Environmental Protection Agency
Clean Water State Revolving Fund
Audit Guide
\
o
EPA
3507
1998.1
June 1998
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Table of Contents
Chapter
PURPOSE AND OBJECTIVES 1
BACKGROUND 2
PLANNING THE AUDIT 3
MANAGEMENT ASSERTIONS AND INTERNAL CONTROLS 4
AUDITING THE FINANCIAL STATEMENTS 5
COMPLIANCE AUDITING 6
AUDIT COMPLETION AND THE AUDITOR'S REPORT 7
APPENDICES:
A. ACRONYMS A-1
B. REFERENCE MATERIAL B-1
C. SAMPLE ENGAGEMENT LETTER C-1
D. FINANCIAL STATEMENT ASSERTIONS AND POTENTIAL D-1
MISREPRESENTATIONS
E. INTERNAL CONTROL REVIEW PROCESS E-1
F. SAMPLE REPRESENTATION LETTER F-1
G. SAMPLE AUDITOR'S REPORT AND FINANCIAL STATEMENTS G-1
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CHAPTER 1 - PURPOSE AND OBJECTIVES
PURPOSE
The purpose of this document is to provide guidance in performing financial audits of
the Clean Water State Revolving Funds (SRF) administered by states. This guide is
for the use of Environmental Protection Agency (EPA), Office of Inspector General
(OIG) auditors. The OIG encourages state auditors and Independent Public
Accountants to use this guide when performing SRF financial audits.
The guide is not intended to be a complete manual of procedures, nor is it an audit
program. The guide incorporates relevant auditing standards, including General
Accounting Office (GAO) guidance where applicable, and outlines key issues to be
considered in SRF programs. However, it is not a substitute for the existing regulations
nor does it eliminate the need to review current GAO and EPA regulations, state laws,
and pronouncements issued by the Financial Accounting Standards Board (FASB) or
the Governmental Accounting Standards Board (GASB). Auditors are expected to
exercise professional judgment in performing SRF financial audits.
The guide was prepared on the assumption that the auditor will have to perform an
audit to accomplish the objectives presented below. However, the auditor may often
determine that work performed by others (EPA annual reviews, other SRF audits, and
Office of Management and Budget [OMB] Circular A-133 audits) may be useful in
meeting the objectives. Audit procedures should assure that auditors build on the work
of others so that there is no duplication of audit effort. Accordingly, while relying on the
work of others, the auditor should exercise judgement whether to perform additional
work in each of the objectives. In such cases, consultation with the OIG is encouraged.
AUDIT OBJECTIVES
Audits of the SRFs administered by states will normally have the following objectives:
• To determine whether the SRF financial statements are presented fairly in all
material respects in conformity with Generally Accepted Accounting Principles
(GAAP).
• To obtain an understanding of internal controls over SRF funds sufficient to
plan the audit to support a low assessed level of control risk for the SRF.
• To determine whether the state has complied in all material respects with laws,
regulations, and the provisions of SRF capitalization grants.
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The product of the audit is expected to include the following:
• Financial statements with an opinion (or disclaimer of opinion) as to whether
the SRF financial statements are presented fairly in all material respects in
conformity with GAAP.
• A report on internal controls related to the SRF financial statements. The
report should describe the scope of testing of internal controls and the results of
tests, and where applicable, refer to a separate schedule of findings and/or costs
questioned.
• A report on compliance that includes an opinion (see Chapter 7 - Audit
Completion and the Auditor's Report) as to whether the state has complied in all
material respects with laws, regulations, and the provisions of the SRF
capitalization grants.
REFERENCE MATERIAL
In planning and conducting financial audits of state SRF's, and reporting the results,
access to and review of certain reference material is important. Reference material is
identified in Appendix B.
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CHAPTER 2 - BACKGROUND
STATUTORY AND REGULATORY AUTHORITY
Title VI of the Clean Water Act of 1987 (the Act) established the SRF program (CFDA
No. 66.458} to replace the wastewater treatment facilities construction grants program.
The SRF program is established in each state by capitalization grants awarded by
EPA. The audit focus is on a state's SRF program, rather than individual
capitalization grants awarded to states by EPA.
The expectation of the SRF program is to create permanent revolving funds in each
state that will provide funds for the state to make loans to local governments to
construct needed wastewater treatment facilities. It can also be used for other types of
projects such as:
• Implementing nonpoint source pollution control management programs under
section 319; and
* Developing and implementing estuary conservation and management plans
according to section 320.
In addition to loans, the SRF can provide the following types of other assistance:
• Refinance existing debt for obligations incurred prior to March 7,1985 for
constructing wastewater treatment facilities.
• Guarantee or purchase insurance for local debt obligations, where such
insurance would improve credit access or lower interest rates.
• Serve as a source of revenue or security for the payments on revenue or
general obligation bonds if the bond proceeds are deposited to the SRF. When
the SRF is used to provide security or guarantees of debt obligations, the
process is known as leveraging. Leveraging increases the funds available for
loans in the early years by using the SRF to offset interest paid on bonds, and
provide a reserve in case of default by the state or local community.
• Provide loan guarantees for similar revolving funds established by
municipaiities or agencies.
• Earn interest on fund accounts, such as loan repayments or a reserve account
used to secure proceeds from a tax-exempt bond issue.
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* Pay the reasonable costs of administering the SRF, provided that the amount
does not exceed 4 percent of all grant awards.
Uses of the SRF are more fully discussed in the Code of Federal Regulations (CFR),
Part 40, Subpart K. The regulations identify the exa'ct types of assistance that the SRF
can provide, and additional requirements, limitations, and procedures for establishing
and operating the SRF.
EPA implements the SRF program in a manner that preserves a high degree of
flexibility for states in operating their revolving funds in accordance with each state's
unique needs and circumstances.
FUNDING THE SRF
EPA's capitalization grants provide the initial SRF financing. The grants require that
the states provide a 20 percent match. The state match can be made by a number of
methods, such as direct appropriation, general obligation bonds, revenue bonds, or
other methods. Through June 30,1997, capitalization grant awards were $13.2 billion
with state matching of $2.7 billion.
When a state receives a capitalization grant, it agrees to a "payment schedule" with
EPA. The "payment schedule" does not represent actual payments, but are authorized
increases to the amount a state can draw from EPA through the Automated Clearing
House (ACH). The payment schedule identifies the dates that the funds will be
available to the state. The state generally has one year after the payment to obligate
the funds, which is known as making "binding commitments". The binding
commitments must equal at least 120 percent of the payments received one year
earlier, which accounts for both the federal and state shares of the SRF.
Cash draws on the SRF are typically made when a state is presented with
reimbursement requests from the loan recipients. In a direct loan program, the state
will draw 83.331 percent of the requested amount from EPA, transfer the state share to
the SRF (16.67 percent), and then issue the reimbursement to the communities
involved. How funds are drawn, and the amounts drawn, will vary for leveraged
programs, depending on the exact method used, but the EPA share wil! be 83.33
percent regardless of whether the funds are disbursed to a community or deposited to a
reserve account as security for bonds.
The Federal and state shares are calculated as follows:
Federal grant
state match
Total SRF funds
Percentage
83.33
16.67
100.00
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KEY DOCUMENTS
In addition to the capitalization grant terms and conditions, there are several other key
documents relating to a state's SRF program:
• Operating Agreement (OA);
• Intended Use Plan (IUP);
• Annual Report; .
• Annual Review; and
• the state's Single Audit Report.
Operating Agreement. At the option of the state, the organizational and administrative
framework and those procedures of the SRF program that are not expected to change
annually may be described in an OA. The OA is incorporated by reference in the
capitalization grant agreement [40 CFR 35.3130(b)].
Intended Use Plan. Prior to each capitalization grant award, the state must prepare a
plan identifying the intended uses of the funds in the SRF and describing how those
uses support the goals of the SRF. The IUP must be prepared annually and must be
subjected to public comment and review before being submitted to EPA (40 CFR .
35.3150).
Annual Report. The state must provide an Annual Report to EPA. The Annual Report
includes information essential to EPA in evaluating the SRF program, and includes how
the state is meeting the goals and objectives of the program [40 CFR 35.3165(a)}.
Annual Review. The Annual Review is EPA's assessment of the success of the
state's performance of goals and activities identified in the IUP and Annual Report, it
also addresses compliance with the terms, of the capitalization grant agreement [40
CFR 35.3165(c)].
State's Single Audit Report. OMB Circular A-133 (formerly A-128) requires a state to
conduct an audit. The scope of this audit includes work that can be of value to the
auditor conducting the SRF financial statement audit.
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CHAPTER 3 - PLANNING THE AUDIT
Conducting an audit of the financial statements of the SRF requires that the audit be
properly planned and supervised. Generally Accepted Government Auditing Standards
(GAGAS) for financial statement audits have incorporated the fieldwork standards
established by the American Institute of Certified Public Accountants (AICPA). The
guidance in the AICPA Statement of Auditing Standards (SAS) No. 22, Planning and
Supervision, provides procedures applicable to planning and supervising an audit.
The auditor plans the audit to determine an effective and efficient way to obtain the
evidential matter necessary to report on the financial statements. The nature, extent,
and timing of planning vary with the size and complexity of the SRF, the auditor's
experience with the particular SRF, and the auditor's knowledge of the SRF's
operations. Audit risk and materiality are also important considerations during the
planning stage. Planning the audit is the key to a quality audit, and requires the
involvement of senior members of the audit team. Although concentrated in the
planning phase, planning is performed throughout the audit. For example, results of
the internal control phase have a direct impact on planning the substantive audit
procedures.
In planning the audit, the auditor needs to: (1) determine the audit scope; (2) obtain
key documents and information; (3) obtain an understanding of the SRF; and (4) define
the engagement with the state and arrange an entrance conference.
AUDIT SCOPE
An audit of a state's SRF financial statements should include the SRF financial
statements for the most current unaudited period. The EPA regional SRF Coordinator
should be contacted prior to initiating the audit engagement to assist in determining the
period of audit. Typically, the SRF financial statements should be available from the
state's Annual Report on the SRF program. The auditor is reminded that the SRF
financial statements are those of the state's SRF management and as such, the state is
required to provide certain explicit and implied assertions with their financial statements
(see Chapter 4 - Management Assertions and Internal Control).
KEY DOCUMENTS AND INFORMATION
Preliminary planning for the audit engagement includes obtaining the key documents
discussed in Chapter 2. In addition, the region's SRF Coordinator should be contacted
to obtain EPA's perspective on strengths or weaknesses of the state's SRF program
and names of state contacts.
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Auditors should carefully review and assess the key documents for planning the
performance of the audit. Auditors are encouraged to build upon the work performed
by others, provided that the auditor is willing to accept full responsibility for the work. In
such cases, the nature, timing and extent of tests performed may be able to be reduced
because of work performed by EPA during its annual review, or by other auditors
performing SRF related audits or audits required by OMB Circular A-133.
OBTAINING AN UNDERSTANDING OF THE SRF
The auditor should obtain a sufficient understanding of the SRF to plan and perform the
audit in accordance with GAGAS and specific EPA requirements. This consists of
gathering information to obtain an overall understanding of the SRF, the origin and
history of the state's SRF, size, organizational structure, mission, operational
strategies, inherent risks, control environment, and internal controls.
The auditor's understanding of the entity and its operations does not need to be
comprehensive but should include:
• SRF management and organization;
* External factors affecting operations;
* internal factors affecting operations; and .
• Accounting policies and procedures.
SRF Management and Organization. As a starting point in gaining an understanding
of the SRF, the state legislation and implementing regulations that established the SRF
should be reviewed. The legislation will normally include the type of fund established
for the SRF, indicate how the SRF will be organized and managed, and establish
levels of authority. Whether the SRF is established within an existing state department
or as an independent entity will affect the accounting policies and internal controls of
the SRF. Legislation and regulations may also include information about cash
management, investments, debt issuance, and interaction with other state departments
or funds.
The auditor should identify key members of management and obtain a general
understanding of the organizational structure. The main objective is to understand how
the entity is managed and how the organization is structured. The style of
management will have a significant impact on the financial statements, internal control
structure and effectiveness, and the conduct of the audit.
One of the first steps in understanding the SRF and the organization is to determine
the type of fund that the state has established for the SRF. The type of fund used will
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dictate many of the accounting principles and policies to be followed, as well as the
presentation of the financial statements. Since one of the primary objectives of the
SRF is to provide a permanent financing institution in each state, much like a bank or
loan company, the accounting and the financial statements should be similar to those
of a financial institution. As such, the preferred method of accounting for the SRF is as
a proprietary (enterprise) fund. However, many states account for the SRF as a special
revenue fund or a trust fund, and some states account for the SRF as part of the
general fund.
External Factors. Regardless of how the state accounts for the SRF, there are a
number of factors that affect the operations, both external and internal. External factors
might include: (1) source of funds for the state matching requirement; (2) whether the
state has "leveraged"2 its program; (3) current political climate; and (4) relevant
legislation.
Internal Factors. Internal factors might include the: (1) type of fund used to account
for the SRF; (2) size of the fund; (3) composition of the loan portfolio; (4) structure of
the program and complexity of operations; (5) number of other governmental agencies
involved; (6) qualifications and competence of key personnel; and (7) turnover of key
personnel.
Accounting Policies and Procedures. In identifying accounting policies and
procedures, the auditor should consider applicable accounting principles and
pronouncements, including whether the entity is likely to be in compliance with those
principles. The auditor should also consider changes in accounting principles that
affect the entity, and whether entity management appears toTollow aggressive or
conservative accounting policies. Understanding the state's SRF operations in the
planning process enables the auditor to identify, respond to, and resolve accounting
and auditing problems early in the audit.
ENGAGEMENT LETTER AND ENTRANCE CONFERENCE
An engagement letter should be sent to the state (with a copy to the Regional SRF
Coordinator). At a minimum, the letter should include the following items: (1)
announcement of the audit, including the audit scope and objectives; (2) proposed
entrance conference date; (3) information needed prior to or at the entrance
conference; (4) schedules to be prepared by the state; and (5) name of the audit team
leader. A sample engagement letter is included in Appendix C.
Leveraging is when a state issues debt to increase the amount available for loans. The SRF can
be used to guarantee the debt and interest earnings can offset the interest on the debt There are
a number of variations on two basic methods used by the states. Specific auditing and financial
reporting issues involved will depend on the leveraging method.
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CHAPTER 4 - MANAGEMENT ASSERTIONS
AND INTERNAL CONTROLS
The majority of an independent auditor's work in forming an opinion on the financial
statements consists of obtaining and evaluating evidential matter concerning the
assertions in the financial statements. The internal control system consists of policies
and procedures established by management to ensure that its assertions are valid.
MANAGEMENT ASSERTIONS
The financial statements of the SRF are the representations of management. The
financial statements are prepared according to various management assertions, which
are either explicit or implied.
The management assertions in the financial statements include the following:
• Existence or occurrence: The assets and liabilities of the organization exist at
a given date, and recorded transactions occurred during the period.
• Completeness: The financial statements include all transactions and accounts
that should be included.
• Rights and obligations: Assets are proper rights of the organization and
liabilities are proper obligations.
• Valuation or allocation: The accounts are recorded and presented at
appropriate amounts.
• Presentation and disclosure: All components of the financial statements are
properly classified, described and disclosed.
The audit serves as an independent review of the assertions, and verifies that
management's assertions are accurate. After the internal controls have been reviewed
and documented, the effectiveness of management's assertions is assessed, as .
discussed in the section titled "Assessing Control Risk."
Appendix D lists each management assertion, along with potential misstatements, and
specific control objectives to address each assertion. Appendix E is a flowchart .
depciting management assertions and the relationship to the internal control review
process.
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INTERNAL CONTROLS
Internal controls can be reviewed once an understanding of the organization,
management and accounting policies is obtained. The AtCPA's second standard of
fieldwork states "a sufficient understanding of internal control is to be obtained to plan
the audit and determine the nature, timing, and extent of tests to be performed." SAS
No. 55, Consideration of Internal Control in a Financial Statement Audit, as amended by
SAS No. 78, Consideration of Internal Control in a Financial Statement Audit: An
Amendment to SAS No. 55, provides guidance on the auditor's consideration of an
entity's internal controls in financial statement audits performed in accordance with
generally accepted auditing standards.
Internal control is defined as:
A process-effected by the entity's board of directors, management, and other
personnel-designed to provide reasonable assurance regarding the
achievement of objectives in the following categories: (a) reliability of financial
reporting, (b) effectiveness and efficiency of operations, and (c) compliance with
applicable laws and regulations.
The objectives are what the entity strives to achieve. The components of the internal
control system represent what is needed to meet those objectives. The internal control
system consists of five interrelated components: the control environment, risk
assessment, control activities, information and communication, and monitoring. The
controls that are relevant to an audit pertain to the state's objective of preparing
financial statements that are fairly presented in conformity with generally accepted
accounting principles or other comprehensive basis of accounting.
INTERNAL CONTROL STRUCTURE
The objectives of the internal control structure are to provide reasonable assurance
that assets are safeguarded against loss, and that transactions are properly recorded
to validate the management assertions. Following are the elements of the internal
control system, and their relationship to the audit of the financial statements.
Control Environment. The control environment sets the overall tone of the
organization. It represents the collective effect of various factors on establishing,
enhancing or mitigating the effectiveness of specific policies and procedures. The
control environment reflects the overall attitude and actions of the SRF program within
the state, including legislative, management, staff and others concerning the
importance of the controls. The control environment includes such factors as:
• Integrity and ethical values;
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• Commitment to competence;
• Legislature or governing board;
• Management's philosophy and operating style;
• Organizational structure;
• Assignment of authority and responsibility; and
• Human resources policies and practices.
The importance of these factors will vary according to the size, complexity, and
sophistication of the SRF program. The auditor should obtain enough knowledge of the
control environment to understand the attitude of management and its actions
regarding the control environment. Auditors should also be aware that the substance
of management's policies and actions are more important than the form because
appropriate policies and procedures may be established, but not followed.
To judge the effectiveness of the control environment, the auditor needs to consider
these factors and how the factors affect the audit. However, not all factors will have the
same weight in each case, and the auditor does not need to understand each factor to
the same degree of detail. The extent of understanding for each factor is a matter of
professional judgement
Risk Assessments. Risk assessment is the identification of risks that may prevent the
SRF program from meeting its organizational objectives, and forms the basis for how
the risks should be managed. The risk assessment for financial reporting purposes
involves identification, analyses, and management of risks relevant to preparing
financial statements in conformity with generally accepted accounting principles.
Risks can be internal, external or both. Risks may affect the organization's ability to
record and process financial data consistent with the management assertions. Risks
can arise or change due to:
* Changes in operating environment;
• New personnel;
• New or revised information systems;
• Rapid growth or technology changes;
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• Reorganizations; or
• Accounting pronouncements.
Sufficient knowledge of the organization's risk assessment process is necessary to
understand how management considers risks relevant to financial reporting objectives,
and determine what actions should be taken to address those risks. Auditors need to
. understand that the organization's risk assessment will likely differ from the auditor's.
The auditor's risk assessment is mainly concerned with likelihood that material
misstatements in the financial statements could occur. The organization's risk
assessments will include factors outside the financial statements.
Control Activities. Control activities are the policies and procedures that assist
management in carrying out its directives. Control activities are generally the specific
activities or procedures that management has established to address the risks that the
management assertions contained in the financial statements are met. Control
activities applicable to the SRF would include the following:
• Performance reviews;
* Information processing;
• Physical controls; and
• Segregation of duties.
A thorough understanding of the control activities is vital to planning the audit. As
information is obtained about other components of the internal control system,
information about the control activities is also obtained. For example, when reviewing
the cash receipts and disbursement functions, the auditor would also determine if bank
accounts are reconciled, and who reconciles them. The presence or absence of
control activities learned from reviewing other activities should have an effect on the
auditors decision to devote additionaltime to certain areas of the audit.
The goal is to determine whether the internal controls are adequate to identify potential
misstatements in the financial statements, and to design substantive tests to provide
reasonable assurance that misstatements do not occur.
Information and Communication. The information and communication system
relevant to financial reporting includes the accounting system. The system consists of
methods and procedures to record, process, summarize and report transactions, and to
maintain accountability over assets and liabilities. The accounting system has a
significant effect on the potential for misstatement, and the design of substantive audit
tests and procedures.
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The system should be effective in:
• Identifying and recording all valid transactions;
• Describing the transactions in enough detail to permit proper classification of
transactions;
• Measuring the proper value of transactions;
• Determining that the transactions are recorded in the proper time period;
• Presenting the transactions and related disclosures in the financial
statements; and
• Allowing and promoting communication among employees.
The type of fund that the state has established for the SRF will dictate many of the
accounting principles and policies that are followed, as well as financial presentation of
the financial statements. One of the objectives of the SRF was to provide a permanent
financing institution in each state, much like a bank or loan company. Therefore, the
accounting and the financial statements should be similar to those of a financial
institution. Accounting for the SRF as an enterprise fund3 allows all transactions to be
recorded in a single fund, including leveraging operations, and facilitates preparing the
financial presentation necessary to assess the financial position and results of
operations. However, some states account for the SRF in other types of funds, most
commonly in Special Revenue funds, although at least one state uses a trust fund, and
another accounts for the SRF as part of the general fund. Regardless of the fund type
used, the auditor should thoroughly understand the accounting records, supporting
information, and specific accounts included in the financial statements for the fund type
used by the state.
If the SRF is not accounted for as an Enterprise fund, there will likely be several other
types of funds or account groups involved, such as the general fund, debt service
funds, capital outlay funds, and the long-term debt and fixed assets groups of accounts.
Auditors should have a complete understanding of how the different funds are
interrelated for the financial statements to fairly present the financial position of the
SRF. -
Monitoring. The effectiveness of management's specific policies for monitoring
internal controls, including internal and external audits, should be evaluated, internal
Non-expendable trust fund would also be acceptable, as the accounting is the same as for
enterprise funds.
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and external audits are important aspects of monitoring internal controls, but monitoring
can also include the normal recurring operations of the organization. For example,
errors can be discovered during the normal operations that could identify a control
activity or procedure that is not effective.
OBTAINING AN UNDERSTANDING OF INTERNAL CONTROLS
The primary methods of obtaining an understanding of the internal controls needed to
make decisions about the extent of reliance that can be placed on the internal control
system include:
• Prior experience with the organization;
• Inquiries of appropriate management, supervisory and staff personnel;
• Inspection and testing of documents and records; and
»
• Observation of the organization's activities and operations.
The extent of the procedures will vary with the size and complexity of the SRF, previous
experience, the particular controls involved, and professional judgement.
DOCUMENTING THE UNDERSTANDING
The understanding of Internal Controls should be property documented in the work
papers. The exact form and extent of the documentation will vary according to the size
and complexity of the organ ization.
The documentation required for a small, direct loan program with a small number of
loans would not be as extensive as a leveraged program with hundreds of loans, bonds
payable, bond reserves, and other complexities. A small program could be adequately
documented by a memorandum in the files that describes the system, whereas a larger
program may require several files, flowcharts, questionnaires, and other audit aides.
Regardless of the form and quantity, the documentation should include information on:
• The classes of transactions that are important to the SRF;
• How the transactions are initiated;
• The source documents;
• The accounting processing, including computer files;
• The chart of accounts;
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• Samples of documents, journals, ledgers and reports generated by the
financial reporting system;
• Descriptions of control activities, and;
• How the state provides the matching share of the SRF; and
• The financial reporting process used to prepare the financial statements.
If the SRF is a leveraged program, the amount of documentation would generally
increase, and should address details on the leveraging, including:
• A description of the leveraging method used;
• The type of bonds issued, such as general obligation, revenue, or other
bonds;
• How the SRF issues and accounts for bond proceeds, and the related
liabilities, reserves, interest earned and paid, bond maturities, and other related
matters;
• Debt service requirements; and
* Financial disclosure requirements, such as interest rates, covenants,
contingencies, and restrictions that may be placed on other assets.
ASSESSING CONTROL RISK
After the internal control structure has been reviewed and documented, auditors need
to assess the risk of a material misstatement in the financial statements. The review
procedures should be sufficient to obtain an understanding of internal control that will
support a low assessed level of control risk. Assessing control risk is a process of
evaluating the design, effectiveness, and structure of the internal controls in preventing
or detecting a material misstatement in the financial statements.
Control risk should be assessed for relevant assertions that are related to each
significant account balance or class, and may be assessed for specific objectives that
relate to the assertions.
However, not all assertions need the same level of evaluation because some
assertions may not be significant for certain account balances or classes of
transactions. Similarly, not all assertions need to be assessed,for every account
because some assertions are affected by the same controls. For example, the
assessment of control risk of the existence, rights and obligations, and gross valuation
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of loans receivable could be made concurrently because the assertions are all affected
by the same controls.
Low Control Risk. Assessing control risk at less than the maximum is related to the
effectiveness of internal controls in preventing a material misstatement of the financial
statements. The process involves identifying specific controls for specific assertions
that are likely to prevent a material misstatement, and testing the effectiveness of the
specific controls.
The controls can directly or indirectly relate to a particular assertion. The more direct
the control, the more effective the control is likely to be in reducing control risk.
Control tests are intended to assess the effectiveness of the control, and whether the
control is suitable to prevent or detect misstatements in financial statement assertions.
Tests normally include procedures such as making inquiries of appropriate personnel,
inspecting documents and reports, and observing specific controls and procedures. A
combination of procedures may be necessary to obtain a level of understanding
sufficient to make an assessment of the control risk.
When the control risk is considered to be less than maximum, the files should contain
enough evidential matter to support the assessment. The evidential matter that is
sufficient to support the assessed level of risk is a matter of judgement, and can vary
from year to year. For complex organizations and programs, flowcharts,
questionnaires, and decision tables may be helpful in applying the tests, analyzing the
results, and documenting the assessed level of risk. Decisions about the nature, extent
and timing of tests of controls al^o affect the degree of assurance the evidential matter
provides.
I
Maximum Control Risk. Assessing control risk at the maximum means that there is a
risk of a material misstatement in an account that would not be detected or prevented
by the internal controls. Control risk should be assessed at the maximum level for
some assertions if the review of the internal control structure reveals that:
• Controls are unlikely to pertain to an assertion; or
• Controls are not effective.
The level of assurance needed from substantive tests remains the same whether
control risk is assessed at the maximum because of audit efficiency reasons or
ineffective controls. The fact that the controls are ineffective may also raise questions
about the auditability of the account, or the entire organization. In such cases,
changing the nature, timing and extent of substantive procedures may be warranted.
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The type of fund used to account for the SRF will also influence control risk
assessments. For example, a leveraged program accounted for as a special revenue
fund would generally have a higher risk of misstatement than a similar program
accounted for as an enterprise fund because not all transactions are accounted for in
the special revenue fund. The interaction between other funds and combining the other
funds into the financial statements would generally increase the chance of a material
misstatement in the financial statements.
Nature. Extent and Timing of Tests. The types of tests depends on the particular
assertion being tested, and the evidential matter that is available to evaluate the
controls. Some controls are well documented, and for others, such as segregation of
duties, documentation may not exist. Assessing whether there is adequate segregation
of duties would be primarily by observations of the operations and inquiries of
appropriate personnel. Evidence obtained directly, such as by observing the
operations of a department, provide more assurance than evidence obtained by other
methods, such as inquiries. However, auditors should be aware that the control
observed may not be followed if the auditors were not present.
More extensive tests normally provide increased evidence about the consistency of the
application of a control, and may support a lower assessed control risk. For example,
observing a daily procedure only once may not be representative of how the procedure
is foiiowed on other days, or by other people. Additional observations or other
procedures may be advisable or necessary to obtain a thorough understanding of the
control, and the consistency of the application.
The timing of audit tests also influences the degree of risk associated with the
assertion. Tests that pertain to only one point in time would be appropriate for some
tests, but not others. The results of tests should be evaluated with the timing of the test
in mind. When tests may not be representative of the entire audit period, other tests or
procedures should be conducted to provide evidential matter about the entire period.
Evidence obtained from prior audits and interim periods may provide the additional
information needed to assess the control risk. However, if the controls or procedures
have changed since the prior audit work, reliance on prior work would not be
appropriate. The length of time that has elapsed between the prior work and the
current audit would also influence the reliance placed on the prior work. When using
prior or interim work, the auditor should consider:
• Evidence about changes in the effectiveness of the design of the controls:
- Are the system and controls in place the same as in the prior or interim
period?
- Is the organization the same, or has it changed?
• Evidence about changes in operating effectiveness: :
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Adverse Conditions:
- Has there been a change in management attitudes about internal
controls?
- Is there any change in the nature or quantity of the transactions
processed?
- Is employee turnover excessive?
- Were there staff reductions that increased the workload for remaining
employees?
Positive Conditions:
- Are procedures manuals well documented and followed?
- Is the department closely supervised, with good communication lines
and lines of responsibility?
- Have there been periodic reviews by internal auditors?
• Are computer controls adequate?
If adverse conditions are not present, the prior audit evidence would be more relevant,
and could be given greater reliance. If there have been a number of changed
conditions, relying on evidence gained from prior audit work would not be appropriate.
When interim audit work is performed for the current year, the auditor needs to
document that the procedures in place during the interim period reviewed are still valid,
and being followed. If the procedures, or any other aspects of the organization have
changed that effect the controls being tested, then the interim work should not be relied
upon for assessing the control risk.
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CHAPTER 5 - AUDITING THE FINANCIAL STATEMENTS
This chapter focuses on the first audit objective: To determine whether the SRF
financial statements are presented fairly in all material respects in conformity with
GAAP. It provides a general overview of the types of funds and accounts that may
support the SRF financial statements, and identifies the auditing and reporting
concerns that face SRF auditors. States use different methods of accounting for SRFs
and its operations. As such, this guide cannot cover every situation -in ail states, and
professional judgement must be used in conducting audits.
FINANCIAL REPORTING ENTITY AND SRF FINANCIAL STATEMENTS
With the audit objective focusing on the SRF financial statements, ideally only the
accounts of the SRF should be audited, with the opinion on the SRF financial
statements. In some states, however, the organization of the SRF may make it more
efficient to audit the financial statements of the entire entity, with supplemental
statements supporting the SRF portion. In the latter situation, it is essential that the
supplemental SRF financial statements be included in the auditor's report.
BASIS OF ACCOUNTING AND TYPES OF FUNDS
Understanding the basis of accounting and type of fund chosen by a state for the SRF
is an essential first step in auditing the SRF financial statements. The basis of
accounting determines when transactions are recorded, and the type of fund (the
measurement focus) determines what transactions and events are recorded.
The National Council of Governmental Accounting (NCGA) Concepts Statement no. 1,
Objectives of Accounting and Financial Reporting for Governmental Units, concludes
that the goals of governmental accounting and financial reporting are to:
(1) provide financial information useful for making economic,
political, and social decisions, and demonstrating accountability and
stewardship and (2) provide information useful for evaluating
managerial and organizational performance.
An important element in achieving these goals is the selection of a basis of accounting
and type of fund for the SRF that provides the necessary information to meet these
goals. The selected basis of accounting and type of fund have a significant effect on
the accounting principles governing the SRF.
Auditor's should also keep in mind that a state may maintain its accounting records on
one basis of accounting, and prepare the financial statements of the SRF on a different
basis. Many states account for the SRF on the cash basis during the year, and make
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adjustments to convert to the accrual or modified accrual basis to present the financial
statements according to GAAP.
Basis of Accounting. The basis of accounting determines when revenues, expenses,
expenditures, and transfers are recorded in the accounting records and reported in the
financial statements. The three primary bases of accounting encountered are cash,
accrual, and modified accrual.
Cash. Under the cash basis, receipts are recorded as revenues, and disbursements
are recorded as expenditures4. The balance sheet has only two accounts, cash and
fund balance. The operating statement (income statement) also has only two accounts,
revenues and expenditures. The excess of revenues over expenditures is "closed" to
fund balance at the end of the accounting period.
The NCGA has concluded that cash is not an appropriate basis of accounting for
governmental organizations. Fortunately, states that use the cash basis of accounting
also maintain records of loans made and repayments. With such supplemental
information, the states are able to prepare SRF financial statements on the .modified
accrual method. If the accounting is maintained on the cash basis, it will be necessary
for the state to modify the SRF financial statements to reflect a presentation of financial
information on the accrual or modified accrual bases.
Accrual. The accrual basis reflects the financial effects of transactions and other
events that have financial consequences in the period in which they occur rather than
in the periods in which the cash is received or paid. The elements of accrual
accounting include:
• Property matching revenues earned against costs incurred;
« Deferring expenditures and subsequent amortization of deferred costs;
• Deferring revenues until earned (revenues received in advance);
* Capitalization of certain expenditures and depreciation of capitalized costs;
and
• Accruing revenues earned and expenses incurred.
The term expenditures is used to indicate decreases in the financial resources (or increases in
current liabilities). Expenditures can be for capital items, such as constructing new buildings, or
operating expenditures, such as salaries and benefits. Expenditures of a governmental entity are
not the same as expenses of a commercial enterprise.
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Very few governmental agencies use the full accrual basis because measuring income
is not the primary objective of governmental entities.
Modified Accrual. Most government entities use a combination of the cash and
accrual basis known as the modified accrual basis. The modified accrual basis is
appropriate because the primary objective of accounting for governmental funds is to
reflect the sources and uses of funds, and not to measure income for the period. The
modified accrual basis records revenues (including issuance of debt and funds
received for other governmental units) when they are susceptible to accrual. In order to
be susceptible to accrual, it needs to be both measurable and available to finance
current expenditures.
For example, interest on loans that has not been received (this assumes loan payments
are made once or twice per year) would be accrued at the end of the year because it
meets both criteria: interest is measurable and available to meet obligations of the
current period. The calculation would be made on the number of days from the date of
the last payment to the end of the year, multiplied by the interest rate. Most
expenditures, such as salaries, supplies and other administrative expenses, would be
accrued because they are measurable when incurred. However, loan funds committed
but not fully paid out to a loan recipient at year end would not be accrued because the
loan agreement could be canceled.
Types of Funds. In addition to selecting a basis of accounting for the SRF, states
also use different types of funds to record SRF activity. The following section briefly
describes the types of funds that may be encountered, and distinctions between the
types as they apply to the SRF.
Proprietary Funds. A proprietary fund is used to account for governmental activities
that are similar to commercial enterprises. The two types of proprietary funds are
Enterprise Funds and Internal Service funds. The most common examples of
enterprise funds are airports, hospitals, state lotteries, state insurance funds, and
public utilities, such as local water, sewer, and electric operations. Internal service
funds operate the same, but provide goods and services only within the organization,
such as motor pools, data processing, and centralized maintenance. General Services
Administration is a good example of an internal service fund.
Accounting for enterprise funds is similar to commercial enterprises because the
activities performed are basically the same, however, the purpose of the fund is
different. The purpose of a proprietary fund is to provide a service to users at a
reasonable cost, whereas the purpose of a commercial entity is to maximize its return
on invested capital.
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Enterprise fund accounting works well for the SRF, and is the preferred fund type for
the SRF. The SRF program was established as a permanent financing source in each
state to provide financing to qualified agencies at reduced interest rates. Since the
SRF acts like a financing company or fending institution, the accounting should be
similar. The advantage to the proprietary fund is that all transactions, including those
of leveraged funds, can be accounted for within a single fund. Having all transactions
recorded in one fund also facilitates financial reporting, and make the financial
statements easier to understand.
Nonexpendable Trust Funds. Nonexpendable trust funds are used to account for
fiduciary operations where the trust principal (capitalization grants) may not be
expended and must remain intact. Earnings can either be expendable or
nonexpendable. If used for an SRF, the earnings would be nonexpendable. A number
of states account for SRF's as nonexpendable trusts. The accounting is the same as for
enterprise funds.
Special Revenue Funds. Special revenue funds are established to account for the
proceeds of a specific revenue source (other than special assessments, expendable
trusts or sources for major capital projects) that are legally restricted to expenditures for
specified purposes. Examples of special revenue funds would be a state gasoline tax
for which expenditures are restricted for road and highway maintenance, and a school
district that is financed partially by property taxes. The NCGA recommends that special
revenue funds be used only when legally mandated.
Many states account for the SRF as a special revenue fund, primarily because the SRF
replaced the construction grant program. These states continued accounting for the
SRF as they did for the construction grants program.
General Fund. Use of a general fund to account for a SRF is the least desirable
option, however, at least one state operates its SRF as part of a general fund.
i
Every state or local government has a general fund. The purpose of a general fund is
to account for all financial resources of an entity except for those resources that must
be accounted for in a special purpose fund. The general fund is not used to account for
fixed assets, long-term debt, trust and agency funds, proprietary funds, or special
revenue funds. General funds normally use the modified accrual basis of accounting.
The measurement focus for the general fund is to determine what transactions and
events should be recorded, and identify the net financial resources available for,
appropriation and expenditure.
The general fund accounts for the current operations of the government. Expenditures
are generally for basic governmental services such as public safety, health and
welfare, and general government administration, such as accounting, auditing, building
departments, data processing and similar activities. Revenues for the general fund
•*
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usually are derived from income taxes, property taxes, sales taxes, fines and penalties,
permits and licenses, and other sources.
AUDIT CONSIDERATIONS
The basis of accounting and fund type address when transactions are recorded and
what transactions are recorded. Regardless of the state's basis of accounting and
fund type, there are certain common audit considerations for all SRF financial
statements.
Cash and cash equivalents, loans receivable, contributed capital and fund balances,
and revenues and expenses are material accounts to the SRF financial statements.
Conceptually, common audit procedures (not audit steps) can be applied, regardless of
the accounting or fund type.
Materiality. The concept of materiality recognizes that some matters are important for
the financial statements to be presented fairly, in conformity with GAAP, while other
matters are not. Financial statements are materially misstated when the effects of the
omission(s) or misstatement(s) of accounting information make it probable that the
judgment of a reasonable person relying on the information would have been changed
or influenced by the omission(s) or misstatement(s). Misstatements can occur because
of errors, the failure to apply accepted accounting principles, departures from fact, or
omissions of necessary information.
Determining what is material is a matter of professional judgement that will vary
depending on the state and the circumstances, What is material to one state may not
be material to another. What is material in one year may not be material in another
year. Auditors should plan the audit and perform auditing procedures so that the risk of
a material misstatement is at a low level.
Cash and Cash Equivalents. Auditing cash depends primarily on how the SRF is
organized. If cash is controlled by a state treasurer (or similar department separate
from SRF operational management), SRF management may have little or no
involvement in the actual disbursement of cash. If the SRF is a separate agency or
authority, its cash may be totally controlled (including disbursement) by SRF personnel.
In the latter situation, the cash may be with a commercial bank, and risk of
misstatement of cash balances could be substantially increased.
The objective of auditing cash is to obtain reasonable assurance that:
• The recorded balances exist and are owned by the SRF;
• The recorded balances are complete and stated at realizable amounts;
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• Balances are properly presented in the financial statements;
• Restrictions on the availability or use of cash are identified and disclosed; and
• Cash receipts, disbursements and transfers between accounts are recorded in
the proper period.
The specific of audit steps and procedures will depend on the circumstances, but
generally include:
• Obtaining a schedule of cash for the SRF;
• Making sure the cash balances agree with the trial balance;
• Reviewing and testing reconciliations at the balance sheet date;
• Confirming cash balances and interest earnings with the bank, state treasurer
or other department responsible for cash;
• Reviewing and testing transactions before and after the balance sheet date to
determine if the transactions are in the proper period; and
• Reviewing and testing transfers between accounts.
Additional procedures would be involved if the SRF has accounts with commercial
banks. Auditors may want to obtain cut-off statements to review checks that were
outstanding at the balance sheet date that cleared after year end, and determine that
cash was properly stated. If there are multiple bank accounts, transfers between
accounts should be scrutinized to determine if all transactions are legitimate, and
property recorded.
Disclosures: Cash and cash equivalents need to be disclosed in SRF financial
statements according to GASB Statement No. 3, Deposits with Financial Institutions, -
Investments [Including Repurchase Agreements] and Reverse Repurchase
Agreements. Also, some cash balances may be restricted, and not available for the
operations of the SRF. The terms of any restrictions, such as uses or collateral for
other activities, should be fully investigated and disclosed.
Cash may also include investments of excess cash, often called "cash equivalents."
Whether the cash is a cash equivalent will depend on the particular investment. The
type of investment, terms, conditions, maturity and availability will govern whether the
investment is cash or not. Typically, money market funds, excess funds with the state
treasurer, certificates of deposits and similar investments are considered cash.
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Loans Receivable. Loans receivable will normally be the most significant asset of the
SRF, and also generate the largest portion of revenue. Loans should be reviewed to
determine how: (1) construction period interest is calculated; (2) such interest affects
the final loan amount; and (3) the transaction is reported in the SRF financial
statements.
The objectives of the audit procedures performed are to provide reasonable assurance
that:
• Loans exist at the stated values and are owned by the SRF;
• Loans are properly classified, described and disclosed in the financial
statements;
• Recorded loans include all such assets of the SRF, and the financial
statements include ail related transactions during the period;
* Interest income, fees and costs and the related balance sheet accounts
(accrued interest receivable, unamortized fees and costs, unamortized premiums
or discounts) are properly measured and recorded; and
• Commitments, guarantees, recourse provisions and collateral are properly
disclosed.
Basic audit procedures for loans receivable would include:
• Obtaining a schedule of loans at the balance sheet date;
• Inspecting loan documents to determine whether the loan was properly
approved, and include the amount, terms, fees, interest rates, purpose,
repayment terms, and other conditions;
• Reviewing draws on loans and calculations of interest earned and accrued;
• Confirming loans and terms with borrowers;
• Performing analytical procedures on the loan portfolio to identify trends or
possible collection problems; and
• Reviewing loans and loan activity to determine if all loans are collectible. If
not, an allowance for uncollectible loans should be established.
If loan fees are charged by the SRF, FASB Statement No. 91, Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
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Initial Direct Costs of Leases, which has been incorporated by GASB 10, Accounting
and Financial Reporting for Risk Financing and Related Insurance Issues, will apply.
Basically, FASB 91 requires any fees to be accounted for as an adjustment of the .
stated interest rate. Many states charge fees for various purposes. FAB 91 and GASB
10 are not applicable only to the banking industry; they are applicable to all loans
entered into by a creditor agency.
For leveraged programs, the procedures may vary because the SRF acts as security or
guaranty of the borrowers debt, and the audit procedures would need to be expanded
to cover the circumstances.
Disclosures: Disclosures for loans receivable should include:
• Major groups of loans (leveraged versus direct, completed loans and loans in
progress);
• The interest rates and method of recognizing interest income, including loan
fees and costs;
• A schedule of principal repayments due by year for next five years;
• Major loan recipients; and
• A discussion of the allowance for uncollectible accounts (or a statement that
management considers ail loans fully collectible).
There may be other factors that need to be disclosed. For example, if a major loan was
refinanced or restructured, the details would need to be fully disclosed.
Contributed Capital and Fund Balances. One of the major differences between the
type of fund used to account for the SRF is in the area of equity. Regardless of how a
state accounts for its SRF, the SRF financial statements need to show cash, loans
receivable, and equity. The equity section needs to identify EPA contributions, state
matching funds (except where state match is funded by debt from the SRF), and
cumulative fund balance/retained earnings.
Under the strict use of the special revenue fund, only fund balance would be reported,
as all contributions from EPA and the state matching funds, as well as interest
earnings, would be recorded as revenues, and all disbursements would be
expenditures. As the excess of revenues over expenditures is closed to the fund
balance at the end of each year, the balance sheet would not fairly present the financial
position of the SRF, because loans receivable, the major asset of the SRF, would be
included as part of fund balance. There would be no distinction in fund balance for
EPA's contributions, state matching amounts, or retained earnings.
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Since cash basts special revenue funds do not facilitate presenting the financial
position of the SRF in a format that meets EPA's needs, most SRF's will be converted
to the modified accrual basis for financial statement presentation. A common audit
situation, at least in initial audits, will be to "convert" the equity section from the cash
basis to an accrual basis. In some cases, the equity section will need to be
reconstructed in order to present the financial statements in accordance with GAAP.
The specific steps involved in reconstructing equity are beyond the scope of this guide,
and will vary depending on each situation, the records available, and the accounting
system. However, common procedures that may assist the conversion or
reconstruction would be to determine:
• Total assets and liabilities;
• Total EPA capitalization grants awarded;
• Draws made on each grant;
* Totai loans awarded, outstanding, and principle repaid;
• The amount of state matching funds, and how the state match is made (direct
contribution, bonds from within or outside the SRF); and
• Any accruals or adjustments made in prior years.
Some of this information (which should be obtained as part of normal audit procedures)
can be obtained from the Regional SRF Coordinator. Auditors should confirm with the
Regional SRF Coordinator the total capitalization grants awarded and draws at the
balance sheet date (and for the first week or two following the balance sheet date).
Other departments within the state may be able to provide information that would also
be helpful.
Disclosures: There are a number of disclosures for equity that are useful for EPA and
others in managing the program. Total capitalization grants awarded, draws to date,
state matching funds (and how state match is made) are all critical disclosures.
Additional disclosures will vary depending on the circumstances.
Revenue and Expense Accounts. Revenue accounts for the SRF will primarily be
interest earned on loans, fees on loans, and investment earnings. Expenses will be for
administering the program, and include salaries and benefits, and other expenses. For
those programs that issue bonds, interest will likely be a significant expense.
There are no specific audit procedures that are unique to the SRF for auditing
revenues and expenses. Specific procedures depend on the situation involved.
Generally, interest income on loans can be tested, confirmed and recalculated, as can
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interest expense. Analytical procedures and trend analysis applied to various accounts
and relationships can provide useful information to verify or substantiate balances, and
indicate possible misstatements.
Other Accounts. There will likely be other accounts on the balance sheet, such as
accrued receivables, investments receivables, accounts payable, accrued expenses
and others. Leveraged programs will normally involve more accounts, especially in
cash and cash accounts with trustees. Auditing procedures will vary, and depend on
the account, amount, and other factors. The auditor is expected to use professional
judgement in determining specific procedures to apply to all accounts.
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CHAPTER 6 - COMPLIANCE AUDITING
This chapter addresses the third audit objeptive: To determine whether the state has
complied in all material respects with laws, regulations, and the provisions ofSRF
capitalization grants. It provides guidance on the compliance matters in SRF
capitalization grants that the auditor should address during the audit. Since the
significance of a particular compliance matter can vary from state to state, professional
judgment in the extent of compliance testing must be exercised.
BACKGROUND
The compliance auditing necessary to satisfy the audit objective compares favorably
with the compliance auditing required by an OMB Circular A-133 audit when the SRF is
a major program. The latest OMB Circular A-133 Compliance Supplement (May 1998)
includes the SRF program compliance considerations when performing a Single Audit.
BUILDING ON THE WORK OF OTHERS
In planning the audit effort to satisfy the compliance audit objective, the auditor should
ascertain whether other auditors have performed work that will partially or completely
satisfy the audit objective. In particular, if an OMB Circular A-133 audit has been
performed and the SRF was treated as a major program, the work and work papers of
the A-133 audit should be reviewed. In instances where the A-133 audit does not
cover the period under audit, the work and work papers of the A-133 audit can still
provide valuable insight into the state's compliance with SRF requirements.
Another source of compliance information is the annual review by the Regional SRF
Coordinator. While the annual review is not an audit, it often addresses SRF
compliance matters and can assist the auditor in determining compiiance aspects that
may/may not be problem areas.
COMPLIANCE REQUIREMENTS
A. Allowabilitv for Specific Activities.
Audit Objective: To determine that SRF funds are used only for qualified projects, and
that the type of assistance provided is allowable. .
The SRF may provide financial assistance: (1) to municipalities, inter-municipal,
interstate, or state agencies for the construction of publicly owned treatment works as
defined in Section 212 of the Act that are on the state's Project Priority List; (2) for
implementing nonpoint source management programs under Section 319 of the Act;
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and (3) for developing and implementing estuary management plans under Section 320
of the Act.
There are five types of financial assistance that can be made to local agencies:
1. Loans (not grants).
2. Refinance existing debt obligations.
The guarantee or purchase of insurance for local debt obligations.
3.
4.
5.
The guarantee of or use as a source of repayment for SRF debt
obligations (provided that the net proceeds of the sale of such
bonds are deposited in the SRF).
Loan guarantees for similar revolving funds established by
municipalities or inter-municipal agencies.
In addition, the SRF can be used to pay administrative expenses incurred by the state
for managing the SRF (up to four percent of the capitalization grant). Any interest
earned from SRF funds must be credited to the fund.
B. Allowable Costs/Cost Principles.
Audit Objective: To determine that SRF administrative expenses (including indirect
costs) are reasonable and allowable in accordance with OMB Circular A-87 cost
principles.
A maximum of 4 percent of all capitalization grants received and added to the SRF may
be used for reasonable and allowable costs incurred for administration and
management of the SRF program, including management of projects receiving financial
assistance.
C. Cash Management.
Audit Objective: To determine that the state has drawn cash consistent with the SRF
requirements.
The state must establish cash management procedures consistent with the intent of
Congress. Cash can only be drawn from EPA for allowable expenses. The timing of
the draws depend on the type of assistance, as follows:
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1. Loans - when the SRF receives a request from a loan recipient, based on
incurred costs, including pre-building and building costs.
i
2. Refinance or purchase of municipal debt - generally, when at a rate no
greater than equal amounts over the maximum number of quarters that
payments can be made, and up to the portion of the LOG committed to the
refinancing or purchase of the local debt.
3. Purchase of insurance - when insurance premiums are due.
4. Guarantees and security for bonds - immediately, in the event of imminent
default in debt service payments on the guaranteed/secured debt.
5. Administrative expenses - cash can be drawn based on a schedule that
coincides with the rate at which administrative expenses will be incurred
(40 CFR 35.3160).
G. State Matching.
Audit Objective: To determine that the state provides the matching funds necessary
and in a timely manner to earn the capitalization grant.
Stetes are required to make a match of twenty (20) percent of each grant payment
drawn from EPA on or before the date on which the funds are drawn. The matching .
can be made by direct appropriation, general obligation bonds, revenue bonds, or other
methods. The matching requirement also applies to draws for administrative expenses.
H. Period of Availability of Funds and Binding Commitments.
Audit Objective: To determine that grant funds are drawn timely and binding
commitments are entered into timely.
Grant funds are made available to the states according to a payment schedule (See
Chapter 2, Funding the SRF) in the capitalization grant agreement. Generally,
payments must start in the quarter in which the grant is awarded, and end no later than
eight quarters after the grant is awarded [40 CFR 35.3155(c)]. Cash draw
requirements are discussed at 40 CFR 35.3155(d). The date funds are available from
EPA leads to a special SRF compliance requirement, binding commitments. States
must enter into cumulative binding commitments of at least 120 percent of the
cumulative capitalization grant payments received one year earlier.
J. Program Income.
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Audit Objective: To determine that interest earned and any other program income is
credited to the SRF.
Interest earned is to be credited to the SRF to increase the fund. Other income/fees
generated by the operation of the SRF should be evaluated against the requirements of
40CFR31.25.
L. Reporting.
Audit Objective: To determine that required reports are submitted and in a timely
manner.
The following reports must be submitted as required by the regulations and the grant
agreements:
1. Intended Use Plan (40 CFR 35.3150). The state must prepare an Intended
Use Plan identifying the intended uses of funds of the SRF, and describing how
those uses support the goals of the SRF. The lUP must be prepared annually,
and must be subjected to public comment and review before being submitted to
EPA. The IUP must be submitted before a capitalization grant can be awarded.
2. Annual Report [40 CFR 35.3165(a)]. The state must provide an annual
report to the EPA Regional Administrator according to the schedule in the grant
agreement. The Annual Report must establish that the state has: (1) reviewed
all projects in accordance with the approved environmental review process; (2)
deposited the matching funds as required; (3) complied with Title (I requirements
of the Act; (4) made binding commitments as required under 40 CFR 35.3135(c);
and (5) expended all funds in an expeditious and timely manner. The annual
report should also include financial statements, a report on the internal controls,
and a report on compliance with Title VI of the Act as required by the
capitalization grant agreements.
3. Financial Reports (40 CFR 31.41). The state is required to submit Financial
Status Reports (SF-269) and Federal Cash Transaction Reports (SF-272).
M. Subrecipient Monitoring.
Audit Objective: To determine that the state monitors loan recipients to ensure that
the accounting system used meets the SRF program requirements.'
The state must require recipients of SRF assistance to maintain project accounts in
accordance with GAAP as issued by the Governmental Accounting Standards Board.
The accounts must be maintained as separate accounts.
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N- Special Tests and Provisions.
Environmental Review Requirements:
Audit Objective: To determine whether the state is complying with the environmental
reviews requirements of 40 CFR 35.3140 before loan recipients initiate construction
under projects.
The state must conduct reviews of the potential environmental impacts of ail Section
212 construction projects receiving assistance from the SRF, including nonpoint source
pollution control and estuary protection projects that are also Section 212 projects.
Fund Establishment:
Audit Objective: To determine that the state has established proper accounts and
accounting procedures that are sufficient to assure proper accounting for SRF
transactions and balances.
The state is to establish the SRF as a separate account or series of accounts dedicated
solely to providing financial assistance in the form of loans and other assistance, but
not grants. The state must establish fiscal controls and accounting procedures that are
sufficient to assure proper accounting for payments received by the SRF,
disbursements made by the SRF and beginning and ending account balances [40 CFR
35.3115 and 40 CFR 35.3135(h)].
Loan Repayments and Fund Earnings Credited to SRF:
Audit Objective: To determine whether principal and interest payments are property
credited to the SRF.
All loan repayments, including principal and interest, and interest earnings on
investments, must be credited directly to the SRF. Repayment of loans must begin
within 1 year after project completion, and loans must be fully amortized over not more
than 20 years after project completion [40 CFR 35.3120(a)].
SRF as Security for Bonds:
Audit Objective: To determine whether the state has complied with requirements for
guaranteeing SRF debt obligations.
If a state uses the SRF as security or a source of revenue for the payment of principal
and interest on revenue or general obligation bonds issued by the state, the net
proceeds of the sale of such bonds must be deposited in the SRF [40 CFR 35.3120(d)].
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Net proceeds are defined as the funds raised from the sale of the bonds minus
issuance costs.
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CHAPTER 7 - AUDIT COMPLETION
AND THE AUDITOR'S REPORT
Completion of the audit after conducting the fieldwork involves: (1) obtaining a
representation letter from the state; (2) presenting the results of audit to the state; and
(3) issuing the auditor's report.
REPRESENTATION LETTER
GAGAS requires that the auditor obtain written representations from management as a
part of the audit. The auditor obtains written representations from management to
complement other auditing procedures. Written representations ordinarily confirm oral
representations given to the auditor, indicate and document the continuing
appropriateness of such representations, and reduce the possibility of
misunderstandings concerning the matters that are the subject of the representations.
SAS No. 19 titled Client Representations provides guidance to assist the auditor in the
content and timing of representations.
formally, the auditor prepares the representation letter for management to sign. The
auditor should work with management to arrive at a mutually acceptable representation
letter. However, the representation letter is management's and should be addressed to
the auditor. Because the auditor is concerned with events occurring through the date
of the auditor's report, the representations should be dated as of the date of the
auditor's report. They should be signed by members of management whom the auditor
believes are responsible for and knowledgeable, directly or through others in the
organization, about the matters covered by the representations.
A sample representation letter is included.as Appendix F.
Management's refusal to furnish written representations constitutes a limitation on the
scope of the audit sufficient to preclude an unqualified opinion.
PRESENTING THE RESULTS OF AUDIT
In accordance with GAGAS and OIGA policies, the state should be kept informed about
the audit progress and tentative findings throughout the audit. At the completion of
fieldwork, the auditor should conduct a fieldwork exit conference to convey the tentative
results of audit. At or immediately after the fieldwork exit conference, the state should
be provided a draft report.
The letter transmitting the draft report should request comments on the factual
accuracy of tile auditor's findings, and the state's reaction to the auditor's
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recommendations. Because the SRF financial statements are management's, any
auditor adjustments or footnotes considered (by the auditor) as material to the.
statements must be accepted by management. Otherwise, the auditor's opinion on the
financial statements may require qualification.
The letter transmitting the draft report should provide a date for receipt of
management's comments, and indicate that a final exit conference will be held after
receipt and evaluation of management's comments.
The exit conference should be scheduled to present the final results of audit to
management, receive any final comments from the state, and advise management on
the expected issuance date for the auditor's report. The exit conference is also an
excellent opportunity to advise management regarding: (1) matters observed by the
auditor during the audit that could improve internal controls or efficiency, effectiveness,
economy of the operation of the SRF program, but which do not warrant inclusion in the
auditor's reports; and (2) procedures for resolving compliance issues or other matters.
Other interested parties, such as the Regional SRF Coordinator, are encouraged to
attend the exit conference.
THE AUDITOR'S REPORT
The auditor's report is normally addressed to the state's management responsible for
the SRF. It includes three components:
• Financial statements with an opinion (or disclaimer of opinion) as to whether
the SRF financial statements are presented fairly in all material respects in
conformity with GAAP.
• A report on internal controls related to the SRF financial statements. The
report should describe the scope of testing of internal controls and the results of
tests, and where applicable, refer to a separate schedule of findings and/or costs
questioned.
• A report on compliance that includes an opinion as to whether the state has
complied in al! material respects with laws, regulations, and the provisions of the
SRF capitalization grants.
The auditor's report should also be transmitted to EPA for resolution of audit findings.
A sample auditor's report is included as Appendix G.
Reports on Compliance. GAGAS requires that audits of Federal programs include
reports on internal controls and compliance. The reports may be included in the report
on the financial statements or in separate reports, if the reports are issued separately,
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the report on the financial statements should state that those additional reports are
being issued.
GAGAS requires auditors to report the scope of the testing of compliance with laws and
regulations. If the tests did not exceed the tests the auditors considered necessary for
a financial statement audit, then a statement that auditors tested compliance with
certain laws and regulations, obtained an understanding of internal controls, and
assessed control risk, would be sufficient to satisfy this requirement. GAGAS also
allows auditors to report whether or not the tests they performed provided sufficient
evidence to support an opinion on compliance or internal controls. As a result, auditors
have been able to disclaim an opinion on compliance because the objective of the audit
was to express an opinion on the financial statements, not to express an opinion on
compliance.
However, one of the principal objectives of auditing the SRF is to determine if the state
met the compliance requirements. As such, disclaimers of opinion on compliance are
not acceptable. Opinions on compliance must be unqualified, qualified or adverse.
Auditors should ensure that the testing of compliance is sufficient to allow them to issue
an opinion on compliance. If auditors plan the audit and design tests to address the
compliance requirements listed above, an opinion on compliance can be issued.
Reporting Requirements: The content of the compliance reports will depend on the
conditions noted. Material instances of noncompliance must be reported. Material
noncompliance are those instances which could cause auditors to conclude that
misstatements from those violations are material to the financial statements. Such
instances could include: the failure to follow program requirements; violations of
statutes, regulations, or contract .terms; or irregularities and other illegal acts. When
material instances of noncompiiance are discovered, the report should include:
• Identification of the material noncompliance noted;
• A statement that the noncompliance was considered in forming an opinion on
whether the financial statements are presented fairly, in all material respects, in
conformity with generally accepted accounting principles; and
• Identify and question any costs as a result of the noncompliance.
This EPA audit guide establishes the reporting requirements for audits of SRFs. The
AICPA standards require that reporting for program specific audits fallow the reporting
requirements of Federal audit guides. The AICPA has established formats for reporting
that should be followed by all auditors, and issued SOP 98-3 (Statement of Position) for
the revised reporting requirements of A-133. The AICPA expects to update its single
audit guidance to conform to A-133 revisions for audits of organizations receiving
Federal awards. It will replace current guidance presented in the audit guide Audits of
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State and Local Governmental UnitSi and will include guidance on program-specific
audit reports. A sample report on compliance, based on draft AICPA guidance, is
included in Appendix G.
For states that currently conduct audits of the SRF, the state must ensure that the
audits are performed in accordance with GAGAS and the EPA audit guide, and contain
the required reports, whether the audit is performed by an outside auditing firm or state
auditors.
This EPA audit guide does not modify the auditor's responsibilities concerning
reporting on irregularities, illegal acts or other material noncompliance. Auditors
should follow Government Auditing Standards and published AICPA guidance if fraud,
irregularities, illegal acts or other material noncompliance is discovered.
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Appendix A
Acronyms
ACH
AICPA
CFDA
CFR
EPA
FASB
GAAP
GAAS
GAGAS
GAO
GASB
IUP
NCGA
OA
DIG
OIGA
OMB
SAS
SRF
The Act
Automated Clearing House
American institute of Certified Public Accountants
Catalog of Federal Domestic Assistance
Code of Federal Regulations
Environmental Protection Agency
Financial Accounting Standards Board
Generally Accepted Accounting Principles
Generally Accepted Auditing Standards
Generally Accepted Government Auditing Standards
General Accounting Office
Governmental Accounting Standards Board
Intended Use Plan
National Council of Governmental Accounting
Operating Agreement
Office of Inspector General
Office of the Inspector General for Audits
Office of Management and Budgets
AICPA Statement of Auditing Standards
State Revolving Funds
Title VI of the Clean Water Act of 1987
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A-2
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Appendix B
Reference Material
SRF Program
Clean Water Act (Title VI), as amended by the Water Quality Act of 1987.
40 CFR Part 35, Subpart K - State Water Pollution Control Revolving Funds
EPA's Initial Guidance for State Revolving Funds, January 1988
SRF Correspondence5
Professional Audit Pronouncements
Government Auditing Standards, 1994 Revision, by the Comptroller General of
the United States
Pronouncements by the AICPA, Financial Standards Board
Pronouncements by the Governmental Accounting Standards Board
AICPA Audit and Accounting Guide, Audits of State and Local Governments,
May 1,1996
AICPA Audit and Accounting Guide, Consideration of Internal Control in a
Financial Statement Audit, April 1,1996
Other Reference Material
Singie Audit Act, as amended July 5,1996
OMB Circular No. A-133, effective July 1,1996
OMB Circular No. A-133 Compliance Supplement (Provisional), June 1997
OMB Circular No. A-133 Compliance Supplement, May 1998
EPA's Office of Water has compiled a listing of correspondence relevant to the SRF. Auditors.
should contact the SRF Coordinator in their region to obtain the listing and the desired
correspondence.
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Appendix C
Sample Engagement Letter
Date
Addressee .
Re: Audit of Financial Statements of State Revolving Fund
Dear:
This is to confirm our arrangements for the Office of the Inspector General to conduct
an audit of the financial statements of the [name of state] State Revolving Fund (SRF)
as of [balance sheet date]. The purpose of our examination is to:
• Express an opinion on the fairness of the financial statements prepared by the
State of [name of state], and to conclude whether such statements are
prepared in accordance with generally accepted accounting principles;
• Report on the internal controls related to the financial statements of the SRF.
The report will describes the scope of testing of the internal controls, the results
of those tests, and if applicable, refer to a separate schedule of findings and/or
costs questioned; and
• Report on compliance with an opinion as to whether the state has complied, in
all material respects, with laws, regulations, and provisions of the SRF
capitalization grants.
Our audit will be made in accordance with generally accepted government auditing
standards and will include tests of your accounting records and other procedures we
consider necessary to enable us to express an opinion that the financial statements of
the State Revolving Fund are fairly presented, in ail material respects. Our procedures.
will include tests of documentary evidence supporting the transactions recorded in the
accounts, direct confirmation of cash balances, loans receivable and certain other
assets and liabilities with selected communities or districts, and other parties as
necessary. We will also request written representations from you about the financial
statements and related matters.
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We understand that you will provide us with basic information required for us to
conduct our audit, and that you are responsible for the accuracy and completeness of
that information. We will advise you about appropriate accounting principles, their
application, and the preparation of your financial statements, but the responsibility for
the financial statements is with the State of [name of state].
As discussed with you, we will start our examination on [date]. In order to facilitate the
examination, we would appreciate it if you could have certain information and
schedules available prior to our arrival. Specifically, we will require:
* Financial statements for the SRF as of [balance sheet date], a trial balance
and chart of accounts;
• A detailed schedule of existing loans at [balance sheet date], including dates
of loans, original loan balance, loan balance at [balance sheet date],
repayment terms, and interest rates;
• A schedule of binding commitments made as of [balance sheet date];
• Copies of the state legislation establishing the SRF, operating agreements,
memorandums of understanding with other departments or agencies;
• Copies of all capitalization grant agreements, including amendments, awarded
by the Environmental Protection Agency through [balance sheet date];
• Access to minutes of the Board; and
• An organization chart of the SRF, and job descriptions for all personnel.
We will also require your assistance in preparing several letters and other
correspondence related to the engagement.
If you should have any questions, please contact me at [telephone number].
Sincerely,
Audit Manager/Team Leader
cc: Divisional Inspector General for Audits
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Appendix D
Financial Statement Assertions and Potential Misstatements
This appendix is provided to identify each financial statement assertion, and the
potential misstatements that could occur in each assertion in an accounting application.
Specific control objectives are also presented to assist in assessing the control risk
associated with each assertion. This information should be tailored to the specific state
and accounting application, and can be supplemented with other control objectives as
the situation dictates. This section is provided only as a reference to assist auditors in
reviewing and assessing the internal controls over the SRF.
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CONTROL OBJECT
Existence or
Occurrence
Transaction-Related
Validity:
1. Recorded transactions do not
represent economic events that
actually occurred.
2. Transactions are recorded in the
current period, but the related
economic events occurred in a
different period.
Summarization:
3. Transactions are summarized
improperly, resulting in an
overstated total.
Line Item/Account-Related
Substantiation:
4. Recorded assets and liabilities do
not exist at a given date
1a. Recorded transactions, underlying events,
and related processing procedures should be
authorized by federal laws, regulations, and
management policy.
1b. Recorded transactions should be
approved by appropriate individuals in
accordance with management's general or
specific criteria.
1c. Recorded transactions should represent
events that actually occurred and should be
properly classified.
2. Transactions recorded in the current
period should represent economic events that
occurred during the current period.
3. The summarization of recorded
transactions should not be overstated
4a. Recorded assets and liabilities should
exist at a given date.
4b, Recorded assets and liabilities of the
entity, at a given date, should be supported
by appropriate detailed records which are
accurately summarized and reconciled to the
account balance.
4c. Access to assets, critical forms, records,
and processing and-storage areas should be
permitted only in accordance with laws,
regulations, and management policy.
-------
CONTROLOBJECTI
Completeness
Transaction-Related
Transaction Completeness:
5. Valid transactions are not
recorded.
Cutoff:
6. Economic events occur in the
current period, but the related •
transactions are recorded in a
different period.
Summarization:
7. Transactions are summarized
improperly, resulting in an
understated total.
Line item/Account-Related
Account Completeness:
8. Assets and liabilities of the entity
exist but are omitted from the
financial statements.
5. All valid transactions should be recorded
and properly classified
6. All economic events that occurred in the
current period should be recorded in the
current period.
7. The summarization of recorded
transactions should not be understated.
8. All accounts that belong in the financial
statements should be so included. There
should be no undisclosed assets or liabilities.
Valuation or
Allocation
Transaction-Related
Accuracy:
9. Transactions are
recorded at incorrect
amounts.
Line Item/Account-Related
Valuation:
10. Assets and liabilities included in
the financial statements are valued
on an inappropriate basis.
Measurement
11. Revenues and expenses
included in the financial statements
are measured improperly.
9. Transactions should be recorded at correct
amounts.
10. Assets and liabilities included in the
financial statements should be valued on an
appropriate valuation basis.
11. Revenues and expenses included in the
financial statements should be properly
measured:
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CONITR0L
Rights and
Obligations
Line Item/Account-Related
Ownership:
12. Recorded assets are owned by
others because of sale,
consignment, or other contractual
arrangements.
Rights:
13. The entity does not have certain
rights to recorded assets because of
liens, pledges, or other restrictions.
Obligations:
14. The entity does not have an
obligation for recorded liabilities at a
given date.
12. Recorded assets should be owned by the
entity.
13. Assets should be the entity's rights at a
given date.
14. Liabilities should be the entity's
obligations at a given date.
Presentation
and Disclosure
Line Item/Account-Related
Account Classification:
15. Accounts are not properly
classified and described in the
financial statements.
Consistency:
16. The financial statement
components are based on
accounting principles different from
those used in prior periods.
Disclosure:
17. Required information is not
disclosed in the financial statements
or in the footnotes thereto.
15. Accounts should be properly classified
and described in the financial statements.
16. The financial statement components
should be based on accounting principles that
are applied consistently from period to period.
17. The financial statements or footnotes
thereto should contain all information required
to be disclosed
See Note Below
Transaction-Related
Segregation of Duties:
18. The entity is exposed to loss of
assets and various potential
misstatements, including certain of
those above, as the result of
inadequate segregation of duties.
18. Persons should be prevented from having
uncontrolled access to both assets and
records.
Note: Segregation-of-duties controls are a type of safeguarding control and are often crucial to the effectiveness of
controls, particularly over liquid or readily marketable assets that are highly susceptible to theft, loss, or
misappropriation. Such controls are designed to reduce the opportunities for any person to be in a position to both
perpetrate and conceal errors or irregularities. The lack of segregation-of-duties controls may be pervasive and
affect several misstatements.
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Appendix E
Internal Control Review Process
The attached flowchart identifies the processes discussed in the SRF Audit Guide,
MANAGEMENT
ASSERTIONS
Existence or QocunvncB
Completeness
RI0hts Slid Obftgnbons
Valuation or Allocation
Prewnlsboo ond Oisdosun
Ban Undemanding of
Organization, Management and
Accounting Potictes
INTERNAL CONTROL 1
STRUCTURE 1
_j Control Environment
^ Risk Assessments
-| Control Activities
Hl-if— i- -mlln_i. aru4
Imuniiawn OnO
ComnuncQbon
-| Monitoring
-
OBTAIN UNOERSTANONG
OF INTERNAL CONTROLS
ASSESSING CONTROL RISK
(EVALUATE INTERNAL
CONTROLS)
Planning and Internal Controls, in reviewing and reporting on internal controls in a
financial statement audit.
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Appendix F
Sample Representation Letter
(On auditee letterhead)
To the Office of the Inspector General
Environmental Protection Agency
[Date of Audit Report]
In connection with your audit of the balance sheet and the related statements of
revenues, expenses and changes in fund balance, and cash flows of the State of
[name of state] Revolving Fund, as of [balance sheet date], for the year then ended,
for the purpose of expressing an opinion as to whether the financial statements present
fairly, in all material respects, the financial position, results of operations, and cash
flows of the State of [name of state] Revolving Fund in conformity with generally
accepted accounting principles, we confirm, to the best of our knowledge and belief,
the following representations made to you during your audit.
1. We are responsible for the fair presentation in the financial statements of
financial position, results of operations, and cash flows in conformity with
generally accepted accounting principles.
2. We have made available to you all:
a. Financial records and related data.
b. Minutes of the meetings of the [Governing Board] of the State
Revolving Fund.
3. There have been no:
a. Irregularities involving management or employees who have
significant roles in the internal control structure.
b. Irregularities involving other employees that could have a material
effect on the financial statements.
c. Communications from regulatory agencies concerning
noncompliance with, or deficiencies in, financial reporting practices
that could have a material effect on the financial statements.
4. We have no plans or intentions that may materially affect the carrying
value or classification of assets and liabilities.
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5. There are no related party transactions or related amounts receivable
with the State of [name of state] Revolving Fund management or the
[Governing Board] members.
6. Arrangements with financial institutions involving compensating balances
or other arrangements involving restrictions on cash balances have been
properly disclosed in the financial statements.
7. There are no:
a. Violations or possible violations of laws or regulations whose
effects should be considered for disclosure in the financial
statements or as a basis for recording a loss contingency.
b. Other material liabilities or gain or loss contingencies that are
required to be accrued or disclosed by Statement of Financial
Accounting Standards No.5.
8. There are no unasserted claims or assessments that our counsel has
advised us are probable of assertion and must be disclosed in
accordance with Statement of Financial Accounting Standards No. 5.
9. There are no material transactions that have not been properly recorded
in the accounting records underlying the financial statements.
10. We have complied with all aspects of contractual agreements that would
have a material effect on the financial statements in the event of
noncompliance.
11. No events have occurred subsequent to the balance sheet date that
would require adjustment to, or disclosure in, the financial statements.
Signatures
Chief Executive Officer
Chief Financial Officer
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Appendix G
Sample Auditor's Report and Financial Statements
Sample State
Water Pollution Control Revolving Fund
Financial Statements with
Independent Auditor's Report
September 30,1997
Audit Report No. E2HTL7-XX-XXXX
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Sample State
Water Pollution Control Revolving Fund
Table of Contents
Independent Auditor's Report ,-. G-5
Balance Sheet G-7
Statement of Revenues, Expenses and Changes in Retained Earnings G-9
Statement of Cash Flows , G-11
Notes to the Financial Statements G-13
Independent Auditor's Report on the Internal Control Structure Based on an
Audit of the Financial Statements Performed In Accordance with
Government Auditing Standards G-21
Independent Auditor's Report on Compliance with the Requirements Applicable to the Environmental
Protection Agency's State Revolving Fund Program in Accordance with
Government Auditing Standards G-23
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G-4
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Independent Auditor's Report
Sample State Water Pollution Control Board
We have examined the accompanying balance sheet of the Sample State Water Pollution Control
Revolving Fund as of September 30, 1997, and the related statements of revenues, expenses and
changes in retained earnings, and cash flows for the year then ended. These financial statements are
the responsibility of the Fund's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
Except as discussed in the following paragraph, we conducted our audit in accordance with generally
accepted auditing standards and Government Auditing Standards issued by the Comptroller General of
the United States. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
This was our first audit of the Fund's financial statements, and the scope of our examination did not
include an audit of the financial statements of the preceding year sufficient to enable us to express, and
we do not express, an opinion on the balance sheet of the Fund as of September 30,1996 or the related
statements of revenue, expenses and changes in retained earnings, and cash flows for the year then
ended, nor do we express an opinion on the consistency of application of accounting principles with the
preceding year.
In our opinion, the financial statements referred to in the first paragraph present fairly, in all material
respects, the financial position of the Sample State Water Pollution Control Revolving Fund as of
September 30,1997 and the results of its operation and its cash flows for the year then ended in
conformity with generally accepted accounting principles.
As discussed in Note 1, the financial statements referred to above are intended to present the financial
position and results of operations of the Sample State Water Pollution Control Revolving Fund, a
component of the Sample State. These statements are not intended to present the financial position or
results of operations for the Sample State or the State Department of the Environmental, of which the
Sample State Water Pollution Control Revolving Fund is a part.
In accordance with Government Auditing Standards, we have also issued a report dated December 11,
1997, on our consideration of the Sample State Water Pollution Control Revolving Fund's internal control
structure and a report dated December 11,1997 on its compliance with laws and regulations.
[Audit Organization Name & Address]
pate]
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G-6
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' Sample State
WATER POLLUTION CONTROL REVOLVING FUND
Balance Sheet
September 30,1997
With Unaudited Comparative Totals for 1996
(in thousands)
Assets
Current Assets:
Cash and cash equivalents
Receivables:
Interest on loans
Interest on investments
Other
Total receivables
Current maturities of loans receivable .
Total current assets
Loans receivable, net of origination fees and current maturities
Total assets
1997
$ 101,082
2,693
1,254
1.206
5,153
16.238
122.473
410.834
Unaudited
1996
$ 67,701
2,284
997
3.364
6,645
14.378
88.724
Liabilities and Fund Equity
Current liabilities:
Accounts payable and accrued expenses
Construction costs payable
Other
Total current liabilities
Fund equity:
Contributed capital:
Environmental Protection Agency
Sample State
Retained earnings
Total equity
Total liabilities and fund equity
& 184
516
18
718
$ 222
4,414
30
4,666
404,408
91.947
36.234
532.589
322,701
83,946
22.442
429.089
The accompanying notes are an integral part of the financial statements.
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Sample State
WATER POLLUTION CONTROL REVOLVING FUND
Statement of Revenues, Expenses and Changes in Retained Earnings
For the year ended September 30,1997
With Unaudited Comparative Totals for 1996
(in thousands)
Revenues:
Interest on loans
Investment income
Total revenues
Expenses:
Administrative expenses
Revenues over expenses
Retained earnings, beginning of year
Retained earnings, end of year
1997
$ 11;943 $
4.513
16,456
2.664
Unaudited
1996
8,423
2.951
11,374
2.637
$
13,792
22.442
36.234
8,737
13.705
i_22A&
The accompanying notes are an integral part of the financial statements.
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Sample State
WATER POLLUTION CONTROL REVOLVING FUND
Statement of Cash Flows
For the year ended September 30,1997
With Unaudited Comparative Totals for 1996
(in thousands)
Cash flows from operating activities:
Revenues over expenses
Adjustments to reconcile operating income to
net cash flow provided by operating activities:
Amortization of loan fees
Changes in assets and liabilities:
(Increase) Decrease in receivables
Increase (Decrease) in accounts payable and
accrued expenses
Net cash provided by operating activities
Cash flows from capital and related financing activities:
Funds received from Environmental Protection Agency
Funds received from the Sample State
Contribution of state matching funds from local agencies
Net cash provided by capital and related financing activities
Cash flows from investing activities:
Loan disbursements
Repayments on loans receivables
Net cash used in investing activities
Increase in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
1997
$ 13,792
Unaudited
1996
$ 8,737
(48)
1,492
(3.948)
11.288
81,707
8,001
1.584
91.292
(83,577)
. 14.378
(69.199)
33,381
67.701
(3,975)
(30)
4.732
73,686
22,148
95.834
(87,218)
11.116
(76.102)
24,464
43.237
The accompanying notes are an integral part of the financial statements.
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G-12
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Sample State
WATER POLLUTION CONTROL REVOLVING FUND
Notes to Financial Statements
September 30,1997
(In thousands)
Organization of the Fund
The Sample State Water Pollution Control Revolving Fund (the Fund) was established pursuant
to Title VI of the Federal Water Quality Act of 1987 (the Act). The Act established the state
revolving fund (SRF) program to replace the construction grants program to provide loans at
reduced interest rates to finance the construction of publicly owned water pollution control
facilities, nonpoint source pollution control projects, and estuary management plans. Instead of
making grants to communities that pay for a portion of building wastewater treatment facilities,
the SRF provides for low interest rate loans to finance the entire cost of qualified projects. The
SRF provides a flexible financing source that can be used for a variety of pollution control
projects, including non-point source pollution control projects/and developing estuary
conservation and management plans. Loans made by the Fund must be repaid within 20 years,
and all repayments, including interest and principal, must remain in the Fund.
The Fund was capitalized by the U.S. Environmental Protection Agency (EPA) by a series of
grants starting in 1989. States are required to provide an additional 20 percent of the Federal
capitalization grant as matching funds in order to receive a grant. As of September 30,1997,
Congress authorized the EPA to award $627,041 in capitalization grants to Sample State (the
State). The State is required to contribute $125,408 in matching funds.
The Fund is administered by the Sample State Department of Environmental Protection (SDEP)
through the Division of Clean Water Programs of the State Water Resources Control Board (the
Board). SDEP's primary activities with regard to the SRF include the making of loans for water
pollution control facilities, and the management and coordination of the Fund. The Board
consists of five members, all of which are appointed by the Governor.
The Fund does not have any full time employees. Instead, SDEP charges the Fund for time
spent on SRF activities by employees of the Board, and the Fund reimburses the State General
Fund for such costs in the following month. The charges include the salaries and benefits of the
employees, as well as indirect costs allocated to the Fund based on direct salary costs.
Employees charging time to the Fund are covered by the benefits of the State. The Fund is also
charged indirect costs of the State through the cost allocation plan for general state expenses.
The Fund is included in the State's general purpose financial statements as a Special Revenue
Fund using the modified accrual basis. Because of the different presentation, there may be
differences between the amounts reported in these financial statements and the general purpose
financial statements.
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Sample State
WATER POLLUTION CONTROL REVOLVING FUND
Notes to Financial Statements
September 30,1997
(In thousands)
2. Summary of Significant Accounting Policies
Basis of Accounting
The Fund presents its financial statements as a nonexpendable trust fund. The Fund uses the
accrual method of accounting whereby revenues are recorded as earned and expenses are
recorded when the liability is incurred. The State has elected to follow the accounting
pronouncements of the Governmental Accounting Standards Board (GASB), as well as
statements issued by the Financial Accounting Standards Board before November 30,1989
unless the pronouncements conflict with or contradict GASB pronouncements.
Cash and Cash Equivalents
All moneys of the Fund are deposited with the State Treasurer's Office, and are considered cash.
According to State law, the Treasurer is responsible for maintaining the cash balances and
investing excess cash of the Fund, as discussed in Note 3. Therefore, management of the Fund
does not have any control over the investment of excess cash, and the statement of cash flows
considers all funds deposited with the Treasurer to be cash or cash equivalents, regardless of
_ actual maturities of the underlying investments.
Loans Receivable
The State operates the Fund as a direct loan program, whereby loans made to communities are
83.3 percent funded by the Federal capitalization grant, and 16.7 percent by the state matching
amount. Loan funds are disbursed to the local agencies as they expend funds for the purposes
of the loan, and request reimbursement from the Fund. Interest is calculated from the date that
funds are advanced, and after the final disbursement has been made, the payment schedule
identified in the loan agreement is adjusted for the actual amounts disbursed, and interest
accrued during the project period. No provision for uncollectible accounts has been made as all
loans are current, and management believes that all loans will be repaid according to the loan
terms.
Contributed Capital
In accordance with generally accepted accounting principles, funds received from the EPA and
the State for the capitalization of the Fund are recorded as contributed capital. In certain cases,
local communities have contributed the State's 20 percent match in exchange for zero interest
rate loans. The state match made by local agencies has been recorded as a reduction in the
loan receivable, and amortized to interest income over the life of the loan in accordance with the
provisions of Financial Accounting Standards Board Statement No. 91, Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases, as further discussed in Notes 4 and 5.
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Sample State
WATER POLLUTION CONTROL REVOLVING FUND
Notes to Financial Statements
September 30,1997
(In thousands)
Summary of Significant Accounting Policies (continued)
Budget Information
Under the Sample State constitution, money may only be drawn from the Treasury by a legal
appropriation. However, the Fund operates under a continuous appropriation because the
funding of the matching funds approved by the voters contained its own appropriation authority.
Therefore, the Fund operations are not included in the State's annual budget
Reclassffications
Certain amounts in the 1996 unaudited financial statements have been reclassified to conform to
the presentation in the 1997 financial statements.
Cash and cash equivalents
All monies of the Fund are deposited with the Treasurer, and are considered to be cash. The
Treasurer is responsible for maintaining the cash balances in accordance with State laws, and
excess cash is invested in the State's Surplus Money Investment Fund (SMIF), which is part of
the Pooled Money Investment Account (PMIA). Details of the investments of the PMIA can be
obtained from the State Treasurer. As of June 30,1997, the latest date available, the State's
total pooled investments were approximately $26 billion, and the average remaining life of the
securities invested was 291 days. The combined deposits of the SMIF as of June 30,1997 was
approximately $12.1 billion, and total earnings for the year ended June 30,1997 were
approximately $662 million.
All cash of the Fund is stated at cost Investments in local government investment pools are not
categorized because they are not evidenced by securities that exist in physical or book entry
form. Details of invested funds at June 30,1997 are:
Not subject to categorization:
Local government investment pool
Carrying
Amount
Market
Value
4. Loans Receivable
The Fund makes loans to qualified agencies for projects that meet the eligibility requirements of
the Act Loans are financed by capitalization grants, state match, local contributions, and
revolving funds. Effective interest rates on loans vary between 1.8 percent and 4.0 percent, and
are generally repaid over 20 years starting one year after the project is completed. Details of
loans receivable as of September 30,1997 are:
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Sample State
WATER POLLUTION CONTROL REVOLVING FUND
Notes to Financial Statements
September 30,1997
(In thousands)
4. Loans Receivable (continued)
Loans by Category:
Loans receivable at September 30,1997, net of loan origination fees, as discussed below, are as
follows:
Completed projects
Projects in progress
Loan
Authorized
$ 280,423
298.204
Remaining
Commitment
$ 0
94.059
Balance
Totals $ 578.627
Less amount due within one year
Loans receivable, net, September 30,1997
$ 224,290
202.782
427,072
16.238
Loans mature at various intervals through September 30,2016. The scheduled principle
payments on loans maturing in subsequent years are as follows:
Year ending September 30:
1998
1999
2000
2001
2002
Thereafter
Amount
$ 16,238
22,199
25,082
27,442
28,270
307.841
Loan Origination Fees:
Beginning in 1997, the Fund offered local agencies the option of receiving zero-interest rate
loans (zero-rate loans). In order to obtain a zero-rate loan, the agency had to pay the State's
matching share of the loan, generally 16.7 percent of the total loan amount. EPA considers the
amounts paid by local agencies as meeting The State's matching requirement .However,
Financial Accounting Standards Board Statement No. 91. Accounting for Nonrefundabie Fees
and Costs Associated with Originating or Acquiring Loans and Direct Initial Costs of Leases
(FASB No. 91), states that fees that reduce the loan's interest rate are considered origination
fees, and requires that loan origination fees be deferred and recognized over the life of the loan
as an adjustment to the interest rate. FASB 91 also requires that the unamortized balance of
such fees be reported as part of the loan to which it relates.
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Sample State
WATER POLLUTION CONTROL REVOLVING FUND
Notes to Financial Statements .
September 30,1997
(In thousands)
Loans Receivable (continued)
As of September 30,1997, seven-agencies entered into agreements for zero-rate loans for
$16,271, which includes total matching funds of $2,712 to be contributed by the local agencies.
At the balance sheet date, the local agencies had provided $1,584 in matching funds on loans
disbursed as of that date. Details of the loans are:
Loan
Amount
Authorized
$
1
3,869
12.402
'16.271
Funds
Disbursed
$ 3,869
4.956
$ 8.825
Unamortized
Loan
Origination Loan
Fee Balance
$ 595
941
$ 1.536
$ 3,274
4,015
$ 7,289
Completed projects
Projects in progress
Totals
Amortization of loan origination fees on completed projects was $48 for the year ended
September 30,1997.
Loans to Major Local Agencies
As of September 30,1997, the Fund had made loans to eleven agencies that, in the aggregate,
exceeded $10 million. The outstanding balances of these loans represents approximately 81
percent of the total loans receivable, as follows:
Local Agency
City & County of San Angelo
Los Pablo County
Western Utility District
Santana Water Authority
City of Bear River
Miller's Valley Sewer District
Union Valley Sanitation District
City of Independence
High Water Flood Control District
City of Gainesville
Moose Jaw Sanitary District
Total
Authorized
Loan Amount
$ 136,316
63,711
60,360
43,933
29,007
18,736
18,000
15,991
12,142
11,675
11.305
Outstanding
Balance
$ 108,469
52,090
51,932
42,087
21,094
15,856
16,376
13,422
9,862
7,624
8.191
$ 347.003
The authorized loan amount includes both completed projects and projects in progress. As of
September 30,1997, principal repayments on completed projects to the above agencies was
$42,826 and remaining amounts to be disbursed on projects in progress was $30,774.
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Sample State
WATER POLLUTION CONTROL REVOLVING FUND
Notes to Financial Statements
September 30,1997
(In thousands)
Contributed Capital and Fund Balance
The Fund is capitalized by grants from EPA authorized by Title VI of the Act, matching funds
from the State, and contributions by certain local agencies. All funds drawn are recorded as
contributed capital from the Environmental Protection Agency and Sample State. As of
September 30,1997, EPA has awarded capitalization grants of $627,041 to the State, of which
$404,408 has been drawn for loans and administrative expenses. The State has provided
matching funds of $91,947. The following summarizes the capitalization grant awarded,
amounts drawn on each grant as of the balance sheet date, and balances available for future
loans:
Year
1989
1990
1991
1992
1993
1994
1995
1996
1997
Grant Amount
$ 76,547
71,866
88,067
83,377
82,479
51,177
52,855
86,578
34.095
Total Draws
September 30,
1996
$ 76,496
69,501
82,706
64,930
27,675
1,393
0
0
Q
1997 Draws
$
18
945
3,901
15,970
23,393
25,299
7,181
5,000
0
Total Draws
September 30,
1997
$ 76,514
70,446
86,607
80,900
51,068
26,692
7,181
5,000
0
Available
September 30,
1997
$ 33
1,420
1,460
2,477
31,411
24,485
45,674
81,578
34.095
Totals $ 627.041 $ 322.701 $ 81.707 $ 404.408
As of September 30,1996 and 1997, State matching contributions were:
September 30, 1997
1996 Contribution
September 30,
1997
Sample State
As discussed in Note 4, certain local agencies provided the State's 20 percent match in
exchange for zero interest loans. As of September 30,1997, the amount contributed by local
agencies was $1,584. The EPA considers the local agency contributions as part of the State's 20
percent matching funds. However, according to generally accepted accounting principles, the
amounts are not included as part of the State's contributed capital in these financial statements.
6. Contingencies and Subsequent Events
Contingencies
The Fund is exposed to various risks of loss related to torts, thefts of assets, errors or omissions,
injuries to state employees while performing Fund business, or acts of God.
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Sample State
WATER POLLUTION CONTROL REVOLVING FUND
Notes to Financial Statements
September 30,1997
(In thousands)
6. Contingencies and Subsequent Events (continued)
*
The Fund maintains insurance for all risks of loss which is included in the indirect costs charged
to the Fund. There.have not been any claims against the Fund since its inception in 1989.
Subsequent events
Subsequent to year end, the EPA awarded the 1998 capitalization grant to the State. The grant
provides $53,489 in additional funds, including the State matching share of $8,915, for making
loans to qualified communities.
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