[Code of Federal Regulations] [Title 7, Volume 11, Parts 1600 to 1899] [Revised as of January 1, 1999] From the U.S. Government Printing Office via GPO Access [CITE: 7CFR1773] [Page 928-959] TITLE 7--AGRICULTURE AGRICULTURE PART 1773--POLICY ON AUDITS OF RUS BORROWERS Subpart A--General Provisions Sec. 1773.1 General. 1773.2 Definitions. Subpart B--RUS Audit Requirements 1773.3 Annual audit. 1773.4 Borrower responsibilities. 1773.5 Qualifications of CPA. 1773.6 Audit agreement. 1773.7 Audit standards. 1773.8 Audit date. 1773.9 Disclosure of irregularities and illegal acts. 1773.10 Access to audit-related documents. 1773.11-1773.19 [Reserved] Subpart C--RUS Requirements for the Submission and Review of the Auditor's Report, Report on Compliance, Report on Compliance and on Internal Controls Over Financial Reporting, and Management Letter 1773.20 CPA's submission of the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter. 1773.21 Borrower's review and submission of the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter. 1773.22-1773.29 [Reserved] Subpart D--RUS Reporting Requirements 1773.30 General. 1773.31 Auditor's report. 1773.32 Report on compliance and on internal control over financial reporting. 1773.33 Management letter. 1773.34-1773.37 [Reserved] Subpart E--RUS Required Audit Procedures and Documentation 1773.38 Scope of engagement. 1773.39 Utility plant and accumulated depreciation. 1773.40 Regulatory assets. 1773.41 Extraordinary retirement losses. 1773.42 Clearing accounts. 1773.43 Capital and equity accounts. 1773.44 Long-term debt. 1773.45 Regulatory liabilities. 1773.46-1773.49 [Reserved] Appendix A to Part 1773--Sample Auditor's Report for an Electric Cooperative Appendix B to Part 1773--Sample Auditor's Report for a Class A or B Commercial Telephone Company Appendix C to Part 1773--Illustrative Independent Auditor's Management Letter for Electric Borrowers Appendix D to Part 1773--Illustrative Independent Auditor's Management Letter for Telecommunications Borrowers Authority: 7 U.S.C. 901 et seq.; 7 U.S.C. 1921 et seq.; Pub. L. 103- 354, 108 Stat. 3178 (7 U.S.C. 6941 et seq.). Source: 56 FR 63360, Dec. 3, 1991, unless otherwise noted. Editorial Note: Nomenclature changes to part 1773 appear at 63 FR 38722, July 17, 1998. Subpart A--General Provisions Sec. 1773.1 General. (a) This part implements those standard provisions of the security instrument utilized by the Rural Utilities Service (RUS) for both electric and telephone borrowers and by the Rural Telephone Bank (RTB) for its telephone borrowers. The provisions require borrowers to prepare and furnish to RUS, at least once during each 12-month period, a full and complete report of its financial condition, operations, and cash flows, in form and substance satisfactory to RUS, audited and certified by an independent certified public accountant (CPA), satisfactory to RUS, and accompanied by a [[Page 929]] report of such audit, in form and substance satisfactory to RUS. (b) This part 1773 applies to both RUS and RTB borrowers. For the purposes of RTB borrowers, as used in this part 1773, RUS means RTB and Administrator means Governor unless the text indicates otherwise. (c) This part complies with the 1994 revision of Government Auditing Standards, issued by the Comptroller General of the United States, United States General Accounting Office. (d) An auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter are required to meet the reporting provisions of the RUS security instrument. (1) The auditor's report must state that the audit was conducted in accordance with generally accepted government auditing standards (GAGAS). (2) The management letter must state that the audit was conducted in accordance with this part. (3) A report of the audit, in form and substance satisfactory to RUS, cannot be issued unless and until an audit has been performed in accordance with GAGAS and this part. (4) A borrower is in violation of provisions of its security instrument with RUS if the borrower fails to provide an audit performed in compliance with GAGAS and this part. RUS security instruments normally provide for notice and an opportunity to cure such violations before RUS can exercise certain remedies. (5) A report prepared in connection with a review or compilation of financial statements, as defined in Statement of Standards for Accounting and Review Services No. 1, Compilation and Review of Financial Statements, does not satisfy the requirements of the RUS security instrument. (6) A report, as described in Statement on Auditing Standards (SAS) No. 62, entitled ``Special Reports'', or in SAS No. 35, entitled ``Special Reports--Applying Agreed-upon Procedures to Specified Elements, Accounts, or Items of a Financial Statement'', does not satisfy the RUS loan security instrument requirements. (7) An annual report containing audited financial statements does not satisfy the RUS security instrument requirements. (e) This part further implements those provisions of the standard RUS security instrument by setting forth the criteria for CPAs to be deemed satisfactory to RUS and the audit procedures and documentation standards that must be performed before a report of the audit satisfactory to RUS can be prepared and issued. [56 FR 63360, Dec. 3, 1991, as amended at 61 FR 107, Jan. 3, 1996] Sec. 1773.2 Definitions. As used in this part: Administrator means the Administrator of RUS and, as provided in Sec. 1773.2 (b), Governor. AICPA means the American Institute of Certified Public Accountants. Audit means an examination of financial statements by an independent CPA for the purpose of expressing an opinion on the fairness with which those statements present financial position, results of operations, and changes in cash flows in conformity with generally accepted accounting principles (GAAP) and for determining whether the borrower has complied with applicable laws, regulations, and contracts for those transactions and events reflected in the financial statements. BAD means the Borrower Accounting Division of RUS. Borrower means an entity that has an outstanding RUS, RTB, or FFB loan or loan guarantee, or that has received a grant for electric, telecommunications, distance learning, or telemedicine purposes under the act. CPA means certified public accountant. The terms CPA and CPA firm are used interchangeably. FFB means the Federal Financing Bank, an instrumentality and wholly owned corporation of the United States. GAAP means generally accepted accounting principles. GAGAS means generally accepted government auditing standards as set forth in Government Auditing Standards, Standards for Audit of Governmental Organizations, Programs, Activities, and Functions, issued by the Comptroller General of the United States. [[Page 930]] GAO means the General Accounting Office. Governor means the Governor of the RTB. Illegal act has the meaning prescribed in SAS No. 54, entitled ``Illegal Acts by Clients''. Irregularity has the meaning prescribed in SAS No. 53, entitled ``The Auditor's Responsibility to Detect and Report Errors and Irregularities''. OIG means the Office of Inspector General, United States Department of Agriculture. OMB means the Office of Management and Budget. PCPS means the Private Companies Practice Section of the AICPA. REA means the Rural Electrification Administration formerly an agency of the United States Department of Agriculture and predecessor agency to RUS with respect to administering certain electric and telephone loan programs. Regulatory asset means an asset resulting from an action of a regulator as prescribed in Statement of Financial Accounting Standards (SFAS) No. 71, entitled ``Accounting for the Effects of Certain Types of Regulation''. Regulatory liability means a liability imposed on a regulated enterprise by an action of a regulator as prescribed in SFAS No. 71, entitled ``Accounting for the Effects of Certain Types of Regulation''. Related party has the meaning prescribed in SFAS No. 57, entitled ``Related Party Disclosures''. Related party transaction has the meaning prescribed in SFAS No. 57, entitled ``Related Party Disclosures''. Reportable condition has the meaning prescribed in SAS No. 60, entitled ``Communication of Internal Control Structure Related Matters Noted in an Audit''. RTB means the Rural Telephone Bank. RUS means the Rural Utilities Service, an agency of the United States Department of Agriculture established pursuant to Section 232 of the Federal Crop Insurance Reform and Department of Agriculture Reorganization Act of 1994 (Pub. L. 103-354, 108 Stat. 3178), successor to REA with respect to administering certain electric and telephone programs. See 7 CFR 1700.1. SAS means Statement on Auditing Standards as prescribed by the AICPA. SEC Practice Section means the Securities and Exchange Commission Practice Section of the AICPA. SFAS means Statements of Financial Accounting Standards as prescribed by the Financial Accounting Standards Board. State means any state or territory of the United States, or the District of Columbia. Uniform System of Accounts means, for telephone borrowers, the Uniform System of Accounts for Telecommunications Companies, prescribed by the Federal Communications Commission and set forth at 47 CFR part 32, as supplemented by RUS pursuant to 7 CFR part 1770, Accounting Requirements for RUS Telephone Borrowers, subpart B, Uniform System of Accounts, and, for electric borrowers, the Uniform System of Accounts Prescribed for Electric Borrowers of the RUS. [56 FR 63360, Dec. 3, 1991, as amended at 59 FR 66440, Dec. 27, 1994; 60 FR 2874, Jan. 12, 1995; 63 FR 38722, July 17, 1998] Subpart B--RUS Audit Requirements Sec. 1773.3 Annual audit. (a) Each borrower must have its financial statements audited annually by a CPA selected by the borrower and approved by RUS as set forth in Sec. 1773.4. (b) Each borrower must establish an annual as of audit date within twelve months of the date of receipt of the first advance of RUS or FFB loan funds and must prepare financial statements as of the date established. (c) Until all loans made or guaranteed by RUS have been repaid, the borrower must furnish three copies of the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter to RUS within 120 days of the as of audit date. (d) A borrower that qualifies as a unit of state or local government or Indian tribe as such terms are defined in the Single Audit Act of 1984 (31 U.S.C. 7501 et seq.), the Single Audit Act Amendments of 1996 (31 U.S.C. 7505 et seq.) and OMB Circular A-133, Audits of States, Local Governments, and Non- [[Page 931]] Profit Organizations (copy available from the Executive Office of the President, Publication Services, 725 17th St., NW., Suite 2200, Washington, DC 20502; 202-395-7332), must comply with this part as follows: (1) A borrower that expends $300,000 or more in a year in Federal awards must have an audit performed and submit an auditor's report meeting the requirements of the Single Audit Act of 1984 and the Single Audit Act Amendments of 1996. (2) A borrower that expends less than $300,000 in Federal awards during the year must have an audit performed in accordance with the requirements of this part. (3) A borrower must notify RUS, in writing, within 30 days of the as of audit date, of the total Federal awards expended during the year and must state whether it will have an audit performed in accordance with the Single Audit Act of 1984 and the Single Audit Act Amendments of 1996, or this part. (i) A borrower that elects to comply with this part must select a CPA that meets the qualifications set forth in Sec. 1773.5. (ii) If an audit is performed in accordance with the Single Audit Act of 1984 and the Single Audit Act Amendments of 1996, an auditor's report that meets the requirements of the Single Audit Act of 1984, and the Single Audit Act Amendments of 1996, will be sufficient to satisfy that borrower's obligations under this part. (e) OMB Circular A-133, Audits of States, Local Governments, and Non-Profit Organizations does not apply to audits of RUS electric and telecommunications cooperatives and commercial telecommunications borrowers. [56 FR 63360, Dec. 3, 1991, as amended at 59 FR 659, Jan. 6, 1994; 63 FR 38722, July 17, 1998] Sec. 1773.4 Borrower responsibilities. (a) Selection of a qualified CPA. The borrower's board of directors is responsible for the selection of a qualified CPA that meets the requirements set forth in Sec. 1773.5. When selecting a CPA, the borrower should consider, among other matters: (1) The qualifications of CPAs available to do the work; (2) The CPA's experience in performing audits of utilities; and (3) The CPA's ability to complete the audit and submit the reports and management letter within 90 days of the as of audit date. (b) Board approval of selection. The board's approval of a CPA must be recorded by a board resolution that states: (1) The CPA meets RUS's qualifications to perform an audit; and (2) The borrower and CPA will enter into an audit agreement in accordance with Sec. 1773.6. (c) Notification of selection. When the initial selection or subsequent change of a CPA by a borrower has been made, the borrower must notify RUS, in writing, at least 90 days prior to the as of audit date. (1) RUS will notify the borrower, in writing, within 30 days of the date of receipt of such notice, if the selection or change in CPA is not satisfactory. (2) Notification to RUS that the same CPA has been selected for succeeding audits of the borrower's financial statements is not required; however, the procedures outlined in this part must be followed for each new CPA selected, even though such CPA may previously have been approved by RUS to audit records of other RUS borrowers. Changes in the name of a CPA firm are considered to be a change in the CPA. (d) Audit agreement. The borrower must enter into an audit agreement with the CPA that complies with Sec. 1773.6. (e) Debarment certification. The borrower is responsible for the receipt, from the selected CPA, of a lower tier covered transaction certification, as required under the provisions of Executive Orders 12549 and 12689, Debarment and Suspension, and any rules or regulations issued thereunder. (f) Submission of auditor's report. The borrower must submit to RUS the required auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter as set forth in Sec. 1773.21. (1) An annual auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter that [[Page 932]] fail to meet the requirements detailed in this part will be returned to the borrower with a written explanation of noncompliance. (2) The borrower must, within 60 days of the date of the letter detailing the noncompliance, submit corrected reports to RUS. (3) If corrected reports are not received within 60 days of the date of the letter detailing the noncompliance, RUS may notify the borrower that a default has occurred under its security instrument or take other appropriate action. The default notice will set forth the period of time during which the default will be remedied. (g) Submission of plan of corrective action. The borrower must submit written comments to RUS on the findings and recommendations in the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter. The borrower must also submit to RUS: (1) A written plan for corrective action taken or planned; and (2) Comments on the status of corrective action taken on previously reported findings and recommendations. If corrective action is not necessary, a written statement describing the reason it is not should accompany the auditor's report. Sec. 1773.5 Qualifications of CPA. For purposes of the RUS standard security instrument, any CPA that meets the qualifications criteria of this section and enters into an audit agreement with the borrower that complies with Sec. 1773.6, will be considered satisfactory to RUS. (a) Certification. The accountant that audits the financial statements of an RUS borrower must be a CPA in good standing of some state. The CPA does not have to be licensed by the state in which the borrower is located; however, the CPA must abide by the rules and regulations of professional conduct promulgated by the accountancy board of the state in which the borrower is located. (b) Independence. The CPA must be independent. A CPA will be considered independent if the CPA: (1) Meets the standards for independence contained in the AICPA Code of Professional Conduct in effect at the time the CPA's independence is under review; (2) Does not have and has not had any direct financial interest or any material indirect financial interest in the borrower during the period covered by the audit; and (3) Is not and was not, during the period under audit, connected with the borrower as a promoter, underwriter, trustee, director, officer, or employee. (c) Peer review requirement. The CPA must belong to and participate in a peer review program, and must have undergone a satisfactory peer review of the accounting and audit practice conducted by an approved peer review program under paragraph (c)(4) of this section, unless a waiver is granted under paragraph (c)(7) of this section. The reviewing organization must not be affiliated with or have had its most recent peer review conducted by the organization currently being reviewed (reciprocal reviews). After the initial peer review has been performed, the CPA must undergo a peer review of the accounting and audit practice within 36 months of the issuance of the previous peer review or at such additional times as designated by the peer review executive committee. (1) A CPA that receives an unqualified peer review report will be satisfactory to RUS provided that the CPA meets the other criteria set forth in this section. (2) If a CPA receives a qualified or adverse peer review report, the CPA must undergo a second peer review within 18 months of the date of the qualified or adverse report. A CPA that receives an unqualified second peer review report will be satisfactory to RUS provided that the CPA meets the other criteria set forth in this section. (3) A CPA that receives a second qualified or adverse peer review report will not be satisfactory to RUS. (4) Approved peer review programs. The following peer review programs are approved by RUS: (i) The peer review programs conducted by the AICPA; (ii) The peer review program conducted by the regulated audit program [[Page 933]] group of the National Conference of CPA Practitioners; and (iii) An independent peer review program that, in RUS's determination, requires its members to: (A) Ensure that the CPA can legally engage in the practice of certified public accounting; (B) Adhere to the quality control standards established by the AICPA; (C) Submit to peer reviews of the CPA's accounting and audit practice every 42 months or at such additional times as designated by its own executive committee; and (D) Ensure that all professionals in the firm, including CPAs and nonCPAs, take part in the qualifying continuing professional education requirements of GAGAS, as set forth in paragraphs (c)(4)(iii)(D)(1) and (c)(4)(iii)(D)(2). A qualified continuing professional education course is one which meets the standards of the AICPA. (1) An auditor responsible for planning, directing, conducting, or reporting on government audits must complete, every two years, at least eighty hours of continuing education and training which contributes to the auditor's professional proficiency. At least twenty hours must be completed in any one year of the two-year period; and (2) An individual responsible for planning, directing, and conducting substantial portions of the field work, or reporting on the government audit must complete at least 24 of the 80 hours of continuing education and training in subjects directly related to the government environment and to government auditing. If the audited entity operates in a specific or unique environment, auditors must receive training that is related to that environment. (5) Notification. The CPA must notify the Assistant Administrator, Program Accounting and Regulatory Analysis, in writing, of participation in a peer review program. RUS will notify the CPA within 60 days of receipt of this notice if the selected peer review program is acceptable. (6) Submission of reports. The CPA must submit to the Assistant Administrator, Program Accounting and Regulatory Analysis, a copy of any peer review report and accompanying letter of comment, if any, within 60 days of the date such report and letter of comment are released by the peer review group. (i) If the peer review report indicates that a follow-up review will be made, the CPA must submit subsequent reports to the Assistant Administrator, Program Accounting and Regulatory Analysis, within 60 days of the date such reports are released by the peer review group. (ii) A peer review report must be submitted to the Assistant Administrator, Program Accounting and Regulatory Analysis, at least once every 42 months, or more frequently, if required by the peer review program. (iii) A copy of the peer review report, accompanying letter of comment, and the partners' inspections must be made available to OIG, upon request. (7) Waiver of the peer review requirement. (i) A CPA may request that the Administrator, RUS, waive the peer review requirement. To be eligible for a waiver, the following criteria must be met: (A) The firm has been in existence for less than 1 year from the date of the request and has not been previously organized under a different name; (B) One of the partners organizing the firm has previously, within 18 months preceding the request, worked for a firm that has been peer reviewed and the partner was partner-in-charge of audits of RUS borrowers in the previous firm; (C) The firm has enrolled in an approved peer review program; and (D) The firm agrees to have the peer review conducted within 18 months of the date of the RUS waiver. (ii) Waiver requests must address each of the criteria in paragraph (c)(7)(i) of this section and should be submitted to the Director, Borrower Accounting Division. (d) Audit agreement. The CPA must enter into an audit agreement with the borrower that complies with Sec. 1773.6. [56 FR 63360, Dec. 3, 1991, as amended at 61 FR 107, Jan. 3, 1996; 63 FR 38722, July 17, 1998] Sec. 1773.6 Audit agreement. (a) An audit agreement must be entered into between the CPA and the borrower. The audit agreement must set forth the auditor's responsibilities [[Page 934]] in a financial statement audit, including the responsibilities for testing and reporting on internal controls and compliance with laws and regulations and the nature of any additional testing of internal controls and compliance required by laws and regulations. These responsibilities should be contrasted with the additional procedures that could be performed that would result in additional assurances or opinions on the internal control structure and compliance with laws and regulations. The audit agreement must also include the following: (1) The borrower and the CPA acknowledge that the audit is being performed and the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter is being issued in order to enable the borrower to comply with the provisions of RUS's security instrument; (2) The borrower and CPA acknowledge that RUS will consider the borrower to be in violation of its security instrument with RUS if the borrower fails to have an audit performed and documented in compliance with GAGAS and this part; (3) The CPA represents that he/she meets the requirements under this part to be satisfactory to RUS; (4) The CPA will perform the audit and will prepare the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter in accordance with the requirements of this part; (5) The CPA will document the audit work performed in accordance with GAGAS, the professional standards of the AICPA, and the requirements of this part; (6) The CPA will make all audit-related documents, including auditor's reports, workpapers, and management letters available to RUS or its representatives (OIG and GAO), upon request, and will permit the photocopying of all audit-related documents; and (7) The CPA will follow the requirements of reporting irregularities and illegal acts as outlined in Sec. 1773.9. (b) The audit agreement may include such additional terms and conditions as the CPA and borrower deem appropriate, including, but not limited to: (1) The CPA will report all audit findings to the board of directors as required in Sec. 1773.20(b); and (2) The auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter with copies for transmittal to RUS, and supplemental lenders, if applicable, will be submitted to the borrower's board of directors within 90 days of the as of audit date; (c) A copy of the audit agreement must be available at the borrower's office for inspection by RUS personnel. One copy of the current audit agreement must be maintained in the CPA's workpapers or permanent file. [56 FR 63360, Dec. 3, 1991, as amended at 61 FR 108, Jan 3, 1996; 63 FR 38722, July 17, 1998] Sec. 1773.7 Audit standards. (a) The audit must be performed in accordance with GAGAS and this part. The audit must be performed in accordance with GAGAS in effect at the audit date unless the borrower is directed otherwise, in writing, by RUS. (b) The audit must include such tests of the accounting records and such other auditing procedures that are sufficient to enable the CPA to express an opinion on the financial statements and to issue the required reports on compliance and internal controls and the management letter. (c) Audit scope limitation. (1) The borrower will not limit the scope of the audit to the extent that the CPA is unable to meet RUS's audit requirements or to provide an unqualified opinion that the financial statements are presented fairly in conformity with GAAP. (2) The security instrument provision requiring the submission of a report of the audit is not satisfied if the CPA must qualify the opinion in the auditor's report due to limitations placed on the scope of the audit by the borrower. (3) If the CPA determines during the audit that an unqualified opinion cannot be issued due to a scope limitation imposed by the borrower, the CPA [[Page 935]] should use professional judgment to determine what levels of the borrower's management should be informed. (4) After informing the borrower's management, if the scope limitation is not adequately resolved, the CPA should immediately contact the Assistant Administrator, Program Accounting and Regulatory Analysis, RUS, U.S. Department of Agriculture, Washington, DC 20250- 1500. The Assistant Administrator, Program Accounting and Regulatory Analysis, will endeavor to resolve the matter with the borrower. Sec. 1773.8 Audit date. (a) The annual audit must be performed as of the end of the same calendar month each year unless prior approval to change the as of audit date is obtained, in writing, from RUS. (1) A borrower may request a change in the as of audit date by writing to the appropriate RUS regional office at least 60 days prior to the newly requested as of audit date. (2) The time period between the prior as of audit date and the newly requested as of audit date must be no longer than twenty-four months. For example, a borrower that wishes to change its as of audit date from December 31, 19X1, to June 30, must make the change effective no later than June 30, 19X3. (b) Comparative financial statements must be prepared and audited for the twelve months ending as of the new audit date and for the twelve months immediately preceding that period. (c) A borrower that changes its as of audit date from December 31, 19X1, to June 30, 19X3, must have the CPA report on statements in the following manner: ------------------------------------------------------------------------ Statements prepared as of Previously issued statements new audit date ------------------------------------------------------------------------ 12/31/X1; 12/31/X0 (Statements need not be 6/30/X3; 6/30/X2 reissued). ------------------------------------------------------------------------ Sec. 1773.9 Disclosure of irregularities and illegal acts. (a) In accordance with GAGAS, the CPA must design audit steps and procedures to provide reasonable assurance of detecting errors, irregularities, illegal acts, and noncompliance with the provisions of contracts or grant agreements that could have a direct and material effect on financial statement amounts. (b) If there is an indication that an irregularity may have occurred or evidence concerning the existence of a possible instance of noncompliance with the provisions of contracts or grant agreements that could have a material direct or indirect effect on the financial statements, the CPA must extend audit steps and procedures to obtain sufficient, competent evidential matter to determine whether, in fact, an irregularity or an instance of noncompliance has occurred and the effect on the borrower's financial statements. (c) Pursuant to the terms of its audit agreement with the borrower, the CPA must immediately report, in writing, all irregularities and all indications or instances of illegal acts, whether material or not, to: (1) The president of the borrower's board of directors; (2) The Assistant Administrator, Program Accounting and Regulatory Analysis; and (3) OIG, as follows: (i) For the States of Delaware, District of Columbia, Maryland, Pennsylvania, Virginia, West Virginia, Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, New York, Puerto Rico, Rhode Island, Vermont and the Virgin Islands, report to USDA-OIG-Audit, Northeast Region, Regional Inspector General, 6505 Belcrest Road, room 428-A, Hyattsville, Maryland 20782; (ii) For the States of Alabama, Florida, Georgia, Kentucky, Mississippi, North Carolina, South Carolina, and Tennessee, report to USDA-OIG-Audit, Southeast Region, Regional Inspector General, 401 W. Peachtree Street, NW., room 2328, Atlanta, Georgia 30365-3520; (iii) For the States of Illinois, Indiana, Michigan, Minnesota, Ohio, and Wisconsin, report to USDA-OIG-Audit, Midwest Region, Regional Inspector General, 111 N. Canal Street, Suite 1130, Chicago, Illinois 60606; (iv) For the States of Arkansas, Louisiana, New Mexico, Oklahoma, and Texas, report to USDA-OIG-Audit, [[Page 936]] Southwest Region, Regional Inspector General, 101 South Main, room 324, Temple, Texas 76501; (v) For the States of Colorado, Iowa, Kansas, Missouri, Montana, Nebraska, North Dakota, South Dakota, Wyoming, and Utah, report to USDA- OIG-Audit, Great Plains Region, Regional Inspector General, P.O. Box 293, Kansas City, Missouri 64141; and (vi) For the States of Alaska, Arizona, California, Hawaii, Idaho, Nevada, Oregon, Territory of Guam, Trust Territories of Pacific, and Washington, report to USDA-OIG-Audit, Western Region, Regional Inspector General, 555 Battery Street, room 511, San Francisco, California 94111. [56 FR 63360, Dec. 3, 1991, as amended at 61 FR 108, Jan. 3, 1996] Sec. 1773.10 Access to audit-related documents. Pursuant to the terms of the audit agreement, the CPA must make all audit-related documents, including auditors' reports, workpapers, and management letters available to RUS, or its designated representative, upon request and must permit RUS, or its designated representative, to photocopy all audit-related documents. Secs. 1773.11-1773.19 [Reserved] Subpart C--RUS Requirements for the Submission and Review of the Auditor's Report, Report on Compliance, Report on Compliance and on Internal Controls Over Financial Reporting, and Management Letter Sec. 1773.20 CPA's submission of the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter. (a) Time limit. As soon as possible after completion of the audit, but within 90 days of the as of audit date, the CPA should deliver the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter to the president of the borrower's board of directors. As a minimum, copies should be provided for each member of the board of directors and the manager. Further, three copies must be provided to the borrower for transmittal to RUS. (b) Communication with the board of directors. In addition to providing sufficient copies of the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter for each member of the borrower's board of directors, RUS requires that the CPA report all audit findings to the borrower's board of directors. RUS recommends that audit findings be communicated orally; however, the communication may be oral or written, at the borrower's discretion. If the information is communicated orally, the CPA must document the communication by appropriate memoranda or notations in the workpapers. If the CPA communicates in writing, a copy of the written communication must be included in the CPA's audit workpapers or permanent file. (c) Matters to be communicated. Matters communicated to the board of directors must include, but are not limited to the matters to be communicated to the audit committee as prescribed in SAS No. 61, entitled ``Communication with Audit Committee'',: (1) The initial selection of and changes in significant accounting policies; (2) The methods used to account for significant or unusual transactions and the effects of significant accounting policies in controversial or emerging areas; (3) The process utilized by management to formulate significant accounting estimates and the basis for the CPA's conclusions regarding the reasonableness of these estimates; (4) Audit findings and recommendations, including audit adjustments that either individually or in the aggregate have a significant effect on the borrower's financial statements; (5) The CPA's responsibility for other information presented with the audited financial statements, any audit procedures performed, and the results thereof; [[Page 937]] (6) Any disagreements with management, whether or not satisfactorily resolved, concerning matters that individually or in the aggregate may be significant to the borrower's financial statements or the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, or management letter; (7) Significant matters that were the subject of consultations with other accountants; (8) Significant issues discussed with management with regard to the initial or recurring retention of the CPA; and (9) Any serious difficulties encountered in dealing with management during the performance of the audit. [56 FR 63360, Dec. 3, 1991, as amended at 59 FR 659, Jan. 6, 1994] Sec. 1773.21 Borrower's review and submission of the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter. (a) The borrower's board of directors should note and record receipt of the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter and any action taken in response to the reports or management letter in the minutes of the board meeting at which such reports and management letter are presented. (b) The borrower must furnish RUS with three copies of the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter within 120 days of the as of audit date. Any provision in RUS's security instrument that requires such documents to be furnished to RUS in a shorter period of time may be disregarded. (c) The borrower must furnish RUS with three copies of its plan for corrective action, if any, within 180 days of the as of audit date. (d) The borrower must furnish RUS, within 120 days of the as of audit date, with a copy of each special report, summary of recommendations or similar communications, if any, received from the CPA as a result of the audit. [56 FR 63360, Dec. 3, 1991, as amended at 59 FR 659, Jan. 6, 1994] Secs. 1773.22-1773.29 [Reserved] Subpart D--RUS Reporting Requirements Sec. 1773.30 General. (a) The CPA must prepare the following: (1) An auditor's report, examples of which are set forth in appendixes A, exhibit 1 (Electric), and B, exhibit 1 (Telephone) of this part 1773; (2) A report on compliance and on internal control over financial reporting, examples of which are set forth in appendices A, exhibits 2 and 3 (Electric) and B, exhibits 4 and 5 (Telecommunications) of this part 1773; and (3) A management letter, an example of which is set forth in appendix C of this part 1773. (b) The CPA should deliver the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter (with copies as required in Sec. 1773.20) to the borrower as soon as possible after completion of the audit but not more than 90 days after the as of audit date. [56 FR 63360, Dec. 3, 1991, as amended at 63 FR 38723, July 17, 1998] Sec. 1773.31 Auditor's report. The CPA must prepare a written report on comparative balance sheets, statements of revenue and patronage capital (or income and retained earnings, depending upon the structure of the borrower) and statements of cash flows. This report must be signed by the CPA, cover all statements presented, and refer to the separate reports on internal controls and on compliance with laws and regulations issued in conjunction with the auditor's report. This report must be signed by the CPA, cover all statements presented, and refer to the separate report on compliance and on internal control [[Page 938]] over financial reporting issued in conjunction with the auditor's report. [61 FR 108, Jan. 3, 1996, as amended at 63 FR 38723, July 17, 1998] Sec. 1773.32 Report on compliance and on internal control over financial reporting. As required by GAGAS, the CPA must prepare a written report on the tests performed for compliance with applicable laws, regulations, contracts, and grants, and on the borrower's internal control structure and on the assessment of control risk made as part of the financial statement audit. This report must be signed by the CPA and must include, as a minimum: (a) The scope of the CPA's work to obtain an understanding of the borrower's internal control structure and in assessing the control risk; (b) A description of the reportable conditions noted which include material weaknesses identified as a result of the CPA's work in understanding and assessing control risk; (c) If no reportable instances of noncompliance and no reportable conditions were found, the CPA must issue a report as illustrated in appendix A, exhibit 2 (Electric), and appendix B, exhibit 4 (Telecommunications) of this part 1773; (d) If material instances of noncompliance and reportable conditions are identified, the CPA must issue a report as illustrated in appendix A, exhibit 3 (Electric), and appendix B, exhibit 5 (Telecommunications) of this part 1773; (e) Other nonmaterial instances of noncompliance should not be disclosed in the report on compliance and on internal control over financial reporting, but should be reported in a separate communication to the board of directors, preferably in writing. All such communications must be documented in the workpapers and submitted to RUS in compliance with Sec. 1773.21. (f) If the CPA has issued a separate letter detailing immaterial instances of noncompliance, the report on compliance and on internal control over financial reporting must be modified to include a statement such as: We noted certain immaterial instances of noncompliance that we have reported to the management of (borrower's name) in a separate letter dated (month, day, year). (g) If the CPA has issued a separate letter to management to communicate other matters involving the design and operation of the internal control over financial reporting, the report on compliance and on internal control over financial reporting must be modified to include a statement such as: However, we noted other matters involving the internal control over financial reporting that we have reported to the management of (borrower's name) in a separate letter dated (month, day, year). (h) The report must contain the status of known but uncorrected significant or material findings and recommendations from prior audits that affect the current audit objective. [63 FR 38723, July 17, 1998] Sec. 1773.33 Management letter. The CPA must prepare a management letter that includes, at a minimum, comments on: (a) Audit procedures. State whether the audit has been performed in accordance with this part; (b) Special reports. State whether any special reports, summaries of recommendations, or similar communications were furnished to the borrower's management during the course of the audit or during interim audit work, and provide a description of the information furnished; (c) Accounting and records. Comment on the adequacy and effectiveness of the borrower's accounting procedures, discuss the general condition of the records, and outline any recommendations for improvement. Comment on the adequacy and fairness of the methods used in accumulating and recording labor, material, and overhead costs, and the distribution of these costs to construction, retirement, and maintenance or other expense accounts, and where appropriate, include: (1) Whether subsidiary plant records agree with the controlling general ledger plant accounts; (2) Whether construction clearing accounts are cleared promptly of costs of completed construction to the proper classified plant accounts and whether [[Page 939]] depreciation was accrued on such completed construction from the date the plant was placed in service; (3) Whether retirements of plant are currently and systematically recorded and properly priced; (4) Whether all costs associated with retirements of plant are properly accounted for in the accumulated provision for depreciation accounts and comment on any unusual charges or credits to such accounts; and (5) Whether RUS approval was obtained for a sale requiring such approval, and whether receipts from sales of plant, material or scrap were not handled in conformance with RUS requirements. (d) Materials control. Comment on the adequacy of the control over materials and supplies. (e) Compliance with RUS loan and security instrument provisions. State whether the following provisions of RUS's loan and security instruments have been complied with: (1) For electric borrowers, provisions relating to: (i) The requirement for funds to be deposited in banks or other depositories designated in the loan documents or approved by RUS. For purposes of this part, funds shall be defined as cash proceeds from loans made or guaranteed by RUS in accordance with 7 CFR 1717.612. (ii) The requirement for a borrower to obtain written approval of mortgagees to enter into any contract for the management, operation, or maintenance of the borrower's system if the contract covers all or substantially all (90 percent) of the electric system. For purposes of this part, the following contracts shall be deemed as requiring RUS approval: (A) Management contracts in which the borrower has contracted to have another borrower or other entity manage its affairs; (B) Management contracts in which the borrower has contracted to manage another borrower or other utility system; (C) Operations and maintenance contracts in which the borrower has contracted to have another borrower or other entity operate and/or maintain all or substantially all (90 percent) of the physical plant facilities of the borrower. (D) Operations and maintenance contracts in which the borrower has contracted to operate and maintain the physical plant facilities of another borrower or other utility system; and (iii) The requirement for a borrower to prepare and furnish mortgagees annual financial and statistical reports on the borrower's financial condition and operations. For borrowers with a December 31 year end, the CPA must state whether the information represented by the borrower as having been submitted to RUS in its most recent December 31 RUS Form 7 or Form 12 is in agreement with the borrower's audited records. For borrowers with a year end other than December 31, the CPA must state whether the information appears reasonable based upon the audit procedures performed. If the borrower represents that an amended report has been filed as of December 31, the comments must relate to the amended report. (2) For telephone borrowers, provisions relating to: (i) The requirement for a borrower to obtain written approval of the mortgagees to enter into any contract for the operation or maintenance of property and for the use of mortgaged property by others, or for services pertaining to toll traffic, operator assistance, or switching. For purposes of this part 1773, the following contracts shall be deemed as requiring RUS approval: (A) Any contract, agreement or lease between the borrower and an affiliate other than as allowed under 7 CFR part 1744, subpart E; (B) Any lease of a building or land; and (C) Any other contract as defined in Sec. 1773.34 (e)(2)(i) except: (1) Industry standard traffic settlement agreements involving interexchange and long distance carriers which, in form and substance, conform with contracts in general use in the telecommunications industry; (2) Billing and collecting agreements; (3) Toll pooling arrangements involving National Exchange Carrier Association and state associations; (4) Directory services agreements; and [[Page 940]] (5) Joint use agreements; (ii) The requirement for funds to be deposited in banks or other depositories designated in the loan documents or approved by RUS. For purposes of this part 1773, funds shall be defined as cash on deposit in demand and time accounts, and certificates of deposit; and (iii) The requirement for a borrower to prepare and furnish mortgagees annual financial and statistical reports on the borrower's financial condition and operations. For borrowers with a December 31 year end, the CPA must state whether the information represented by the borrower as having been submitted to RUS in its most recent December 31 RUS Form 479 is in agreement with the borrower's audited records. For borrowers with a year end other than December 31, the CPA must state whether the information appears reasonable based upon the audit procedures performed. If the borrower represents that an amended report has been filed as of December 31, the comments must relate to the amended report. (iv) The requirement that a borrower maintain either a net plant to secured debt ratio or a funded reserve. (A) For loans approved after June 10, 1991, and before October 7, 1997, if a borrower selected a loan maturity period in excess of the expected economic life of the facilities financed, the borrower must maintain a secured debt ratio of at least 1.2 or a funded reserve. If, during the audit period, the borrower has been issued refunding notes that match the remaining composite economic life of the facilities thus eliminating the requirement, the auditor should so state. (1) If the net plant to secured debt ratio option was selected, this ratio must be achieved one year following the first advance of funds. (2) If the funded reserve option was selected, the reserve must be of such amount that the balance of the reserve plus the value of the facilities less depreciation be at least equal to the remaining principal payments on the loan. Funding of the reserve must begin within one year of approval of release of funds and must continue regularly over the composite economic life of the facilities financed. (B) For loans approved after October 7, 1997, if a borrower selected a loan maturity period in excess of the expected economic life of the facilities financed, the borrower must maintain a funded reserve in such amount that the balance of the reserve plus the value of the facilities less depreciation be at least equal to the remaining principal payments on the loan. Funding of the reserve must begin within one year of approval of release of funds and must continue regularly over the composite economic life of the facilities financed. If, during the audit period, the borrower has been issued refunding notes that match the remaining composite economic life of the facilities thus eliminating the requirement for maintaining the funded reserve requirement, the auditor should so state. (f) Related party transactions. State whether all material related party transactions have been disclosed in the notes to the financial statements in accordance with SFAS No. 57, entitled ``Related Party Disclosures''. If the audit did not disclose any related party transactions considered to be material, either individually or in the aggregate, so state; (g) Depreciation rates. For electric borrowers, comment when the depreciation rates used in computing monthly accruals are not in compliance with RUS requirements (See RUS Bulletin 183-1, Depreciation Rates and Procedures), which require the use of depreciation rates that are within the ranges established by RUS for each primary plant account, or with the requirements of the State regulatory body having jurisdiction over the borrower's depreciation rates; and (h) Deferred debits and deferred credits. For electric borrowers, provide a detailed analysis of the totals reported as deferred debits and deferred credits, including, but not limited to, margin stabilization plans, revenue deferral plans, and expense deferrals. The CPA must state whether RUS has approved, in [[Page 941]] writing, each regulatory asset and liability. [56 FR 63360, Dec. 3, 1991, as amended at 59 FR 659, Jan. 6, 1994; 61 FR 108, Jan. 3, 1996. Redesignated and amended at 63 FR 38723, July 17, 1998; 63 FR 40169, July 28, 1998] Secs. 1773.34-1773.37 [Reserved] Subpart E--RUS Required Audit Procedures and Documentation Sec. 1773.38 Scope of engagement. (a) RUS requires that the audit procedures set forth in Secs. 1773.39 through 1773.45 be performed annually by the CPA during the audit of the RUS borrowers' financial statements, which audit procedures may be in addition to the conduct of a GAGAS audit. (b) The CPA must exercise professional judgment in determining whether any auditing procedures in addition to those mandated by GAGAS or this part should be performed in order to afford a reasonable basis for rendering the auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, and management letter. Sec. 1773.39 Utility plant and accumulated depreciation. (a) General. The audit of these accounts must include tests of additions, replacements, retirements, and changes. Based upon the CPA's determination of materiality, an appropriate sample of transactions must be selected for testing. The CPA's workpapers must document that he/she: (1) Examined direct labor and material transactions to determine whether the borrower's accounting records reflect a complete accumulation of costs; (2) Examined indirect costs and overhead charges to determine if they conform to the Uniform System of Accounts; (3) Reviewed the costs of completed construction and retirement projects to determine if they were cleared promptly from the work in progress accounts to the classified plant in service accounts and the related depreciation reserves; (4) Examined direct purchases of special equipment and general plant; (5) Determined the degree of accuracy and control of costing retirements, including tests of salvage and removal costs; (6) Reviewed the borrower's work order procedures; and (7) Reviewed depreciation rates for adequate support, compared them to RUS guidelines, and determined if they are in compliance. (b) Construction work in progress. (1) The workpapers must include a summary of open work orders reconciled to the general ledger. The CPA must note on the summary any unusual or nontypical projects. (2) Based upon the CPA's determination of materiality, an appropriate sample of work orders must be selected for testing. The CPA's workpapers must document that he/she: (i) Reviewed equipment purchases charged to work orders, including payments and receiving reports; (ii) Reviewed contracts showing the scope of the work, the nature of the contract, the contract amount, and scheduled payments and reviewed supporting documents to determine that all services contracted for were in fact rendered; (iii) Reviewed time cards and pay rates for several employees who allocate their time to work orders; (iv) Reviewed the nature of material and supplies issued to the project, traced amounts and quantities to supporting documents, and reviewed the reasonableness of clearing rates for assignment of stores expense to the work order; (v) Reviewed the accuracy of the computation of overheads applied to the work order; and (vi) Reviewed other costs charged to the work order for support and propriety. (3) Based upon the CPA's determination of materiality, an appropriate sample of completed contracts must be selected for testing. The CPA's workpapers must document that he/she: (i) Scheduled payments to contractors and traced to verify payments and supporting invoices; (ii) Traced contract costs to final closeout documents, to the general [[Page 942]] ledger, and to the continuing property records; and (iii) Verified the costs of owner furnished materials, if applicable. (4) The CPA must review the borrower's procedures for unitization and classification of work order and contract costs. Based upon the CPA's determination of materiality, an appropriate sample of transactions must be selected for testing. The CPA's workpapers must document that he/she: (i) Reviewed the tabulation of record units for construction from the work order staking sheets to the tabulation of record units, to the unitization sheets, and to the continuing property records; (ii) Reviewed the procedures for unitizing and distributing costs of completed construction to the plant accounts; (iii) Verified that standard costs were being used; (iv) Evaluated the basis for development of standard costs; and (v) Determined that costs of completed construction were cleared promptly from work in progress accounts. (c) Continuing property records. Based upon the CPA's determination of materiality, an appropriate sample of transactions must be selected for testing. The CPA's workpapers must document that he/she: (1) Determined whether the subsidiary plant records agree with the controlling general ledger plant accounts; (2) Noted differences in the workpapers; and (3) Commented, in the management letter, on any discrepancies. (d) Retirement work-in-progress. Based upon the CPA's determination of materiality, an appropriate sample of transactions must be selected for testing. The CPA's workpapers must document that he/she: (1) Determined that plant retirements are currently and systematically recorded and priced on the basis of the continuing property records, and determined that costs of removal have been properly accounted for; (2) Explained the method used in computing the cost of units of plant retired if continuing property records have not been established and determined whether costs appeared reasonable; and (3) Determined the manner in which net losses due to retirements were accounted for and traced clearing entries to the depreciation reserve, the plant accounts, and the continuing property records. (e) Provision for accumulated depreciation. The CPA's workpapers must include an analysis of transactions. Based upon the CPA's determination of materiality, an appropriate sample of transactions must be selected for testing. The CPA's workpapers must document that he/she: (1) Verified the depreciation accruals for the period, including the depreciation base; (2) Reviewed the basis of the depreciation rates, any change in rates and the reason therefor, and, if appropriate, determined whether the rates are in compliance with RUS requirements or with the requirements of the state regulatory body having jurisdiction over the borrower's depreciation rates; (3) Reviewed salvage and removal costs; and (4) Searched for unrecorded retirements. (f) Other reserves. The CPA's workpapers must include an account analysis for all other material plant reserves, such as the reserve for the amortization of plant acquisition adjustments. Based upon the CPA's determination of materiality, an appropriate sample of transactions must be selected for testing. The CPA's workpapers must document that appropriate tests of transactions were performed. (g) Narrative. The CPA must prepare and include in the workpapers a comprehensive narrative on the scope of work performed, observations made, and conclusions reached. Specific matters covered in this narrative must include: (1) The nature of construction and other additions; (2) The control over, and the accuracy of pricing retirements; (3) The accuracy of distributing costs to classified utility plant accounts; (4) An evaluation of the method of: [[Page 943]] (i) Capitalizing the direct loadings on labor and material costs; (ii) Distributing transportation costs and other expense clearing accounts; and (iii) Capitalizing overhead costs; (5) The tests of depreciation; (6) A review of agreements such as those relating to acquisitions, property sales, and leases which affect the plant accounts; and (7) Notations, if applicable, of RUS approval of property sales and the propriety of the disposition of the proceeds. Sec. 1773.40 Regulatory assets. The CPA's workpapers must document whether all regulatory assets comply with the requirements of SFAS No. 71. For electric borrowers only, the CPA's workpapers must document whether all regulatory assets have received RUS approval. [59 FR 660, Jan. 6, 1994] Sec. 1773.41 Extraordinary retirement losses. The CPA's workpapers must contain an analysis of retirement losses, including any required approval by a regulatory commission with jurisdiction in the matter, or RUS, in the absence of commission jurisdiction. Sec. 1773.42 Clearing accounts. The CPA's workpapers must contain an analysis of all clearing accounts. Based upon the CPA's determination of materiality, an appropriate sample of transactions should be selected for testing. The CPA's workpapers must document that transactions were reviewed for proper allocation between expense and capital accounts. Sec. 1773.43 Capital and equity accounts. (a) Capital stock. For privately owned companies, the workpapers must include analyses of all stock transactions during the audit period. Based upon the CPA's determination of materiality, an appropriate sample of transactions must be selected for testing. The CPA's workpapers must document that he/she: (1) Reviewed the subsidiary records and reconciled them to the general ledger control account; (2) Reviewed authorizations and issuances or redemptions of capital stock for proper approvals by the board of directors, stockholders, and regulatory commissions; (3) Determined that transactions were made in accordance with the appropriate provisions of the articles of incorporation, bylaws, and RUS loan documents; and (4) Determined that transactions were recorded in accordance with the Uniform System of Accounts. (b) Memberships. For cooperative organizations, the workpapers must include an analysis of the membership transactions during the audit period. Based upon the CPA's determination of materiality, an appropriate sample of transactions must be selected for testing. The CPA's workpapers must document that he/she: (1) Reviewed the subsidiary records and reconciled them to the general ledger control account; and (2) Determined that transactions were made in accordance with the appropriate provisions of the articles of incorporation, bylaws, and RUS loan documents. (c) Patronage capital, retained earnings, margins, and other equities. The workpapers must include an analysis of the patronage capital, retained earnings, margins and other equities, and any related reserve accounts. Based upon the CPA's determination of materiality, an appropriate sample of transactions must be selected for testing. The CPA's workpapers must document that he/she: (1) Determined that the transactions were made in accordance with the appropriate provisions of the articles of incorporation, bylaws, RUS loan documents, Uniform System of Accounts, or orders of regulatory commissions; (2) Traced payments to underlying support; and (3) Determined whether, under the terms of the RUS security instrument, restrictions of retained earnings or margins are required and, if so, whether they have been properly recorded. [[Page 944]] Sec. 1773.44 Long-term debt. The CPA's workpapers must document that he/she: (a) Confirmed RUS, FFB, and RTB debt to the appropriate confirmation schedule (RUS Form 690, Confirmation Schedule Obligation to the FFB as of: or Form 691, Confirmation Schedule--Long-term Obligation to RUS as of; or RTB Form 12, Confirmation Schedule); (b) Confirmed other long-term debt directly with the lender; (c) Examined notes executed or canceled during the audit period; and (d) Tested accrued interest computations. Sec. 1773.45 Regulatory liabilities. The CPA's workpapers must document whether all regulatory liabilities comply with the requirements of SFAS No. 71. For electric borrowers only, the CPA's workpapers must document whether all regulatory liabilities have received RUS approval. [59 FR 660, Jan. 6, 1994] Secs. 1773.46-1773.49 [Reserved] Appendix A to Part 1773--Sample Auditor's Report for an Electric Cooperative Appendix A includes an example of an auditor's report, report on compliance, report on compliance and on internal controls over financial reporting, financial statements and accompanying notes for an electric distribution cooperative. The sample auditor's report is intended as a guide only and, while it is recommended that the format be followed, each auditor's report should be prepared to adequately cover the circumstances. To the extent possible, it should be used as a guide in preparing auditors' reports for other types of electric borrowers. For power supply borrowers and for distribution borrowers with production or transmission plant, the same general format should be followed. However, the Statement of Revenue and Patronage Capital must be expanded to show separate totals for operations expenses and maintenance expenses for each class of production plant and for transmission plant. Exhibit 1--Sample Auditor's Report Certified Public Accountants, 1600 Main Street, City, State 24105 The Board of Directors, Center County Electric Cooperative: Independent Auditor's Report We have audited the accompanying balance sheets of Center County Electric Cooperative as of December 31, 1998 and 1997, and the related statements of revenue and patronage capital, and cash flows for the years then ended. These financial statements are the responsibility of Center County Electric Cooperative's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audits in accordance with generally accepted auditing standards and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards required that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Center County Electric Cooperative as of December 31, 1998 and 1997, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. In accordance with Government Auditing Standards, we have also issued a report dated March 2, 1999, on our consideration of Center County Electric Cooperative's internal control over financial reporting and our tests of its compliance with certain provisions of laws, regulations, contracts, and grants. Certified Public Accountants March 2, 1999 Exhibit 2--Sample Report on Compliance and on Internal Control over Financial Reporting, the CPA found No Reportable Instances of Noncompliance and No Material Weaknesses (No Reportable Conditions Identified). Certified Public Accountants, 1600 Main Street, City, State 24105 The Board of Directors, Center County Electric Cooperative: We have audited the financial statements of Center County Electric Cooperative as of and for the years ended December 31, 1998 and 1997, and have issued our report thereon dated March 2, 1999. We conducted our audit in accordance with generally accepted auditing standards and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. [[Page 945]] Compliance As part of obtaining reasonable assurance about whether Center County Electric Cooperative's financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grants, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance that are required to be reported under Government Auditing Standards. [If the CPA has issued a separate letter to the management detailing immaterial instances of noncompliance, modify this paragraph to include a statement such as the following: However, we noted certain immaterial instances of noncompliance which we have reported to the management of Center County Electric Cooperative in a separate letter dated March 2, 1999.] Internal Control Over Financial Reporting In planning and performing our audit, we considered Center County Electric Cooperative's internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on the internal control over financial reporting. Our consideration of the internal control over financial reporting would not necessarily disclose all matters in the internal control over financial reporting that might be material weaknesses. A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. We noted no matters involving the internal control over financial reporting and its operation that we consider to be material weaknesses. [If the CPA has issued a separate letter to management to communicate other matters involving the design and operation of the internal control over financial reporting, modify this paragraph to include a statement such as the following: However, we noted other matters involving the internal control over financial reporting which we have reported to the management of Center County Electric Cooperative in a separate letter dated March 2, 1999.] This report is intended for the information of the audit committee, management, the Rural Utilities Service, and supplemental lenders. However, this report is a matter of public record and its distribution is not limited. Certified Public Accountants March 2, 1999 Exhibit 3--Sample Report on Compliance and on Internal Control over Financial Reporting, the CPA found Reportable Instances of noncompliance and Reportable Conditions Identified. Certified Public Accountants, 1600 Main Street, City, State 24105 The Board of Directors, Center County Electric Cooperative: We have audited the financial statements of Center County Electric Cooperative as of and for the years ended December 31, 1998 and 1997, and have issued our report thereon dated March 2, 1999. We conducted our audit in accordance with generally accepted auditing standards and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Compliance As part of obtaining reasonable assurance about whether Center County Electric Cooperative's financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grants, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed instances of noncompliance that are required to be reported under Government Auditing Standards. [A description of the findings should be included in the report.][If the CPA has issued a separate letter to the management detailing immaterial instances of noncompliance, modify this paragraph to include a statement such as the following: We also noted certain immaterial instances of noncompliance which we have reported to the management of Center County Electric Cooperative in a separate letter dated March 2, 1999.] Internal Control Over Financial Reporting In planning and performing our audit, we considered Center County Electric Cooperative's internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on the internal control over financial reporting. However, we noted [[Page 946]] certain matters involving the internal control over financial reporting and its operation that we consider to be reportable conditions. Reportable conditions involve matters coming to our attention relating to significant deficiencies in the design or operation of the internal control over financial reporting that, in our judgment, could adversely affect Center County Electric Cooperative's ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements. [A description of the reportable conditions should be included in the report.] A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. Our consideration of the internal control over financial reporting would not necessarily disclose all matters in the internal control that might be reportable conditions and, accordingly, would not necessarily disclose all reportable conditions that are also considered to be material weaknesses. However, we believe none of the reportable conditions described above is a material weakness. [If conditions believed to be material weaknesses are disclosed, the last sentence should be deleted and instead the report should identify which of the reportable conditions described above are considered to be material weaknesses.][If the CPA has issued a separate letter to management to communicate other matters involving the design and operation of the internal control over financial reporting, modify this paragraph to include a statement such as the following: We also noted other matters involving the internal control over financial reporting which we have reported to the management of Center County Electric Cooperative in a separate letter dated March 2, 1999.] This report is intended for the information of the audit committee, management, the Rural Utilities Service, and supplemental lenders. However, this report is a matter of public record and its distribution is not limited. Certified Public Accountants March 2, 1999 EXHIBIT 4--SAMPLE FINANCIAL STATEMENTS Center County Electric Cooperative Balance Sheets--December 31, 19X9 and 19X8 Assets (Notes 1 and 2) ------------------------------------------------------------------------ 19X9 19X8 ------------------------------------------------------------------------ ELECTRIC PLANT: (Note 3) In Service--at cost................. $9,524,646 $9,365,264 Construction Work in Progress....... 407,943 317,166 ------------------------------- 9,932,589 9,682,430 Less: Accumulated Provisions for 3,117,629 2,917,295 Depreciation....................... ------------------------------- 6,814,960 6,765,135 =============================== OTHER ASSETS AND INVESTMENTS: Nonutility Property................. 20,227 20,227 Investments in Associated 391,258 292,798 Organizations (Note 4)............. ------------------------------- 411,485 313,025 =============================== CURRENT ASSETS: Cash--General Funds................. 37,350 51,544 Cash--Construction Funds............ 10,034 20,193 Accounts Receivable (Less 36,527 35,255 accumulated provision for uncollectible accounts of $2,207 in 19X9 and $1,933 in 19X8)........... Materials and Supplies (at average 83,652 80,882 cost).............................. Other Current and Accrued Assets.... 8,613 8,692 ------------------------------- 176,176 196,566 =============================== DEFERRED CHARGES (Note 5):.............. 5,666 1,762 ------------------------------- $7,408,287 $7,276,488 ------------------------------------------------------------------------ The accompanying notes are an integral part of these statements. [[Page 947]] Center County Electric Cooperative Balance Sheets--December 31, 19X9 and 19X8 Equities and Liabilities (Note 1) ------------------------------------------------------------------------ 19X9 19X8 ------------------------------------------------------------------------ EQUITIES: Memberships......................... $60,145 $59,440 Patronage Capital (Note 6).......... 1,761,798 1,526,833 Other Equities (Note 7)............. 53,647 35,900 ------------------------------- 1,875,590 1,622,173 =============================== LONG-TERM DEBT: RUS Mortgage Notes less current 5,249,115 5,396,385 maturities (Note 8)................ CURRENT LIABILITIES: Current Maturities of Long-Term Debt 145,000 140,000 Accounts Payable--Purchased Power... 48,916 52,117 Accounts Payable--Other............. 21,859 6,556 Consumer Deposits................... 32,660 33,085 Accrued Taxes....................... 10,958 9,146 Other Current and Accrued 12,285 6,461 Liabilities........................ ------------------------------- 271,678 247,365 ------------------------------- DEFERRED CREDITS (Note 10).............. 11,904 10,565 ------------------------------- $7,408,287 $7,276,488 ------------------------------------------------------------------------ The accompanying notes are an integral part of these statements. Center County Electric Cooperative Statements of Revenue and Patronage Capital for the Years Ended December 31, 19X9 and 19X8 ------------------------------------------------------------------------ 19X9 19X8 ------------------------------------------------------------------------ OPERATING REVENUES...................... $1,719,467 $1,605,690 OPERATING EXPENSES: Cost of Power....................... 587,729 625,411 Distribution--Operation............. 111,058 121,682 Distribution--Maintenance........... 158,622 182,740 Consumer Accounts................... 76,675 72,927 Sales............................... 38,378 40,755 Administrative and General.......... 94,682 87,058 Depreciation and Amortization....... 288,389 279,776 Taxes............................... 34,920 34,438 ------------------------------- 1,390,453 1,444,787 =============================== OPERATING MARGINS BEFORE FIXED CHARGES 329,014 160,903 FIXED CHARGES: Interest on Long-Term Debt............ 113,713 115,082 =============================== OPERATING MARGINS AFTER FIXED CHARGES... 215,301 45,821 G&T AND OTHER CAPITAL CREDITS........... 14,460 17,500 =============================== NET OPERATING MARGINS................... 229,761 63,321 =============================== NONOPERATING MARGINS: Interest Income......................... 24,289 18,802 Other Nonoperating Income............... 1,200 1,200 ------------------------------- 25,489 20,002 =============================== NET MARGINS............................. 255,250 83,323 PATRONAGE CAPITAL--BEGINNING OF YEAR.... 1,526,833 1,469,125 =============================== 1,782,083 1,552,448 RETIREMENT OF CAPITAL CREDITS........... 20,285 25,615 ------------------------------- PATRONAGE CAPITAL--END OF YEAR.......... $1,761,798 $1,526,833 ------------------------------------------------------------------------ [[Page 948]] The accompanying notes are an integral part of these statements. Center County Electric Cooperative Statements of Cash Flows for the Years Ended December 31, 19X9 and 19X8 ------------------------------------------------------------------------ 19 x 9 19 x 8 ------------------------------------------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES: Cash Received from Consumers...... $1,721,496 $1,609,933 Cash Paid to Suppliers and (1,049,139) (1,126,367) Employees........................ Interest Received................. 24,289 18,802 Interest Paid..................... (114,131) (115,607) Taxes Paid........................ (33,108) (32,132) --------------------------------- Net Cash Provided by Operating 549,407 354,629 Activities....................... ================================= CASH FLOWS FROM INVESTING ACTIVITIES: Construction and Acquisition of (322,234) (216,427) Plant............................ Plant Removal Costs............... (25,994) (19,268) Materials Salvaged from 10,014 7,327 Retirements...................... (Increase)/Decrease In: Materials Inventory........... (2,770) 1,916 Deferred Charges-Preliminary (3,486) (2,617) Survey & Investigation....... Investments-CFC Capital Term (82,472) (69,412) Certificates................. Inventory Adjustment-Deferred (2,290) (1,057) Credit Decrease.................. --------------------------------- Net Cash Used in Investing (429,232) (299,538) Activities....................... ================================= CASH FLOWS FROM FINANCING ACTIVITIES: Retirements of Patronage Capital (20,285) (25,615) Credits.......................... Retired Capital Credits--Gain..... 1,200 1,200 Donated Capital................... 16,547 6,178 RUS Loan Advances................. 174,976 197,450 Payments on RUS Debt.............. (317,246) (279,575) Increase/(Decrease) In: Consumer Deposits............. (425) 575 Memberships Issued............ 705 450 --------------------------------- Net Cash Used in Financing (144,528) (99,337) Activities....................... --------------------------------- Net Increase/(Decrease) in Cash... (24,353) (44,246) Cash--Beginning of Year........... 71,737 115,983 --------------------------------- Cash--End of Year................. 47,384 71,737 The accompanying notes are an integral part of these statements. RECONCILIATION OF NET MARGINS TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Net Margins........................... $255,250 $83,323 Adjustments to Reconcile Net Margins to Net Cash Provided by Operating Activities: Depreciation and Amortization. 288,389 279,776 G&T and Other Capital Credits (14,460) (17,500) (Non-Cash)................... Patronage Capital Credits- (1,528) (1,200) NRUCFC (Non-Cash)............ Provision for Uncollectible 274 (526) Accounts Receivable.......... (Increase)/Decrease In: Customer and Other Accounts (1,546) 2,523 Receivable................... Current and Accrued Assets- 79 112 Other........................ Increase/(Decrease) In: Accounts Payable.............. 12,102 5,117 Accrued Taxes................. 1,812 2,306 Deferred Energy Prepayments... 3,629 2,246 Current and Accrued 5,824 (1,023) Liabilities-Other............ Deferred Interest Expense......... (418) (525) --------------------------------- Total Adjustments............... 294,157 271,306 ================================= Net Cash Provided by Operating 549,407 354,629 Activities........................... ------------------------------------------------------------------------ The accompanying notes are an integral part of these statements. [[Page 949]] Center County Electric Cooperative Notes to Financial Statements December 31, 19X9 and December 31, 19X8 ------------------------------------------------------------------------ 19X9 19X8 ------------------------------------------------------------------------ 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Include a brief description of the reporting entity's significant accounting policies in accordance with Accounting Principles Board Opinion No. 22, Disclosure of Accounting Policies. Disclosure of accounting policies should identify and describe the accounting principles followed by the borrower and the methods of applying those principles that materially affect the determination of financial position, cash flow, and results of operations. Disclosures of accounting policies do not have to be duplicated in this section if presented elsewhere as an integral part of the financial statements. 2. ASSETS PLEDGED: Substantially all assets are pledged as security for long-term debt to RUS. 3. ELECTRIC PLANT AND DEPRECIATION RATES AND PROCEDURES: Listed below are the major classes of the electric plant as of December 31, 19X9, and 19X8: Intangible Plant...................... $2,194 $2,194 Distribution Plant.................... 9,011,036 8,873,957 General Plant......................... 511,416 489,113 --------------------------------- Electric Plant in Service............. 9,524,646 9,365,264 ================================= Construction Work in Progress......... 407,943 317,166 ================================= 9,932,589 9,682,430 Provision has been made for depreciation of distribution plant at a straight-line composite rate of 2.86 percent per annum. General Plant depreciation rates have been applied on a straight-line basis as follows: Structures and Improvement........ 2.5% Office Furniture.................. 6.0% Transportation Equipment.......... 14.0% Power Operated Equipment.......... 12.0% Other General Plant............... 4.0% Communications Equipment.......... 6.0% 4. INVESTMENTS IN ASSOCIATED ORGANIZATIONS: Investments in associated organizations consisted of the following at December 31, 19X9 and 19X8: Capital Term Certificates of $385,193 $288,261 the National Rural Utilities Cooperative Finance Corporation (NRUCFC)......... NRUCFC Patronage Capital 5,065 3,537 Credits...................... Other......................... 1,000 1,000 --------------------------------- 391,258 292,798'