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Inspector General's Report on EPA's Fiscal
2006 and 2005 Consolidated Financial Statements
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Contents
At a Glance	274
Inspector General's Report on EPA's Fiscal 2006 and 2005 Consolidated Financial
Statements (Report No. 2007-1-00019 issued November 15, 2006)
Review of EPA's Required Supplementary Stewardship Information, Required Supplementary
Information, Supplemental Information, and Management's Discussion and Analysis	276
Evaluation of Internal Controls	277
Tests of Compliance with Laws and Regulations	279
Prior Audit Coverage	280
Agency Comments and OIG Evaluation	280
Attachments
L Reportable Conditions	281
EPA's Implementation of Accounting Processes Resulted in Misstatements	281
EPA Misclassified Interagency Agreement Advances to Other Federal Agencies	282
2.	Compliance with Laws and Regulations	284
EPA Did Not Reconcile Differences With Trading Partners	284
3.	Status of Prior Audit Report Recommendations	285
Appendices
L EPA's Fiscal 2006 and 2005 Consolidated Financial Statements	2I6
II.	Agency's Response to Draft Report	286
III.	Report Distribution List	288
273

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Fiscal Year 2006 Performance and Accountability Report, U.S. Environmental Protection Agency
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November 1 5, 2006
At a Glance

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Why We Did This Audit
We performed this audit in
accordance with the
Government Management
Reform Act, which requires the
U.S. Environmental Protection
Agency (EPA) to prepare, and
the Office of Inspector
General to audit, the Agency's
financial statements each year.
Our primary objectives were
to determine whether:
•	EPA's consolidated financial
statements were fairly pre-
sented in all material
respects.
•	EPA's internal controls over
financial reporting were in
place.
•	EPA management complied
with applicable laws and reg-
ulations.
Background
The requirement for audited
financial statements was enact-
ed to help bring about
improvements in agencies'
financial management practices,
systems, and controls so that
timely, reliable information is
available for managing Federal
programs.
For further information, con-
tact our Office of
Congressional and Public
Liaison at (202) 566-2391.
To view the full report, click
on the following link:

Audit of EPA's Fiscal 2006 and 2005
Consolidated Financial Statements
EPA RECEIVES UNQUALIFIED OPINION
We rendered an unqualified, or clean, opinion on EPA's
Consolidated Financial Statements for fiscal 2006 and 2005, meaning
that they were fairly presented and free of material misstatement.
INTERNAL CONTROL REPORTABLE CONDITIONS NOTED
We noted the two following reportable conditions:
•	EPA implemented two accounting processes in fiscal 2006 that led
to misstatements of the Agency's fiscal 2006 bad debt expense, rev-
enue, contra revenue, advance accounts, and unearned revenue
accounts. The processes included reclassifying receivables older
than 2 years as currently not collectible, and transferring the
receivables and related allowance accounts from regional financial
management offices to financial management centers.
•	EPA did not properly account for advance funding agreements
with other Federal Government agencies. EPA recorded advances
disbursed under Interagency Agreements as expenses instead of as
assets. As a result, EPA overstated expenses and understated
assets by $55,982,983.
NONCOMPLIANCE WITH LAWS AND REGULATIONS
NOTED
EPA is in noncompliance with regulations relating to reconciling
intragovernmental transactions. The Agency did not reconcile mate-
rial activity and balances with the Department of Health and Human
Services during the year, and had out of balance situations with many
other agencies.
AGENCY COMMENTS AND OFFICE OF INSPECTOR
GENERAL EVALUATION
In a memorandum received on November 13, 2006, from the
Chief Financial Officer, the Agency agreed with the issues raised and
indicated it will take needed corrective actions.
274

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UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
WASHINGTON, D.C. 20460
November 15,,2006	inspector general
MEMORANDUM
SUBJECT: Audit of EPA's Fiscal 2006 and 2005 Consolidated Financial Statements
Report No. 2007-1-00019
FROM: Paul C. Curtis
Director, Financial Statement Audits
TO:	Lyons Gray
Chief Financial Officer
Attached is our audit report on the U.S. Environmental Protection Agency's fiscal 2006 and 2005 consoli-
dated financial statements. We are reporting a reportable condition and noncompliance with laws and
regulations related to EPA's accounting for interagency activity, as well as a reportable condition related to erro-
neous postings to bad debt expense. Attachment 3 contains the status of recommendations from prior years.
The estimated cost of this report—calculated by multiplying the project's staff days by the applicable daily
full cost billing rates in effect at the time—is $2,561,416.
This audit report represents the opinion of the OIG, and the findings contained in this report do not neces-
sarily represent the final EPA position. EPA managers in accordance with established EPA audit resolution
procedures will make final determinations on matters in this audit report. Accordingly, the findings described in
this audit report are not binding upon EPA in any enforcement proceeding brought by EPA or the Department
of Justice. We have no objections to the further release of this report to the public. This report will be available
at http://www.epa.gov/oig/.
In accordance with EPA Manual 2750, Audit Mamgement Process, you are required to provide us with a writ-
ten response to the final audit report within 90 days of the final report date. The response should address: all
issues and recommendations contained in Attachments 1 and 2. For corrective actions planned but not complet-
ed by the response date, reference to specific milestone dates will assist us in deciding whether or not to close
this report in our audit tracking system.
Should you or your staff have any questions about the report, please contact me at
(202) 566-2523, or Melissa Heist, Assistant Inspector General of Audit, at
(202) 566-0899.
Attachments
cc: See Appendix III, Report Distribution List

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Fiscal Year 2006 Performance and Accountability Report, U.S. Environmental Protection Agency
Inspector General's Report on
EPA's Fiscal 2006 and 2005
Consolidated Financial Statements
The Administrator
U.S. Environmental Protection Agency
We have audited the consolidated balance sheets
of the U.S. Environmental Protection Agency (EPA, or
the Agency) as of September 30, 2006 and 2005, and
the related consolidated statements of net cost, net cost
by goal, changes in net position, financing and custodi-
al liability, and the combined statement of budgetary
resources for the years then ended. These financial
statements are the responsibility of EPA's management.
Our responsibility is to express an opinion on these
financial statements based upon our audit.
We conducted our audit in accordance with gen-
erally accepted auditing standards; the standards
applicable to financial statements contained in
Government Auditing Standards, issued by the
Comptroller General of the United States; and Office
of Management and Budget (OMB) Bulletin 06-03,
Audit Requirements for Federal Financial Statements.
These standards require that we plan and perform the
audit to obtain reasonable assurance about whether
the financial statements are free of material misstate-
ments. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in
the financial statements. An audit also includes
assessing the accounting principles used and signifi-
cant estimates made by management, as well as
evaluating the overall financial statement presenta-
tion. We believe that our audit provides a reasonable
basis for our opinion.
As discussed in Note I.J., the Agency changed its
accounting for delinquent debts in fiscal 2006 to
comply with OMB Circular A-129, Policies for
Federal Credit Programs and Non-Tax Receivables.
The financial statements include expenses of
grantees, contractors, and other Federal agencies. Our
audit work pertaining to these expenses included test-
ing only within EPA. Audits of grants, contracts, and
interagency agreements performed at a later date may
disclose questioned costs of an amount undeter-
minable at this time. The U.S. Treasury collects and
accounts for excise taxes that are deposited into the
Superfund and Leaking Underground Storage Tank
Trust Funds. The U.S. Treasury is also responsible for
investing amounts not needed for current disburse-
ments and transferring funds to EPA as authorized in
legislation. Since the U.S. Treasury, and not EPA, is
responsible for these activities, our audit work did not
cover these activities.
The Office of Inspector General (OIG) is not
independent with respect to amounts pertaining to
OIG operations that are presented in the financial
statements. The amounts included for the OIG are
not material to EPA's financial statements. The OIG
is organizationally independent with respect to all
other aspects of the Agency's activities.
In our opinion, the consolidated financial state-
ments present fairly, including the accompanying
notes, in all material respects, the consolidated assets,
liabilities, net position, net cost, net cost by goal,
changes in net position, reconciliation of net cost to
budgetary obligations, custodial activity, and com-
bined budgetary resources of EPA, as of and for the
years ended September 30, 2006 and 2005, in con-
formity with accounting principles generally accepted
in the United States of America.
Review of EPA's Required
Supplementary Stewardship
Information, Required Supplementary
Information, Supplemental
Information, and Management's
Discussion and Analysis
We inquired of EPA's management as to its meth-
ods for preparing Required Supplementary
Stewardship Information (RSSI), Required
Supplementary Information, Supplemental
Information, and Management's Discussion and
Analysis, and reviewed this information for consis-
tency with the financial statements. The
Supplemental Information includes the unaudited
Superfund Trust Fund financial statements for fiscal
2006 and 2005, which are being presented for addi-
tional analysis and are not a required part of the basic
financial statements. However, our audit was not
designed to express an opinion and, accordingly, we
do not express an opinion on EPA's RSSI, Required

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Section IV FY 2006 Annual Financial Statements—Inspector General's Report
Supplementary Information, Supplemental
Information, and Management's Discussion and
Analysis.
We did not identify any material inconsistencies
between the information presented in EPA's consoli-
dated financial statements and the information
presented in EPA's RSSI, Required Supplementary
Information, Supplemental Information, and
Management's Discussion and Analysis.
Evaluation of Internal Controls
As defined by OMB, internal control, as it relates
to the financial statements, is a process, affected by
the Agency's management and other personnel,
designed to provide reasonable assurance that the fol-
lowing objectives are met:
•	Reliability of financial reporting: Transactions
are properly recorded, processed, and summarized
to permit the preparation of the financial state-
ments and RSSI in accordance with generally
accepted accounting principles, and assets are
safeguarded against loss from unauthorized acqui-
sition, use, or disposition.
•	Reliability of performance reporting:
Transactions and other data that support reported
performance measures are properly recorded,
processed, and summarized to permit the prepara-
tion of performance information in accordance
with criteria stated by management.
•	Compliance with applicable laws and regula-
tions: Transactions are executed in accordance
with laws governing the use of budget authority
and any other laws, regulations, and government-
wide policies identified by OMB that could have
a direct and material effect on the financial state-
ments or RSSI.
In planning and performing our audit, we consid-
ered EPA's internal controls over financial reporting
by obtaining an understanding of the Agency's inter-
nal controls, determining whether internal controls
had been placed in operation, assessing control risk,
and performing tests of controls in order to determine
our auditing procedures for the purpose of expressing
our opinion on the financial statements. We limited
our internal control testing to those controls necessary
to achieve the objectives described in OMB Bulletin
No. 06-03, Audit Requirements for Federal Financial
Statements. We did not test all internal controls rele-
vant to operating objectives as broadly defined by the
Federal Managers' Financial Integrity Act of 1982
(FMFIA), such as those controls relevant to ensuring
efficient operations. The objective of our audit was
not to provide assurance on internal controls and,
accordingly, we do not express an opinion on internal
controls.
Our consideration of the internal controls over
financial reporting would not necessarily disclose all
matters in the internal control over financial report-
ing that might be reportable conditions. Under
standards issued by the American Institute of
Certified Public Accountants, reportable conditions
are matters coming to our attention relating to signif-
icant deficiencies in the design or operation of the
internal control that, in our judgment, could adverse-
ly affect the Agency's ability to record, process,
summarize, and report financial data consistent with
the assertions by management in the financial state-
ments. Material weaknesses are reportable conditions
in which the design or operation of internal control
does not reduce to a relatively low level the risk that
errors, fraud or noncompliance in amounts that
would be material in relation to the financial state-
ments or RSSI being audited, or material to a
performance measure or aggregation of related per-
formance measures, may occur and not be detected
within a timely period by employees in the normal
course of performing their assigned functions. Because
of inherent limitations in internal controls, misstate-
ments, losses, or noncompliance may nevertheless
occur and not be detected. We noted certain matters
discussed below involving the internal control and its
operation that we consider to be reportable condi-
tions, although none of the reportable conditions is
believed to be a material weakness.
In addition, we considered EPA's internal control
over the RSSI by obtaining an understanding of the
Agency's internal controls, determined whether these
internal controls had been placed in operation,
assessed control risk, and performed tests of controls
as required by OMB Bulletin No. 06-03. Our proce-
dures were not designed to provide assurance on these
internal controls and, accordingly, we do not express
an opinion on such controls.

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Fiscal Year 2006 Performance and Accountability Report, U.S. Environmental Protection Agency
Finally, with respect to internal controls related
to performance measures presented in EPAs FY 2006
Performance and Accountability Report, we obtained an
understanding of the design of significant internal
controls relating to the existence and completeness
assertions, as required by OMB Bulletin No. 06-03.
Our procedures were not designed to provide assur-
ance on internal control over reported performance
measures and, accordingly, we do not express an opin-
ion on such controls.
REPORTABLE CONDITIONS
Reportable conditions are internal control weak-
nesses coming to the auditor's attention that, in the
auditor's judgment, should be communicated because
they represent significant deficiencies in the design or
operation of internal controls that could adversely
affect the organization's ability to meet the OMB
objectives for financial reporting discussed above. In
evaluating the Agency's internal control structure, we
identified two reportable conditions, as follows:
Implementing Accounting Processes Resulted in
Misstatements
EPA implemented two accounting processes in fis-
cal 2006 that led to misstatements of the Agency's
fiscal 2006 bad debt expense, revenue, contra revenue,
advance accounts, and unearned revenue accounts.
The Agency adopted OMB Circular A-129, Policies for
Federal Credit Programs and Non-Tax Receivables,
which provides for the reclassification of receivables
older than 2 years as currently not collectible (CNC).
The Agency's revised CNC transaction posting model
was not mapped to the allowance account and did not
include an entry to offset the reduction of current year
revenue. The combination of subsequent CNC reclas-
sifications and allowance adjustment caused the
misstatement of EPA's fiscal 2006 bad debt expense,
revenue, contra revenue, and advance accounts. In
addition, the Agency transferred the receivables and
related allowance accounts from regional financial
management offices to financial management centers.
Inadvertent increases of allowance accounts and sub-
sequent adjustments to remove the allowance
accounts resulted in incorrect postings to bad debt
expense, revenue, contra revenue, and unearned rev-
enue accounts.
Misclassified Interagency Agreement Advances to
Other Federal Agencies
EPA did not properly account for advance fund-
ing agreements with other Federal Government
agencies. Though Federal accounting standards and
EPA's accounting procedures require that advances
made to other agencies be recorded as assets, EPA
recorded advances disbursed under Interagency
Agreements (IAGs) as an expense. This occurred
because the other Federal agencies drew down the
funds under the IAGs soon after the funds were obli-
gated. EPA contributed to the problem by not
following its own accounting policies or that of the
U.S. Treasury. In addition, the Agency has not devel-
oped written procedures for recovering advances from
other Agencies. As a result, EPA overstated expenses
and understated assets by $55,982,983.
We have reported less significant matters regard-
ing internal controls in the form of position papers
during the course of the audit. We will not issue a
separate management letter.
COMPARISON OF EPAS FMFIA REPORT
WITH OUR EVALUATION OF INTERNAL
CONTROLS
OMB Bulletin No. 06-03, Audit Requirements for
Federal Financial Statements, requires us to compare
material weaknesses disclosed during the audit with
those material weaknesses reported in the Agency's
FMFIA report that relate to the financial statements
and identify material weaknesses disclosed by the
audit that were not reported in the Agency's FMFIA
report.
For reporting under FMFIA, material weaknesses
are defined differently than they are for financial
statement audit purposes. OMB Circular A-123,
Management Accountability and Control, defines a
material weakness as a deficiency that the Agency
head determines to be significant enough to be
reported outside the Agency.
For financial statement audit purposes, OMB
defines material weaknesses in internal control as
reportable conditions in which the design or opera-
tion of the internal control does not reduce to a
relatively low level the risk that errors, fraud, or non-
compliance in amounts that would be material in
relation to the financial statements or RSSI being

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Section IV FY 2006 Annual Financial Statements—Inspector General's Report
audited, or material to a performance measure or
aggregation of related performance measures, may
occur and not be detected within a timely period by
employees in the normal course of performing their
assigned functions.
The Agency did not report, and our audit did not
detect, any material weaknesses for fiscal 2006.
Tests of Compliance with Laws and
Regulations
EPA management is responsible for complying
with laws and regulations applicable to the Agency.
As part of obtaining reasonable assurance about
whether the Agency's financial statements are free of
material misstatement, we performed tests of its com-
pliance with certain provisions of laws and
regulations, noncompliance with which could have a
direct and material effect on the determination of
financial statement amounts, and certain other laws
and regulations specified in OMB Bulletin No. 06-03,
Audit Requirements for Federal Financial Statements.
The OMB guidance also requires that we report on
EPA's compliance with the Federal Financial
Management Improvement Act (FFMIA) of 1996.
We limited our tests of compliance to these provi-
sions and did not test compliance with all laws and
regulations applicable to EPA.
Providing an opinion on compliance with certain
provisions of laws and regulations was not an objec-
tive of our audit and, accordingly, we do not express
such an opinion. A number of ongoing investigations
involving EPA's grantees and contractors could dis-
close violations of laws and regulations, but a
determination about these cases has not been made.
In addition, the Agency is changing the confidential
financial disclosure forms required to be filed by EPA
employees, the forms are for the period October 1,
2005 thru December 31, 2006 and are due February
15, 2007. Since the Agency did not require these
forms to be prepared in time to be reviewed for this
audit, we did not perform any tests or inquiries about
those reports. Had the Agency required the confiden-
tial financial disclosure forms be prepared and had we
been able to review the reports and perform tests or
make additional inquires, matters may have come to
our attention that would require reporting.
Our tests of laws and regulations disclosed the fol-
lowing noncompliance issue.
EPA DID NOT RECONCILE DIFFERENCES
WITH TRADING PARTNERS
EPA has taken some action to reconcile its
intragovernmental activity on a quarterly basis, but
did not reconcile differences for intragovernmental
transactions with 47 of its trading partners. During
the fourth quarter, these differences totaled $518 mil-
lion. EPA has experienced problems reconciling with
its intragovernmental trading partners in prior years,
including differences with the HHS that prohibited
EPA from fully complying with the applicable U.S.
Treasury requirements. In fiscal 2006, we found that
HHS records receipts from EPA as deferred revenue
while EPA erroneously records disbursements to HHS
as expenses when paid, rather than advances.
Without confirmation from its trading partners, EPA
has limited assurance that intragovernmental bal-
ances are accurate. Attachment 2 provides additional
details, and our recommendation on actions that
should be taken on this matter.
FEDERAL FINANCIAL MANAGEMENT
IMPROVEMENT ACT NONCOMPLIANCE
Under FFMIA, we are required to report whether
the Agency's financial management systems substan-
tially comply with the Federal financial management
systems requirements, applicable Federal accounting
standards, and the United States Government
Standard General Ledger at the transaction level.
OMB memorandum dated January 4, 2001, Revised
Implementation Guidance for the Federal Financial
Management Improvement Act, lists the specific
requirements of FFMIA, as well as factors to consider
in reviewing systems and for determining substantial
compliance with FFMIA. It also provides guidance to
Agency heads for developing corrective action plans
to bring an Agency into compliance with FFMIA. To
meet the FFMIA requirement, we performed tests of
compliance with FFMIA section 803(a) requirements
and used the OMB guidance, revised on January 4,
2001, for determining substantial noncompliance
with FFMIA.
The results of our tests did not disclose any
instances where the Agency's financial management
systems did not substantially comply with FFMIA
requirements.

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Fiscal Year 2006 Performance and Accountability Report, U.S. Environmental Protection Agency
We reported other less significant matters involv-
ing compliance with laws and regulations in position
papers during the course of our audit. We will not be
issuing a separate management letter.
Prior Audit Coverage
During previous financial or financial-related
audits, we reported weaknesses that impacted our
audit objectives in the following areas:
•	Payroll Internal Controls.
•	General Ledger Adjustments for Receivables
Transferred to Cincinnati Finance Center (CFC).
•	Contingency Plans for Financial Applications.
•	Reconciling and reporting intragovernmental
transactions, assets, and liabilities by Federal trad-
ing partner.
•	Recording Marketable Securities.
•	Correcting Rejected Transactions.
•	Assessing automated application processing con-
trols for IFMS.
•	Security Screenings for Non-Federal Personnel.
•	Change Control Procedures for IFMS.
Attachment 3, Status of Prior Audit Report
Recommendations, summarizes the current status of
corrective actions taken on prior audit report recom-
mendations.
Agency Comments and OIG
Evaluation
In a memorandum dated November 13, 2006,
the Office of the Chief Financial Officer (OCFO)
responded to our draft report.
The rationale for our conclusions and a summary
of the Agency comments are included in
the appropriate sections of this report, and the
Agency's complete response is included as Appendix
II to this report.
This report is intended solely for the information
and use of the management of EPA, OMB, and
Congress, and is not intended to be and should not
be used by anyone other than these specified parties.
J
Paul C. Curtis
Director, Financial Audit
Office of Inspector General
U.S. Environmental Protection Agency
November 14, 2006
280

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Section IV FY 2006 Annual Financial Statements—Inspector General's Report
Attachment I: Reportable Conditions
I EPA's Implementation of Accounting
Processes Resulted in Misstatements
In fiscal 2006, EPA adopted OMB Circular A-
129, Policies for Federal Credit Programs and Non-Tax
Receivables, which provides for the reclassification of
receivables older than 2 years as currently not col-
lectible (CNC). The general ledger automated
posting model established by the Agency to record
CNC entries reduced the receivables—related rev-
enue or advance account—and recorded the CNC
receivables in memo accounts. However, the posting
model was not mapped to the allowance accounts and
did not include an entry to offset the reduction of
current year revenue. The allowance account was
subsequently adjusted for decreases in the open
accounts receivable due to CNC reclassifications.
The combination of the CNC reclassifications and
subsequent allowance adjustment caused the initial
misstatement of EPA's fiscal 2006 bad debt expense,
revenue, contra revenue, and advance accounts. In
the fourth quarter, the Agency revised the accounting
model to include the allowance account.
In addition, the Agency has been moving its
financial operations from the regional FMOs to the
finance management centers over the past several
years. In fiscal 2006, the receivables and related
allowance accounts were transferred from FMOs to
financial management centers. Fourth quarter trans-
fers included amounts previously classified by the
FMOs as CNC under the original accounting model.
By reducing the receivables recorded by the FMOs
under the original accounting model, and recording
the transfer under the revised accounting model, the
allowance accounts were inadvertently increased.
Subsequent adjustments to remove the allowance
accounts resulted in additional incorrect postings to
bad debt expense, revenue, contra revenue, and
unearned revenue accounts.
As a result, at the end of fiscal 2006, bad debt
expense has a credit balance of $54,792,630 and sev-
eral revenue accounts have debit balances totaling
$9,342,912. The US Standard General Ledger dictates
that bad debt expense and contra revenue accounts
Contents
1.	EPA's Implementation of Accounting
Processes Resulted in Misstatements	281
2.	EPA Misclassified Interagency Agreement
Advances to Other Federal Agencies	282
should normally have a debit balance and revenue
accounts should normally have a credit balance. In
addition, the advance account for Superfund future
cost special account receivables has a debit balance of
$2,749,860. The account for advances received from
others should normally have a credit balance.
RECOMMENDATIONS
We recommend the OCFO require the Reporting
and Analysis Staff:
1.	Make the necessary corrections to properly adjust
fiscal 2006 bad debt expense, revenue and
advance accounts to their normal balances.
2.	Work with finance offices to correct the impact
of any future CNC reductions.
We recommend the OCFO have the Financial
Management Offices and Finance Centers:
3.	Monitor CNC decrease entries to transactions for
abnormal increases in the allowance accounts and
decreases in revenue.
4.	Notify Reports and Analysis Staff of these CNC
decrease entries and any allowance for doubtful
account decrease entries needed to correct
allowance accounts.
AGENCY COMMENTS AND OIG
EVALUATION
The Agency generally concurred with our recom-
mendations; however, OCFO only made a partial
adjustment to bad debt expense for financial state-
ment purposes. Our analysis indicated that there were
entries that created abnormal balances in certain rev-
enue and liability accounts that need to be adjusted.
281

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Fiscal Year 2006 Performance and Accountability Report, U.S. Environmental Protection Agency
2 EPA Misclassified Interagency
Agreement Advances to
Other Federal Agencies
EPA did not properly account for advance fund-
ing agreements with other Federal Government
agencies. These agreements usually involve the joint
funding of expenses, grants or contracts for projects
that are administered by another Government
agency. Federal accounting standards and EPA's
accounting procedures require that advances made to
other agencies be recorded as assets that are reduced
when goods and services are received, contract terms
are met, or progress is made. However, EPA recorded
advances disbursed to administering agencies under
IAGs as an expense. This occurred because the other
Federal agencies drew down the funds under the
IAGs soon after the funds were obligated. EPA con-
tributed to the problem by not following its own
accounting policies or that of the U.S. Treasury by
not ensuring it received support for the funds dis-
bursed under the IAGs. In addition, the Agency has
not developed written procedures for recovering
advances from other Agencies when they do not pro-
vide proper cost documentation on advance
agreements. As a result, EPA overstated expenses and
understated assets by $55,982,983.
The Treasury Financial Manual Volume 1, Part 2,
Chapter 2500, Section 2515.10, Payments to Other
Appropriations and Funds as Reimbursements or
Advances, states:
"Advance Payments Required by Law—These trans-
actions are required by a specific law, by which a
determined amount is to be transferred from one
agency and merged with a specific account of another
agency. The amount is payment in advance for goods
and services that will be provided by the second
agency.
Advance Payments to Certain Revolving and
Working Capital Funds—These are transactions
authorized by law, by which certain revolving and
working capital funds are permitted to request pay-
ment for goods and services in advance of delivery.
These advances represent a liability of the revolving or
working capital fund pending delivery of the goods
and services.
Advance Payments to Management Funds—
Management fund accounts are authorized by specific
laws to receive advances from appropriations to ease
accounting for and administration of intra-govern-
mental activities. These accounts are classified either
as annual or no-year accounts, depending on the cir-
cumstances.
Advance Payments to Consolidated Working
Funds—advances for goods and services to be provid-
ed within the same fiscal year by the performing
agency through use of its own facilities may be made
to "consolidated working fund" accounts of the per-
forming agency under Section 601 of the Economy
Act, 31 U.S. C. 686. This method of financing reim-
bursement for goods and services provided by one
agency to another should be used only in instances
where arrangements for current billings and reim-
bursements would be impractical."
Statement of Federal Financial Accounting
Standards No. 1, Accounting for Selected Assets and
Liabilities, dated March 30, 1993, defines advances as
cash outlays made by a Federal entity to its employ-
ees, contractors, grantees, or others to cover a part or
all of the recipients' anticipated expenses. Statement
of Federal Financial Accounting Standards No. 1
states that advances should be recorded as assets. The
advances should be reduced when goods or services
are received, contract terms are met, or progress is
made.
A Disbursement Interagency Agreement is an
agreement in which another Federal agency delivers
goods or services to EPA, and EPA disburses funds to
the other agency's account to pay for that agency's
expenses. EPA Resource Management Directives
2550c, Paragraphs 6. a. and b. define the methods of
payment for goods or services under disbursement
IAGs.
"a. Reimbursable Payment. The agency performing
the work specified in the agreement periodically
bills the other agency or agencies who are party to
the agreement for amounts obligated or costs
incurred in providing the services or goods. The
agency is then reimbursed by the other agencies
for those costs.
b. Advance Payment. Some agencies which perform
work on a reimbursable basis must receive pay-

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Section IV FY 2006 Annual Financial Statements—Inspector General's Report
merit for the provision of goods or services in
advance, i.e., before they actually incur costs. In
this arrangement, the agency requesting the work
provides advance payment to the other agency;
these funds are placed in the other agency's work-
ing fund account. As work is performed, the
agency doing the work will report its expenditures
on a regular basis to the agency requesting the
work. The requesting agency is then able to liqui-
date the advance payment in its accounting
records."
During disbursement testing at CFC, we identi-
fied an advance funded IAG in our sample universe
that was misclassified in IFMS. Based on the results of
that testing, we expanded our review to look at all
EPA advance IAGs with other Federal agencies. The
review included data retrieved from the Integrated
Grants Management System that identified EPA
IAGs with other Federal agencies that were marked
"advance" funded. From the search of the Integrated
Grants Management System and discussions with
EPA project officers and grant specialists, CFC veri-
fied which IAGs were truly advance funded. Then
they tried to determine the status of those IAGs by
obtaining progress reports with supporting cost detail.
Where available, CFC used the most recent progress
reports that included supporting cost detail from its
files. CFC reviewed the detailed cost documentation
to try to determine total advances, expenditures
incurred to date, and the remaining outstanding
advance for the advance funded IAGs. Based on this
review CFC identified IAG advances totaling
$55,982,983 that were misclassified as operating
expenses.
Payments made under disbursement IAGs are
typically processed with transaction codes and types
that record transactions as operating expenses. We
found that CFC recorded the entire $55,982,983 of
advance payments to other Federal agencies as oper-
ating expenses rather than as advances. Further, CFC
did not originally record the advance payments as an
advance in fiscal 2006, and did not follow up on the
status of the outstanding advance. As a result of CFC
recording advances as expenses, expenses were over-
stated by $55,982,983.
RECOMMENDATIONS
We recommend the OCFO have the CFC:
5.	Ensure all future payments under advanced fund-
ed disbursement IAGs are recorded as advances,
and expenses are recognized in the period
incurred.
We recommend the OCFO:
6.	Establish written procedures for recovering
advances from other agencies when those agen-
cies fail to provide proper and timely supporting
documentation of the funds being used.
AGENCY COMMENTS AND OIG
EVALUATION
The CFO generally agreed with our recommenda-
tions, agreeing to coordinate efforts with the Office of
Grants and Debarment to strengthen procedures when
entering into agreements with other Federal entities
so that both entities will be able to accurately compile
financial reporting information. However, the OCFO
stated they have written policies and procedures in
place governing intragovernmental transactions, and
will refine them after issuance of OMB business rules
governing such transactions. OCFO volunteered to
participate on the government-wide committee
designed to resolve trading partner issues among
agencies.
283

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Fiscal Year 2006 Performance and Accountability Report, U.S. Environmental Protection Agency
Attachment 2: Compliance with Laws and Regulations
3 EPA Did Not Reconcile
Differences With Trading Partners
EPA has taken some action to reconcile its
intragovernmental activity on a quarterly basis, but
has not reconciled differences for intragovernmental
transactions with 47 of its trading partners. During
the fourth quarter, these differences totaled $518 mil-
lion. EPA has experienced problems reconciling with
its intragovernmental trading partners in prior years,
including being unable to reconcile differences with
the HHS that prohibited EPA from fully complying
with the applicable U.S. Treasury requirements. In
fiscal 2006, we found that HHS records receipts from
EPA as deferred revenue, while EPA erroneously
Contents
3. EPA Did Not Reconcile Differences
With Trading Partners	
..284
records disbursements to HHS as expenses when paid,
rather than advances. Without confirmation from its
trading partners, EPA has limited assurance that
intragovernmental balances are accurate.
Of the 47 trading partners with differences, we
identified three with material differences, as shown
below. Two of the three, DHS and HHS, had outstand-
ing material differences for each quarter of fiscal 2006.
Federal Agency
Department of Treasury General Fund
Department of Homeland Security
Department of Health and Human Services
Other Federal Agencies
Difference
$237 million
$204 million
($96 million)
$173 million
The U.S. Treasury's Federal Intragovernmental
Transactions Accounting Policies Guide (July 2005) pro-
vides Government-wide accounting policies for
Federal agencies to account for and reconcile
intragovernmental transactions. The Guide states
that agencies should reconcile and confirm intragov-
ernmental activity and balances with their trading
partners before submitting year-end data and report-
ing it in audited financial statements. The Guide also
provides tools (procedures and examples) to facilitate
quarterly reconciliation of intragovernmental activi-
ties.
Intragovernmental transactions have been classi-
fied by the Government Accountability Office as a
Government-wide internal control weakness due to
the lack of standardization in recording and process-
ing intragovernmental activities. To resolve the issue,
OMB established standard business rules
(Memorandum M-03-01, October 4, 2002) to be
used in intragovernmental exchange activities. OMB
Circular A-136, Financial Reporting Requirements,
which was updated July 24, 2006, requires Federal
agencies to report intragovernmental assets, liabili-
ties, revenue, and certain reporting entities with their
Category of Difference
Not Assigned to Any Category
Unbilled Accounts Receivables/Revenue
Advances from Other Agencies
Various Categories
trading partners. This information is presented in the
financial statements, the Closing Package, and should
be in agreement with line items reported on the bal-
ance sheet. Intragovernmental balances and
transactions are a key component in the consolida-
tion of the financial information submitted by Federal
entities and in the overall compilation process of the
government-wide financial report.
Since FY 2003 we have reported the need to rec-
oncile differences with HHS as a noncompliance
issue. The Agency has not acted to reconcile its
intragovernmental activity on a quarterly basis with
HHS, causing these differences to continue. EPA
should increase its efforts to resolve these differences.
RECOMMENDATION
We recommend the OCFO:
7. Require the Office of Financial Management to
reconcile the Agency's intragovernmental trans-
actions to comply with Federal financial reporting
requirements.
AGENCY COMMENTS AND OIG EVALUATION
OCFO agreed with our recommendation.

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Section IV FY 2006 Annual Financial Statements—Inspector General's Report
Attachment 3: Status of Prior Audit
EPA's position is that "audit follow-up is an inte-
gral part of good management," and "corrective action
taken by management on resolved findings and rec-
ommendations is essential to improving the
effectiveness and efficiency of Government opera-
tions." The Chief Financial Officer is the Agency
Follow-up Official and is responsible for ensuring that
corrective actions are implemented. In fiscal 2006,
OCFO included in its Organizational Assessment
Report Recommendations
Measures a metric for audit follow-up. OCFO manage-
ment regularly reviews these measures during OCFO's
monthly Budget and Performance Review meetings.
The Agency has continued to make substantial
progress in completing corrective actions from prior
years. The status of issues from prior financial state-
ment audits, that have corrective actions in process,
are listed in the following table.
Audit Issue Areas with Corrective Actions in Process
Automated. Application Processing Controls for IFMS:
EPA has made progress towards replacing IFMS. However, until EPA implements the planned replacement automated
accounting system that addresses past issues, we will continue to disclose a reportable condition concerning documenta-
tion of the current accounting system and its automated application processing controls.
EPA Needs to Strengthen Practices Regarding Security Screening for Non-Federal Personnel:
EPA had not completed the remaining actions in the Agency's fiscal 1999 Remediation Plan by the end of fiscal 2006.
However, EPA reported that in October 2006 it published the Personal Identity Verification Handbook, which outlines
procedures for conducting background investigations for non-Federal workers.We will schedule a review to evaluate the
effectiveness of the Agency's implemented procedures.
EPA Did Not Promptly Record Marketable Securities:
The Agency plans to transfer the processing of marketable securities to the Cincinnati Finance Center (CFC) in January
2007. As part of the transfer, CFC will develop a reconciliation procedure to ensure a proper and complete non-cash
asset balance.
EPA Continues to Experience Difficulties in Reconciling Intragovemmental Transactions:
The Agency has been working to reconcile I ntragovemmental Transactions, however, as described in attachment 2,
Compliance with Laws and Regulations, the Agency still has reconciling differences with many other Federal Government
Agencies.
Weaknesses in Change Control Procedures for Integrated Financial Management System:
EPA had not completed the remaining corrective action needed by the end of fiscal 2006. However, EPA reported that in
October 2006 it finalized the ENDEVOR security plan that documents the system's implemented security controls.We
will schedule a review to evaluate the effectiveness of the Agency's implemented procedures.
EPA Should Improve Payroll Internal Controls:
EPA has made progress towards improving payroll internal controls to reduce default payments to current and separated
employees. However, EPA has not implemented an automated control in PeoplePlus to limit the number of consecutive
default payments. EPA plans to complete the remaining action by December 31, 2006.
EPA Needs to Improve Correction of Rejected Transactions:
EPA had not completed the remaining action needed by the end of fiscal 2006. However, EPA published on November I,
2006, formal procedures for managing rejected payroll transactions between PeoplePlus and IFMS.We will schedule a
review to evaluate the effectiveness of the Agency's implemented procedures.
EPA Needs to Improve Contingency Plans for Financial Applications:
Although EPA has made some progress in correcting this reportable condition, EPA still needs to (I) finalize contingency
plans for all OCFO applications not subscribing to the National Computer Center Disaster Recovery Services Plan, and (2)
update the personnel contact information within the NCC Critical Application Disaster Recovery Plan. OCFO plans to com-
plete the first action by December 31,2006. OCFO requested NCC update the Critical Application Disaster Recovery Plan.
285

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Appendix II: Agency's Response to Draft Report
i A v0
iSjfef
%PR0^
OFFICE OF THE
CHIEF FINANCIAL OFFICER
November 13, 2006
MEMORANDUM
SUBJECT: Draft Audit Report: Response to Audit of EPA's FYs 2006 and 2005 Financial Statements
FROM: Lyons Gray
Chief Financial Officer
TO:	Bill Roderick
Acting Inspector General
My staff and I thank you for the opportunity to respond to the Draft Audit Report of the U. S.
Environmental Protection Agency's FYs 2006 and 2005 Financial Statements. We agree with
the issues raised and have some observations and clarifications to offer. These are provided in the
attachment.
We believe our existing controls, policies and procedures are effective:. We are in the final stages
of consolidating several financial functions that will improve our efficiency and effectiveness and have
already assisted in streamlining the audit process. As with anything new, challenges exist, but we are
currently evaluating ways to improve operations without compromising fiscal integrity.
This year was a model year for both of us. We worked closely implementing some of the best
practices in Government, which resulted in a smoother audit process. We thank you for your commit-
ment and diligence.
We look forward to another productive year working with the Office of Inspector General. If you
have any questions, please contact Lorna McAllister, Director of the Office of Financial Management at
202-564-4905.
Attachment
cc: Melissa Heist
Paul Curtis
Maryann Froehlich
Joshua BaylsOn
Lorna M. McAllister
Iantha Gilmore
Milton Brown
Raffael Stein
UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
WASHINGTON, D.C. 20460

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Section IV FY 2006 Annual Financial Statements—Inspector General's Report
Attachment I: OCFO's Response to the FY 2006 and FY 2005 Draft Audit Report
INTRODUCTION
We offer the following obser-
vations and clarifications:
•	The transfer of receivables to
the Finance Centers started in
FY 2004 and continued into FY
2006. EPA was consolidating
processes for efficiency, consis-
tency, and improved internal
controls. The consolidation did
not cause changes in accounting
processes or internal controls.
•	As part of the transition, we
concede that transferring the
receivables from the regions to
Cincinnati could have been
executed more effectively.
•	Consolidating accounting
functions and reclassifying debt
over two years old consistent
with OMB Circular A-129 and
Treasury guidance during FY
2006 contributed to the unan-
ticipated abnormal account
balances including the year-
end bad debt expense account.
•	Each quarter EPA works to rec-
oncile differences reported by
the Department of Treasury
with our major trading partners.
As a result of our preliminary
review of the 4th quarter
Treasury Intragovernmental
Activity Report, OCFO identi-
fied potential adjustments that
will reduce the total unrecon-
ciled difference from $518
million to $231 million.
REPORTABLE
CONDITIONS
1. EPA's Implementation of
Accounting Processes
Resulted in Misstatements
OIG Recommendation 1: We
recommend the OCFO require
the Reporting and Analysis
Staff: Make the necessary cor-
rections to properly adjust
fiscal 2006 bad debt expense,
revenue and advance accounts
to their normal balances.
OCFO Response: OCFO
agrees. OCFO's review deter-
mined that only the bad debt
expense account required an
adjustment. This adjustment
was made for financial state-
ment purposes and will be
posted in the accounting sys-
tem in FY 2007.
OIG Recommendation 2: We
recommend the OCFO require
the Reporting and Analysis
Staff: Work with finance
offices to correct the impact of
any future Currently Not
Collectible (CNC) reductions
against entries originally
recorded in the first through
third quarters of fiscal 2006.
OCFO Response: OCFO
believes that the recommenda-
tion should be modified to end
after the word "reductions."
An analysis was completed on
all fiscal 2006 CNC activity.
For FY 2007, the accounting
model will be re-evaluated and
the impact will be monitored.
OIG Recommendation 3: We
recommend the OCFO have
the Financial Management
Offices and Finance Centers:
Continually monitor CNC
decrease entries to transactions
originally recorded in the first
through third quarters of fiscal
2006 for abnormal increases in
the allowance accounts and
decreases in revenue.
OCFO Response: OCFO
believes that the recommenda-
tion should delete the words
"continually" and "originally
recorded the first through third
quarters of fiscal 2006." OCFO
will formally monitor these
transactions monthly instead
of quarterly.
OIG Recommendation 4: We
recommend the OCFO have
the Financial Management
Offices and Finance Centers:
Notify Reporting and Analysis
Staff of these CNC decrease
entries and any allowance for
doubtful account decrease
entries needed to correct
allowance accounts.
OCFO Response: OCFO will
revise the appropriate account-
ing models and amend the
CNC policy.
2. EPA Misclassified Interagency
Agreement Advances to Other
Federal Agencies
OIG Recommendation 5: We
recommend the OCFO have
the CFC: Ensure all future pay-
ments under advanced funded
disbursement IAGs are record-
ed as advances and expenses
are recognized in the period
incurred.
OCFO Response: OCFO will
coordinate efforts with the
Office of Grants and
Debarment to strengthen pro-
cedures when entering into
advance agreements with other
federal entities. Such agree-
ments will establish terms and
conditions within the IAG
process, so that both entities
will be able to compile com-
plete, accurate and timely
financial information for
reporting and recognizing rev-
enue and expenses in the
proper period.
OIG Recommendation 6: We

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Fiscal Year 2006 Performance and Accountability Report, U.S. Environmental Protection Agency
recommend the OCFO:
Establish written procedures for
recovering advances from other
agencies when those agencies
fail to provide proper and time-
ly supporting documentation of
the funds being used.
OCFO Response: OCFO has
written policy and procedures
in place governing intragov-
ernmental transactions with
trading partners. These poli-
cies and procedures will be
refined after issuance of OMB
business rules (expected by
early calendar year 2007) with
stringent requirements govern-
ing the accounting for
intragovernmental transac-
tions including the appropriate
handling of advances and
other accounting transactions.
In addition, OCFO volun-
teered to participate on the
government-wide committee
designed to resolve trading
partner issues among agencies.
COMPLIANCE WITH
LAWS AND
REGULATIONS
3. EPA Did Not Reconcile
Differences with Trading
Partners
OIG Recommendation 7: We
recommend the OCFO:
Require the Office of
Appendix III: Report Distribution List
Chief Financial Officer, Agency
Follow-up Official
Assistant Administrator for
Administration and Resources
Management
Assistant Administrator for
Environmental Information
Director, Office of Policy and
Resources Management, Office
of Administration and
Resources Management
Director, Office of Grants and
Debarment
Director, Office of Technology
Operations and Planning
Director, Office of Budget
Director, Grants Administration
Division
Director, Office of Administrative
Services
Director, Office of Financial
Management
Director, Office of Financial
Services
Director, Cincinnati Finance
Center
Director, Las Vegas Finance Center
Director, Reporting and Analysis
Staff
Director, Financial Systems Staff
Director, Financial Policy and
Planning Staff
Director, Washington Finance
Center
Agency Follow-up Coordinator
Audit Liaison for the Office of
Chief Financial Officer
Audit Liaison for the Office of
Administration and Resources
Management
Audit Liaison for the Office of
Solid Waste and Emergency
Response
Audit Liaison for the Office of
Administrative Services
Audit Liaison for the Office of
Environmental Information
Audit Liaison for the Office of
Enforcement and Compliance
Assurance
Audit Liaison for the Grants
Administration Division
Audit Liaison for the Office of the
Administrator
Audit Liaison for the Offices of
Financial Management and
Financial Services
Office of General Counsel
Acting Inspector General
Financial Management to rec-
oncile the Agency's
intragovernmental transac-
tions to comply with Federal
financial reporting require-
ments.
OCFO Response: OCFO
agrees with the recommenda-
tion and will continue to
make progress in this area.
The Office of Financial
Services will work with the
appropriate EPA offices and
other federal agencies to
obtain the necessary docu-
mentation to support these
transactions.
Abbreviations
CFC
Cincinnati Finance Center
CNC
Currently Not Collectible
EPA
U.S. Environmental

Protection Agency
FFMIA
Federal Financial

Management

Improvement Act
FMFIA
Federal Managers' Financial

Integrity Act
FMO
Financial Management

Office
IAG
Interagency Agreement
IFMS
Integrated Financial

Management System
HHS
Heath and Human

Services
OCFO
Office of the Chief

Financial Officer
OIG
Office of Inspector

General
OMB
Office of Management and

Budget
RSSI
Required Supplementary

Stewardship Information

-------