidencing litigation or potential
               litigation related to discriminatory rental practices.

            f. *During the review of cash disbursements under audit step 3-5.I.1.2.c,
               look for payments that would evidence actual or potential litigation for
               any discriminatory rental practices.

            g. During the review of tenant files under audit step 3-5.J.1.2.e(16), look
               for evidence of discriminatory practices.*

            h. Determine that the HUD-approved equal housing opportunity logo,
               slogan, or statement is displayed in marketing materials.
C. Mortgage Status.
        1. Compliance Requirement. Owners shall promptly make all payments due
           under the note and mortgage.

        2. Suggested Audit Procedures.
            a. Obtain a copy of the mortgage note, mortgage (or deed of trust), and
               associated loan amortization schedule to determine the terms and
               conditions of those agreements.




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               b. Obtain an understanding of the owner’s procedures for assuring prompt
                  payment of the mortgage.

               c. *Determine whether all related mortgage and escrow payments were
                  made by either*

                          (1) Obtaining or preparing a schedule of the client’s mortgage
                              and escrow payments and withdrawals for the period under
                              audit (the schedule should include the amount, including
                              escrow items, and date each item was paid or disbursed.
                              Determine whether monthly payments were made on time
                              and the loan was current at the end of the fiscal year) or

                          (2) Confirming the outstanding loan balance and annual escrow
                              account activity with the lender as of the project’s fiscal year
                              end (determine whether monthly payments were made on
                              time and the loan was current at the end of the fiscal year).

               d. If the project is operating under a mortgage modification agreement,
                  workout agreement, forbearance agreement, use agreement, or other
                  agreement, determine whether the owner is complying with the terms
                  and conditions of the agreement.

  D. Replacement Reserve.

          1. Compliance Requirement. Owners, if required, shall establish a reserve for
             replacement account and make deposits in accordance with HUD
             requirements, usually the regulatory agreement *or business agreement*. The
             reserve for replacement account is usually required to be under the control of
             the lender. Disbursements from the reserve for replacement fund may be
             made only after written consent is received from HUD.

             *Reserve for replacement funds are to be invested in interest-bearing accounts
             for certain projects. Interest earned on these projects is required to be
             maintained in the reserve for replacement account. For other projects, HUD
             strongly encourages owners to invest the reserve for replacement funds. The
             mortgagee is authorized to invest funds in excess of $100,000 (the Federal
             Deposit Insurance Corporation (FDIC) federally insured limit) in approved
             securities and/or financial institutions as long as it follows the requirements in
             HUD Handbook 4350.1, paragraph 4-22. Interest on those investments is*




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   *considered project funds and may not be disbursed directly to owners or
   directly to any individual associated with the project. All interest must flow
   through the project accounts and be disclosed in the accounting records.*

2. Suggested Audit Procedures.

    a. Obtain an understanding of the project owner’s deposit and maintenance
       requirements included in the regulatory agreement,*business agreement*
       and any amendments or other written agreements with HUD and
       determine whether there were any changes to the funding requirement by

               (1) *Reviewing Form HUD-9250,             Reserve    Funds     for
                   Replacement Authorization, or

               (2) Questioning the owner/management agent if any changes
                   were made when rents were increased. Increases will be
                   documented on Form HUD-92458, Rent Schedule Low Rent
                   Housing.*

    b. Obtain an understanding of the project owner’s procedures for
       depositing, maintaining, requesting, and disbursing reserve for
       replacement funds.

    c. Determine whether the reserve fund has been established in a federally
       insured depository under the control of the mortgagee, if required. *For
       funds in excess of federally insured limits, determine whether the
       owner/management agent reviewed the depository quarterly to verify
       that it met HUD requirements as described in HUD Handbook 4350.1.

    d. Using confirmation or the schedule prepared for the mortgage status
       compliance requirement in 3-5.C.2.c, determine whether all required
       deposits to the reserve for replacement were made in compliance with
       HUD requirements and agreements.*

    e. Determine whether all disbursements from the reserve for replacement
       account, identified in the mortgage confirmation or the schedule
       prepared in 3-5.C.2.c, were properly authorized by HUD.

    f. *Select a sample of repairs covered by funds from the reserve for
       replacement account. Trace the reimbursed amount to cancelled*




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                  *invoices and determine whether funds were used for the purpose
                  authorized by HUD.

               g. For projects for which HUD requires funds to be invested, determine
                  whether funds were invested and interest was only withdrawn with HUD
                  approval.

               h. For projects for which HUD does not require funds to be invested,
                  determine whether funds were invested. Perform the following steps:

                          (1). If funds were not invested, determine why and consider
                               including a comment in the management letter or other auditor
                               communication.

                          (2). If funds were invested, determine whether interest was
                               disbursed to the project by the lender and if so, whether the
                               interest was deposited into project accounts and recorded in the
                               project’s accounting records.

                          (3). If funds were invested, determine whether interest was
                               disbursed directly to owners or any individual associated with
                               the project in violation of HUD requirements.*

  E. Residual Receipts.

          1. Compliance Requirement. *Non-profit owners and owners of limited
             distribution projects, Section 202 projects, and Section 811 projects* shall
             establish a residual receipts account and make deposits into the account in
             accordance with HUD requirements *within 90 days after the close of the
             fiscal year.* Disbursements from such fund may be made only after written
             consent is received from HUD.

          2. Suggested Audit Procedures.

               a. Obtain a copy of the project’s regulatory agreement and any amendments
                  or other HUD business agreements, to identify the project owner’s
                  requirements for making deposits into the residual receipts fund and
                  copies of the surplus cash calculations from the end of the prior audit
                  period and semiannual period, as applicable.




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              b. Obtain an understanding of the owner/management agent’s procedures
                 for determining and depositing residual receipts.
              c. *Determine whether the surplus cash calculations were prepared in
                 accordance with the regulatory agreement and other HUD guidance.
              d. Determine whether the project deposited all required amounts into the
                 residual receipts account for the period under audit according to the
                 surplus cash calculation(s)*.
              e. Using the confirmation or the alternative schedule prepared for the
                 mortgage status compliance requirement in 3-5C2c, determine whether
                 residual receipts were deposited in the residual receipts account within
                 *90* days after the end of the fiscal year or semiannual period, if
                 applicable.
              f. *Determine whether disbursements from the residual receipts account,
                 identified on the confirmation or alternative schedule prepared in 3-
                 5.C.2.c, were properly authorized by HUD and used for the purpose
                 intended*.

F. Distributions to Owners.
        1. Compliance Requirement. Owners may not make, receive, and/or retain any
           distribution of assets or any income of any kind of the project except surplus
           cash and then only under certain conditions. Surplus cash distributions can
           only be made as of and after the end of a semiannual or annual fiscal period.
           Surplus cash distributions cannot be made when the owner is in default under
           any of the terms of the regulatory agreement, the note, or mortgage. *Surplus
           cash distributions cannot be made out of borrowed funds or if the owner has
           not complied with all outstanding notices, from HUD or from the mortgagee,
           for proper maintenance of the project.* The allowable distribution for limited
           distribution owners is further restricted to a percentage of the owner’s initial
           equity investment as described in the regulatory agreement, business
           agreement or subsequent HUD-approved agreements *with the balance of
           surplus cash required to be deposited in a residual receipts account (see steps
           3-5.E).*
        2.   Suggested Audit Procedures.
              a. Obtain a copy of the project’s regulatory agreement, business agreement
                 and any amendments or associated documents to determine the owner’s




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                 rights for receiving distributions and surplus cash calculations for the
                 prior fiscal period and semiannual period, if applicable.

              b. *Obtain an understanding of the owner/management agent’s procedures
                 for determining surplus cash and making distributions.*

              c. Scan minutes of board or partnership meetings for discussions
                 authorizing distributions.

              d. Question the owner or management agent about the existence of any
                 notices of default or other items of noncompliance under any of the
                 terms of the regulatory or business agreement.

              e. *Determine whether the surplus cash calculations were prepared in
                 accordance with the regulatory or business agreement and other HUD
                 guidance.

              f. Determine whether distributions taken during the audit period exceeded
                 the amounts calculated and/or authorized for that period.*

              g. Scan cash disbursements for evidence of any payments made to the
                 project owners *or related parties. Scan journal entries for unexplained
                 decreases in accounts payable, notes payable, and related interest to
                 project owners or related parties.            Determine whether the
                 owner/management agent paid partnership management fees, asset
                 management fees, incentive management fees, and write-offs of related
                 party receivables from funds other than surplus cash or distributions.

              h. Scan the bank statements for any deposit, from the project owners and/or
                 related parties, which would evidence that incorrect distributions or
                 payments were made and that those funds were redeposited into the
                 project’s accounts before the audit.

              i. Review inspection reports and owner responses to verify compliance
                 with all outstanding notices for proper maintenance of the project.
                 Delays in making repairs could erroneously result in surplus cash being
                 reported to be on hand at the end of the reporting period, making funds
                 available for distribution to the owners.*




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G. *Equity Skimming.

        1. Compliance Requirement. Equity skimming is the willful misuse of any part
           of the rent, assets, proceeds, income, or other funds derived from the project
           covered by the mortgage for any purpose other than to meet actual or
           necessary expenses of the project. Equity skimming deprives the project of
           needed funds for repairs, maintenance, and improvements, which contributes
           to the financial and physical deterioration of the project and the standard of
           living conditions for the families who depend on the federal government to
           provide housing. Also, a community where the project is located suffers since
           the project may become the breeding ground for crime, violence, and drugs.
           Appendix B includes areas disclosed in audit reports in which equity
           skimming was found in the operations of multifamily projects.

        2. Suggested Audit Procedures. In the various compliance areas in this chapter,
           we have included audit steps that are designed to disclose equity skimming.
           The auditor should be aware of the conditions noted in appendix B and modify
           any of the audit steps based on the policies/procedures of the auditee.

H. Cash Receipts.

        1. Compliance Requirement. All cash receipts, including those collected by a
           management agent, must be deposited into an account in the name of the
           project at an institution in which deposits are federally insured. The project’s
           owner must verify that depositories where it maintains funds in excess of
           $100,000 meet certain conditions as outlined in chapter 2 of HUD Handbook
           4370.2.

           Most projects will have at least three bank accounts including a regular
           operating account, a reserve for replacement account (held by the mortgagee,
           see paragraph 3-5.D for audit steps), and a tenant security deposit account (see
           paragraph 3-5.L for audit steps). Non-profits and limited distribution projects
           will also have a residual receipts account (see paragraph 3-5.E for audit steps).

           The regular operating account is a general operating account in the name of
           the project, which is used for depositing receipts of the project other than those
           specifically designated for the security deposits account. A centralized
           account can only be used as provided for in chapter 2 of HUD Handbook
           4270.2.*




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          2. *Suggested Audit Procedures.

              a. Obtain an understanding of the owner/management agent’s procedures
                 for handing cash receipts.

              b. Determine whether the project owner’s written and actual procedures for
                 receiving and depositing funds in the regular operating
                 account/centralized account are in compliance with the regulatory
                 agreement and chapter 2 of HUD Handbook 4370.2.

              c. Determine whether the account is exclusively in the name of the project
                 except as allowed by HUD Handbook 4370.2 for centralized accounts.

              d. Select a sample of deposits from the cash receipts ledger and perform the
                 following steps:

                         (1) Determine whether the deposits were made in a timely
                             manner after receipt of funds and are in the name of the
                             project. Usually tenant cash receipts are deposited daily
                             during the heavy rent collection days during the first part of
                             the month and when certain amounts of funds are
                             accumulated during the rest of the month.

                         (2) Test the supporting documentation for each deposit in the
                             sample and determine whether all funds that were received
                             were properly accounted for and included in the deposit.

                         (3) Determine that all deposits in the books of account are in
                             agreement with the related bank statements as to amounts and
                             dates.

                         (4) Determine whether the deposits were posted to the
                             appropriate general ledger accounts.

                         (5) Trace all amounts other than tenant/member rental receipts to
                             any contracts, agreements, or other documentation and
                             determine whether the amount that was received was properly
                             deposited and posted to the appropriate account.

                         (6) Select a sample of tenant/member rental receipts and trace the
                             amount from the source documents to the individual*




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             *tenant/member accounts receivable record and their
             executed leases.

          (7) If any amounts are added to the account by way of an
              institution’s memorandum or other type of document,
              determine the reason for that transaction and whether it was
              proper.
e. Owners may be motivated to both understate and overstate revenue. The
   following audit steps are designed to disclose such occurrences:
          (1) Consider the fraud risk factors and the potential for material
              misstatement of the financial statements related to revenue
              recognition including vacancy loss and bad debt expense.
              Perform testing to address any material fraud risk factors
              identified. The auditor should tailor audit steps/procedures
              based on the individual risk factors identified and the results
              of other audit evidence gathered.
          (2) Determine whether vacancy loss is greater than 15 percent of
              total rental revenue or if the change in vacancy loss between
              the current year and prior year is greater than 5 percent. If so,
              the following steps should be performed:
                i. Determine whether rent potential and vacancy loss were
                   properly calculated.
               ii. For all revenue accounts, scan the detailed general
                   ledger. Review the supporting documentation for all
                   material manual entries and unusual entries.
               iii. Determine the reason for the increase or cause of the
                    high vacancy rate via discussion with management. The
                    auditor may also want to select a sample of vacant units
                    and perform tests to substantiate the high vacancy rate.
                    Possible tests on the sample include but are not limited
                    to the following:
                               (i). Reviewing the move-out notice from the
                                    tenant.

                               (ii).Reviewing the documentation from the
                                    move-out inspection.*



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                                             (iii). *Determining whether the security
                                                  deposit was refunded to the tenant.

                                             (iv). Reviewing the itemized list of damages
                                                 and charges provided to the tenant,
                                                 which was used to reduce the amount of
                                                 security deposit due back to the tenant.

                                             (v). Inspecting the vacant unit if the unit is
                                                  still unoccupied.

                                             (vi). Questioning site personal, including
                                                 the resident manager and the building
                                                 manager, to determine the period when
                                                 the unit was vacant.

                                             (vii). Reviewing work orders to determine
                                                 the period when the unit was vacant.

                         (3) Determine whether bad debt expense is greater than 10
                             percent of total rental revenue or whether the change in bad
                             debt expense is greater than 5 percent between the current
                             year and the prior year. If so, the following steps should be
                             performed:

                               i. Obtain an understanding of the owner/management
                                  agent’s procedures for collecting delinquent debt and
                                  policy for writing off debt.
                              ii. Determine whether delinquent accounts are sufficiently
                                  pursued according to procedures.
                             iii. Select a sample of accounts written off to bad debts
                                  expense and review supporting documentation to
                                  determine whether debt was written off in accordance
                                  with policy and generally accepted accounting
                                  principles.
              f. Determine the reason for any activity on the tenant record after the debt
                 was written off. *




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I. *Cash Disbursements.

       1. Compliance Requirement. All disbursements from the regular operating
          account must be supported by approved invoices, bills, or other supporting
          documentation. Project funds should only be used to pay for mortgage
          payments, required deposits to the reserve for replacement fund, reasonable
          expenses necessary for the operation and maintenance of the project,
          distributions of surplus cash as permitted, and repayment of owner advances
          from surplus cash or as authorized by HUD. Disbursements from a centralized
          account must clearly be traceable to each project. The actual cash position of
          each project in this account must be easily identifiable at all times without
          exception.

       2. Suggested Audit Procedures.

            a. Obtain an understanding of the project owner/management agent’s
               procedures for withdrawing funds from the regular operating account or
               centralized account and determine whether they are properly supported
               and used in accordance with the regulatory agreement.

            b. Select a sample of disbursements from the cash disbursement ledger or
               similar record and perform the following steps:

                     (1) For centralized accounts, determine whether the disbursements
                         were recorded in the books of the appropriate project in
                         accordance with HUD Handbook 4370.2. Review cash account
                         balances of each project to ensure that balances are easily
                         identifiable to each project. Also, determine whether any
                         projects have a negative or zero balance, which could indicate
                         an improper loan between projects.

                     (2) Determine whether the disbursements are supported by
                         approved invoices, bills, or other supporting documentation; the
                         supporting documents are in the name of the project; and the
                         costs are reasonable and necessary for the operation of the
                         project. If the supporting documentation is not in the name of
                         the project, determine whether only the portion applicable to
                         the project was paid from project funds.*




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                         (3) *Determine whether the disbursements were made on behalf of
                             other projects or entities since project funds cannot be loaned or
                             used for nonproject purposes. Report instances even if amounts
                             have been repaid.

                         (4) Determine whether the disbursements were properly charged to
                             the correct account.

                c. Scan the cash disbursements journal for payments that would evidence
                   actual or potential litigation for any discriminatory rental practices.

                d. If any amounts are withdrawn from the project account by way of an
                   institution’s memorandum or other type of document, determine the
                   reason for that transaction and that it is proper.

                e. For accounts with balances in excess of FDIC-insured limits, determine
                   whether the owner or management agent followed the steps outlined in
                   chapter 2 of HUD Handbook 4370.2 to determine the eligibility of the
                   financial institution.

  J. Tenant Application, Eligibility, and Recertification.

          1. Compliance Requirement. Owners who participate in HUD’s rent subsidy
             programs are responsible for accepting applications, maintaining a waiting list,
             determining eligibility, calculating the tenant’s contribution toward rent and
             utilities, calculating subsidy, and recertifying the tenant annually in
             accordance with HUD requirements.

          2. Suggested Audit Procedures.

                a. Obtain a copy of the housing assistance payments contracts or equivalent
                   subsidy contracts with any amendments to determine the owner’s
                   responsibilities in this compliance area.

                b. Obtain an understanding of the owner/management agent’s procedures
                   for accepting applications, managing the waiting list, determining initial
                   eligibility, determining a tenant’s rent and subsidy, and recertifying
                   annually and determine whether they are in compliance with the
                   provisions in HUD Handbook 4350.3.*




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c. *Review the results of any field reviews performed covering tenant
   application, eligibility, and recertification activity. Consider the impact
   on the audit steps to be preformed. If deficiencies were disclosed,
   additional testing should be performed on current activity to determine
   whether the problem has been corrected or corrective action was put in
   place.

d. Select a sample of applicants that were selected from the waiting list
   during the fiscal year. The sample should include some tenants that were
   denied admission. Perform the following steps at a minimum:

         (1). Determine whether applicants were selected in the correct
              order.

         (2). Determine whether preferences granted were verified before
              admitting the applicant as a tenant, if applicable.

         (3). Determine whether the waiting list was purged. If so,
              determine whether it was done in accordance with written
              procedures.

         (4). For denied applicants, determine whether the following
              documentation was maintained:

               i. The reason the applicant was denied admittance in
                  accordance with the tenant selection plan and that the
                  reason was properly supported.

               ii. Any indication of discriminatory rental practices or if the
                   applicant threatened or entered litigation because of
                   discriminatory practices.

              iii. The rejection letter provided to the applicant advising the
                   applicant of his/her right to appeal.

e. Select a sample of tenant files. The sample should include some recently
   admitted tenants as well as some tenants who no longer reside at the
   project. The requirements below are covered in HUD Handbook 4350.3.
   The auditor should review the Handbook to determine whether
   requirements have been added or removed to ensure completeness of*




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                 *review in this area. Perform a minimum of the following steps, as
                 applicable:

                      (1)   Determine whether       all   appropriate   parties    signed   the
                            application.

                      (2)   Determine whether household members were correctly
                            identified and the head, cohead, and all tenants age 18 and older
                            signed the applicant’s/tenant’s consent to the release of
                            information, Form HUD 9887-A.

                      (3)   Determine whether the owner/management agent verified
                            Social Security numbers of all occupants six years of age and
                            older, disability status, waiting list preferences, and income and
                            allowances for adjusted income (refer to Handbook 4350.3,
                            appendix 3, for additional information on acceptable form of
                            verification).

                      (4)   Determine whether the resident rights and responsibilities were
                            acknowledged.

                      (5)   Determine whether citizenship         declaration      or   eligible
                            immigrant status was obtained.

                      (6)   Determine whether all adult tenants were screened for criminal
                            and drug background checks as well as sex offender
                            registration.

                      (7)   Determine whether the correct HUD model lease and
                            addendums were used and correctly signed/executed.

                      (8)   Determine whether the appropriate security deposit and
                            prorated rent were correctly calculated and collected.

                      (9)   Determine whether the appropriate security deposit and prepaid
                            rent were returned within 30 days after move-out.

                      (10) Determine whether the owner’s certification of compliance
                           with HUD’s tenant eligibility and rent procedures, Form
                           HUD-50059, was completed correctly.*




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                    (11) *Determine whether move-in and move-out inspection forms
                         were completed.

                    (12) Determine whether the computation of the tenant’s contribution
                         toward rent and utilities and the subsidized portion of the
                         tenant’s monthly rent were properly calculated.

                    (13) Determine whether the initial certification and the last
                         recertification forms were completed correctly and were
                         accurate (Form HUD-50059).

                    (14) Verify that the Section 8 rents charged and paid did not exceed
                         the contract rents approved by HUD.

                    (15) Trace the housing assistance payment calculated in the tenant
                         file to the amount charged to HUD in the monthly voucher
                         request.

                    (16) For those tenants who were evicted, determine whether

                           i. The basis for the eviction was in accordance with the
                              established rental policy, or

                           ii. The tenant was evicted for any discriminatory reasons.

                    (17) Determine whether any evidence is contained in the file
                         indicating that any improper or inaccurate information was
                         discovered while determining tenant eligibility or rent
                         calculation. If so, determine that the owner followed the
                         guidance in HUD Handbook 4350.3 pertaining to overpayment
                         of a subsidy and follow up on suspected fraud.

K. Units Leased to Extremely Low-Income Families.

        1. Compliance Requirement. For each project assisted under a contract for
           project-based Section 8 assistance, the owner must lease not fewer than 40
           percent of the dwelling units to extremely low-income families (HUD
           Handbook 4350.3, chapter 3, and chapter 4, paragraph 4-5).

        2. Suggested Audit Procedures.*




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               a. *Select a sample of Section 8 tenants or use the sample selected in step
                  3-5.J above if all tenants in that sample receive subsidy. For the sample
                  items selected,

                          (1) Obtain a copy of the tenant selection plan for a description of
                              the methodology the owner uses in income targeting.

                          (2) Obtain an understanding of the owner/management agent’s
                              procedures for implementing that plan and determine whether
                              the procedures properly implement the tenant selection plan.

               b. Determine whether at least 40 percent of the units that became available
                  during the period under review served extremely low-income families.

                          (1) If the tenant files that were stated in the owner’s income
                              target determination were in the sample selected, determine
                              that extremely low-income families occupied those units.

                          (2) If none of the extremely low-income families were in the
                              sample selected, select a separate sample from the owner’s
                              determination documentation and determine whether the units
                              were rented to extremely low-income families.

               c. If the 40 percent has not been reached and the owner is renting units to
                  other eligible families, determine whether the owner has documented its
                  marketing efforts to target extremely low-income families.

  L. Tenant Security Deposits.

          1. Compliance Requirement. Funds collected as a security deposit shall be
             kept in the name of the project, separate and apart from all other funds of the
             project in a trust account. The amount of this account shall at all times equal
             or exceed the aggregate of all outstanding obligations under that account.
             Funds must not be commingled with funds from any other projects. All
             disbursements from the security deposit account must be only for refunds to
             tenants and for payment of expenses incurred by or on behalf of the tenant, not
             to exceed the amount to which the tenant is entitled. All disbursements must
             have supporting documentation. In addition, state and local governments may
             have specific regulations governing the handling of tenant security deposits.*




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2. *Suggested Audit Procedures.

    a. Obtain an understanding of the project owner’s procedures, including
       state and local laws, and regulatory agreement and HUD requirements
       (HUD Handbook 4370.2, chapter 2) for establishment and maintenance
       of the security deposit account and making approved disbursements from
       that account.

    b. Determine whether the account has been established in a federally
       insured depository in the name of the project, which is segregated from
       project operating funds, and the owner’s records support the amount on
       deposit.

    c. Determine whether, at the end of the reporting period and throughout the
       period under review, the amount on deposit is at least equal to the
       outstanding obligations under the security deposit account.

    d. Determine whether interest is earned on the security deposit account and
       the disposition of that interest. If state and local law requires the owner
       to pay the tenant for interest earned, determine that the tenant interest is
       credited to tenants and paid upon termination of tenancy.

    e. Select a sample of tenants that moved in and tenants that moved out
       during the period under review and perform the following steps:

               (1) Determine whether security deposits were collected at the
                   time of the initial lease and agree with the amount required in
                   the lease agreement and regulations.

               (2) Determine whether security deposits collected were deposited
                   promptly in the security deposit account.

               (3) Trace tenant balances reported on the balance sheet at the end
                   of the fiscal year as the outstanding obligation to the tenant
                   list of security deposits for the same period and determine if it
                   agrees.

               (4) Determine whether refunds and/or an itemized list of claims
                   were provided to tenants within 30 days after move-out or as
                   required by state or local law. *




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                         (5) *Determine whether refunds were disbursed to the former
                             tenant and in the appropriate amount. Determine the
                             disposition of or proposed disposition of the amounts for
                             checks outstanding for more than 60 days.

                         (6) Identify disbursements from the security deposit bank
                             account statement that do not appear to be tenant refunds to
                             ensure that those disbursements were only made for payment
                             of appropriate expenses incurred by the tenant or on behalf of
                             the tenant.

                         (7) Determine whether forfeited security deposits applied to rents
                             and damages were appropriately recorded as rental income.*

  M. Management Functions.

          1. Compliance Requirement. The owner is responsible for complying with all
             requirements of the regulatory agreement. *The owner may perform all
             management functions or contract with a management agent to provide project
             management, but the responsibility cannot be delegated to the management
             agent. The owner or management agent must be approved by HUD and must
             certify that it will follow HUD’s rules and regulations. *

          2. Suggested Audit Procedures.

               a. Obtain a copy of the most recent HUD-approved management agent’s
                  certification (Form HUD-9839-A, B, or C, as appropriate). Perform the
                  following steps:

                        (1). Determine whether HUD has approved the owner or current
                             management agent.

                        (2). If the project owner’s/management agent’s certification, Form
                             HUD-9839-B, was used, determine whether companies that
                             have an identity-of-interest relationship with the owner (item
                             12) have been reported in the notes to the financial statements.

                        (3). Obtain a copy of the management entity profile, Form HUD-
                             9832, to identify additional identity-of-interest companies
                             *(items 11a and b) that were not included in the management*




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            *agent certification for inclusion in the notes to the financial
            statements.*

        (4). Review maintenance contracts and major contracts and vendor
             invoices to determine whether there are additional identity-of-
             interest relationships with the owner/agent that need to be
             reported to HUD and in the notes to the financial statements.

        (5). Determine whether the management agent fees paid exceeded
             the amount listed on the management agent certification. This
             amount should also agree with the amount in the management
             agreement.

        (6). *For payments made to identity-of-interest companies,
             determine whether the amounts paid exceed the amounts
             ordinarily paid for such services and supplies. The amounts
             ordinarily paid can be determined by comparing costs to similar
             disbursements noted during the cash disbursement analysis or
             from the auditors’ knowledge of amounts generally paid for
             services and supplies in the same geographic area, gained
             through their audits of other area clients.*

b. Determine whether the owner or the management agent has obtained a
   fidelity bond in accordance with chapter 2.14 of HUD Handbook 4381.5.

c. *Determine whether hazard insurance has been obtained in the amount
   required by the project’s mortgage.*

d. Determine whether liability coverage is sufficient as determined by
   chapter 21 of HUD Handbook 4350.1.

e. Determine whether the owner or management agent has responded to all
   HUD management review reports, physical inspection reports, and
   inquiries regarding annual financial statements or monthly accounting
   reports within 30 days.

f. *On a sample basis, test work orders and tenant complaints for timely
   follow up and compliance with management’s procedures. Handbook
   4381.5 states that whenever possible, owners/agents should take*




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                           *immediate action to address problems or concerns registered by the
                           resident.

                       g. Determine whether the project is maintained in good repair and
                          condition. If the units are subsidized, determine whether management’s
                          procedures ensure that units meet applicable housing quality standards.

                       h. Inquire whether HUD, a contract administrator, or the lender has
                          conducted routine unit and general property inspections. If findings
                          were identified, determine whether corrective action was taken.

                       i. Question management and scan revenue accounts for any fees charged to
                          the project or residents for additional services. Conduct followup or
                          corroboration of management’s responses as considered necessary to
                          ensure that fees charged agree with the management agent certification
                          or have been approved by HUD.*

    N. Unauthorized Change of Ownership/Acquisition of Liabilities.

                1. Compliance Requirements. Owners shall not, without the prior written
                   consent of HUD, convey, assign, transfer, dispose of, or encumber any of the
                   mortgaged property or permit the conveyance, transfer, or encumbrance of
                   such property.

                2. Suggested Audit Procedures.

                       a. Question management about the existence of any agreements to sell,
                          assign, dispose of, or encumber any of the mortgaged property or assets
                          of or beneficial interest 4 in the property. Review any agreements.
                          Determine whether HUD has approved transactions or is in the process
                          of approving transactions and report any instances of noncompliance.

                       b. Confirm all material liabilities listed on the client’s balance sheet.
                          Review for indications of change of ownership or additional
                          encumbrances that may have been made without HUD approval.

                       c. *Report any other instances of unauthorized conveyance, assignment,
                          transfer, disposal, or encumbrance of any of the mortgaged property or*

4
 Beneficial interest is generally the right to profits from an estate or property without owning the estate or
property.




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                *assets of or beneficial interest in the property identified during the
                course of the audit.*

O. Unauthorized Loans of Project Funds.

        1. Compliance Requirements. Owners shall not, without the prior written
           consent of HUD, assign, transfer, dispose of, or encumber any personal
           property of the project, including rents, or pay out any funds except for
           reasonable operating expenses and necessary repairs.

        2. Suggested Audit Procedures.

             a. Question management about the existence of any agreements to assign,
                transfer, dispose of, or encumber any of the personal property of the
                project, including rents, and read any agreements.

             b. Review the results of the audit procedures applied to specific accounts or
                other general procedures to identify the existence of any unauthorized
                transactions.

             c. *Test accounts receivable to determine whether receivables are the result
                of routine operations and whether project funds have been loaned to the
                management agent, other projects, employees, or the owner.*

P. *Excess Income.

        1. Compliance Requirements. Owners of properties with mortgages insured
           under Section 236 of the National Housing Act must submit excess income
           within 10 days of the end of the month in which it was collected.

        2. Suggested Audit Procedures.

             a. Obtain copies of the monthly report of excess income, Form HUD-
                93094, for the period under review and any approval letters from HUD
                regarding retention of excess income.

             b. *Select a sample of the reports and determine whether the reports were
                prepared in accordance with HUD instructions.*




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               c. *For the sample items selected, determine whether the client remitted the
                  full amount collected to HUD in accordance with HUD instructions and
                  in a timely manner.

               d. If excess income was not remitted to HUD, determine whether funds
                  were retained in accordance with HUD approval and funds were used for
                  the intended purpose.

  Q. Leased Nursing Homes.

          1. Compliance Requirements. Owners may enter into lease agreements to
             operate the facility, in which case the operator will be required to execute a
             regulatory agreement (HUD 92466-NHL) with HUD before the note is
             endorsed for insurance. The regulatory agreement requires lease payments to
             be sufficient to pay all mortgage payments including payments to reserves for
             taxes, insurance, etc., and payments to the reserve for replacements. If at the
             end of any fiscal year, payments under the lease have not been sufficient to
             pay for the above items, the owner and operator/lessee, upon request in writing
             from HUD, shall renegotiate the amounts due under the lease so that the lease
             payments shall be sufficient to pay for such items. In addition, the
             operator/lessee shall provide HUD, within 30 days of request, a financial
             report, in a form satisfactory to HUD, covering the operations of the
             mortgaged property and of the project.

             The regulatory agreement also requires the operator/lessee to not sublease the
             project and maintain it in good repair. The owner’s regulatory agreement
             requires the owner to make mortgage payments and reserve deposits. These
             responsibilities cannot be assigned.

          2. Suggested Audit Procedures.

               a. Obtain a copy of the lease agreement, as may be amended, to operate the
                  facility, if applicable, and the executed regulatory agreements (there will
                  be one for the owner and one for the operator/lessee).

               b. Determine whether the owner received lease payments in a timely
                  manner.

               c. Determine whether the total lease payments were adequate to cover the
                  debt service (including tax and insurance escrows) and reserve for
                  replacement deposits.*




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                     d. *Obtain maintenance logs, inspection reports, and other data to
                        determine that the lessee has properly maintained the project. On a
                        sample basis, review that documentation to determine whether the lessee
                        made repairs to the project to properly maintain the property in
                        accordance with housing quality standards. Visual inspection of the
                        common areas and grounds should be made.

                     e. Determine whether major changes have been made to the project without
                        HUD approval.

                     f. Determine whether the owner or operator/lessee complied with
                        nondiscrimination, equal opportunity, or other requirements of state or
                        local law or of HUD/FHA.

                     g. Examine the terms of the lease to determine whether responsibility for
                        making mortgage payments and reserve deposits has been
                        assigned/delegated to the lessee. Verify that payments were made by the
                        owner.

3-6.   Mark-to-Market Program (M2M).

       In 1997, Congress established the Mark-to-Market Program (M2M) to help preserve the
       availability and affordability of low-income rental housing while reducing the cost to the
       federal government of rental assistance provided to low-income households using project-
       based Section 8 funds. Under this program, HUD resets the rents to the prevailing market
       level and restructures the property’s mortgage debt, if needed, to permit a positive cash
       flow. The operations of M2M projects are to be audited using the steps in section 3-5 in
       addition to the following audit procedures. The auditor must obtain the business agreement
       and conform the requirements in that agreement to the audit steps in this section. Changes,
       as found necessary, should be made to the audit steps since these steps were established
       based on the M2M procedures stated in the M2M Program Operating Procedure Guide
       which may be different from those set forth in the Business Agreement.

          A. Capital Recovery Payments for M2M Projects.

                1. Compliance Requirements. In most M2M transactions, owners are required
                   to invest new money either out-of-pocket or through borrowing. These funds
                   cannot be provided through a loan secured by the project assets. In return, the
                   owner receives capital recovery payments. These payments provide a market*




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             *rate of return to owners on the new money invested and may only be
             collected when certain conditions are met. This requirement is not applicable
             to cooperatives.

          2. Suggested Audit Procedures.

              a. Obtain a copy of the restructuring commitment and other restructuring
                 documents to determine whether the owner invested new funds as
                 required, including any new funds for reserves, repairs, transaction costs,
                 or similar property costs.

              b. Obtain a copy of the source documents identifying the interest rate and
                 payments period for the capital recovery payments. Obtain or prepare an
                 amortization schedule of the payments showing the amount advanced for
                 the restructuring, interest rate, and payment period. Determine whether
                 the capital recovery payment is being paid as authorized over the
                 applicable period of 7-10 years.

              c. Determine whether the terms and conditions of the capital recovery
                 payments listed below were met on a monthly basis.

                       (1). All expenses are paid, and there are no material accrued
                            payables.

                       (2). The first mortgage is current.

                       (3). The property is in acceptable physical condition (the most
                            recent REAC score is at least 60 or the multifamily HUB or
                            program center has accepted the owner’s proposal for curing a
                            less favorable score).

                       (4). There are no unresolved HUD audit or management findings,
                            including any finding that the owner is not in compliance with
                            the rehabilitation escrow deposit agreement.

                       (5). The project’s most recently issued audited financial statements
                            reflected positive surplus cash, and any payables shown as due
                            on the surplus cash schedule have been paid.*




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                   (6). *If funds are not available, payment will accrue until surplus
                        cash becomes available. Interest is paid on the accrued
                        amount.*


B. *Incentive Performance Fee for M2M Projects.

    1. Compliance Requirements. The incentive performance fee is provided to
       recognize owner equity and as an incentive for demonstrating operating
       efficiencies. This fee is a percentage, generally 3 percent, of annual effective
       gross income with a floor of $100 and a ceiling of $200 per unit per year. The
       owner can collect this payment annually if certain conditions are met. The
       percentage can be increased or decreased by the participating administrative
       entity to establish a fee within the maximum and minimum limitations.

    2. Suggested Audit Procedures.

         a. Obtain a copy of the restructuring commitment and other restructuring
            documents and determine the incentive performance fee percentage.

         b. Determine whether the terms and conditions of payment listed below
            were met for the annual period during which the owner collected the
            incentive performance fee.

                   (1). All expenses are paid, and there are no material accrued
                        payables.

                   (2). The first mortgage is current.

                   (3). The property is in acceptable physical condition (the most
                        recent REAC score is at least 60 or the multifamily HUB or
                        program center has accepted the owner’s proposal for curing a
                        less favorable score).

                   (4). There are no unresolved HUD audit or management findings,
                        including any finding that the owner is not in compliance with
                        the rehabilitation escrow deposit agreement.

                   (5). Only funds available after payment of the expenses, debt
                        service on any first mortgage, and any capital recovery*




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                            *payment were used.      If funds are not available, payment
                            cannot accrue.


     C. Distribution of Surplus Cash for M2M Projects.

          1. Compliance Requirements. After payment of all operating expenses, debt
             service on any first mortgage, any capital recovery payment, and the incentive
             performance fee, the owner will receive up to 25 percent of the remaining
             surplus cash annually. The remainder of surplus cash will be paid toward the
             M2M second (or third) mortgage. Since requirements in the Business
             Agreements my vary from the procedures contained in the M2M Program
             Operating Procedure Guide which were used to establish the audit steps listed
             below, the auditor must obtain a copy of the Business Agreement and compare
             it to the audit guide steps and make the changes deemed appropriate,

          2. Suggested Audit Procedures.

               a. Obtain a copy of the restructuring commitment and other restructuring
                  documents and determine the requirements and/or restrictions that exist
                  for the capital recovery payment, the incentive performance fee, and the
                  M2M (surplus cash) note payment and distributions

               b. Review the prior-year surplus cash computation and note that the owner
                  distribution does not exceed 25 percent of the surplus cash available for
                  distribution or the percentage determined by Office of Affordable
                  Housing Preservation.

               c. Determine that the M2M (surplus cash) note payment and distributions
                  were paid after all required payments were made and that the capital
                  recovery payment and incentive performance fee were properly made as
                  determined in audit steps 3-6.A and 3-6.B.

     D. Special Rules for Cooperatives.

          1. Compliance Requirements. For cooperatives, additional requirements are
             included in the audit procedures listed below. The compliance requirements in
             3-6.B and 3-6.C also apply to cooperatives. Capital recovery payments listed
             in 3-6.A do not apply.

          2. Suggested Audit Procedures. *




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                     a. *Obtain a copy of the restructuring commitment and other restructuring
                        documents and note the additional operating reserve requirement.

                     b. Determine whether the cooperative is in compliance with the annual
                        escrow deposit of 3 percent of annual operating expenses plus principal
                        and interest and mortgage insurance premium.

                     c. Determine whether the surplus cash and the incentive performance fee of
                        the cooperative were deposited in a separate residual receipts account.

                     d. Determine whether withdrawals from the residual receipts account for
                        the period under audit were approved by the multifamily HUB or
                        program center director and were used for the purpose requested.

3-7.   Section 236 Decoupling Projects.

                1. Compliance Requirements. As a condition for receiving continued interest
                   reduction payments (IRP) under section 236(e)(2) and section 236(b), the
                   owner agrees to operate the project in accordance with all low-income
                   affordability restrictions for the period identified by the use agreement.

                2. Suggested Audit Procedures.

                     a. Obtain a copy of the applicable IRP agreement, any use agreements, and
                        Housing Notice 00-8, Guidelines for Continuation of Interest Reduction
                        Payments after Refinancing, and related notices for reinstatement and
                        extension.

                     b. On a sample basis, review tenant files and ensure that the owner is in
                        compliance with the low-income affordability restrictions for the period
                        covered by the IRP and use agreements.


3-8.   Audit Finding Reporting.

       All instances of conditions contained in Appendix B, material noncompliance with any
       HUD requirement or regulations which result in material questioned or disallowed cost
       and/or, deficiencies in internal control, instances of fraud or illegal acts, or contract
       violations that were disclosed during the audit process must be reported as findings in the*




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  *audit report. All nonmaterial instances of noncompliance disclosed during the audit
  process must be reported separately to management. Such reporting must be in writing in a
  management letter or other type of written communication, and form and date of written
  communication must be mentioned in the independent auditor’s report. Noncompliance,
  deficiencies, or violations that were corrected before the issuance of the audit report must
  be included in the report as resolved findings or in a management letter or other written
  communication depending on their materiality.

     A. Content of Finding.

       Findings are to be presented in accordance with the standards and requirements of
       GAGAS. Refer to chapter 2 for further information on the information that is to be
       included in a finding.

     B. Corrective Action Not Started or in Process.

     When the project’s management has not started to correct the findings or is in the
     process of correcting a finding at the time of report issuance, the auditee can include a
     description of the action completed and the action remaining to be taken in the auditee’s
     response to the finding, stated in the auditee’s comment section of the finding and in the
     corrective action plan.

     C. Corrective Action Completed.

     When the project’s management has corrected a finding, the action taken should be
     included in the auditee’s response to the finding, stated in the auditee’s comment
     section of the finding and in the corrective action plan, and should be validated by the
     auditor. The auditor’s recommendation in the finding should state the results of the
     auditor’s validation testing. In addition, the auditor could include any additional
     recommendations that he/she believes are necessary based on the auditor’s validation of
     that action.

     D. Reporting When Using the Group Project-Based Sample Method.

     When a condition or weakness is found in one of the projects in the sample, during the
     audit testing, that is required to be reported in a finding, it must be reported in the audit
     report for each project in the population from which the sample was drawn. Reference
     should be made to each report that contains that type finding. If dollars are involved,
     only the dollars belonging to that specific project should be included in that project’s
     audit finding. For example, the following illustrates wording that can be used: “This
     internal control problem applies to and is reported in 15 audit reports, 5 for projects*




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          *owned by companies related to the X Housing Cooperation and 10 projects owned by
          two unrelated owners. The total disallowed cost is $450,000, of which $100,000
          applies to this project, and $200,000 applies to the other 4 projects owned by companies
          related to the X Housing Cooperation and $150,000 applies to the 10 projects owned by
          the two unrelated owners.”

          If the condition is only to be reported in the management letter or other written
          communication, it must be communicated similarly in all projects of the population
          from which the sample was drawn.

3-9.   Technical Assistance Needed.

          The Office of Asset Management is responsible for answering programmatic questions
          for the programs being audited using the procedures outlined in this chapter.
          Programmatic questions on audits performed using this chapter should be referred to
          that office, (202) 402-3730.

          REAC is responsible for the Financial Assessment Subsystem (FASS). Questions
          regarding that system are to be referred to REAC’s technical assistance center, (888)
          245-4860.*




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                                                                             *Appendix A

                                     Attribute Sampling

When planning to test a particular sample of transactions, the auditor should consider the
specific audit objective to be achieved and should determine whether the audit procedure, or
combination of procedures, to be applied will achieve that objective. The size of a sample
necessary to provide sufficient evidential matter depends on both the objectives and the
efficiency of the sample. As noted in section 3-8 of this chapter, all material instances of
noncompliance, including those identified through sampling, must be reported as findings in
the audit report.

Determining Test Objective, Defining the Population, and Defining an Exception.

Before beginning testing, the auditor must understand and document what attribute and/or
assertions are being tested. The auditor needs to identify and document the appropriate
population and should also perform procedures (e.g., reconciliations, inquiry) to ensure that the
population from which the samples are selected is complete.

Each compliance requirement selected for testing should be considered a separate population,
and samples should be selected accordingly. The sample selected could possibly be used to test
multiple attributes within each compliance requirement. Additionally, auditors must assess the
control environment at entities with multiple locations. If controls at the different locations are
significantly different, each location must be considered a separate population.

The auditor must document the “sampling unit,” which is the individual item subject to
sampling in the population (i.e., reconciliations, loan files, cash disbursements, cash receipts,
etc.).

When selecting the sample of individual items, auditors must ensure that the sample is
representative of the universe for the compliance requirement being tested.

The auditor should also clearly define what would be considered an exception. A single
exception would indicate noncompliance, subject to further determination of materiality
necessary to determine the required method of reporting.

Determining the Sample Size.*




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*To determine attribute testing sample sizes, the auditor needs to determine the value for three
inputs: desired confidence level, tolerable exception rate, and expected exception rate.

Desired Confidence. Auditors should obtain a high degree of assurance by using a
confidence level of 90, 95, or 99 percent.

Tolerable Exception Rate. A 5-10 percent exception rate is acceptable.

Expected Exception Rate. No exceptions should be accepted.

Materiality. Using attribute testing, monetary materiality or tolerable misstatement is not a
necessary input for determining sample size.

Sample Size Table.         Using the preferences above and an attribute sampling software
program, if a high level of assurance is defined as 90 percent confidence and tolerable
exception rate is 5 or 10 percent with an expectation of zero exceptions, the sample size is 48 or
23 (respectively for 5 and 10 percent exception rates), which is rounded to 50 and 25 below.
Similarly, using 95 percent confidence, zero exceptions, and a 5 or 10 percent tolerable
exception rate, the sample size is 64 or 32, which is rounded to 65 and 35 below.

                               Compliance sample size table
 Importance/significance of       Confidence       Tolerable    Minimum sample size for
  the attribute being tested        level            rate        populations over 200

             Low                      90%                5%                  50
             Low                      90%               10%                  25
             High                     95%               5%                   65
             High                     95%               10%                  35

This table is illustrative but does not replace professional judgment. As noted in the table,
these are minimum sample sizes, and there may be many situations in which the auditor should
also consider qualitative factors when determining sample size. Such qualitative factors may
include but are not limited to

   (1).   First year the auditor audited an entity.
   (2).   Larger, decentralized entities.
   (3).   High number of findings in the past.
   (4).   Significant deficiencies or material weaknesses in the past.*




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   (5). *Poor internal controls.
   (6). Extremely high volume of activity in a particular compliance requirement.
   (7). High project employee turnover in a particular area or department.

If the initial sample does not include a particular attribute being tested, then typically there
would be a need to have additional items included in the sample to address just that specific
attribute.

Each compliance test performed should be evaluated separately for purposes of determining
sample size. Judgment should be used to determine what tests are considered low risk and
which are considered high risk. When making the determination of high or low risk, it will be
important to understand the population.

Populations of 200 or Fewer Items.

When performing compliance testing of populations of fewer than 200 items, the following
guidance is provided. Generally examine at least

 (1).   20 items when the population being tested contains between 100 and 199 items,
 (2).   10 items when the population being tested contains between 50 and 99 items,
 (3).   Five items when the population being tested contains between 20 and 49 items, and
 (4).   Fewer than five items for smaller populations

As noted above, these are suggested minimum sample sizes, and there may be quantitative
factors used to determine the sample size to be used.

Testing and Evaluating Results.

The sample sizes in the table above are based on an expectation of no exceptions. If the testing
performed discovers no exceptions, then the auditor has achieved a high degree of confidence
that the attribute/assertion is performed at an acceptable level.

If there are observed exceptions, the auditor should investigate the nature and cause of the
exceptions to determine whether the exceptions are immaterial or material compliance findings,
significant deficiencies, or material weaknesses in internal control. It is not necessary to
expand testing when exceptions are found. All exceptions must be reported. Refer to
paragraph 3-8 for reporting requirements using this audit guide.

In cases in which an exception is found, the auditor must determine whether the individual
exception is material enough to be included in the report. If it is determined that an exception*




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*is not material enough to be reported as a finding, the auditor may want to apply additional
procedures to evaluate the magnitude of the exception.

The auditor should consider whether the lack of an effective internal control constitutes a
significant deficiency or a material weakness and document the basis for an unqualified opinion
if a finding is determined to be a significant deficiency or material weakness.

Work Paper Documentation Needed.

Documentation of sampling procedures must include the test objective, definition of an
exception, description of the population tested and the sampling unit, confidence level,
significance of the attribute, sample size, and the results of testing.

Technical Assistance Available.

Technical guidance on audit sampling is available in the following documents:

         SAS No. 39. Audit Sampling (AICPA)
         SAS No 111. Amendment to SAS No. 39, Audit Sampling (AICPA, Professional
         Standards, vol. 1, AU sec. 350), as amended
         AICPA Audit Guide. Audit Sampling, New Edition as of April 1, 2001
         AICPA Audit Guide. Government Auditing Standards
         SAS No. 74. Compliance Auditing Considerations in Audits of Governmental Entities
         and Recipients of Governmental Financial Assistance (AICPA, Professional
         Standards, vol. 1, AU sec. 801)*




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                                                                                        *Appendix B

                                        Information on
                                       Equity Skimming

This appendix discusses conditions that were found in audits of multifamily programs that are
categorized as equity skimming. This information is included to help establish an
understanding of equity skimming conditions.

Equity skimming is considered to be a fraud, which can be prosecuted through either criminal
or civil statutes. When the auditor suspects equity skimming exists, the auditor must contact
OIG’s National Single Audit Coordinator, at 215-430-6733, to discuss the auditor’s findings
and the method used to report them.

Review of Cash Disbursements and Expense Accounts. A review of cash disbursements
and/or expense accounts of projects revealed use of project funds to pay for

       (a). Maintenance, administrative, or other expenses of the owner, other programs, or
            other projects.

       (b).Debts of the owners or management agent.

       (c). Loans to owners, principals, or affiliate companies.

       (d).Mortgages and related expenses not related to the project.

       (e). Personal expenses, such as food, clothing, entertainment of wife and friends, private
            car expenses, etc., on a project credit card.

       (f). Individual partner tax preparation or counseling fees (the preparation of the project tax
            return may be paid from operations).

       (g). Legal fees for handling disputes among partners.

       (h). Expenses related to arranging the sale of the project or part of the project.

       (i). Splitting of fees with the management agent or others who provide services to the
            project. This can be an illegal kickback whereby a company agrees to refund a portion
            of its fees to an owner in return for awarding the management or services contract to
            the company.*




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       (j). *Theft of funds in which owners or management agents may write checks to
            themselves or relatives and not try to hide the fact that they have taken the funds.

       (k). Expenses to identity-of-interest companies when

              (1). The identity-of-interest company is a conduit for the purchase of materials
                   and supplies and adds on an excessive percentage markup beyond what it
                   needs to cover its own costs.

              (2). The identity-of-interest company is paid for labor and materials to repair the
                   project but is using on-site maintenance staff and/or materials to do the work.

              (3). The identity-of-interest company is leasing equipment to the project at rates
                   significantly in excess of those charged on the open market.

              (4). No work was ever done. The identity-of-interest company may not actually
                   exist, and the bank account may be used to launder funds.

              (5). The cost for property and liability insurance for the project is in excess of
                   prices charged on the open market or for coverage that is inadequate to
                   protect HUD’s interests.

              (6). The identity-of-interest company provides insurance for the property under a
                   blanket policy covering several HUD and non-HUD properties. The owner
                   or management agent may be prorating an excessive amount to the HUD
                   properties and using the excess reimbursement to offset insurance costs for
                   its non-HUD projects or as a means to divert project funds.

Review of Project Income.

A review of cash receipts and/or revenue accounts of projects revealed that

             (a). Rental units were used for owner activities without HUD approval and no rent
                  was collected for the unit.

             (b).Income from contracted services such as laundry services, cell tower leases,
                 and cable fees to tenants was retained by the owner.

             (c). Units were recorded as vacant but were actually rented. The rent received was
                  split between the owner and the management agent.*




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