[Federal Register Volume 66, Number 98 (Monday, May 21, 2001)]
[Rules and Regulations]
[Pages 27833-27853]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-12127]


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DEPARTMENT OF AGRICULTURE

Rural Utilities Service

7 CFR Part 1773

RIN 0572-AB62


Policy on Audits of RUS Borrowers; Generally Accepted Government 
Auditing Standards (GAGAS)

AGENCY: Rural Utilities Service, USDA.

ACTION: Direct final rule.

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SUMMARY: The Rural Utilities Service (RUS) is amending its regulations 
to include in its audit requirements for electric and 
telecommunications borrowers recent amendments to the Generally 
Accepted Government Auditing Standards (GAGAS) issued by the Government 
Accounting Office (GAO) and to make other minor changes and 
corrections.

DATES: This rule will become effective July 5, 2001 unless we receive 
written adverse comments or written notice of intent to submit adverse 
comments on or before June 20, 2001. If we receive such comments or 
notice, we will publish a timely document in the Federal Register 
withdrawing the rule. A second public comment period will not be held. 
Parties interested in commenting on this action should do so at this 
time.

ADDRESSES: Submit adverse comments or notice of intent to submit 
adverse comments to F. Lamont Heppe, Jr., Director, Program Development 
and Regulatory Analysis, Rural Utilities Service, U.S. Department of 
Agriculture, 1400 Independence Ave., SW., STOP 1522, Washington, DC 
20250-1522. RUS requests a signed original and three copies of all 
comments (7 CFR 1700.4). All comments received will be made available 
for public inspection at room 4030, South Building, Washington, DC, 
between 8 a.m. and 4 p.m. (7 CFR 1.27(b)).

FOR FURTHER INFORMATION CONTACT: Richard Annan, Chief, Technical 
Accounting and Auditing Staff, Program Accounting Services Division, 
Rural Utilities Service, U.S. Department of Agriculture, 1400 
Independence Ave., SW., STOP 1523, Washington, DC 20250-1523. 
Telephone: 202-720-5227.

SUPPLEMENTARY INFORMATION:

Executive Order 12866

    This rule has been determined to be not significant for the 
purposes of Executive Order 12866 and, therefore, has not been reviewed 
by the Office of Management and Budget (OMB).

Executive Order 12372

    This rule is excluded from the scope of Executive Order 12372, 
Intergovernmental Consultation, which may require consultation with 
state and local offices. See the final rule related notice entitled 
``Department Programs and Activities Excluded from Executive Order 
12372,'' (50 FR 47034).

Executive Order 12988

    This rule has been reviewed under Executive Order 12988, Civil 
Justice Reform. RUS has determined that this rule meets the applicable 
standards provided in section 3 of the Executive Order. In addition, 
all State and local laws and regulations that are in conflict with this 
rule will be preempted; no retroactive effect will be given to this 
rule; and, in accordance with section 212(e) of the Department of 
Agriculture Reorganization Act of 1994 (7 U.S.C. 6912(e)) 
administrative appeal procedures, if any are required, must be 
exhausted before an action against the Department or its agencies.

Regulatory Flexibility Act Certification

    The Administrator of RUS has determined that this rule will not 
have significant impact on a substantial number of small entities 
defined in the Regulatory Flexibility Act (5 U.S.C. 601 et seq.). The 
RUS loan programs provide borrowers with loans at interest rates and 
terms that are more favorable than those generally available from the 
private sector. Borrowers, as a result of obtaining federal financing, 
receive economic benefits that exceed any direct cost associated with 
RUS regulations and requirements.

National Environmental Policy Act Certification

    The Administrator of RUS has determined that this rule will not 
significantly affect the quality of the human environment as defined by 
the

[[Page 27834]]

National Environmental Policy Act of 1969 (42 U.S.C. 4321 et seq.). 
Therefore, this action does not require an environmental impact 
statement or assessment.

Catalog of Federal Domestic Assistance

    The program described by this rule is listed in the Catalog of 
Federal Domestic Assistance programs under Nos. 10.850, Rural 
Electrification Loans and Loan Guarantees, 10.851, Rural Telephone 
Loans and Loan Guarantees, and 10.852, Rural Telephone Bank Loans. This 
catalog is available on a subscription basis from the Superintendent of 
Documents, the United States Government Printing Office, Washington, DC 
20402-9325, telephone number (202) 512-1800.

Information Collection and Recordkeeping Requirements

    The reporting and recordkeeping requirements contained in this rule 
has been approved by the Office of Management and Budget (OMB) under 
OMB Control Number 0572-0095, pursuant to the Paperwork Reduction Act 
of 1995 (44 U.S.C chapter 35).
    Send questions or comments regarding this burden or any other 
aspect of these collections of information, including suggestions for 
reducing the burden, to F. Lamont Heppe, Jr., Director, Program 
Development and Regulatory Analysis, Rural Utilities Service, USDA, 
1400 Independence Ave., SW, Stop 1522, Washington, DC 20250-1522.

Unfunded Mandates

    This rule contains no Federal mandates (under the regulatory 
provision of title II of the Unfunded Mandates Reform Act) for State, 
local, and tribal governments or the private sector. Thus, this rule is 
not subject to the requirements of sections 202 and 205 of the Unfunded 
Mandates Reform Act.

Background

    Title 7 part 1773 implements the standard RUS security instrument 
provision requiring RUS electric and telecommunications borrowers to 
prepare and furnish to RUS, at least once during each 12-month period, 
a full and complete report of their 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 report of such audit, in form 
and substance satisfactory to RUS.
    This rule amends part 1773 to reflect two amendments to Generally 
Accepted Government Auditing Standards (GAGAS) adopted in 1999 by the 
General Accounting Office (GAO): Amendment No. 1 to GAGAS, dated May 
13, 1999, and Amendment No. 2 to GAGAS, dated July 30, 1999.
    Amendment No. 1 to GAGAS established a new field work standard that 
requires auditors to document in the working papers the basis for 
assessing control risk at the maximum level for assertions related to 
material accounts balances, transaction classes, and disclosure 
components of financial statements when such assertions are 
significantly dependent on computerized information systems. The new 
standard also requires the auditors to document their consideration 
that the planned audit procedures are designed to achieve audit 
objectives and to reduce audit risk to an acceptable level. These new 
requirements are achieved through compliance with Secs. 1773.7(a) and 
1773.7(b).
    Amendment No. 2 to GAGAS created a new fieldwork standard for 
planning titled ``Auditor Communication'' by moving and expanding an 
existing standard from the reporting standards. This rule revises 
Sec. 1773.6 to comply with this new standard. Amendment No. 2 also 
changed the term ``irregularities'' to ``fraud'' in regards to the 
requirements for reporting on compliance with laws and regulations and 
internal control over financial reporting. This rule revises 
Sec. 1773.9 to incorporate this change in terminology. Finally, GAGAS 
requires the auditor to emphasize in the auditor's report the 
importance of the report on compliance and on internal control over 
financial reporting when this report is issued separately from the 
report on the financial statements. This rule revises Sec. 1773.31, to 
incorporate this requirement into the auditor's report.
    On July 17, 1998, RUS issued, as a final rule, 7 CFR part 1773 (63 
FR 38720) which incorporated the 1994 revisions of GAGAS. Those 1994 
GAGAS revisions, as well as the 1999 amendments noted above, revised 
and updated some of the standard terminology used to describe the 
requirements for performing audits in conformance with GAGAS. This rule 
updates the appropriate sections of this part to conform to the GAGAS 
requirements.
    The 1998 revisions to part 1773 combined the separate report on 
compliance and report on internal control into a single report titled 
``Reports on Compliance and on Internal Control Over Financial 
Reporting''. In making the changes to substitute the combined report in 
the appropriate sections of part 1773, the references to the separate 
report on compliance were not removed thus leading the reader to 
conclude that the separate report on compliance was still required. 
This rule eliminates all the references to the report on compliance. In 
addition, the 1998 revision references to the telephone program were 
changed to telecommunications program. Not all of the references were 
changed and this rule will serve to make those additional corrections. 
The 1998 revision also reduced, from 42 months to 36 months, the period 
of time required in which the CPA must undergo the issuance of a new 
peer review. Two references to the 42-month requirement in 
Sec. 1773.5(c) that were missed in the 1998 final rule are revised with 
this rule.
    This rule adds, changes, and deletes definitions to reflect the 
GAGAS amendments noted above as well as the changing structure of the 
RUS organization and its policies and procedures. A definition is added 
for Assistant Administrator, Program Accounting and Regulatory 
Analysis, to replace the Director, Program Accounting Services 
Division. The name of the Borrower Accounting Division was changed to 
Program Accounting Services Division in the 1998 rule, but the 
definition was not removed from Sec. 1773.2, Definitions. The 
definition of ``irregularity'' is replaced with the definition of 
``fraud'' to conform to the changes made in Amendment No. 2 to GAGAS. 
The definition of the Private Companies Practice Section (PCPS) is 
removed. The peer review program conducted by this group was combined 
with the American Institute of Certified Public Accountants' (AICPA) 
quality review program in 1995, thus the reference to the PCPS is 
removed. The definition of REA is eliminated, as it is no longer 
necessary. The definition of Uniform System of Accounts for Electric 
Borrowers is revised to include the complete citation of the 
requirement to maintain a uniform system of accounts prescribed by RUS 
(7 CFR Part 1767, Accounting Requirements for RUS Electric Borrowers, 
Subpart B, Uniform System of Accounts). This rule amends Sec. 1773.2, 
to reflect these changes.
    Section 1773.1(d)(6) provides that a report described in the 
Statement on Auditing Standards (SAS) No. 35 does not meet the audit 
requirement of RUS. This SAS was superseded and retitled with the 
issuance of SAS No. 75.
    In previous versions of part 1773 the sample reports, financial 
statements, and management letters were contained

[[Page 27835]]

in four appendices, two for electric borrowers and two for 
telecommunications borrowers. Beginning with this revision of part 
1773, the appendices will no longer be codified in the Code of Federal 
Regulations. The appendices are attached to this notice for information 
only. The appendices are sample formats to be used as a reference guide 
to assist CPAs in completing their reports. The appendices will be 
available in new RUS Bulletin 1773-1, which will contain all of 7 CFR 
part 1773 and the appendices. Appendix A will contain the sample 
reports, financial statements and management letter for electric 
borrowers while Appendix B will contain similar samples for 
telecommunications borrowers. Publishing part 1773 in bulletin form 
will provide the RUS audit policy in a user-friendly format. A single 
copy of this publication will be provided to all RUS borrowers and 
certified public accountants approved to perform audits of RUS 
borrowers and will be available at http://www.usda.gov/rus/ruswide.htm.

List of Subjects in 7 CFR Part 1773

    Accounting, Electric power, Loan programs--communications, Loan 
programs--energy, Reporting and recordkeeping requirements, Rural 
areas, Telephone.

    For the reasons set forth in the preamble, RUS amends 7 CFR Chapter 
XVII as follows:

PART 1773--POLICY ON AUDITS OF RUS BORROWERS

    1. The authority citation for Part 1773 is revised to read as 
follows:

    Authority: 7 U.S.C. 901 et seq., 1921 et seq., 6941 et seq.


Secs. 1773.1 through 1773.7, 1773.20, 1773.21, 1773.30, and 
1773.38  [Amended]

    2. For each section listed below remove the word, phrase, or date 
indicated in the remove column, and replace it with that indicated in 
the add column.

----------------------------------------------------------------------------------------------------------------
                  Section                                  Remove                              Add
----------------------------------------------------------------------------------------------------------------
Sec.  1773.1(a), two occurrences Sec.        telephone........................  telecommunications.
 1773.2, under definition for RUS.
Sec.  1773.1(d); Sec.  1773.3(c); Secs.      report on compliance, report on    report on compliance and on
 1773.4 (f), (f)(1), and (g); Secs.  1773.6   compliance and on internal         internal control over financial
 (a)(1) and (a)(4); Secs.  1773.20, (a),      controls over financial            reporting.
 (b), and (c)(6); Sec.  1773.21, (a), and     reporting.
 (b); Sec.  1773.30(b); Sec.  1773.38(b).
Sec.  1773.8(a)(2) and (c).................  19X1.............................  20X1.
Sec.  1773.8(a)(2) and (c).................  19X3.............................  20X3.
Sec.  1773.6(a)(7).........................  irregularities...................  fraud.
----------------------------------------------------------------------------------------------------------------


    3. Section 1773.1(c) and (d)(6) are revised to read as follows:


Sec. 1773.1  General.

* * * * *
    (c) This complies with the 1994 revision of Government Auditing 
Standards, issued by the Comptroller General of the United States, 
United States General Accounting Office, including amendments dated May 
13, 1999, and July 30, 1999.
    (d) * * *
    (6) A report, as described in Statement on Auditing Standards (SAS) 
No. 62, entitled ``Special Reports'', or in SAS No. 75, entitled 
``Engagements to Apply Agreed-upon Procedures to Specified Elements, 
Accounts, or Items of a Financial Statement'', does not satisfy the RUS 
loan security instrument requirements.
* * * * *

    4. Section 1773.2 is amended by:
    A. Removing the definitions for ``BAD'', ``Irregularity'', 
``PCPS'', and ``REA''
    B. Revising the definition for ``Uniform System of Accounts'' and
    C. Adding new definitions for ``AA-PARA'', ``Fraud'', and ``RUS 
Bulletin 1773-1''.
    The new and revised definitions to read as follows:


Sec. 1773.2  Definitions.

* * * * *
    AA-PARA means Assistant Administrator, Program Accounting and 
Regulatory Analysis.
* * * * *
    Fraud has the same meaning prescribed in SAS No. 82 entitled 
``Consideration of Fraud in Financial Statements''.
* * * * *
    RUS Bulletin 1773-1, Policy on Audits of RUS Borrowers, is a 
publication prepared by RUS that contains the RUS regulation 7 CFR part 
1773 and exhibits of sample audit reports, financial statements, and a 
management letter used in preparing audit of RUS borrowers. This 
bulletin is available from USDA, Rural Utilities Service, Program 
Development and Regulatory Analysis, 1400 Independence Ave., SW., Stop 
1522, Washington, DC 20250, or available on the internet at http://www.usda.gov/rus/.
* * * * *
    Uniform System of Accounts means, for telecommunications borrowers, 
the Uniform System of Accounts for Telecommunications Companies, 
prescribed by the Federal Communications Commission and published 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, as contained in 7 CFR 
Part 1767, Accounting Requirements for RUS Electric Borrowers, subpart 
B, Uniform System of Accounts.

    5. Revise Sec. 1773.3(b) to read as follows:


Sec. 1773.3  Annual audit.

* * * * *
    (b) Each borrower must establish an annual as of audit date within 
twelve months of the date of receipt of the first advance of funds from 
grants and insured and guaranteed loans approved by RUS and RTB and 
must prepare financial statements as of the date established.
* * * * *

    6. Revise Sec. 1773.4(d) to read as follows:


Sec. 1773.4  Borrower responsibilities.

* * * * *
    (d) Audit engagement letter. The borrower must enter into an audit 
engagement letter with the CPA that complies with Sec. 1773.6.
* * * * *


Sec. 1773.5  [amended]

    7. Amend Sec. 1773.5 by:
    A. Removing paragraphs (c)(5) and (d);
    B. Redesignating paragraphs (c)(6) and (c)(7) to (c)(5) and (c)(6), 
respectively;
    C. In paragraph (c)(4)(iii)(C) and redesignated (c)(5)(ii), 
revising the

[[Page 27836]]

reference ``42 months'' to read ``36 months'', and
    D. In redesignated paragraph (c)(6)(ii), revising the reference 
from ``Director, Borrower Accounting Division'' to read ``Assistant 
Administrator, Program Accounting and Regulatory Analysis'.

    8. Amend Sec. 1773.6 by revising the title and paragraph (a) 
introductory text to read as follows:


Sec. 1773.6  Auditor communication.

    (a) During the planning stages of a financial statement audit, 
GAGAS and AICPA standards require the auditor to communicate certain 
information regarding the nature and extent of testing and reporting on 
compliance with laws and regulations and internal control over 
financial reporting. The communication must include the nature of any 
additional testing of compliance and internal control required by laws 
and regulations or otherwise requested, and whether the auditors are 
planning to provide opinions on compliance with laws and regulations 
and internal control over financial reporting. This communication must 
take the form of an audit engagement letter prepared by the CPA and 
formally accepted by the board of directors or an audit committee 
representing the board of directors. The engagement letter must also 
encompass those items prescribed in SAS 83, entitled ``Establishing an 
Understanding with the Client''. It must also include the following:
* * * * *
    9. In Sec. 1773.7, paragraphs (b) and (c)(4) are revised to read as 
follows:


Sec. 1773.7  Audit standards.

* * * * *
    (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 report on compliance and on internal control over financial 
reporting and the management letter.
    (c) * * *
    (4) After informing the borrower's management, if the scope 
limitation is not adequately resolved, the CPA should immediately 
contact the AA-PARA, RUS, U.S. Department of Agriculture, Washington, 
DC 20250-1523. The AA-PARA will endeavor to resolve the matter with the 
borrower.

    10. In Sec. 1773.8, paragraphs (a)(1) and the table following 
paragraph (c) are revised to read as follows:


Sec. 1773.8  Audit date.

    (a) * * *
    (1) A borrower may request a change in the as of audit date by 
writing to the AA-PARA at least 60 days prior to the newly requested as 
of audit date.
* * * * *
    (c) * * *

------------------------------------------------------------------------
                                              Statements prepared as of
       Previously issued statements                new audit date
------------------------------------------------------------------------
12/31/20X1; 12/31/20X0 (Statement need not  6/30/20X3; 6/30/20X2.
 be reissued).
------------------------------------------------------------------------


    11. Amend Sec. 1773.9 by revising the title and paragraphs (a), 
(b), and (c) introductory text, to read as follows:


Sec. 1773.9  Disclosure of fraud, illegal acts, and other 
noncompliance.

    (a) In accordance with GAGAS, the auditor must design the audit to 
provide reasonable assurance of detecting fraud that is material to the 
financial statements and material misstatements resulting from direct 
and material illegal acts, and noncompliance with the provisions of 
contracts or grant agreements that could have a direct and material 
effect on financial statements amounts.
    (b) If specific information comes to the auditor's attention that 
provides evidence concerning the existence of possible illegal acts 
that could have a material indirect effect on the financial statements 
or material noncompliance with the provisions of contracts or grant 
agreements that could have a material indirect effect on the financial 
statements, auditors should apply audit procedures specifically 
directed to ascertaining whether an illegal act or noncompliance with 
provisions of contract or grant agreements has occurred.
    (c) Pursuant to the terms of its audit engagement letter with the 
borrower, the CPA must immediately report, in writing, all instances of 
fraud and all indications or instances of illegal acts, whether 
material or not, to:
* * * * *

    12. Revise the title to subpart C to part 1773, to read as follows:

Subpart C--RUS Requirements for the Submission and Review of the 
Auditor's Report, Report on Compliance and on Internal Control Over 
Financial Reporting, and Management Letter

    13. In Sec. 1773.21, revise the title and add a new paragraph (e) 
to read as follows:


Sec. 1773.21  Borrower's review and submission of the auditor's report, 
report on compliance and on internal control over financial reporting, 
and management letter.

* * * * *
    (e) All required submissions to RUS described in paragraphs (a) 
through (d) of this section should be sent to: Assistant Administrator, 
Program Accounting and Regulatory Analysis, Stop 1523, 1400 
Independence Ave., SW, Washington, DC 20250-1523.

    14. Section 1773.30 paragraph (a) is revised to read as follows:


Sec. 1773.30  General.

    (a) The CPA must prepare the following (examples of which are set 
forth in RUS Bulletin 1773-1):
    (1) An auditor's report;
    (2) A report on compliance and on internal control over financial 
reporting; and
    (3) A management letter.
* * * * *

    15. Section 1773.31 is revised to read as follows:


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 report on 
compliance and on internal control over financial reporting issued in 
conjunction with the auditor's report. The auditor's report should also 
state that the report on compliance and on internal control over 
financial reporting is an integral part of a GAGAS audit, and in 
considering the results of the audit, this report should be read along 
with the auditor's report on the financial statements.

    16. Amend Sec. 1773.32 by revising the introductory text, 
paragraphs (a) through (d), and the ``note'' at the end of paragraph 
(f) to read as follows:


Sec. 1773.32  Report on compliance and on internal control over 
financial reporting.

    As required by GAGAS, the CPA must prepare a written report 
describing the auditors testing of compliance with applicable laws, 
regulations, contracts, and grants, and on internal control over 
financial reporting and present the results of those tests. This report 
must be signed by the CPA and must include, as a minimum:
    (a) The scope of the CPA's testing of compliance with laws and 
regulations and internal control over financial reporting including 
whether or not the

[[Page 27837]]

tests performed provided sufficient evidence to support an opinion on 
compliance or internal control over financial reporting and whether the 
CPA is providing such opinions;
    (b) If conditions believed to be material weaknesses considered to 
be reportable conditions are disclosed, the report should identify the 
material weaknesses that have come to the CPA's attention;
    (c) If no reportable instances of non-compliance and no reportable 
conditions were found, the CPA must issue a report as illustrated in 
RUS Bulletin 1773-1.
    (d) If material instances of non-compliance and reportable 
conditions are identified, the CPA must issue a report as illustrated 
in RUS Bulletin 1773-1.
* * * * *
    (f) * * *

    We noted certain immaterial instances of noncompliance, which we 
have reported to the management of (borrower's name) in a separate 
letter dated (month, day, year).
* * * * *

    17. Remove Appendices A through D to part 1773.

    Dated: May 8, 2001.
Blaine D. Stockton,
Acting Administrator, Rural Utilities Service.

Appendix A to RUS Bulletin 1773-1--Sample Auditor's Report for an 
Electric Cooperative

    Appendix A includes an example of an auditor's report, report on 
compliance and on internal control over financial reporting, 
financial statements and accompanying notes, and management letter 
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 Energy Association, 
Inc.: Independent Auditor's Report

    We have audited the accompanying balance sheets of Center County 
Electric Energy Association, Inc. as of December 31, 20X1 and 20X0, 
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 Energy Association, 
Inc.'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 require 
that we plan and perform the audit to obtain reasonable assurance 
about whether the financial statements are free of material 
misstatement. An audit includes examining, on a test basis, evidence 
supporting the amounts and disclosures in the financial statements. 
An audit also includes assessing the accounting principles used and 
significant estimates made by management, as well as evaluating the 
overall financial statement presentation. We believe that our audit 
provides a reasonable basis for our opinion.
    In our opinion, the financial statements referred to above 
present fairly, in all material respects, the financial position of 
Center County Electric Energy Association, Inc. as of December 31, 
20X1 and 20X0, 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 our report dated March 2, 2002, on our consideration of 
Center County Electric Energy Association, Inc.'s internal control 
over financial reporting and our tests of its compliance with 
certain provisions of laws, regulations, contracts, and grants. That 
report is an integral part of an audit performed in accordance with 
Government Auditing Standards and should be read in conjunction with 
this report in considering the results of our audit.
Certified Public Accountants
March 2, 20X2

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 Energy Association, 
Inc.:

    We have audited the financial statements of Center County 
Electric Energy Association, Inc. as of and for the years ended 
December 31, 20X1 and 20X0, and have issued our report thereon dated 
March 2, 20X2. 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 Energy Association, Inc.'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 
Energy Association, Inc. in a separate letter dated March 2, 20X2.]

Internal Control Over Financial Reporting

    In planning and performing our audit, we considered Center 
County Electric Energy Association, Inc.'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 Energy Association, Inc. in a separate letter 
dated March 2, 20X2.]
    This report is intended solely for the information and use of 
the audit committee, management, the Rural Utilities Service, and 
supplemental lenders and is not intended to be and should not be 
used by anyone other than these specified parties. However, this 
report is a matter of public record and its distribution is not 
limited.
Certified Public Accountants
March 2, 20X2

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

[[Page 27838]]

The Board of Directors, Center County Electric Energy Association, 
Inc.:

    We have audited the financial statements of Center County 
Electric Energy Association, Inc. as of and for the years ended 
December 31, 20X1 and 20X0, and have issued our report thereon dated 
March 2, 20X2. 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 Energy Association, Inc.'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 Energy Association, Inc. in a 
separate letter dated March 2, 20X2.]

Internal Control Over Financial Reporting

    In planning and performing our audit, we considered Center 
County Electric Energy Association, Inc.'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 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 Energy Association, Inc.'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 
Energy Association, Inc. in a separate letter dated March 2, 2002.]
    This report is intended solely for the information and use of 
the audit committee, management, the Rural Utilities Service, and 
supplemental lenders and is not intended to be and should not be 
used by anyone other that these specified parties. However, this 
report is a matter of public record and its distribution is not 
limited.

Certified Public Accountants
March 2, 2002

Exhibit 4--Sample Financial Statements

 Center County Electric Energy Association, Inc. Balance Sheets December
                        31, 20X1 and 20X0 Assets
                             [Notes 1 and 2]
------------------------------------------------------------------------
                                                  2001          2000
------------------------------------------------------------------------
Utility Plant (Note 3):
    Electric Plant in Service...............   $48,382,000   $46,826,000
    Construction Work in Progress...........     2,040,000     1,586,000
                                             ---------------------------
        Total Utility Plant.................    50,422,000    48,412,000
    Accumulated Provision for Depreciation..    15,588,000    14,586,000
                                             ---------------------------
    Net Utility Plant.......................    34,834,000    33,826,000
Investments (Note 4):
    Investments in Associated Organizations.     4,493,000     4,048,000
    Other...................................     1,040,000     1,410,000
                                             ---------------------------
        Total Investments...................     5,533,000     5,458,000
Current Assets:
    Cash and Cash Equivalents...............       359,000       359,000
    Short-Term Investments (Note 4).........         8,000         8,000
    Accounts Receivable, less allowance for        183,000       176,000
     doubtful accounts of $11,000 in 2001
     and $10,000 in 2000....................
    Materials and supplies..................       418,000       404,000
    Prepayments.............................        43,000        43,000
                                             ---------------------------
        Total current assets................     1,011,000       990,000
Deferred Charges (Note 5)...................        28,000         9,000
                                             ===========================
        Total assets........................   $41,406,000   $40,283,000
------------------------------------------------------------------------

    The accompanying notes are an integral part of these statements.

[[Page 27839]]



 Center County Electric Energy Association, Inc. Balance Sheets December
                            31, 20X1 and 20X0
                   [Equities and Liabilities] [Note 1]
------------------------------------------------------------------------
                                                  20X1          20X0
------------------------------------------------------------------------
Equities:
    Memberships.............................       $60,000       $59,000
    Patronage Capital (Note 6)..............    16,683,000    15,343,000
    Other Equities (Note 7).................       268,000       180,000
    Net Unrealized Gain on Investments (Note        15,000         8,000
     4).....................................
                                             ---------------------------
        Total Equities......................    17,026,000    15,590,000
                                             ---------------------------
Long-term liabilities:
    RUS Mortgage Notes, less current portion    16,956,000    17,532,000
     (Note 8)...............................
    CFC Mortgage Notes, less current portion     4,333,000     4,482,000
     (Note 8)...............................
    Post-retirement benefit obligation (Note     1,004,000       841,000
     9).....................................
                                             ---------------------------
        Total Long-term liabilities.........    22,293,000    22,855,000
                                             ---------------------------
Current Liabilities:
    Line of credit note payable.............       425,000       300,000
    Current portion of long-term debt (Note        725,000       700,000
     8).....................................
    Accounts Payable--Purchased Power.......       245,000       203,000
    Accounts Payable--Other.................       109,000        91,000
    Consumer Deposits.......................       408,000       413,000
    Other Current and Accrued Liabilities...       116,000        78,000
                                             ---------------------------
        Total Current Liabilities...........     2,028,000     1,785,000
Deferred Credits (Note 10)..................        59,000        53,000
                                             ===========================
        Total Equities and Liabilities......   $41,406,000   $40,283,000
------------------------------------------------------------------------

    The accompanying notes are an integral part of these statements.

  Center County Electric Energy Association, Inc. Statements of Revenue
                          and Patronage Capital
            [For the years ended December 31, 20X1 and 20X0]
------------------------------------------------------------------------
                                                  20X1          20X0
------------------------------------------------------------------------
Operating Revenues..........................   $12,899,000   $12,042,000
Operating Expenses:
    Cost of Power...........................     4,408,000     4,095,000
    Distribution Operations.................       833,000       913,000
    Distribution Maintenance................     1,553,000     1,236,000
    Consumer Accounts.......................       575,000       547,000
    Consumer Service and Information........       288,000       306,000
    Administrative and General..............       710,000       653,000
    Depreciation and Amortization...........     2,163,000     2,098,000
    Other...................................       262,000       258,000
                                             ---------------------------
        Total Operating Expenses............    10,792,000    10,106,000
Operating Margins Before Interest Expense...     2,107,000     1,936,000
                                             ---------------------------
Interest Expense............................     1,137,000     1,151,000
                                             ---------------------------
Operating Margins After Interest Expense....       970,000       785,000
Nonoperating Margins:
    Interest Income.........................        50,000        30,000
    Other Nonoperating Income...............         6,000         6,000
                                             ---------------------------
        Total Nonoperating Margins..........        56,000        36,000
Generation and Transmission Cooperative            361,000       283,000
 Capital Credits............................
Net Margins.................................     1,387,000     1,104,000
Patronage Capital at Beginning of Year......    15,343,000    14,345,000
Less: Retirements of Capital Credits........        47,000       106,000
                                             ---------------------------
Patronage Capital at End of Year............   $16,683,000   $15,343,000
------------------------------------------------------------------------

    The accompanying notes are an integral part of these statements.

[[Page 27840]]



      Center County Electric Energy Association, Inc. Statements of
   Comprehensive Income for the Years Ended December 31, 20X1 and 20X0
------------------------------------------------------------------------
                                                  20X1          20X0
------------------------------------------------------------------------
Net Margins.................................    $1,387,000    $1,104,000
Other Comprehensive Income:
    Unrealized holding gains (losses)                7,000         8,000
     arising during the year................
                                             ---------------------------
        Comprehensive Income................    $1,394,000    $1,112,000
------------------------------------------------------------------------

    The accompanying notes are an integral part of these statements.

 Center County Electric Energy Association, Inc. Statements of Cash Flows for the Years Ended December 31, 20X1
                                                    and 20X0
----------------------------------------------------------------------------------------------------------------
                                                                                      20X1             20X0
----------------------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities:
    Cash Received from Consumers..............................................     $12,882,000      $12,017,000
    Cash Paid to Suppliers and Employees......................................      (8,335,000)      (7,784,000)
    Interest Received.........................................................          50,000           30,000
    Interest Paid.............................................................      (1,137,000)      (1,151,000)
                                                                               ---------------------------------
        Net Cash Provided by Operating Activities.............................       3,460,000        3,112,000
                                                                               ---------------------------------
Cash Flows From Investing Activities:
    Construction and Acquisition of Plant.....................................      (2,010,000)      (3,285,000)
    Plant Removal Costs.......................................................      (1,378,000)        (270,000)
    Materials Salvaged from Retirements.......................................         217,000          197,000
    (Increase) Decrease In:
        Materials Inventory...................................................         (14,000)          10,000
        Deferred Charges-Preliminary Surveys and Investigations...............         (19,000)          24,000
        Investments in Associated Organizations...............................         (76,000)         (56,000)
        Other Investments.....................................................         370,000          323,000
    Inventory Adjustment-Deferred Credit Decrease.............................         (12,000)          (5,000)
                                                                               ---------------------------------
        Net Cash Used in Investing Activities.................................      (2,922,000)      (3,062,000)
                                                                               ---------------------------------
Cash Flows From Financing Activities:
    Retirements of Patronage Capital Credits..................................         (47,000)        (106,000)
    Retired Capital Credits-Gain..............................................           6,000            6,000
    Donated Capital...........................................................          82,000           31,000
    RUS Loan Advances.........................................................  ...............       1,025,000
    Payments on RUS Debt......................................................        (540,000)        (502,000)
    Payments on CFC Debt......................................................        (160,000)        (149,000)
    Line of Credit............................................................         125,000         (225,000)
    Increase/(Decrease) In:
        Consumer Deposits.....................................................          (5,000)          (1,000)
    Memberships Issued........................................................           1,000            1,000
                                                                               ---------------------------------
        Net Cash Used in Financing Activities.................................        (538,000)          80,000
                                                                               ---------------------------------
    Net Increase/(Decrease) in Cash...........................................              $0         $130,000
    Cash--Beginning of Year...................................................         359,000          229,000
                                                                               ---------------------------------
    Cash--End of Year.........................................................        $359,000         $359,000
----------------------------------------------------------------------------------------------------------------


                   Reconciliation of Net Margins to Net Cash Provided by Operating Activities
----------------------------------------------------------------------------------------------------------------
                                                                                      20X1             20X0
----------------------------------------------------------------------------------------------------------------
Net Margins...................................................................      $1,387,000       $1,104,000
    Adjustments to Reconcile Net Margins to Net Cash Provided by Operating
     Activities:
    Depreciation and Amortization.............................................       2,163,000        2,098,000
    G&T and Other Capital Credits (Non-Cash)..................................        (362,000)        (283,000)
    Provision for Uncollectible Accounts Receivable...........................           1,000           (3,000)
    Accumulated Provision for Pensions and Benefits...........................         163,000          150,000
    (Increase)/Decrease In:
        Customer and Other Accounts Receivable................................          (8,000)          13,000
        Current and Accrued Assets--Other.....................................  ...............           1,000
    Increase/(Decrease) In:
        Accounts Payable......................................................          60,000           26,000
        Deferred Energy Prepayments...........................................          18,000           11,000

[[Page 27841]]

 
        Current and Accrued Liabilities--Other................................          38,000           (5,000)
                                                                               ---------------------------------
    Total Adjustments.........................................................       2,073,000        2,008,000
                                                                               =================================
Net Cash Provided by Operating Activities.....................................      $3,460,000       $3,112,000
----------------------------------------------------------------------------------------------------------------

    The accompanying notes are an integral part of these statements.

   Center County Electric Energy Association, Inc. Notes to Financial
                  Statements December 31, 20X1 and 20X0
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 and NRUCFC.
3. Electric Plant and Depreciation Rates and Procedures:
    Listed below are the major classes of the electric plant as of
     December 31, 20X1 and 20X0:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Intangible Plant........................         $11,000         $11,000
Distribution Plant......................      45,753,000      44,370,000
General Plant...........................       2,618,000       2,445,000
                                         -------------------------------
Electric Plant in Service...............     $48,382,000     $46,826,000
Construction Work in Progress...........       2,040,000       1,586,000
                                         -------------------------------
    Total Utility Plant.................     $50,422,000     $48,412,000
------------------------------------------------------------------------


 
 
 
Provision has been made for depreciation of distribution plant at a
 straight-line composite rate of 3.00 percent per annum. General Plant
 depreciation rates have been applied on a straight-line basis as
 follows:
 
     Structures and Improvements...............................     2.5%
    Office Furniture and Equipment.............................    10.0%
    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 20X1 and 20X0:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
National Rural Utilities Cooperative
 Finance Corporation:
    Membership Fee......................          $1,000          $1,000
    Capital Term Certificates...........         839,000         839,000
    Patronage Capital...................         288,000         276,000
    Fall River Power Cooperative........       3,019,000       2,898,000
    Other...............................         346,000          34,000
                                         -------------------------------
                                              $4,493,000     $ 4,048,000
------------------------------------------------------------------------


 
Center County Electric Energy Association, Inc. has adopted SFAS No.
 115, ``Accounting for Certain Investments in Debt and Equity
 Securities.'' In accordance with SFAS No. 115, the Association has
 classified all the Other Investments as available-for-sale. Available-
 for-sale investments are stated at fair value with unrealized gains and
 losses included in members' equities. The cost of investments sold is
 based on the specific identification method.
Long-term and short-term investments classified as available-for-sale
 were as follows at December 31, 20X1 and 20X0:
 


----------------------------------------------------------------------------------------------------------------
                                                                               20X1
                                                 ---------------------------------------------------------------
                   Description                                         Gross           Gross
                                                  Amortized cost    unrealized      unrealized      Fair value
                                                                       gain            loss
----------------------------------------------------------------------------------------------------------------
U.S. Treasury notes, bills and bonds............        $222,000         $14,000          $1,000         235,000
Other U.S. Government agency securities.........         380,000           6,000           4,000         382,000

[[Page 27842]]

 
Other debt securities...........................         431,000           3,000           3,000         431,000
                                                 ---------------------------------------------------------------
                                                      $1,033,000         $23,000          $8,000      $1,048,000
----------------------------------------------------------------------------------------------------------------


 
                                                                               20X0
                                                 ---------------------------------------------------------------
                   Description                                         Gross           Gross
                                                  Amortized cost    unrealized      unrealized      Fair value
                                                                       gain            loss
----------------------------------------------------------------------------------------------------------------
U.S. Treasury notes, bills and bonds............        $397,000          $5,000          $1,000        $401,000
Other U.S. Government agency securities.........         410,000           2,000  ..............         412,000
Other debt securities...........................         604,000           1,000  ..............         605,000
                                                 ---------------------------------------------------------------
                                                      $1,411,000          $8,000          $1,000      $1,418,000
----------------------------------------------------------------------------------------------------------------


At December 31, 20X1, maturities of investments classified as available-
 for-sale were as follows:
 


------------------------------------------------------------------------
                                          Amortized cost    Fair value
------------------------------------------------------------------------
Less than One Year......................          $8,000          $8,000
One through Five Years..................         958,000         961,000
After Five Years........................          67,000          79,000
                                         -------------------------------
    Total...............................      $1,033,000      $1,048,000
------------------------------------------------------------------------


5. Deferred Charges:
    Following is a summary of amounts recorded as deferred charges as of
     December 31, 20X1 and 20X0:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Preliminary Surveys and Investigations..         $28,000          $9,000
------------------------------------------------------------------------


6. Patronage Capital:
    At December 31, 20X1 and 20X0, patronage capital consisted of:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Assignable..............................      $1,387,000      $1,104,000
Assigned to date........................      15,955,000      14,851,000
                                         -------------------------------
                                             $17,342,000     $15,955,000
Less: Retirements to Date...............         659,000         612,000
                                         -------------------------------
                                             $16,683,000     $15,343,000
------------------------------------------------------------------------


Under the provisions of the Mortgage Agreement, until the equities and
 margins equal or exceed thirty percent of the total assets of the
 cooperative, the return to patrons of contributed capital is generally
 limited to twenty-five percent of the patronage capital or margins
 received by the cooperative in the prior calendar year. The equities
 and margins of the cooperative represent 41 percent of the total assets
 at balance sheet date. Capital credit retirements in the amount of
 $47,000 were paid in 20X1.
 


7. Other Equities:
    At December 31, 20X1 and 20X0, other equities consisted of:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Retired Capital Credits-Gain............        $181,000        $175,000
Donated Capital.........................          87,000           5,000
                                         -------------------------------
                                                $268,000        $180,000
------------------------------------------------------------------------


8. Mortgage Notes:
    Long-term debt is primarily represented by mortgage notes payable to
     the United States of America and to the National Rural Utilities
     Cooperative Finance Corporation. Following is a summary of
     outstanding long-term debt as of December 31, 20X1 and 20X0:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
RUS, 2% Notes due March 31, 2007........        $544,000        $562,000
RUS, 5% Notes due December 31, 2033.....      16,971,000      17,510,000
                                         -------------------------------
                                             $17,515,000     $18,072,000
Less: Current Maturities................         559,000         540,000
                                         -------------------------------
                                             $16,956,000     $17,532,000


[[Page 27843]]


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
CFC, 5.75% Notes due March 31, 2013.....        $166,000        $171,000
CFC, 6.95% Notes due July 31, 2018......       1,453,000       1,499,000
CFC, 7.00% Notes due September 30, 2009.         443,000         457,000
CFC, 6.40% Notes due October 31, 2026...       2,437,000       2,515,000
                                         -------------------------------
                                              $4,499,000      $4,642,000
Less: Current Maturities................         166,000         160,000
                                         -------------------------------
                                              $4,333,000      $4,482,000
------------------------------------------------------------------------


    Unadvanced loan funds of $286,000 and $2,500,000 are available to
     the cooperative on loan commitments from RUS and CFC as of December
     31, 20X1. As of December 31, 20X1, annual maturities of long-term
     debt outstanding for the next five years are as follows:
 


----------------------------------------------------------------------------------------------------------------
                                                          RUS             CFC            Total
--------------------------------------------------------------------------------------------------
20X2..............................................        $559,000        $166,000        $725,000
20X3..............................................         563,000         167,000         730,000
20X4..............................................         565,000         167,000         732,000
20X5..............................................         568,000         168,000         736,000
20X6..............................................         570,000         169,000         739,000
----------------------------------------------------------------------------------------------------------------


9. Employee Benefits:
    Substantially all of the employees of the Association are covered by
     the ABC Retirement and Security Program, a defined benefit pension
     plan.
    In addition to pension contributions the Association provides health
     care benefits for substantially all retired employees and
     dependents until they reach age 65.
    The following illustrates the pension and postretirement benefits
     plans for the year ended December 31, 20X1 and 20X0.
 


----------------------------------------------------------------------------------------------------------------
                                                      Pension benefits                   Other benefits
                                             -------------------------------------------------------------------
                                                    20X1             20X0             20X1             20X0
----------------------------------------------------------------------------------------------------------------
Benefit obligation at December 31...........      $1,762,000       $2,080,000       $1,899,000       $1,800,000
Fair value of plan assets at December 31....         715,000          513,000                0                0
                                             -------------------------------------------------------------------
Funded status...............................     $(1,047,000)     $(1,567,000)     $(1,899,000)     $(1,800,000)
                                             -------------------------------------------------------------------
Prepaid (Accrued) benefit cost..............       $(243,000)       $(365,000)     $(1,004,000)       $(841,000)
Weighted-average assumptions as of December
 31:
    Discount rate...........................           6.75%            5.50%            8.00%            8.00%
    Expected return on plan assets..........           6.50%            6.00%
    Rate of compensation increase...........           5.00%            5.50%            6.00%            6.00%
----------------------------------------------------------------------------------------------------------------


    For measurement purposes, a 10 percent annual rate of increase in
     the per capita cost of covered health benefits was assumed for
     20X2. The rate was assumed to decrease gradually to 5 percent and
     remain at that level thereafter.
 


----------------------------------------------------------------------------------------------------------------
                                                      Pension benefits                   Other benefits
                                             -------------------------------------------------------------------
                                                    20X1             20X0             20X1             20X0
----------------------------------------------------------------------------------------------------------------
Benefit cost................................        $253,000         $232,000         $220,000         $220,000
Employer Contribution.......................         160,000          225,000           57,000           55,000
Benefits Paid...............................          (7,000)         (48,000)         (57,000)         (55,000)
----------------------------------------------------------------------------------------------------------------


10. Deferred Credits:
    Following is a summary of the amounts recorded as deferred credits
     as of December 31, 20X1 and 20X0:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Customer Energy Prepayments.............         $33,000         $15,000
Inventory Adjustment....................          26,000          38,000
                                         -------------------------------
                                                 $59,000         $53,000
------------------------------------------------------------------------


11. Litigation:
    The association is a defendant in an action in which the plaintiff
     claims damages totaling $200,000 for personal injuries sustained.
     The action has been dismissed by the District Court, but is on
     appeal before the State Supreme Court. Management is of the opinion
     that no liability will be incurred by the association as a result
     of this action.
12. Commitments:
    Under its wholesale power agreement, the association is committed to
     purchase its electric power and energy requirements from Fall River
     Power Cooperative, Inc., until December 31, 20X7. The rates paid
     for such purchases are subject to review annually.
 


[[Page 27844]]

Exhibit 5--Illustrative Independent Auditor's Management Letter for 
Electric Borrowers

    RUS requires that CPAs auditing RUS borrowers provide a 
management letter in accordance with Sec. 1773.33. This letter must 
be signed by the CPA, bear the same date as the auditor's report, 
and be addressed to the borrower's board of directors.

Illustrative Independent Auditors' Management Letter for Electric 
Borrowers

March 2, 20X2
Board of Directors
Center County Electric Energy Association, Inc.
[City, State]

    We have audited the financial statements of Center County 
Electric Energy Association, Inc. for the year ended December 31, 
20X1, and have issued our report thereon dated March 2, 20X2. We 
conducted our audit in accordance with generally accepted auditing 
standards, the standards applicable to financial audits contained in 
Government Auditing Standards issued by the Comptroller General of 
the United States, and 7 CFR Part 1773, Policy on Audits of Rural 
Utilities Service (RUS) Borrowers. Those standards require that we 
plan and perform the audit to obtain reasonable assurance about 
whether the financial statements are free of material misstatement.
    In planning and performing our audit of the financial statements 
of Center County Electric Energy Association, Inc. for the year 
ended December 31, 20X1, we considered its internal control over 
financial reporting in order to determine our auditing procedures 
for the purpose of expressing an 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 that we consider to be material weaknesses. [If 
a material weakness was noted, refer the reader to the independent 
auditors' report on compliance and on internal control over 
financial reporting.]
    Section 1773.33 requires comments on specific aspects of the 
internal control over financial reporting, compliance with specific 
RUS loan and security instrument provisions, and other additional 
matters. We have grouped our comments accordingly. In addition to 
obtaining reasonable assurance about whether the financial 
statements are free from material misstatements, at your request, we 
performed tests of specific aspects of the internal control over 
financial reporting, of compliance with specific RUS loan and 
security instrument provisions, and of additional matters. The 
specific aspects of the internal control over financial reporting, 
compliance with specific RUS loan and security instrument 
provisions, and additional matters tested include, among other 
things, the accounting procedures and records, materials control, 
compliance with specific RUS loan and security instrument provisions 
set forth in Sec. 1773.33(e)(1), related party transactions, 
depreciation rates, a schedule of deferred debits and credits, and a 
schedule of investments upon which we express an opinion. In 
addition, our audit of the financial statements also included the 
procedures specified in Sec. 1773.38 through 1773.45. Our objective 
was not to provide an opinion on these specific aspects of the 
internal control over financial reporting, compliance with specific 
RUS loan and security instrument provisions, or additional matters, 
and accordingly, we express no opinion thereon.
    No reports other than our independent auditors' report and our 
independent auditors' report on compliance and on internal control 
over financial reporting, all dated March 2, 2002 or summary of 
recommendations related to our audit have been furnished to 
management.
    Our comments on specific aspects of the internal control over 
financial reporting, compliance with specific RUS loan and security 
instrument provisions, and other additional matters as required by 
Sec. 1773.33 are presented below.

Comments on Certain Specific Aspects of the Internal Control Over 
Financial Reporting

    We noted no matters regarding Center County Electric Energy 
Association, Inc.'s internal control over financial reporting and 
its operation that we consider to be a material weakness as 
previously defined with respect to:

--The accounting procedures and records [list other comments];
--The process for accumulating and recording labor, material, and 
overhead costs, and the distribution of these costs to construction, 
retirement, and maintenance or other expense accounts [list other 
comments]; and
--The materials control [list other comments].

Comments on Compliance With Specific RUS Loan and Security 
Instrument Provisions

    At your request, we have performed the procedures enumerated 
below with respect to compliance with certain provisions of laws, 
regulations, contracts, and grants. The procedures we performed are 
summarized as follows:

--Procedures performed with respect to the requirement for a 
borrower to obtain written approval of the mortgagee to enter into 
any contract for the operation or maintenance of property, or for 
the use of mortgaged property by others for the year ended December 
31, 20X1:

    1. Obtained and read a borrower-prepared schedule of new written 
contracts entered into during the year for the operation or 
maintenance of its property, or for the use of its property by 
others as defined in Sec. 1773.33(e)(1)(i).
    2. Reviewed Board of Director minutes to ascertain whether 
board-approved written contracts are included in the borrower-
prepared schedule.
    3. Noted the existence of written RUS [and other mortgagee] 
approval of each contract listed by the borrower.

--Procedure performed with respect to the requirement to submit RUS 
Form 7 or Form 12 to the RUS:

    1. Agreed amounts reported in Form 7 or Form 12 to Center County 
Electric Energy Association, Inc.'s records.
    The results of our tests indicate that, with respect to the 
items tested, Center County Electric Energy Association, Inc. 
complied, except as noted below, in all material respects, with the 
specific RUS loan and security instrument provisions referred to 
below. The specific provisions tested, as well as any exceptions 
noted, include the requirements that:

--The borrower has obtained written approval of the RUS [and other 
mortgagees] to enter into any contract for the operation or 
maintenance of property, or for the use of mortgaged property by 
others as defined in Sec. 1773.33(e)(1)(i) [list all exceptions]; 
and
--The borrower has submitted its Form 7 or Form 12 to the RUS and 
the Form 7 or Form 12, Financial and Statistical Report, as of 
December 31, 20X1, represented by the borrower as having been 
submitted to RUS is in agreement with the Center County Electric 
Energy Association, Inc.'s audited records in all material respects 
[list all exceptions] [or if the audit year end is other than 
December 31], appears reasonable based upon the audit procedures 
performed [list all exceptions].

Comments on Other Additional Matters

    In connection with our audit of the financial statements of 
Center County Electric Energy Association, Inc., nothing came to our 
attention that caused us to believe that Center County Electric 
Energy Association, Inc. failed to comply with respect to:

--The reconciliation of continuing property records to the 
controlling general ledger plant accounts addressed at 
Sec. 1773.33(c)(1) [list all exceptions];
--The clearing of the construction accounts and the accrual of 
depreciation on completed construction addressed at 
Sec. 1773.33(c)(2) [list all exceptions];
--The retirement of plant addressed at Sec. 1773.33(c)(3) and (4) 
[list all exceptions];
--Approval of the sale, lease, or transfer of capital assets and 
disposition of proceeds for the sale or lease of plant, material, or 
scrap addressed at Sec. 1773.33(c)(5) [list all exceptions];
--The disclosure of material related party transactions, in 
accordance with Statement of Financial Accounting Standards No. 57, 
Related Party Transactions, for the year ended December 31, 2001, in 
the financial statements referenced in the first paragraph of this 
report addressed at Sec. 1773.33(f) [list all exceptions];

[[Page 27845]]

--The depreciation rates addressed at Sec. 1773.33(g) [list all 
exceptions];
--The detailed schedule of deferred debits and deferred credits; and
--The detailed schedule of investments.

    Our audit was made for the purpose of forming an opinion on the 
basic financial statements taken as a whole. The detailed schedule 
of deferred debits and deferred credits required by Sec. 1773.33(h) 
and the detailed schedule of investments required by 
Sec. 1773.33(i), and provided below, are presented for purposes of 
additional analysis and are not a required part of the basic 
financial statements. This information has been subjected to the 
auditing procedures applied in our audit of the basic financial 
statements and, in our opinion, is fairly stated in all material 
respects in relation to the basic financial statements taken as a 
whole.

    [The detailed schedule of deferred debits and deferred credits 
would be included here. The total amount of deferred debits and 
deferred credits as reported in the schedule must agree with the 
totals reported on the Balance Sheet under the specific captions of 
``Deferred Debits'' and ``Deferred Credits''. Those items that have 
been approved, in writing, by RUS should be clearly indicated.]
    [The detailed schedule of investments would be included here. 
The total of the investment in each company reported must agree with 
the detail investment subsidiary account(s).]
    This report is intended solely for the information and use of 
the board of directors, management, and the RUS and supplemental 
lenders and is not intended to be and should not be used by anyone 
other than these specified parties. However, this report is a matter 
of public record and its distribution is not limited.

Certified Public Accountants

Appendix B to RUS Bulletin 1773-1--Sample Auditor's Report for a Class 
A or B Commercial Telecommunications Company

    Appendix B includes an example of a short-form auditor's report, 
report on compliance and on internal control over financial 
reporting, financial statements and accompanying notes for a 
commercial telecommunications company. 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 telecommunications borrowers.

Exhibit 1--Sample Auditor's Report

Certified Public Accountants, 1600 Main Street, City, State 24105
The Board of Directors, Center County Telecommunications Systems, 
Inc.: Independent Auditor's Report

    We have audited the accompanying balance sheets of Center County 
Telecommunications Systems, Inc., as of December 31, 20X1 and 20X0, 
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 Telecommunications Systems 
Inc.'s management. Our responsibility is to express an opinion on 
these financial statements based on our audit.
    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. Those standards require 
that we plan and perform the audit to obtain reasonable assurance 
about whether the financial statements are free of material 
misstatement. An audit includes examining, on a test basis, evidence 
supporting the amounts and disclosures in the financial statements. 
An audit also includes assessing the accounting principles used and 
significant estimates made by management, as well as evaluating the 
overall financial statement presentation. We believe that our audits 
provide a reasonable basis for our audit.
    In our opinion, the financial statements referred to above 
present fairly, in all material respects, the financial position of 
Center County Telecommunications Systems, Inc. as of December 31, 
20X1 and 20X0, and the results of its operations and its cash flows 
for the years then ended in conformity with general accepted 
accounting principles.
    In accordance with Government Auditing Standards, we have also 
issued our report dated March 2, 20X2, on our consideration of 
Center County Telecommunications Systems, Inc.'s internal control 
over financial reporting and our tests of its compliance with 
certain provisions of laws, regulations, contracts, and grants. That 
report is an integral part of an audit performed in accordance with 
Government Auditing Standards and should be read in conjunction with 
this report in considering the results of our audit.

Certified Public Accountants
March 2, 20X2

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 Telecommunications Systems, 
Inc.:

    We have audited the financial statements of Center County 
Telecommunications Systems, Inc. as of and for the years ended 
December 31, 20X1 and 20X0, and have issued our report thereon dated 
March 2, 20X2. 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 Telecommunications Systems, Inc.'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 
Telecommunications Systems, Inc. in a separate letter dated March 2, 
20X1.]

Internal Control Over Financial Reporting

    In planning and performing our audit, we considered Center 
County Telecommunications Systems, Inc.'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 Telecommunications Systems Inc., in a separate letter 
dated March 2, 20X2.]
    This report is intended solely for the information and use of 
the audit committee, management, the Rural Utilities Service, and 
supplemental lenders and is not intended to be and should not be 
used by anyone other than these specified parties. However, this 
report is a matter of public record and its distribution is not 
limited.

Certified Public Accountants
March 2, 20X2

[[Page 27846]]

Exhibit 3--Sample Report on Compliance and on Internal Control Over 
Financial Reporting, the CPA Found Reportable Instances of 
Noncompliance and Reportable Conditions Were Identified

Certified Public Accountants, 1600 Main Street, City, State 24105
The Board of Directors, Center County Telecommunications Systems 
Inc.

    We have audited the financial statements of Center County 
Telecommunications Systems Inc., as of and for the years ended 
December 31, 20X1 and 20X0, and have issued our report thereon dated 
March 2, 20X2. 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 Telecommunications Systems' 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 Telecommunications Systems, Inc. in a 
separate letter dated March 2, 20X2.]

Internal Control Over Financial Reporting

    In planning and performing our audit, we considered Center 
County Telecommunications Systems, Inc.'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 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 Telecommunications Systems, Inc.'s ability to record, 
process, summarize and report financial data consistent with the 
assertions of management in the financial statements. [A description 
of the findings pertaining to 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 
Telecommunications Systems, Inc., in a separate letter dated March 
2, 20X2.]
    This report is intended solely for the information and use of 
the audit committee, management, the Rural Utilities Service, and 
supplemental lenders and is not intended to be and should not be 
used by anyone other than these specified parties. However, this 
report is a matter of public record and its distribution is not 
limited.

Certified Public Accountants
March 2, 20X2

Exhibit 4--Sample Financial Statement

 Center County Telecommunications Systems, Inc. Balance Sheets December
                        31, 20X1 and 20X0 Assets
                             [Notes 1 and 2]
------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Current Assets:
    Cash--Construction Funds............            $500            $300
    Cash--General Funds.................          60,000          32,000
    Temporary Investments...............          26,000          24,000
    Accounts Receivable, less                    740,000         667,000
     accumulated provision of $35,000 in
     20X1 and $34,000 in 20X0...........
    Materials and Supplies..............         250,000         210,000
    Prepayments (Note 3)................          50,000          31,700
    Other Current Assets................          25,000          30,000
                                         -------------------------------
        Total Current Assets............       1,151,500         995,000
                                         -------------------------------
Noncurrent Assets:
    Investments (Note 4):
        Marketable Securities...........         741,500         705,000
        Nonregulated....................       1,550,000       1,450,000
    Other deferred charges..............          39,000          12,000
                                         -------------------------------
        Total Noncurrent Assets.........       2,330,500       2,167,000
                                         -------------------------------
Property, Plant and Equipment:
    Telecommunications Plant in Service       22,800,000      20,100,000
     (Note 5)...........................
    Telecommunications Plant Under             1,200,000       1,100,000
     Construction.......................
                                         -------------------------------
                                              24,000,000      21,200,000
    Accumulated Provision for                  8,500,000       7,200,000
     Depreciation.......................
                                         -------------------------------
        Total Property, Plant and             15,500,000      14,000,000
         Equipment......................

[[Page 27847]]

 
                                         ===============================
Total Assets............................     $18,982,000     $17,162,000
------------------------------------------------------------------------

    The accompanying notes are an integral part of these statements.

 Center County Telecommunications Systems, Inc. Balance Sheets December
           31, 20X1 and 20X0 Liabilities and Retained Earnings
                                [Note 2]
------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Current Liabilities:
    Accounts Payable....................        $320,000        $324,000
    Customer Deposits...................          33,000          30,000
    Current portion of long-term debt...         579,000         449,000
    Accrued Taxes.......................             500          49,800
    Other Current Liabilities...........          22,000          15,000
                                         -------------------------------
        Total Current Liabilities.......         954,500         867,800
                                         -------------------------------
Long-term debt:
    RUS Mortgage Notes, less current           8,900,000       8,100,000
     portion (Note 6)...................
    Accrued Postretirement benefits              664,000         503,000
     (Note 7)...........................
                                         -------------------------------
        Total Long-term liabilities.....       9,564,000       8,603,000
                                         -------------------------------
Other Liabilities and Deferred Credits:
    Deferred Income Taxes (Note 8)......         190,000         176,000
    Other...............................         110,000          98,000
                                         -------------------------------
        Total Other Liabilities and              300,000         274,000
         Deferred Credits...............
                                         -------------------------------
Stockholder's Equities:
    Capital Stock--Common $100 par               350,000         350,000
     value--5,000 shares authorized;
     3,500 outstanding 20X1 and 20X0....
    Additional Paid-in Capital..........         250,000         250,000
    Retained Earnings...................       7,560,500       6,814,800
    Accumulated Other Comprehensive                3,000           2,400
     Income (Loss)......................
                                         -------------------------------
        Total Stockholder's Equities....       8,163,500       7,417,200
                                         ===============================
Total Equities and Liabilities..........     $18,982,000     $17,162,000
------------------------------------------------------------------------

    The accompanying notes are an integral part of these statements.

  Center County Telecommunications Systems, Inc. Statements of Income and Retained Earnings for the Years Ended
                                           December 31, 20X1 and 20X0
----------------------------------------------------------------------------------------------------------------
                                                                                      20X1             20X0
----------------------------------------------------------------------------------------------------------------
Operating Revenues:
    Local Network Services....................................................      $1,481,000         $924,000
    Network Access Services...................................................       3,706,700        3,023,800
    Billing and Collection Services...........................................         306,000          279,000
    Miscellaneous.............................................................         206,000          139,000
    Less: Uncollectible Revenues..............................................         (26,000)         (22,000)
                                                                               ---------------------------------
        Total Operating Revenues..............................................       5,673,700        4,343,800
                                                                               ---------------------------------
Operating Expenses:
    Plant Specific Operations.................................................         976,000          676,000
    Plant Nonspecific Operations..............................................         222,000          174,000
    Depreciation and Amortization.............................................       1,341,000          855,000
    Customer Operations.......................................................         737,000          544,000
    Corporate Operations......................................................       1,034,000          809,000
    Other Taxes...............................................................          26,000           36,000
                                                                               ---------------------------------
        Total Operating Expenses..............................................       4,336,000        3,094,000
                                                                               ---------------------------------
Operating Income..............................................................       1,337,700        1,249,800
Other Income (Expense):

[[Page 27848]]

 
    Interest and dividend income..............................................         238,000          236,000
    Interest expense..........................................................        (489,000)        (429,000)
    Interest during construction..............................................          53,000           28,000
                                                                               ---------------------------------
        Net Other Income and Expenses.........................................        (198,000)        (165,000)
                                                                               ---------------------------------
Income Before Income Taxes....................................................       1,139,700        1,084,800
Income Taxes..................................................................         126,000           81,000
                                                                               ---------------------------------
Net Income Before Nonregulated Income.........................................       1,013,700        1,003,800
                                                                               ---------------------------------
Nonregulated Income...........................................................          33,000           27,000
                                                                               ---------------------------------
Net Income for the Period.....................................................       1,046,700        1,030,800
Retained Earnings at Beginning of Year........................................       6,814,800        6,053,000
Dividends Paid................................................................         301,000          269,000
                                                                               ---------------------------------
Retained Earnings at End of Year..............................................      $7,560,500       $6,814,800
----------------------------------------------------------------------------------------------------------------

    The accompanying notes are an integral part of these statements.

      Center County Telecommunications Systems, Inc. Statements of
   Comprehensive Income for the Years Ended December 31, 20X1 and 20X0
------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Net Income..............................      $1,046,700      $1,030,800
Other Comprehensive Income:
    Unrealized holding gains (losses)                600           1,500
     arising during the year............
                                         -------------------------------
Comprehensive Income....................      $1,047,300       $1,032,30
------------------------------------------------------------------------

    The accompanying notes are an integral part of these statements.

 Center County Telecommunications Systems, Inc. Statements of Cash Flows
             for the Years Ended December 31, 20X1 and 20X0
------------------------------------------------------------------------
                                              20X1             20X0
------------------------------------------------------------------------
Cash Flows From Operating Activities:
    Cash Received from Consumers......      $5,382,000       $4,276,000
    Cash Paid to Suppliers and              (2,580,400)      (2,026,200)
     Employees........................
    Interest Received.................         238,000          236,000
    Interest Paid.....................        (489,000)        (429,000)
    Taxes Paid........................        (141,500)         (94,000)
                                       ---------------------------------
        Net Cash Provided by Operating       2,409,100        1,962,800
         Activities...................
Cash Flows From Investing Activities:
    Construction and Acquisition of         (2,612,000)      (2,523,000)
     Plant............................
    Plant Removal Costs...............        (229,000)         (82,000)
    (Increase) Decrease In:
        Materials Inventory...........         (40,000)         (58,000)
        Investments in Marketable              (37,900)         (34,500)
         Securities...................
        Other Investments.............        (100,000)        (135,000)
        Deferred Charges..............         (27,000)          23,000
        Nonregulated Income...........          33,000           27,000
                                       ---------------------------------
            Net Cash Used in Investing      (3,012,900)      (2,782,500)
             Activities...............
Cash Flows From Financing Activities:
    Dividends Paid....................        (301,000)        (269,000)
    Debt Proceeds.....................       1,379,000        1,158,000
    Payments on Long-Term Debt........        (449,000)        (444,000)
    Increase/(Decrease) In:
        Consumer Deposits and Advance            3,000           13,000
         Payments.....................
                                       ---------------------------------
            Net Cash Provided by               632,000          458,000
             Financing Activities.....
                                       =================================
            Net Increase/(Decrease) in          28,200         (361,700)
             Cash.....................
            Cash--Beginning of Year...          32,300          394,000
                                       ---------------------------------

[[Page 27849]]

 
            Cash--End of Year.........          60,500           32,300
------------------------------------------------------------------------


     Reconciliation of Net Margins to Net Cash Provided by Operating
                               Activities
------------------------------------------------------------------------
                                              20X1             20X0
------------------------------------------------------------------------
Net Margins...........................      $1,046,700       $1,030,800
    Less: Nonregulated Income.........          33,000           27,000
                                       ---------------------------------
        Net Income from Regulated            1,013,700        1,003,800
         Operations...................
        Adjustments to Reconcile Net
         Margins to Net Cash Provided
         by Operating Activities:
            Depreciation and                 1,341,000          855,000
             Amortization.............
            Provision for                        1,000            1,000
             Uncollectible Accounts
             Receivable...............
            Accumulated Provision for          161,000          133,000
             Pensions and Benefits....
        (Increase)/Decrease In:
            Customer and Other                 (74,000)         (69,000)
             Accounts Receivable......
            Current and Accrued                  5,000           15,000
             Assets--Other............
            Prepayments...............         (18,300)          15,000
        Increase/(Decrease) In:
            Accounts Payable..........          (4,000)          29,000
            Accrued Taxes.............         (49,300)         (13,000)
            Other Current and Accrued            7,000           (2,000)
             Liabilities..............
            Deferred Credits..........          26,000           (5,000)
                                       ---------------------------------
                Total Adjustments.....         959,000        1,395,400
                                       =================================
Net Cash Provided by Operating              $2,409,100       $1,962,800
 Activities...........................
------------------------------------------------------------------------

    (The accompanying notes are an integral part of these 
statements.)

    Center County Telecommunications Systems, Inc. Notes to Financial
                  Statements December 31, 20X1 and 20X0
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. Prepaid Expenses:
    Following is a summary of the amounts recorded as prepaid items as
     of December 31, 20X1 and 20X0:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Prepaid Taxes...........................         $10,000         $10,000
Prepaid Insurance.......................           3,000           1,700
Prepaid Rent............................          37,000          20,000
                                         -------------------------------
                                                 $50,000         $31,700
------------------------------------------------------------------------


4. Investments:
    Marketable Debt and Equity Securities:
    Center County Telecommunications System, Inc., has adopted SFAS No.
     115, ``Accounting for Certain Investments in Debt and Equity
     Securities.'' In accordance with SFAS No. 115, the company has
     classified all the Other Investments as available-for-sale.
     Available-for-sale investments are stated at fair value with
     unrealized gains and losses included in stockholder's equities. The
     cost of investments sold is based on the specific identification
     method.
 
    The cost and fair values of marketable securities available-for-sale
     at December 31, 20X1 and 20X0 were:
 


----------------------------------------------------------------------------------------------------------------
                                                                               20X1
                                                 ---------------------------------------------------------------
                   Description                                         Gross           Gross
                                                  Amortized cost    unrealized      unrealized      Fair value
                                                                       gain            loss
----------------------------------------------------------------------------------------------------------------
U.S. Government Treasury securities.............         $62,500          $2,900            $900         $64,500
Certificate of Deposit..........................         420,000  ..............  ..............         420,000
Debt Securities.................................         280,000           6,000           3,000         283,000
                                                 ---------------------------------------------------------------

[[Page 27850]]

 
                                                        $762,500          $8,900          $3,900        $767,500
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                               20X0
                                                 ---------------------------------------------------------------
                   Description                                         Gross           Gross
                                                  Amortized cost    unrealized      unrealized      Fair value
                                                                       gain            loss
----------------------------------------------------------------------------------------------------------------
U.S. Government Treasury securities.............         $68,000          $1,200            $200         $69,000
Certificate of Deposit..........................         408,000  ..............  ..............         408,000
Debt Securities.................................         249,000           5,000           2,000         252,000
                                                 ---------------------------------------------------------------
                                                        $725,000          $6,200          $2,200        $729,000
----------------------------------------------------------------------------------------------------------------


    At December 31, 20X1, maturities of investments classified as
     available-for-sale were as follows:
 


------------------------------------------------------------------------
                                          Amortized cost    Fair value
------------------------------------------------------------------------
Less than One Year......................         $25,000         $26,000
One through Five Years..................         681,000         684,000
After Five Years........................          56,500          57,500
                                         -------------------------------
    Total...............................        $762,500        $767,500
------------------------------------------------------------------------


    As of December 31, 20X1 and 20X0, the amount of unrealized gains on
     available for sale securities included in accumulated other
     comprehensive income is shown net of deferred income taxes of
     $2,000 and $1,600, respectively.
Nonregulated Investments:
    Investments in nonregulated activities consist of the following:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Customer Premises Equipment.............        $493,000        $500,000
CATV equipment..........................         650,000         678,000
Cellular facilities.....................       1,329,000       1,047,000
Other...................................          28,000          35,000
    Total Nonregulated Investments......       2,500,000       2,260,000
                                         -------------------------------
Less: Accumulated Depreciation..........         950,000         810,000
                                         -------------------------------
                                              $1,550,000      $1,450,000
------------------------------------------------------------------------


    Nonregulated property is stated at cost. The company provides for
     depreciation on a straight-line basis at annual rates which will
     amortize the depreciable property over its estimated useful life.
 
    Following is a summary of net income from nonregulated investments
     for the year ending December 31, 20X1 and 20X0:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Income..................................        $400,000        $268,000
Expenses................................         367,000         241,000
                                         -------------------------------
                                                 $33,000         $27,000
------------------------------------------------------------------------


    Income tax expense related to these activities totaled $15,000 in
     20X1 and $12,000 in 20X0.
5. Investment in Telecommunications Plant:
    Telecommunications Plant in Service and under construction is stated
     at cost. Listed below are the major classes of the
     telecommunications plant as of December 31, 20X1 and 20X0:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Land....................................        $185,000        $185,000
Buildings...............................       1,385,000       1,435,000
Central Office Equipment................       9,929,000       8,379,000
Outside Plant...........................      10,226,000       9,120,000
Furniture and Office Equipment..........         352,000         256,000
Vehicles and Work Equipment.............         723,000         725,000
                                         -------------------------------
                                             $22,800,000     $20,100,000
------------------------------------------------------------------------


    The company provides for depreciation on a straight-line basis at
     annual rates which will amortize the depreciable property over its
     estimated useful life. Such provision, as a percentage of the
     average balance of telecommunications plant in service was 7.2
     percent in 20X1 and 7.1 percent in 20X0.
6. Mortgage Notes:

[[Page 27851]]

 
    Long-term debt is represented by mortgage notes payable to the
     United States of America. Following is a summary of outstanding
     long-term debt as of December 31, 20X1 and 20X0:
 


------------------------------------------------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
2% Notes due September 30, 20X8.........      $2,495,000      $2,373,000
5% Notes due March 31, 20X12............       6,984,000       6,176,000
                                         -------------------------------
                                               9,479,000       8,549,000
Less: Current Maturities................         579,000         449,000
                                         -------------------------------
                                              $8,900,000      $8,100,000
------------------------------------------------------------------------


    As of December 31, 20X1, there were no unadvanced funds.
 
    Principal and interest installments on the above notes are due
     quarterly in equal amounts of $254,000. As of December 31, 20X1,
     annual maturities of long-term debt outstanding for the next five
     years are as follows:
 


20X2.......................................................     $579,000
20X3.......................................................      600,000
20X4.......................................................      612,000
20X5.......................................................      624,000
20X6.......................................................      637,000
 


    The long-term debt agreements contain restrictions on the payment of
     dividends or redemption of capital stock. The terms of the Mortgage
     Agreement require the maintenance of defined amounts in member's
     equity and working capital after payment of dividends.
7. Employee Benefits:
    Substantially all of the employees of the Company are covered by the
     ABC Retirement and Security Program, a multiemployer plan.
 
    In addition to pension contributions the Company provides health
     care benefits for substantially all retired employees and
     dependents until they reach age 65.
 
    The following illustrates the pension and postretirement benefits
     plans for the year ended December 31, 20X1 and 20X0.
 


----------------------------------------------------------------------------------------------------------------
                                                      Pension benefits                   Other benefits
                                             -------------------------------------------------------------------
                                                    20X1             20X0             20X1             20X0
----------------------------------------------------------------------------------------------------------------
Change in benefit obligation:
    Benefit obligation beginning of year....      $1,871,000       $1,841,000       $1,552,000       $1,464,000
    Service Cost............................         115,000          145,000           39,000           39,000
    Interest Cost...........................          95,000           86,000          104,000          104,000
    Actuarial Gain..........................        (490,000)        (157,000)
    Benefits Paid...........................          (6,000)         (43,000)         (58,000)         (56,000)
                                             -------------------------------------------------------------------
    Benefit obligation at end of year.......      $1,585,000       $1,872,000       $1,637,000       $1,551,000
Change in plan assets:
    Fair value of plan assets beginning of          $461,000         $281,000               $0               $0
     year...................................
    Actual return on plan assets............          45,000           21,000
    Employer Contribution...................         144,000          203,000           58,000           56,000
    Benefits Paid...........................          (6,000)         (43,000)         (58,000)         (56,000)
                                             -------------------------------------------------------------------
    Fair value of plan assets at end of year        $644,000         $462,000               $0               $0
    Funded status...........................       $(941,000)     $(1,410,000)     $(1,637,000)     $(1,551,000)
    Unrecognized net actuarial loss (gain)..         (97,000)         428,000   ...............  ...............
    Unrecognized prior service cost.........         627,000          654,000   ...............  ...............
    Unrecognized transition obligation......  ...............  ...............         973,000        1,048,000
                                             -------------------------------------------------------------------
    Prepaid (Accrued) benefit cost..........       $(411,000)       $(328,000)       $(664,000)       $(503,000)
Weighted-average assumptions as of December
 31:
    Discount rate...........................           6.75%            5.50%            8.00%            8.00%
    Expected return on plan assets..........           6.50%            6.00%   ...............  ...............
    Rate of compensation increase...........           5.00%            5.50%            6.00%            6.00%
Components of net periodic benefit cost:
    Service cost............................        $115,000         $145,000          $39,000          $39,000
    Interest cost...........................          95,000           86,000          104,000          104,000
    Expected return on plan assets..........         (33,000)         (22,000)  ...............  ...............
    Amortization of prior service cost......          27,000           27,000   ...............  ...............
    Amortization of transition obligation...  ...............  ...............          75,000           75,000
    Recognized net actuarial loss...........          24,000          (28,000)  ...............  ...............
                                             -------------------------------------------------------------------
    Net periodic benefit cost...............        $228,000         $208,000         $218,000         $218,000
----------------------------------------------------------------------------------------------------------------


8. Income Taxes and Deferred Income Taxes:
    Deferred income taxes reflect the net tax effects of temporary
     differences between the carrying amount of the company's assets and
     liabilities for financial reporting basis and the amounts used for
     income tax purposes.
 
    Deferred federal and state tax assets and liabilities in the
     accompanying balance sheet include the following:
 


[[Page 27852]]


------------------------------------------------------------------------
                                                   December 31,
                                         -------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Deferred Tax Liabilities:
    Federal.............................        $192,000        $152,000
    State...............................          31,000          25,000
                                         -------------------------------
        Total Deferred Tax Liabilities:.         223,000         177,000
Deferred Tax Assets:
    Federal.............................          28,000             700
    State...............................           5,000             300
                                         -------------------------------
        Total Deferred Tax Assets.......          33,000           1,000
                                         ===============================
Net Deferred Tax Liability..............        $190,000        $176,000
Current Portion.........................              $0              $0
Long-term portion.......................         190,000         176,000
                                         -------------------------------
    Net Deferred Tax Liability..........        $190,000        $176,000
------------------------------------------------------------------------


    Income taxes reflected in the Statement of Income and Retained
     Earnings include:
 


------------------------------------------------------------------------
                                                   December 31,
                                         -------------------------------
                                               20X1            20X0
------------------------------------------------------------------------
Federal income taxes:
    Current tax expense.................        $103,000         $71,000
    Deferred tax expense................          10,000           5,000
State income taxes:
    Current tax expense.................          12,000           6,000
    Deferred tax expense................           1,000         (1,000)
                                         -------------------------------
        Total income tax expense........        $126,000         $81,000
------------------------------------------------------------------------


9. Commitments:
    The company has executed contracts for construction programs for
     approximately $1,600,000 at December 31, 20X1. The amount unpaid
     against these commitments at December 31, 20X1 is $1,100,000.
 

Exhibit 5-Illustrative Independent Auditor's Management Letter for 
Telecommunications Borrowers

    RUS requires that CPAs auditing RUS borrowers provide a 
management letter in accordance with Section 1773.33. This letter 
must be signed by the CPA, bear the same date as the auditor's 
report, and be addressed to the borrower's board of directors.

Illustrative Independent Auditors' Management Letter for 
Telecommunications Borrowers

March 2, 20X2
Board of Directors
Center County Telecommunications Systems, Inc.
[City, State]

    We have audited the financial statements of Center County 
Telecommunications Systems, Inc. for the year ended December 31, 
20X1, and have issued our report thereon dated March 2, 20X2. We 
conducted our audit in accordance with generally accepted auditing 
standards, the standards applicable to financial audits contained in 
Government Auditing Standards issued by the Comptroller General of 
the United States, and 7 CFR Part 1773, Policy on Audits of Rural 
Utilities Service (RUS) Borrowers. Those standards require that we 
plan and perform the audit to obtain reasonable assurance about 
whether the financial statements are free of material misstatement.
    In planning and performing our audit of the financial statements 
of Center County Telecommunications Systems, Inc. for the year ended 
December 31, 20X1, we considered its internal control over financial 
reporting in order to determine our auditing procedures for the 
purpose of expressing an 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 that we consider to be material weaknesses. [If 
a material weakness was noted, refer the reader to the independent 
auditors' report on compliance and on internal control over 
financial reporting.]
    Section 1773.33 requires comments on specific aspects of the 
internal control over financial reporting, compliance with specific 
RUS loan and security instrument provisions, and other additional 
matters. We have grouped our comments accordingly. In addition to 
obtaining reasonable assurance about whether the financial 
statements are free from material misstatements, at your request, we 
performed tests of specific aspects of the internal control over 
financial reporting, of compliance with specific RUS loan and 
security instrument provisions, and of additional matters. The 
specific aspects of the internal control over financial reporting, 
compliance with specific RUS loan and security instrument 
provisions, and additional matters tested include, among other 
things, the accounting procedures and records, materials control, 
compliance with specific RUS loan and security instrument provisions 
set forth in Sec. 1773.33(e)(2), and related party transactions and 
investments. In addition, our audit of the financial statements also 
included the procedures specified in Sec. 1773.38 through 1773.45. 
Our objective was not to provide an opinion on these specific 
aspects of the internal control over financial reporting, compliance 
with specific RUS loan and security instrument provisions, or 
additional matters, and accordingly, we express no opinion thereon.
    No reports other than our independent auditors' report, and our 
independent auditors' report on compliance and on internal control 
over financial reporting, all dated March 2, 20X2 or summary of 
recommendations related to our audit have been furnished to 
management.

[[Page 27853]]

    Our comments on specific aspects of the internal control over 
financial reporting, compliance with specific RUS loan and security 
instrument provisions, and other additional matters as required by 
Sec. 1773.33 are presented below.

Comments on Certain Specific Aspects of the Internal Control Over 
Financial Reporting

    We noted no matters regarding Center County Telecommunications 
Systems, Inc.'s internal control over financial reporting and its 
operation that we consider to be a material weakness as previously 
defined with respect to:
--The accounting procedures and records [list other comments];
--The process for accumulating and recording labor, material, and 
overhead costs, and the distribution of these costs to construction, 
retirement, and maintenance or other expense accounts [list other 
comments]; and
--The materials control [list other comments].

Comments on Compliance With Specific RUS Loan and Security 
Instrument Provisions

    At your request, we have performed the procedures enumerated 
below with respect to compliance with certain provisions of laws, 
regulations, contracts, and grants. The procedures we performed are 
summarized as follows:

--Procedures performed with respect to the requirement for a 
borrower to obtain written approval of the mortgagee to enter into 
any contract, agreement or lease between the borrower and an 
affiliate of Center County Telecommunications Systems, Inc. for the 
year ended December 31, 20X1:

    1. Obtained and read a borrower-prepared schedule of new written 
contracts, agreements or leases entered into during the year between 
the borrower and an affiliate as defined in Sec. 1773.33(e)(2)(i).
    2. Reviewed Board of Director minutes to ascertain whether 
board-approved written contracts are included in the borrower-
prepared schedule.
    3. Noted the existence of written RUS [and other mortgagee] 
approval of each contract listed by the borrower.

--Procedure performed with respect to the requirement to submit RUS 
Form 479 to the RUS:

    1. Agreed amounts reported in Form 479 to Center County 
Telecommunications Systems, Inc.'s records.
    The results of our tests indicate that, with respect to the 
items tested, Center County Telecommunications Systems, Inc. 
complied, except as noted below, in all material respects, with the 
specific RUS loan and security instrument provisions referred to 
below. The specific provisions tested, as well as any exceptions 
noted, include the requirements that:

--The borrower has obtained written approval of the RUS [and other 
mortgagees] to enter into any contract agreement or lease with an 
affiliate as defined in Sec. 1773.33(e)(2)(i) [list all exceptions]; 
and
--The borrower has submitted its Form 479 to the RUS and the Form 
479, Financial and Statistical Report, as of December 31, 20X1, 
represented by the borrower as having been submitted to RUS is in 
agreement with the Center County Telecommunications Systems, Inc.'s 
audited records in all material respects [list all exceptions] [or 
if the audit year end is other than December 31], appears reasonable 
based upon the audit procedures performed [list all exceptions].

Comments on Other Additional Matters

    In connection with our audit of the financial statements of 
Center County Telecommunications Systems, Inc., nothing came to our 
attention that caused us to believe that Center County 
Telecommunications Systems, Inc. failed to comply with respect to:

--The reconciliation of continuing property records to the 
controlling general ledger plant accounts addressed at 
Sec. 1773.33(c)(1) [list all exceptions];
--The clearing of the construction accounts and the accrual of 
depreciation on completed construction addressed at 
Sec. 1773.33(c)(2) [list all exceptions];
--The retirement of plant addressed at Sec. 1773.33(c)(3) and (4) 
[list all exceptions];
--The approval of the sale, lease, or transfer of capital assets and 
disposition of proceeds for the sale of lease of plant, material, or 
scrap addressed at Sec. 1773.33(c)(5) [list all exceptions];
--The disclosure of material related party transactions, in 
accordance with Statement of Financial Accounting Standards No. 57, 
Related Party Transactions, for the year ended December 31, 20X1, in 
the financial statements referenced in the first paragraph of this 
report addressed at Sec. 1773.33(f) [list all exceptions]; and
--The detailed schedule of investments.

    Our audit was made for the purpose of forming an opinion on the 
basic financial statements taken as a whole. The detailed schedule 
of investments required by Sec. 1773.33(i) and provided below is 
presented for purposes of additional analysis and is not a required 
part of the basic financial statements. This information has been 
subjected to the auditing procedures applied in our audit of the 
basic financial statements and, in our opinion, is fairly stated in 
all material respects in relation to the basic financial statements 
taken as a whole.

[The detailed schedule of investments would be included here. The 
total of the investment in each company reported must agree with the 
detail investment subsidiary account(s).]
    This report is intended solely for the information and use of 
the board of directors, management, and the RUS and supplemental 
lenders and is not intended to be and should not be used by anyone 
other than these specified parties. However, this report is a matter 
of public record and its distribution is not limited.

Certified Public Accountants

[FR Doc. 01-12127 Filed 5-18-01; 8:45 am]
BILLING CODE 3410-15-P