Strong Audits:   An Essential
                        Ingredient in Delegating
                          Construction Grants

                    U.S. Environmental Protection Agencv
                    Library, Room 2404 PM-ail-A  Asency
                    401 M Street, S.W.
                    Washington, DC _ 20460
                                            . --..'.; ;•.:••.:.*.A';'
                                       Gail Withuhn
                                       Program Evaluation  Division
                                       September  15,  1980


     The purpose of this paper is to stimulate discussion,
not to advocate specific solutions.  It will succeed if it

imparts enough information for people to understand and

discuss four problems related to audits of construction

                       •    SUMMARY

     A strong auditing function is essential if to

delegate the Construction Grants program successfully.

Environmental groups, EPA, and Congress must have reason to

believe that the financial integrity of construction grants

will continue unsmirched by major scandal.  To retain a

strong audit function, EPA must address four problems.

     Problem (1)  Small grantees are unable to meet the

accounting requirements of the Construction Grants program.

     Chapter I suggests options to assist grantees with the

record keeping requirements of a construction grant, options

which range from actively marketing seminars now available

in grants management, to reimbursing grantees' costs for

having CPA's.set up their accounts, to having states or third

parties manage the construction grants of the smallest


     Problem (2)  Auditors have difficulty in assessing the

financial integrity of construction grants when delays in

starting final audits create "cold audit trails".


     Chapter II suggests that EPA delegate audits of construc-
tion grants to states as a way to eliminate the audit backlog,
follow "warm audit trails," and so improve the financial inte-
grity of the Construction Grants program.  Training, oversight,
and quality control carried out by the Office of Audit should
let EPA meet the requirements of the Inspector General Act of
     Problem (3)  (A)  The number of "final determinations"
appealed by grantees to the Office of General Counsel has
increased dramatically.  Region IX interpreted EPA Order
2750.2 as requiring it to make final determinations in 60
days.  (B)  The Inspector General wants to make the 60 day
requirement universal.
     Only two regions concurred with the proposed 60 day
requirement in a recent "Red Border" package.  The Adminis-
trator has yet to make;his decision about this proposed
requirement.  Of equal importance, however, in resolving
audits is the recent- offer by the Office of General Counsel
to mediate at a regional level disagreements among auditors,
grantees, and program personnel.  If taken, this offer would
save money and speed audit resolution.  To enact this arrange-
ment all regions,  EPA would modify Order 2750.2.
     Problem (4) The quality of interim and final audits
conducted by CPA firms often has been poor.
     EPA will soon change the way that it scores proposals
submitted by CPA firms;.  It will weigh the technical excel-
lence of a CPA proposal more heavily than the dollar bid


accompanying the proposal.  This change will let the Office

of Audit contract with better CPA firms.  The combination of

technically excellent, hew CPA firms with several experienced,

proficient firms should improve the quality of audits performed

by CPA's.

     Any of the four changes suggested in this paper will

improve the quality of Construction Grant audits, enhance the

financial integrity of the Construction Grants program, and
increase the satisfaction of grantees and the public.  Taken

together, however, these four changes envision a Construction

Grants program in which grantees adequately manage and account

for funds, audits are timely, findings are appropriate, and

regional counsel minimize appeals by mediating disagreements

among auditors, regions, and grantees.  This combination of

improvements should make delegated management of cpnstruct-ion

grants more popular, more efficient, and more credible.

Table 2 charts the four problems just mentioned, the changes

suggested, and the offices involved.

                                    Table  1
                             Offices Involved
    Inability of small
    grantees to meet
    the accounting
    requirements of the
    Construction Grants
Choose among 5 options for
up-front help to grantees:

(1) Market grant eligible
    seminars which teach
    proper accounting

(2) Hire CPA's to set u£
    C.G. accounts for

(3) Combine options 1 and

(4) Set up teams of accoun-
    tants to help grantees
    States or third parties.
(5) Have States or third
    parties manage the
    smallest grants.
                                                        (1) Office of Water
                                                            Programs Operations
                                                        (2) Regional Offices
                                                        (3) States
   Delays in starting
   audits create "cold
   audit trails."
                          Delegate more audits to
                          State auditing agencies
                          and allow states to augment
                          their own staffs by con-
                          tracting with "certified"
                          CPA firms.
                              (1)  Office of Audit
                              (2)  State auditing
                              (3)  CPA firms
   Appeals of final
   determinations to
   Office of General
                          (1) Allow 90-120 days for
                              final determinations.
                          (2) Use the Office of
                              Regional Counsel as
                              mediators between
                              (1) auditors and
                              (2) program personnel
                                  and grantees.
                              (1) Offices of Regiona
                              (2) Divisional Offices
                                  of Audit
                              (3) Regional Offices
Poor quality of
 nterim and final
 udits conducted
 v CPA firms.
Select technically
excellent CPA firms.
(1)  Office of Audit

                      TABLE OF CONTENTS
I. Difficulties of Small Grantees

II. The Backlog of Construction Grant Audits
III. Increased Appeals to the General Counsel	35
IV. The Quality of Contracted Audits
Appendix 1:  The Office, of Inspector General
Appendix 2:  The Minimal Effect of Attachment P..	51

                         -  -5-

                         CHAPTER I

             The  Difficulties of Small Grantees

Init r o du c t i on

     The accounting requirements of a construction grant are

considerable, requiring a grantee, for example, to understand

the principles of cost accounting, to separate eligible from

ineligible costs, to follow federal procurement policies,

and to document all expenditures.  Failure to fulfill any of

the accounting requirements of a construction grant will cause

auditors (who may examine a project's books years after it

has been completed) ,to "question" specific costs.  Disputes

over questioned costs can delay final payments in California

and New York.  If EPA has already paid 75 percent of these

"questioned costs," regional offices usually will try to recover

EPA's share from grantees.-

     The frequency, the relative size, and the relative impor-

tance (utility) of questioned costs become acute for small

grantees.  Too often their questioned costs are eligible

generically, but documented incompletely.  At other times the

small grantee has not separated eligible from ineligible costs

or has comingled funds.  Unfortunately, the small grantee may

not have enough current revenues to repay the federal government

and must borrow money at high rate of interest to settle his

account.  The result is that this additional debt increases

his already high cost per capita (or per household) of building

and operating a POTW.*
* See the papers on fiscal assessment and on the third party
  management of small grantees for fuller descriptions of
  the costs of POTW's in small communities.


     Our thesis is that helping grantees early in the con-
struction grants program to establish acceptable accounting
systems will simplify preparations of payment requests, will
eliminate many questioned costs, and will shorten the time
to resolve audit disputes.  Further, EPA itself will benefit
by completing audits more quickly, by having fewer audit
disputes, and by closing projects with more dispatch —in
short improving the fiscal integrity of the C.G. program.
The Nature of JSraall Grantees
     Small grantees are villages, towns, or cities of 10,000
or fewer people and sewer districts serving unincorporated
areas of the same size.  Typically, these grantees have small,
financially naive staffs.  The village or small town may have
only a part-time mayor and a part-time bookkeeper.  The small
sewer district may have an engineer and a part time bookkeeper,
but not an accountant.  Further, most small grantees do not
follow "generally accepted accounting principles." Some do
not use the accrual method of accounting, many allocate
overhead expenses primitively, others do not have separate
capital and operating budgets.  The "shoe box method" of
filing is not unusual.  For many small communities, construc-
tion grants will be their first and only experiences with a
federal program, since they are too small for housing grants,
and counties and states handle highway grants.

The Significance ofSmall Grantees

     At the same time, the number of small grantees in the

Construction Grants program is significant.  The 1978 Needs

Survey suggests that 88 percent of future treatment works

will serve 10/000 or fewer people.  Together, these small

works will account for 42 percent of the Section 201 funds


The Problems of Small Grantees

     Simply put, the difficulties in auditing small grantees

arise because a gap exists between the accounting requirments

of the Construction Grants program and the expertise and

experience of small recipients.  EPA's regulations exacerbate

the effect of this gap because they make ineligible the costs
°*- setting up a system that will meet its requirements. *  One

common result is that the small grantee reads the regulations,

attempts to understand the Accounting Guide for Construction

Grant8, may attend a pre-application conference, but turns over

the management of his grant to his architectural/engineering

firm.  Unfortunately, the A/E firm may have no certified

accountant and, further, has little incentive to propose alter-
nate systems or to control costs the grantee or the federal

government will bear.  Yet, the grantee, caught between his

own inexperience and the seeming expertise of the A/E firm,

feels he has little choice.  The probability is small that

he can safely "muddle through."
1 The costs of maintaining the system are eligible expenses.

     Presented  later with questioned costs and a "final deter-
mination" requiring him to return thousands of dollars to the
federal government, the bitter grantee often resorts to a method
he has used in  the past to solve problems: calling his State or
Congressional representatives.  Both Senator Leahy (D. Vermont)
and Senator Hayakawa (R. California) have investigated cases
involving small grantees.1
     Other grantees use the appeals process through the Office
of General Counsel to protest "final determinations" of audit
findings.  In addition/ Region IX1s attempt to make final
determinations within 60 days of receiving final audit
reports has greatly increased the number of appeals.  Between
January 1, 1980, and June 23, 1980, 33 grantees in Region IX
alone appealed  final determinations.  However, filing appeals
is costly for grantees and is not an eligible expense.  Many
small grantees can afford neither to appeal the final deter-
mination nor to repay EPA.
EPA's Responsibility Toward Small Grantees
     EPA cannot assume that grantees are sufficiently good
accountants to meet the requirements of the CG program, nor
can EPA assume that its guidance in this area is adequate.
Frankly,  one has to have had a course in cost accounting to
understand the ramifications of the Accounting Guide for
Construction Grants.  Since the Office of Audit is short of
  Senator Hayakawa recently investigated $5,000 in questioned
  costs for Antioch, California.


 resources and since auditors are trained primarily to react
 to situations,  rather than to prevent them,  the Construction -
 Grants program itself ought to help grantees set up proper
 procedures and appropriate accounting systems.   Moreover, if
 the Administrator  decides  that all regions have only 60  days
 to make final determinations,  and if small grantees must
 abate  pollution under existing laws,  it  is incumbent upon
 EPA to assist them in an explicit fashion to establish
 acceptable record  keeping  systems.   As stated earlier, the
 benefits of doing  so should accrue not only  to  grantees  but
 also to EPA.  We believe that auditors will  be  more efficient,
 that audit disputes will be fewer,  that  projects will close
 more quickly, and  that grantees and the  public  will be more
 Proxies for Early  Help              '
     Moves to help small grantees have occurred in California.
•The first was an "Evaluation Assistance  Service":  state  repre-
 sentatives of the  CG program in a "one on one"  fashion checked
 how well grantees'  accounting  systems met CG requirements.
 The California  Water Resources Control Board felt this program
 of 4 -FTE's especially benefitted small grantees.   Unfortu-
 nately,  California.discontinued the Evaluation  Assistance
 Service because it felt it did not have  enough  205{g)  funds to
 support an optional activity.
     To substitute for the "Evaluation Assistance Service,"
 California made a  second attempt to help small  grantees:  it
 sponsored ten 2-day workshops  in accounting  and -negotiations


developed by a private firm, the Cilren Company 1.  .These

workshops were designed especially for recipients of Con-

struction Grants.  They combined lectures with practical

exercises and provided participants with flow charts, a set

of sample forms, specific examples, and "do's and don'ts"

of managing construction grants.2  These instructions, forms,

and procedures enable grantees to document expenditures

properly, to blaze an "audit trail." EPA has since made the

costs of attending the Cilren workshops grant eligible.

The Cilren Company is now marketing these workshops nationwide

     Several questions occur.  Are such workshops a viable

way to help small grantees set up accounts to meet EPA's

requirements?  Do they result in fewer costs being questioned

or in audits being completed more quickly?  Unfortunately, no

audits have been conducted yet of grantees who attended

Cilren1s workshops in Steps 1 and 2.3 Nevertheless, managers

of the Construction Grants program in California support

these seminars.  Neil Dunham of the California Water Resources

Control Board states the following:

     The Division of Water Quality is pleased to endorse this
     set of seminars conducted by the Cilren Company.  This
     seminar is specifically designed to help you avoid the
     pitfalls that have beset other grantees in the past ...
  The' Cilren Company, 9912 Fair Oaks Blvd.,
  Fair Oaks, California 95628.

  PED has copies of Cilren's three manuals: Financial Systems,
  Grant Administration, and Proposals, Price Analysis, Negotiations

  Auditors have examined the books of a few grantees who attended
  the seminars in Step 3. (e_._g_., Colton, CA).


James Hanlon, Chief of .the Environmental Engineering Branch
in Region V, points out that "Cilren provides information
about grants information in a more understandable form than
is available elsewhere."  An informal telephone poll of 12
small California grantees one year later supports anecdotally
the thesis that these sessions have changed the behavior of
many grantees.   The key question in the poll asked grantees
for specific examples of what they did differently as  a
result of attending the accounting or negotiations workshops.
Table 2 reports their answers in detail.
     In general, most grantees felt the seminars were well-
organized, informative and genuinely helpful.  Their responses,
however, ranged widely, from one who felt the accounting
session useless to those to those who have made the workshops
a frame of reference in their own negotiations.  How helpful
the sessions were depended upon the Step in which the grantee
stood; grantees in Step 1 benefitted immensely? grantees in
Step 3 benefitted only marginally.  The common theme enuni-
cated was that Cilren's record-keeping forms are vital and
that grantees had improved their documentation, of costs and
activities.  Almost all wished the workshops had been available
earlier.  Grantees using the accounting and filing system
presented in the workshops uniformly hoped to reduce the
dollars their auditors would question.  Grantees also found
that using Cilren's system allowed them to substantiate
their payment requests easily.

      The answer,  then,  to the question of whether such  work-
 shops and manuals are a viable way to help small  grantees  is a
 tentative   (A firm yes  must await the audit  reports of
 grantees who attended workshops in Steps  1 or 2).  The  current
 local cost of attending the  2 workshops appears reasonable:
 $41.  per day, plus 25 percent of reasonable travel expenses for
 grantees and their contractors. ^
      The.purpose  of conducting the poll,  however, was not  to"
 enhance the Cilren Company so much as it  was to use its work-
 shops to suggest  the usefulness of "up-front" help to grantees.
 Having found support for the idea of helping grantees early to
 establish acceptable accounts and "papertrails,"  EPA may wish
 to  consider other methods of accomplishing the same purpose.
 SPA'sOptions for Helping Small Grantees
     We  suggest  five  options.   They  lie  on  a  continuum of
 least  cost  to greatest  cost  to  EPA.   The goal of  each  is  the
 same:  to establish workable accounting  and managerial systems
 which  meet  CG requirements and  which save grantees  money.   To
 this end, each option provides  federal support for  part or
 all of the  cost  to set  up books,  files,  and procedures.
     Option 1:   Actively market aids to  grantees  which are
 already  available.  EPA headquarters, regions,  and  states
  uld urge small grantees to attend Cilren-like workshops
and to use the systems and handbooks demonstrated there.
   Potential, pre-step  1  grantees  must pay the  full  $165  fee
   to  attend  these  workshops.


Essentially, such workshops allow the private sector to give
"technical assistance" to grantees.  Insofar as the workshops
are not required, firms presenting them would have to tailor
their material to grantees' actual needs.  To foster compet-
ition among .firms, CG personnel and the Divisional Offices
of Audit should work with and advise other groups that may
wish to enter this market.
     Option 2:  Require or encourage each small grantee to hire
a CPA to set up its accounts and to oversee the books of its
Construction Grant.  Make grant eligible the cost of setting
up the accounts.         •
     Option 3;  Combine options 1 and 2 so that a grantee may
both hire an accountant to set up the books and send him to
the workshops suggested in Option 1.
     Option 4:  Set up a nationwide "Evaluation Assistance
Service."   Use EPA or state sponsored teams of accountants
to help small grantees set up their books. Periodically,
members of the teams would check small grantees' records and
procedures.  Since time and funds are limited, the team would
initiate visits only with grantees likely to have auditing
problems. Upon request, however, they would advise other
     Option 5;  States operating under broad delegation agree-
ments would either manage or arrange for third parties to manage
the grants of the smallest recipients.  Among other things,
States or third parties would negotiate contracts, direct
A/E firms, and set up accounting and record keeping systems.


By managing a number of small grants, States should achieve

some economies of scale.1

The Context:

     A useful frame of reference for evaluating these options

is the model of EPA acting as a franchiser of the Construction

Grants program, as a source of managerial systems and tech-

niques for states and grantees to use in building and operating

cost-effective POTW's.

The Constraints

      Constraints do limit the feasibility of some options.

(1)  The Office of Audit does not have the resources

to take on the task of helping grantees set up systems and

procedures.  Now part of the Office of Inspector General (OIG),

the Office of Audit defines its function as meeting the re-

quirements of the Inspector General Act to promote economy

and efficiency and to prevent and detect -fraud.  The Inspector

General (IG) perceives her role primarily as protecting the

public interest.  She has assigned half of EPA's in-house

auditors to her first priority: "Project Look."  Project

Look uses teams- of auditors, investigators, and an engineer

to review thoroughly the management controls, compliance,

costs, efficiency, and honesty of selected recipients of
  Stan Meiburg, "Options for Third Party Management of
  Construction Grants for Small Communities," Program
  Evaluation Division, July 9, 1980.


construction grants. ^   Using teams of auditors, inspectors,

and an engineer is new; their combination allows EPA to

examine construction grants more thoroughly.  The IG hopes

that Project Look will detect patterns of fraud and mismanage-

ment.  The shift of EPA auditors to Project Look, however,

has affected traditional auditing activities? pre-award

audits of A/E firms have been discontinued, travel budgets

have shrunk, the backlog of interim and  final audits is

increasing. ^                              .

     (2) 205(g) funds in some states, notably California, will

not support "optional" efforts to visit small grantees..  Right

now states are projecting three year budgets for the CG acti-

vities they will assume.  The Office of Program Management

Operations will have these reports in August 1980 and should

be able to judge the adequacy of 205{g) funds.  The Association

of State and Interstate Water Pollution Control Administrators

(and others) is working to alter the Clean Water Act so that

205 (g) funds are either 2 percent of authorized monies or 3

percent of appropriations.  But no one knows when or whether

these efforts will succeed.

     (3)  EPA and the States have finite numbers of personnel.

Inflation- makes the costs of personnel an "increasingly large

percentage of state budgets.  The result is that states often

leave positions vacant,, and the reduced number of personnel

limits the direct help that governments can give grantees.
  A pilot "Project Look" took place in Jackson, Mississippi.
  Four reviews are occurring now (e .g. , Monterrey,
  California; Ramsey, New Jersey).   About 30 Project Look
  reviews will occur in 1982.
  "Project Look" did not cause the backlog.  It is, however,
  exacerbating the backlog.


 Importantly,  the argument for having states  manage  the  grants

 of the smallest recipients hinges on the premise  that the

 largest grantees require little  supervision  and need only

 "certify"  that they have met-EPA1s requirements.  States

 would then shift personnel from  attending to large  grants  to

 managing the  smallest ones.

      (4)  Other, competing demands for  States' time and money

 may make them unwilling  to take  on new  initiatives  in accounting

 and audits.

 Evaluating the Options

      Option 1,  marketing grant eligible workshops,  is the

 least expensive and most broadly based  choice.  It  is the

 easiest to implement and presents  an "approved system"  to

 grantees.   It would require  no added program personnel  and

 would not  occupy a  line  in any state budget.  EPA's cost

 would appear  only in requests for  payment.   Success, however,

 would depend  not only on the workshops  teaching an  "approved

 system," but  also on how much the  regions and states support

 and publicize the workshops.   Workshops in California have

 succeeded  because the California Water  Resources  Control Board

.urged grantees to attend.   Regions III  and V have also  had

 successful workshops.  However,  few grantees  have responded

 in  regions whose staff did not contact  grantees.  Beset by a

 multitude  of  requirements, grantees with small staffs are

 likely to  ignore flyers  advertising grant-eligible  workshops,

 no  matter  how well  designed.


                . '      •:
     Option2 provides more help to grantees than option 1.

Unfortunately, it requires grantees to assess the competence

of local accountants/ something small grantees may not do

easily.  Nevertheless, option 2 is easy to implement and

inexpensive, insofar as it does'not require staff or 205(g)


     Option  3 provides both an "approved system" and contin-

uing help to grantees.  Grantees who can afford to hire an

accountant,  in effect,. pursue Option 3 now but are not reim-

bursed for the costs'of setting up their accounting systems.

     Option  4, teams of state or EPA accountants, provides

grantees both "an approved system" and'personal help.  However,

Option 4 is  expensive.  Further, because Option 4 approaches

only grantees likely to have auditing problems (i.e./ large

questioned costs), it may overlook small grantees whose

questioned costs look small but are great in relation to local

personal income and local property values.

     Option  5 benefits the smallest grantees, but does not help

the small to middle sized grantee.  It averts the most searing

economic hardships,  but depends oh good political relation-

ships between grantees and state agencies administering

construction grants.

Other Consijierat ions   -                      •     • .

     Most of the 12 California grantees polled commented on

the utility of the forms designed by the Cilren .Company.  The

availability of equally:good, equally detailed forms would

enhance Options 2 and 4.


     Several variations of these 5 options come to mind.  EPA

might choose Option 1, but decide to contract with Cilren (or

a similar firm) to conduct the workshops rather than market

them through the mechanism of grant eligibility.  Or EPA might

choose combinations of options, such as 5 and 1, or 5 and 2.

In these scenarios states would manage the most difficult

small grants, while somewhat -larger grantees could take

advantage of workshops or hire a CPA.



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                         CHAPTER II

           The Backlog of Construction Grant Audits

INTRODUCTION                .                                 .

     A second problem with audits of Construction Grants has

been inordinate delay in starting audits..  It is common for

final audits in Region X to take place three years after

plants have come on line.  Typical delays in regions range

from 9 months to 4 years.  The Office of Audit's "Fiscal

Year 1980 Workplan" suggests the backlog of Construction

Grants audits would consume 81 workyears (see Exhibit A in

the Workplan).  That is considerable in relation to the 110

total workyears available then for audits of Construction

Grants.  -

     The Semi-annual Report of the Inspector General (IG) for

March 31, 1980, depicts the backlog of Construction Grants

audits as 50.6 years, but the IG has committed no current

resources (in-house auditors or CPA contractors) to reducing

the backlog.  Rather, most in-house auditors are working on

"Project Look," the the IG's tool to carry out the require-

ments of The Inspector General Act. 1/2 "Project Look"

uses teams composed of auditors, investigators and an engineer

to conduct a few intensive, three month interim audits.
1 The purpose of the Office of Inspector General is (A) to
  promote economy, efficiency, and effectiveness, and (B) to
  prevent and detect fraud and abuse.  The office contains
  both auditors and investigators.

2 The IG has committed 50 percent of in-house personel (53
  staff years) to "Project Look."  A pilot.has been completed
  in Jackson, Mississippi? several other "Project Look" efforts
  are taking place now.  Eventually 30 "Project Look" reviews
  will occur each year.  Pages 14-15 and 49-50 describe Project
  Look more fully.


     Two results of committing so many personnel to "Project
Look" are that both the backlog of Construction Grant audits
and the delays are increasing.  Unfortunately, the conse-
quences of delaying audits can be serious.  In New York and
California, delayed audits mean delayed final payments. !
In both places, grantees must borrow funds to pay contractors'
bills and then wait for partial reimbursement of the principle,
The questions, of course, are how long grantees must wait
and how much unreimbursed interest they must pay.
     Even more important, delaying final audits makes it
difficult to assess the financial integrity of construction
grants.  When auditors arrive to conduct an audit, they
frequently find that a municipality's personnel have changed,
the new ones knowing little of what transpired, during the
period of the Construction grant.  If a grantee's documen-.
tation is poor, there is little chance of piecing together
what happened years before.
     Following the rules of the Audit Guide, auditors in such
instances question all undocumented costs.  For their part,
grantees feel betrayed, believing that if only auditors had
arrived sooner they could have "straightened things out."
Whatever the truth here, the point is that "cold audit trails"
affect EPA's ability to assess the financial integrity of  .
construction grants.
1 New York withholds 5 pecent of a grant until .the final audit,
  California withholds: its estimate of a grantee's questioned
  costs, approximately 2-5 percent.


     The Inspector General has asked  for 30 more auditors to

assist in "Project Look" and to perform audits of construction

grants.1  In actuality, the Inspector General will receive no

new auditors in FY 81.  Thirty more staff in FY 82 would mean

receiving funding at "Level 5" (120 percent of current resources)

We ask the question of whether the Office of Audit may not gain

more resources by delegating audits of Construction Grants to



     The momentum for delegating the Construction Grants

Program to the states arises from two additions to the Clean

Water Act (P.L. 92-500).  The first appears in §101{b): "It is

the policy of Congress that the States manage the constuction

grant program under this Act..." (emphasis added).  §205(g)


       The Administrator, is authorized to grant to any
       State from amounts reserved to such state under
       this subsection, the reasonable costs of admin-
       istering any aspects of Section 201, 203, 204
       and 212 of this Act the responsibility for
       administration of which the Administrator has
       delegated to such States. 1

The "amounts reserved" are 2% of each state's allotment

under §201. .As administrative expenses, audits fall within

the realm of delegable activities.   Moreover, the language in

the Clean Water Act suggests that delegation is not an "all
1 Office of Inspector General, Semiannual Report,
  March 31, 1980, p. 16.

2 U.S. Congress, The Clean Water Act §205(g)(2).


or nothing" affair.  Partial delegation can occur—:and indeed

is the norm.   If a State accepts partial delegation, it still

receives its full allotment of 205  (g) money.

     Further, audits, although administrative expenses, are

a standard yet special .function which stands apart from

daily operations.  The principle is that an independent

accountant examines a grantee's financial records and safe-

guards against embezzlement and inclusion of ineligible
costs.  Auditors apply a number of  "tests," tracing, for
example, the history of change orders through filed documents

and records.   If after -examining a grantee's records, auditors

find nothing amiss, they express the written opinion that

the grantee's records present fairly its financial position

as of a certain date.       '                               •

     If audits of construction grants were delegated to the

states, their separate and independent nature would have to

be maintained.  The Office of Audit and the auditing arms

of the State governments would therefore write .their own

portions of the delegation agreements.


     Concerns about delegating audits usually fall into

three categories.  These concerns reflect the implications

of full, as opposed to ,'partial delegation; nevertheless, one

should take note of them.


     Concern  1;  Congressional Intent.  The Office of Water

Program Operations interpreted the phrase "administer any

aspects of .201, 203, 204, and 212 of this Act,"1 as including

audits within the scope of a delegation argeement.  However,

Inspector General Act of 1978 2 casts doubt on that inter-

pretation.  Thus, discussion of Congressional intent to

delegate audits revolves around the extent that the Office

of Audit can delegate audits to states and still meet the

requirement of the IG Act to supervise audits and to report

to Congress any deficiencies that it finds.   A second point is

that in delegating any audits, the Inspector General must

retain the capacity to investigate fraud, waste, and abuse.

Partisans of federally conducted audits voice their feelings

in terms of EPA's need to retain ultimate control of the

Construction Grants program.

     Concern 2; Delegation Will.Increase Problems with Audits

Conducted by CPA's.   The Office of Audit states that it has

experienced many problems in contracting with and training

CPA firms to audit construction grants.  Letting contracts
1 Op. Cit., Clean Water Act.

2 The Inspector General is "(1) to conduct and supervise
  audits and investigations relating to programs and
  operations of...the Environmental Protection Agency...
  (2) recommend policies for activities designed
  (A) to promote economy, efficiency," and effectiveness...
  and (B) to prevent and detect fraud and abuse, and (3)"
  to provide a means for keeping the head of the establish-
  ment fully and currently informed about problems and
  deficiencies relating to the administration of such
  programs and operations and the necessity for and progress
  of corrective action."


 to  low bidders, "high  turnover rates within CPA  firms, the

 three  year  competitive  bidding cycle,  and the changing  emphasis

 of  the office of Audit  from bidding cycle to bidding cycle

 have created a situation  in which only 2 CPA firms of 15 CPA

 contractors have as many  as five  years' experience in auditing

 construction grants (EPA  also contracts with 6  state auditing

 agencies).  Moreover, even three-month training periods and

 a program of quality  control  (sampling) have not been enough

 to  eliminate gross mistakes by CPA firms in judging the the

 compliance of grantees.   Those troubled by delegating audits

 argue  that if the Federal government has had trouble with

 CPA contractors, States,hiring local CPA firms will have as

 much trouble fifty times  over.

     Further, according to this argument, delegation will

 wreak havoc with recent prospects for  improving CPA audits.

 Improvements in the quality of CG audits under Federal control

will occur (1)  as experienced CPA firms bid successfully for

 second contracts with EPA and  (2) as EPA in selecting CPA

 firms emphasizes the technical excellence of their proposals.

 In this view,  delegating audits to State agencies whose own

auditors have to learn the complexities of construction

grants would increase the number of unproductive audits.

     Concern 3t   Are 205  (g)  Funds Sufficient to Fund Audits?

Proponents of EPA conducted audits point out that the auditing

staffs of many  States  are small.  They add that because of low

salaries or limits to  State salaries,  these staffs sometimes


are unqualified to audit construction grants.  Such states

would need both training programs and more money if they

assumed responsibilities for audits.

     To respond to this concern* EPA must determine whether/

in each State, 205 (g) funds would cover not only the daily

management of construction grants but also the cost of audit-

ing them.  Additional money may have to be found for some

states (perhaps increasing 205(g) to 2 percent of authori-

zations).  Otherwise, according to this argument, audit

functions will suffer, and the construction grant program will

be worse off after delegation.  The serious point is that under

delegation States must be able to maintain a trained core of

auditors to achieve even that level of financial integrity that

now exists. 1

     In contrast to the three concerns discussed above, there

is one possible advantage to delegating audits.  Delegation

May Give Us Flexible, Responsive Audits.  Those raising this

point contrast the benefits of decentralization (delegation)

with the "economies of scale" resulting from centralization

(federally conducted audits).  In general, they argue that the

benefits of decentralization are flexibility (taking account

of local conditions) and increased responsiveness.   On the

other hand, centralization provides a single locus of

control,  standard procedures, and presumably standard products.
  The Office of Program Management Operations . is asking
  States with delegation agreements to project CG budgets
  for the next 3 years.  The projections are due in August.
  OPMO expects to learn whether 205 (g) allotments will cover
  delegated activities.


     Applied to the  Construction Grants program/ this reason-

ing suggests that if EPA wants audits done more quickly, it

should delegate audits to the States.   If EPA wants to explore

varying accounting requirements for different classes of

grantees, it should  consider delegating audits.  On the other

hand, if EPA wants to apply a standard process (audits) to

relatively uniform raw materials (accounts), the advantages

seem to lie with central control.


   .  Unfortunately,  the legitimacy of the concerns raised.

appears unresolvable because each is raised in an implied

either/or context: either full delegation or no delegation.

None envisions the partial delegation suggested in the

Clean Water Act and  described in the Delegation Guidelines.•

Seriously dealing with any of these issues, however, requires

EPA to specify degrees of delegation, and to describe the

particular blend of  centralization/decentralization in each.

     First, however, review the problems experienced by the

Office of Audit.  Recall that the purposes of auditing con-

struction grants are to maintain fiscal integrity, to reduce

waste,  and at the same time not to impede the progress of

projects without good cause.  The questions here are whether

delegating audits will reduce the backlog and whether delegating

audits will improve  the Construction Grants Program — or at

least will decrease  the resource burden on EPA without sacri-

ficing the program's quality.  Answering these two questions

depends  upon the kind of  partial delegation EPA accepts  —
the  combination of centralized  and decentralized activities
it attempts.   Complete delegation of audits (of the block
grant  sort) does counter  the  intent of Congress by ignoring
the  I . G . Act .  It  would force the use of  State auditors,
largely  untrained  in the  complexities of  construction grants/
and  create fifty auditing systems, sacrificing all to the
principles of  decentralization.
.Build  delegation options  upon the following points
1.   A carefully conceived combination of partial delegation,
     with EPA  training, guidance, oversight, and evaluation,
     may meet  the  requirements  the Inspector General Act.
2.   Take advantage of the recent changes in the Office of
     Audit:  The use of "repeat" CPA firms in successive
     bidding cycles and an emphasis upon  technical excellence
     in  choosing firms will alleviate the problem of control-
     ling the  quality of  CPA audits.
3.   EPA already contracts with six State auditing organi-
     zations. 1 The Semi-annual Report of the Office of the
     Inspector General for September 1979 shows that, for
     the. Construction Grants program. State auditors per-
     formed 36 of  130 interim audits (27%) and 56 of 259
     final audits  (22*).,  Between September 30, 1979, and
  EPA has contracts with Massachussetts, New York, Pennsylvania,
  Tennessee, and Washington.  EPA has a looser "cooperative
  agreement" with California.  These six states, together with
  15, CPA firms, make up EPA's 21 external auditors.


     March 31, 1980, State auditors conducted 39 interim

     audits and 59 final audits.  Further, the Office of

     Audit.affirms that state auditors, already familiar

     with municipal finance, learn the intricacies of con-

     struction grants more quickly than their private sector

     counterparts (CPA's).  Granted, State auditors conducted

     the simpler audits —final audits and small interim

     audits.  The point is that a core of trained State

     auditors does exist and, further, that the potential

     exists to enlarge this core.  These State auditors form

     a base for delegation upon which EPA can build.  In

     essence, the seeds of delegation—partial delegation,

     that is—have already been sown.

4.   Current guidelines make 205(g) money available for

     audits.  Thus,  delegating audits in States whose 205(g)

     allotments exceed the expenses of daily managing con-

     struction grants can increase the resources available

     to the Office of Audit.

5.   EPA can develop a "certification" program for CPA firms

     from its current 3' month training program.  EPA will

     continue to train CPA firms for audits it still super-

     vises.  But it  would certify the better firms to augment

     States' auditing staffs.  EPA would provide the States

     with a list of  certified firms, and delegation agreements

     would permit the States to negotiate individual contracts

     with these certified firms.  Certification would probably


     involve a training period longer than the current three .

     to six months.  Certainly EPA would have to weigh tech-

     nical excellence very highly in selecting firms to

     participate.  Further, firms should be recertified

     periodically. ^

6.   EPA should ascertain the extent to which it may legally

     change the accounting requirements of small grantees.

     Small grantees have difficulty setting up accounting

     systems.  They frequently co-mingle funds,  they do not

     successfully separate eligible from ineligible costs,

     and their procurement systems are often informal.  Often

     they relinquish control of their construction grants to

     A/E firms.  One approach to the problems of the small

     grantee is to have States manage the construction grants

     of all small grantees.  A second approach is to adjust

     accounting requirements that EPA and GAO impose on

     small grantees, perhaps devising a lump sum schedule for

     administrative, legal, and fiscal costs (suggested in the

     1990 paper on simplifying the eligibility of such costs).2

7.   EPA should "sell" the auditing function to the States on

     the grounds that State auditors are more familiar with

     regional problems and that State auditing programs can

     shorten the lag between audits requests and audit reports.
1 Conceivably, EPA could also certify individual CPA's: former
  members of firms who want to operate alone or present, members
  of firms.   The intent of paragraph 5 is to build on EPA's
  present scheme of contracting with CPA firms.

2 Chapter I describes other ways to help small grantees surmount
  the accounting requirements of a construction grant.


     Construct Options'to Meet the Following Criteria

     (1)  Delegated audits should be conducted in such a way

          as to lessen, not increase, confusion.  This means

          that EPA will have to clarify its policies about

          the construction grants program.  Decisions by the

          Audit Resolution Board have this intent.  Further,

          project officers must interpret similarly the

          administrative requirements placed upon grantees.

     (2)  Delegated audits should not simply result in another

          layer of government.  Rather, any delegated audits

          should increase the responsiveness of government

          (begin audits more quickly? close them with more

          dispatch) and at the same time use similar standards

          to judge grantees of the same class.

     (3)  The speed with which delegation proceeds should not

          jeoparidze the quality of CPA work.  The CPA firms

          with which EPA contracts are small.  Certified CPA

          firms must not expand their operations so quickly

          that they are forced to hire poor auditors in order

          to have full staffs.

     (4)  Measurable benefits should accompany any increase

          in the total amount of money spent auditing

          construction grants.


     Given these four criteria and the proceeding six points,

consider five choices available to EPA.  They are arranged

on a continuum of increasing delegation.


     Option  1 is the current  state of affairs.  While  fewer

problems with CPA audits may  occur and audit disputes  may be

settled more quickly with the Audit Management System  (the

allowable  limit is  270 days), the backlog of audit requests

will remain.  Moreover, the "shadow backlog" —the requests

that have  not been  made because regional offices have  little

incentive  to request final audits—will remain as large as ever.

     Option 2 uses  the delegation agreements to increase the

number of  state auditors performing work for EPA's Office of

Audit.  State auditors would  focus, as they do now, on final

and small  interim audits.  EPA would remain responsible for

training auditors,  controlling the quality of delegated

audits, and performing midsized and large interim audits.

The advantage of this option  is that the Office of Audit is

able to use 205 (g) funds to  increase its staff and so reduce

the backlog of audits.  The disadvantages are that state

auditors may work only within their geographic boundaries,

that 205(g) money in a given  state may be insufficient to

meet the demand for audits, and that an increase in the

number of  auditing  agreements means a corresponding increase

in administrative costs for the Office of Audit.

     Option 3 combines participation by State auditors in dele-

gation agreements with the use by the States of EPA "certified"

CPA firms.  Under this option States would assume responsiblity

for small grantees and for controlling the quality of the audits

which they either perform or contract for.  Yet to oversee

delegated audits,  EPA would retain the right of Federal access

to audits and actual records.  For its part, EPA would:


     o   train State and EPA auditors

     o   certify the best CPA firms

     o   audit middle size and large grantees

     o   continue Project Look

     o   evaluate States' audit programs, basing its judge-

         ment on both the Audit Guide and the terms of the

         delegation agreements.

     Again, one advantage would be the reduction of the back-

log of audit requests.  Audit trails also would be "warmer".

Possibly a third advantage of Option 3 would be the de_ facto

establishment of a two tiered accounting system, one for

large grantees, another for small ones.  A disadvantage is

that small certified accounting firms might expand too

quickly and jeopardize the quality of their work.  A second

disadvantage is that the quality of State auditing staffs

varies.  Delegating too much too quickly may require EPA to

deal with and train under-qualified State staffs at an

unrealistic rate.

     Option 4 would delegate to State auditing organizations

responsibility not only for small grantees but also for mid-

sized grantees—and eventually for large grantees in States

that perform well.  States would choose contractors from the

EPA certified list of CPA firms.  EPA would retain training

and oversight functions, evaluating State auditing programs

as outlined in Option 3 and performing Project Look reviews.

The advantages, again,:would be a reduced backlog of pending

audits (already requested) and possibly more flexibility.


The disadvantage, however, is that unless this option were
implemented gradually, variance in the quality of work per-
formed by State auditing groups would greatly increase.
     Option 5 is complete delegation, of the block grant
variety.  States would write their own audit guides and
train their own auditors.  EPA would evaluate only overall
programs and would have minimal control over audits.  The
disadvantages here would outweigh the advantages.  Total
delegation would eliminate any economies of scale; problems
in contracting with CPA firms would increase 50 fold.  Further,
it would be difficult for the the Inspector General to report
to Congress because she would have little connection with
the audit program.
                          *   *   *
     In summary, the problem addressed in the chapter is that
of tardy audits.  Although audits are not essential to the
construction of treatment works, poor audits and delayed audits
make construction grants end haphazardly, raise doubts about
their financial integrity, subject communities to needless
unreimbursed expenses, 'and stain the reputation of  EPA and the
Construction Grants program.  Options for delegation address
both the timing and quality of-audits.
     We recommend that the Agency explore the  feasibility of
delegating audits consistent with Options 3 and  4.   These
options give the Office of Audit access  to 205(g)  funds, which
would enable it to reduce the backlog of pending audits and
possibly reinstate preaward audits.


     Using "certified" CPA firms and expanding the role of

State auditors would probably not decrease the quality of

work performed.  Quite the contrary: following "warm" audit

trails and possibly having some flexibility with regard to

small grantees will improve audits and thereby the quality

of the construction grants program.

     Finally, Options 3 and 4 build upon existing elements

in the Office of Audit:  a core of well trained auditors in

six states; several small, competent CPA firms; a mechanism

for quality control; and the Office of Audit's own experience

in managing contracts.                       •            .


                       :   CHAPTER III

            Appeals  of Final  Determinations  to  the
                   Office  of General Counsel

     A third, recent problem  in  auditing  construction grants

 is the increasing  number  of appeals of  "final determinations"

 to the Office of General  Counsel (OGC).   Between January  1, 1980,

 and June  30, 1980, 47 grantees filed appeals, 33 from Region IX


     Appeals from  Region  IX increased sharply because its

 Regional  Administrator believed  EPA Order 2750.2 (which sets

 up the Audit Resolution Board and the Audit  Management System)

 required  him to make  a "final determination" within  60 days

 of receiving a final  audit report.  Often grantees could  not

 provide documentation in  60 days to rebut questioned costs.

 Rather than accept final  determinations made under these

 conditions, 33 grantees appealed to the General Counsel.

     The  problem of increased appeals is not, however, unique

 to Region IX.  The Inspector .General has issued a "Red Border '

 Package" which proposes requiring . "final determinations"  in

 60 days of all regions.   She argues that regional personnel

 and grantees have enough  time to prepare responses to audit

 reports because they receive draft reports well in advance

of final audit reports.1  She further argues that this limit

 is necessary in order to  met the  requirement of OMB Circular
1 Region V finds it difficult to respond to a draft report
  because a copy of the file does not accompany the draft

                              -36-     -

 A-73 that audit disputes be resolved in 180 days.1

      Importantly,  only two respondents concurred with the

 proposed 60 day limit.  Most described the difficulties of

 making fair final  determinations in 60 days.  Others foresaw

 many more appeals  to the Office of General Counsel.   Regions

 must now wait for  the Administrator's decision.

      Already besieged by appeals beyond its capacity,  the

 Office of General  Counsel maintains that no audit dispute

.exists until a grantee has responded to the audit report and

 until auditors have weighed its response.   Accordingly, 15

 of Region XX's appeals are "in suspense";  that is, the parties

 are settling "out  of court," preparing and responding  to docu-

 ments that they otherwise would have presented in the  audit

 resolution process.   The other 18 appeals  will probably go

 into suspense".  In essence, grantees and  auditors are using

 the appeals process to accomplish what they otherwise  would

 have done in the audit resolution process.

      That resolution process,  the Audit.Management System, is

 described by EPA Order 2750.2 (June 8,  1979) and diagrammed

 Phase  1:
 Phase  2:
 Phase  3:
I Regional Action Officer
 Division Office of
 Asst. I.G. for Audit
IH.Q.  Action Officer!
             I Audit Resolution
             I      Board
-JOffice of Asst. I.G.I
 I for Audit   	      I
           I Inspector
           I General
           I Role)
   EPA now operates  under a waiver allowing it 270 days  to
   resolve audits.


This process occurs in three phases;

Phase 1:  A Divisional Office of Assistant Inspector General

          for Audit (DOAIGA) sends an audit report to the

          appropriate Regional Action Officer (AO), who in

          most cases is the Regional Administrator (RA).  The

          RA has sixty days in Which to respond to the findings

          of the auditors.1

          If the Regional Administrator either does not respond

          or disagrees with the audit findings, the DOAIGA

          refers the case to the Office of the Assistant

          Inspector General for Audit (OAIGA).

Phase 2:  The OAIGA works with the Headquarters Action Officer

          to resolve the disagreements.  If a dispute is not

          resolved within 270 days after the audit report was

          issued, the OAIGA decides whether the materiality

          and/or special nature.of the case warrants its review

          by the Audit Resolution Board.

          If the case is judged insignificant, the DOAIGA will

          be told to close the file—with presumably no action

          being taken by EPA or by the grantee.

Phase 3s  If the OAIGA refers the case to the Audit Resolution

          Board (ARE), ,the ARB determines the official position

          of EPA and the Agency's initial action.

1 Order 2750.2 deems invalid a response that the Regional
  Administrator is "working on the problem."


     Several points can be made about this Audit Management
System.  First, its intent is to force the resolution of

audit disputes.  Few incentives heretofore existed for project

managers to resolve such disagreements.  The resulting failure

to close projects had created a in EPA's manage-

ment of the Construction Grants program.  Second, the Audit

Management System requires some explicit decision (even a

decision to do nothing) about each set of audit findings.

At the same time the process depicted in Order 2750.2 appears

to allow a Regional Administrator to resist trivial or

inappropriate recommendations, although at some cost.  In

other words, a case must officially close, but it may close

only because the office of the Assistant Inspector General

for Audit deems it too insignificant to bring before the

Audit Resolution Board.  Third, the composition of the Audit

Resolution Boardl and the advisory nature of the Inspector

General's role vis a vis the ARB attempt to ensure that the

Office of Inspector General will not set EPA policy.  Yet,

the questions put to the Audit Resolution Board are those

pursued by auditors, not those raised by program personnel.2
1 Sitting on the Audit Resolution Board are:  a) the EPA Deputy
  Administrator, b) the EPA General Counsel, c) the Asst.
  Administrator for Planning and Management, d) the Asst.
  Administrator of the program in question, and e) a Regional

2 The first three ARB decisions concern the base for computing
  design fees, the costs of marketing bonds, and additional costs
  claimed by grantees after final audits have been performed.
  These decisions did clarify policies and resolve a number of
  audit disputes.

     Perhaps one could have predicted some immediate effects

of the Audit Management System.  Region IX's attempt to make

final determinations in 60 days has indeed "closed" more

audits.  In itself/ the greater number of closed cases suggests

that EPA's management of the Construction Grants Program has

improved.  However, the number of appeals confirms the intuition

that "closed" cases may not indicate resolved cases.

     Further, the general failure of the Regions to concur with

the proposed 60 day requirement (and with two other proposals

in this Red Border1) package reveals the gap between the prio-

rities of auditors and program personnel.  Auditors believe

their charge is to protect federal dollars.  Program personnel

see theirs as helping communities to build sewage treatment

works.  These two sets of priorities will not overlap until

(1) auditors concentrate upon important issues, and (2)

regional offices see the establishment of good financial

management in municipalities as one goal of the Construction

Grants program.

     The Office of General Counsel (OGC) and the Offices of

Regional Counsel (ORC) may serve to bring auditors and program

personnel together.  With more appeals than it can handle,

the OGC proposed in a Denver, Colorado, grants seminar2 to
1 The Red Border package also proposes (1) to shorten the total
  time for resolving audits from 270 to 180 days and (2) to
  require a legal, opinion whenever a region does not recover
  costs questioned in a final audit.
2 Denver, Colorado, April 8-11, 1980.


involve itself in the audit follow-up process.  The OGC
suggested that it become involved  (1) as soon as a draft
audit report appears and (2) during the time between the
final audit and the final determination..  The OGC would view
itself and its regional counsel as mediators between auditors
on the one hand and the grantee and program personnel on the
other.  For example, the regional counsel.would play a cri-
tical role when auditors recommend recovering a sizeable sum
from a grantee or when a final indirect cost rate established
for an A/E firm is much less than the firm's provisional or
proposed final rate.
     In essence, accepting this offer from the Office of
General Counsel would modify the Audit Management System
established .by EPA Order 2750.2.  Instead of two actors in
Phase lf the regional Action Officer and the Divisional
Office of Audit, there would be three actors:  the regional
office, the Divisional Office of Audits, and the Office of
Regional Counsel.  Moreover, mediation by regional counsel
appears to further two purposes of the Audit Management
System:  (1) to identify quickly major problems disclosed by
audits and (2) to respond speedily to audit recommendations.
In addition, such mediation would ensure that final deter-
minations reflect significant, rather than trivial, audit
     While efforts by the Office of General Counsel to
mediate disagreements would narrow differences between
auditors and program personnel, other events are also making


the priorities of auditors and program personnel converge.

Studies of the economic impact of paying for, operating, and

maintaining sewage treatment plants show that successful

communities must actively plan and manage their finances.*

Such findings encourage project officers to take accounting

concerns seriously.  Thus if the Construction Grants program

begins, to assist grantees in record keeping and financial

planning/ the distance between the Office of Audit and the

regional offices should narrow further.
  See 1990 papers on fiscal assessment and local financial
  capability.  See also the GAO report titled "EPA Should
  Help Small Communities Cope with Federal Pollution Control


                          CHAPTER IV

               The Quality of Contracted Audits

     Regional program staff have consistently expressed their

frustration with audits done by CPA firms.  Their frustration

occurs because CPA auditors often do not know the Construction

Grant regulations well, and as a consequence, their audit

findings are sometimes invalid.  A frequent complaint is that

CPA auditors apply regulations retroactively.  This means

that CPA auditors question costs which grantees legitimately

incurred under regulations in force at the time of the expenses,

They question these costs because they fail to distinguish

such costs from costs incurred later under modified regulations,

Program staff then must ascertain which audit findings are

appropriate.  Contract officers in the Office of Audit freely

state their difficulties.  Whether poorly conducted CPA

audits are an issue, however, depends upon the extent to

which the Office of Audit is working to solve its problems.

The Office of Audit is taking steps to improve the quality

of contracted audits.

     Some background.  The responsibilities of the Office of

Audit include, audits of programs, grants, and contracts for

all environmental programs over which EPA has statutory

responsibility.  In addition, the Office of Audit conducts

internal audits of EPA.headquarters, regional offices, and

laboratories.  Without contracts with CPA firms and state

auditing agencies, and without interagency agreements, the


Office of Audit cannot perform its duties.  The current plan
is  for CPA firms and state auditors to conduct all interim
and final audits of construction grants.   (EPA auditors will
devote themselves largely to  Project Look.)
     To choose CPA firms, the Office of Audit solicits
proposals and bids every three years.  Each firm chosen
receives a twelve month contract, which the Office of Audit
may extend for two successive twelve month periods.  Receiving
a set of proposals, the Office of Audit scores their technical
content.  Then the Office of Contracts evaluates the price of
each.  In the past, a low bid has been more important to EPA.
than an excellent proposal.  The Office of Audit has been
compelled to award contracts to the the lowest bidding CPA
firms on the grounds that EPA needs only "adequate" auditors.
     This situation has been responsible for the poor quality
of many CPA audits.  Even lengthy training periods and site
visits have not improved audits quickly.
     Now, however, the situation has changed.  First, the
Office of Audit may weigh technical excellence more heavily
than price in the next bidding cycle.   Second, several CPA
firms have held contracts for five years and have become
excellent auditors of construction grants.  Indeed, Region
III attributes a recent decline in the mean time between an
audit request and the subsequent audit report to the increased
proficiency of CPA firms (a decline from 14 to 13 months).
Third,  EPA has good experience with the six state auditing


agencies with whom it also contracts.1  The familiarity of

their auditors with municipal finance and with other grant

programs has enabled them to grasp quickly the complexities

of construction grants.  This changed situation, together

with the Office of Audit's training program for new contractors

and its program of quality control (sampling),.allow one to

be sanguine about contracted audits.  The training program

lasts from three to six months, with the project officer

conducting classes and making site visits.  The contract

officer reviews all audits a CPA firm performs during the

training period.  To control the quality of audits after the

training period, Headquarters samples 10 percent of audit

reports.  Individual project officers in the audit divisions

also may check CPA audits.

     Thus the Office of Audit believes that the prospect is

good that CPA audits will improve.  Indeed, the question

seems to be whether the Office of Audit should not use its

CPA firms and State auditors as a base upon which to construct

a delegated program of audits.
  New York, Tennessee, California, Washington, Pennsylvania,
  and Massachusetts.


     Correcting any of the  four  problems discussed  in this
paper will "benefit the Construction Grants program  and
improve its integrity.  Correcting all  four problems
will create a kind  of synergy.  Table  3 diagrams the re-
lationships.  Specifically, helping grantees to establish
good records will reduce both questioned costs and  the time
necessary to complete audits.  Delegating audits will re-
duce both the time between requests and conduct of  audits
and questioned costs.  Competent CPA's will conduct audits
faster and produce significant findings.  These changes,
along with mediation by the Offices of Regional Counsel,
will speed audit resolution by promoting fair and legally
sound final determinations.  The result will be a better
Construction Grants program.

O  50 O 3
0  !D  Mi 
C UJ  (•
3  H- H- H-
ffl  0  0




                          APPENDIX 1

         Background:  The Office of Inspector General

     The Inspector General Act of1978 — and the subsequent

reorganization of the Office of Audit and the Security and

Inspection Division 	 has changed the focus of the Office

of Audit.  Prior to the Inspector General Act, the Office of

Audit was part of the Office of Planning and Management.

There, the role of the Office of Audit was to develop, conduct,

and coordinate audits of EPA's programs.  This assignment

included:    ,                                          .

         o   independently appraising the economy, effective-

            ness of financial and program operations;

         o   establishing general and specific audit programs

            within EPA and for grantees, and contractors;

         o  prescribing procedures, standards, and criteria

            for auditors to use;

         o  reviewing legislative and program proposals for

            impact on audit policy; and

         o  arranging for audits by other Federal, State or

            private organizations when appropriate.

     With the Inspector GeneralAct (P.L. 95-452), two objectives

overshadowed all others.  They are:

         o  the promotion of economy and efficiency in federal

            programs and operations; and

         o  the prevention and detection of fraud, waste, and

            abuse in federal government programs and operations.


     The Inspector General Act of 1978 created independent
Offices of Inspector General in many departments and agencies,
including EPA.  In essence, each Inspector General is an
ombudsman within his agency for the public interest.  Each
Inspector General:  1) conducts and supervises audits and
investigations and 2} recommends policies to prevent and
detect fraud and to promote economic, efficient and effectively
administered programs.  Each Inspector General is appointed
by the President, confirmed by the Senate, and responsible
only to the Administrator of the department or agency in
Which he serves.  At EPA, the Office of Inspector General
has brought together the Security and Inspection Division
and the Office of Audit.
     With a specific mandate to encourage economy and to
detect fraud, Inez Reid, the Inspector General of EPA, has
chosen to change the emphasis of the Office of Audit.  The
chart below suggests some of the changes she has made.

               Activitles o>f the Of f ic e of Audit
                Relating to Construction Grants
 Before 'the !<»__ Act

 a) Pre-award audits

*b) Interim audits

*c) Final audits
 d) Management audits on
    specific topics, e.g./
    audits of lease-buy
    decisions or of
    negotiations with
    A/E firms
After the IG Act

a) Investigation of
   allegations by
   investigative staff

#b) Interim audits

#c) Final audits

 d) "Project Look" —
    a comprehensive
    examination of
    selected construction

 e) Fewer management
      The first change is that the Office of Audits (OA) no

 longer performs preaward audits of construction grants.!

 Preaward audits assessed the costs of proposed A/E contracts

 and analyzed the accounting and management systems of A/E
 *CPA firms performed some, but not all, interim and final
  audits of grantees. . EPA staff conducted interim and final
  audits when Regional Administrators suspected irregularities,

 #CPA firms and state auditing agencies now do all interim and
  final audits.
     the Office of Audit receives funds in FY 82 only through
  "level 3" (100 percent of current resources), it expects to
  contract for no more than 7 preaward audits (through the
  Defense Contract Audit Agency and other federal agencies) .
  Formerly, it performed or a.rranged for about 200 preaward
  audits each year.


 firms prior to their receiving contracts.  Typically, regions

 requested preaward audits  for new contractors, for contractors

 who had not been audited recently, and for contractors proposing

 very large contracts.  These  audits generally reduced the

 prices of contracts and prevented later problems among grantees,

 contractors, and EPA.

     The second change is  that external auditors now do all

 interim and final audits of grantees.  There have been many

 problems associated with the  use of CPA firms in the Con-

 struction Grants Program.  Suffice to say that the con-

 tinued and growing use of  CPA firms is requiring changes in

 the approach used by OA in contracting with those firms.

     Third, EPA's investigations of allegations now occur as

 separate activities conducted by investigators outside the

 context of interim and final  audits.  Previously EPA investi-

 gated allegations in connection with interim and final audits

 performed by its own staff.

     Fourth, the Inspector General instituted "Project Look,"

comprehensive examinations of selected grantees whose federal

 funding is very large or whose practices have been questioned.

 Each comprehensive examination replaces an interim audit and

uses a team of auditors, investigators, and an engineer who not

only conduct a broadly construed audit but also examine the

technical integrity and economy of treatment works.  Each

 'Project Look' be thorough.  By doing 30 such

reviews each year,  the Inspector General hopes to detect


patterns of mismanagement  and fraud.   The question of most
observers concerns  the wisdom of  allocating  50 percent
of  in-house personnel to Project  Look.
     Nevertheless,  these four changes  together enable the
Inspector General to make  visible her  execution of The Inspector
General Act.   Investigations  of allegations  occur separately
and are not "buried" within the audit process.  Similarly,
assessing efficiency, economy, and effective administration
occurs separately and visibly as  "Project Look".
     It is not obvious, however,  that these  revised priorities
will make the Office of.Audit  more efficient.  The I.G. has
rearranged activities according to the legislative mandate in
The Inspector General Act.   Scarce resources have apparently
dictated fewer management audits  and the deletion of preaward
audits.  Two questions seem to be whether Project Look will
uncover substantially more fraud  than previous investigations
and how much,  if at all,  other auditing responsibilities
will suffer.

                           APPENDIX 2

              The Minimal  Effect  of Attachment  P

       Attachment P alters OMB  Circular A-102 to  allow  re-

 cipients of Federal grants to hire their own auditors" subject

 to conditions specified by OMB.   The intent of  Attachetnent  P

 is to  "audit the organization,  not the  grant"?  that  is, to  have

 a single audit for each recipient which serves  all federal

 agencies making grants.  To assure compliance-with federal

 regulations, each recipient has a "cognizant agency" which

 reviews the quality of the audit,  gives technical advice to the

 recipient, distributes the audit  report to appropriate

 agencies, and follows up audit  findings.  .Recently .OMB

 made EPA cognizant agency  for recipients of construction

 grants.  EPA, however, is  not using Attachment  P As  a way to-

 delegate audits of construction grants.

     EPA's first concern was that the requirements audits

 must meet under Attachment P fall  short of the  regulations

 imposed on construction grants.   Thus EPA feared that if

 another agency were designated the cognizant agency  for

 recipients of construction grants, that agency  and locally

hired CPA's unfamiliar with the regulations of  the Construction

 Grants program vrauld impair the fisca-1  integrity of  the

program.                             •  .       '            ' -    '

     Accordingly,  the Office of Audit argued that construction

grants  cire atypical grants.  .Unlike other grants, (e^.g. , CETA

grants),  t'n«ir recipients  do not  spend  federal  funds primarily

to acid city employees. , Rather, construction grants are the

means to contract  for services:   the services of A/E firms,

construction  companies,  and suppliers,  A municipality, in effect,

is only a conduit  for funds.

     Further, the  complexity of  an audit of a construction  grant

is a function of the  number of sub-agreements into which the grantee

has entered.  Those agreements,  the accounting and management

systems to monitor them,  and the regulations which each agreement

must meet, form the heart of a construction grants audit.  That

EPA  would need to train auditors of such grants is apparent.

     Hence as cognizant  agency,  EPA will minimize the role of

locally hired auditors.   True, such auditors will audit

recipients' other  grants according to the terms outlined in

Attachment P.  But for construction grants they will examine

only grantees' administrative costs and personnel costs

(force "accounts).  They  will  not examine the sub-agreements

neceasary to  erect sewage treatment plants.   Further, locally

hired auditors may issuejonly, qualified opinions regarding

construction  grants.  To: assure  the fiscal integrity of

construction  grants,  EPA;1 s Office of Audit will continue to

use final audits performed by its own contractors,  who are

trained not only to examine municipal accounts but also to

apply federal regulations to  the sub-agreements with A/E

firms,  construction firms,  and other entities performing

work for grantees.                                          ,  ~      •
                        . U.S. Environmental Protection Agency-
                         Library, Room 2404  FM-211-A
                         401 M Street, S.W.
                         Washington, DC .  20460