Strong Audits: An Essential
Ingredient in Delegating
Construction Grants
(V
*
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
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PURPOSE
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
grants.
• SUMMARY
A strong auditing function is essential if EPA.is 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
recipients.
Problem (2) Auditors have difficulty in assessing the
financial integrity of construction grants when delays in
starting final audits create "cold audit trails".
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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
1978.
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
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)
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.
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Table 1
Problem
Corrections)
Offices Involved
Inability of small
grantees to meet
the accounting
requirements of the
Construction Grants
program.
Choose among 5 options for
up-front help to grantees:
(1) Market grant eligible
seminars which teach
proper accounting
procedures.
(2) Hire CPA's to set u£
C.G. accounts for
grantees.
(3) Combine options 1 and
2.
(4) Set up teams of accoun-
tants to help grantees
States or third parties.
i
(5) Have States or third
parties manage the
smallest grants.
I
(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
agencies
(3) CPA firms
Appeals of final
determinations to
Office of General
Counsel.
(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
Counsel
(2) Divisional Offices
of Audit
(3) Regional Offices
f
•
Poor quality of
nterim and final
udits conducted
v CPA firms.
Select technically
excellent CPA firms.
(1) Office of Audit
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TABLE OF CONTENTS
I. Difficulties of Small Grantees
Page
5
II. The Backlog of Construction Grant Audits
,19
III. Increased Appeals to the General Counsel 35
IV. The Quality of Contracted Audits
42
Appendix 1: The Office, of Inspector General
46
Appendix 2: The Minimal Effect of Attachment P.. 51
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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.
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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.
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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
expended.
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-
A
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.
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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.
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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
satisfied.
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
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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).
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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.
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The answer, then, to the question of whether such work-
shops and manuals are a viable way to help small grantees is a
tentative y.es. (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
•L
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.
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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
grantees.
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.
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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.
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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.
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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.
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. ' •:
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)
funds.
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.
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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.
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-20-
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.
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-21-
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
States.
AUDITS MAY BE DELEGATED
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)
elaborates:
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).
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-22-
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
i
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
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.
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-23-
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)...to 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."
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-24-
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
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-25-
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.
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-26-
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.
CRITERIA FOR DELEGATING AUDITS
. 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
-------
-27-
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.
-------
-28-
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
r
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
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-29-
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.
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-30-
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.
OPTIONS FOR DELEGATING AUDITS
Given these four criteria and the proceeding six points,
consider five choices available to EPA. They are arranged
on a continuum of increasing delegation.
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-31-
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:
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-32-
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.
-------
-33-
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.
RECOMMENDATION
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.
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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. • .
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: 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
alone.
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
report.
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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
below:
Phase 1:
Phase 2:
Phase 3:
I Regional Action Officer
I(RA)
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(Advisory
I Role)
EPA now operates under a waiver allowing it 270 days to
resolve audits.
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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."
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Several points can be made about this Audit Management
•i
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 visible.gap 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
Administrator.
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.
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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.
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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
findings.
While efforts by the Office of General Counsel to
mediate disagreements would narrow differences between
auditors and program personnel, other events are also making
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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
Requirements."
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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
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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
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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.
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CONCLUSION
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.
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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.
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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.
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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
grants.
e) Fewer management
audits.
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.
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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,"
•x
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' promises.to be thorough. By doing 30 such
reviews each year, the Inspector General hopes to detect
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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.
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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
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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
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