    Financial Audit: Federal Financing Bank's 1993 and 1992 Financial
    Statements (Letter Report, 12/06/94, GAO/AIMD-95-4).

    This report presents the results of GAO's review of the independent
    certified public accountants' audits of the Federal Financing Bank's
    financial statements for fiscal years 1993 and 1992.  In the auditors'
    opinions, the Bank's statements are presented fairly in accordance with
    generally accepted accounting principles.  The independent auditors'
    reports on the Bank's internal accounting and administrative controls
    and on its compliance with laws and regulations are also provided.  The
    Bank's fiscal year 1993 financial statements reflect an accumulated
    deficit of more than $2 billion.  When it last audited the Bank in 1988,
    GAO reported material weaknesses in the Bank's internal control
    structure.  Because of these long-standing weaknesses, GAO supports the
    independent certified public accountants' recommendation that the
    Treasury Department appoint an individual to oversee both the credit
    accounting and administrative functions of the Bank.  Because the Bank
    will not be able to repay its liability to Treasury associated with loan
    prepayments under its current operating scenario, Treasury should
    consider eliminating this liability as well as the related account
    receivable on its books, including, if necessary, requesting
    legislation.

    --------------------------- Indexing Terms -----------------------------

     REPORTNUM:  AIMD-95-4
         TITLE:  Financial Audit: Federal Financing Bank's 1993 and 1992
                 Financial Statements
          DATE:  12/06/94
       SUBJECT:  Financial statement audits
                 Off-budget federal entities
                 Government guaranteed loans
                 Loan repayments
                 Internal controls
                 Financial records
                 Financial management
                 Federal agency accounting systems
                 Budget deficit

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    Cover
    ================================================================ COVER

    Report to the Congress

    December 1994

    FINANCIAL AUDIT - FEDERAL
    FINANCING BANK'S 1993 AND 1992
    FINANCIAL STATEMENTS

    GAO/AIMD-95-4

    Federal Financing Bank Financial Statements

    (917638)

    Abbreviations
    =============================================================== ABBREV

      FFB - Federal Financing Bank
      IPA - independent public accountant

    Letter
    =============================================================== LETTER

    B-259368

    December 6, 1994

    To the President of the Senate and the
    Speaker of the House of Representatives

    This report presents the results of our review of the independent
    certified public accountants' audits of the Federal Financing Bank's
    (FFB) financial statements for the fiscal years ended September 30,
    1993 and 1992.  In the auditors' opinions, FFB's statements are
    fairly presented in all material respects in accordance with
    generally accepted accounting principles.  The independent auditors'
    reports on FFB's internal accounting and administrative controls and
    on its compliance with laws and regulations are also provided.  FFB's
    fiscal year 1993 financial statements reflect an accumulated deficit
    of over $2 billion.  When we last performed an audit of FFB in 1988,
    we reported material weaknesses in FFB's internal control structure.
    The current auditors' reports indicate that material internal control
    weaknesses still exist.

       BACKGROUND
    ------------------------------------------------------------ Letter :1

    The Federal Financing Bank was created by the Federal Financing Bank
    Act of 1973.  FFB was established to (1) finance federal and
    federally assisted borrowings in ways that least disrupt private
    markets, (2) coordinate such borrowing programs with the government's
    overall fiscal policy, and (3) reduce the costs of such borrowings
    from the public.

    FFB provides financial assistance to or on behalf of federal agencies
    by (1) making direct loans to federal agencies to help them fund
    their programs, (2) purchasing loan assets from federal agencies, and
    (3) making direct loans to nonfederal borrowers (including foreign
    governments) that are secured by federal agency guarantees against
    risk of default by borrowers on loan principal and interest payments.

    FFB obtains funds by borrowing from the Department of the Treasury.
    Each loan made by Treasury matches the terms and conditions, except
    for the interest rate, of the corresponding loans made by FFB.  FFB
    charges its borrowers the interest it incurs on the Treasury
    borrowing, plus a fee of one-eighth of 1 percent to cover
    administrative costs.

       OBJECTIVES, SCOPE, AND
       METHODOLOGY
    ------------------------------------------------------------ Letter :2

    The Department of the Treasury contracted with two independent public
    accounting firms to perform audits of FFB's financial statements for
    fiscal years 1993 and 1992 as required by the Government Corporation
    Control Act,\1 as amended by the Chief Financial Officers Act of
    1990.  Under the act, the Comptroller General may review any
    financial audit conducted by an external auditor.  We elected to
    review FFB's 1993 and 1992 audits because we remain concerned about
    the long-standing internal control weaknesses that we reported on in
    our prior audits.  In addition, FFB's financial statements still
    reflect a $2 billion deficit, which was first reported in 1989.

    We conducted our review of the auditors' work between January 1994
    and September 1994, in accordance with generally accepted government
    auditing standards.  To determine the reasonableness of the auditors'
    work and the extent to which we could rely on it, we

      -- reviewed the auditors' approach and planning of the audits,

      -- evaluated the independence and qualifications of the audit
         staff,

      -- reviewed the financial statements and auditors' reports to
         evaluate compliance with generally accepted accounting
         principles and generally accepted government auditing standards,
         and

      -- reviewed and tested the auditors' working papers to determine
         (1) the nature, timing, and extent of audit work performed, (2)
         the extent of audit quality control methods the auditors used,
         (3) whether an understanding was obtained of the entity's
         internal control structure, (4) whether the auditors tested
         transactions for compliance with applicable laws and
         regulations, and (5) whether the evidence in the working papers
         supported the auditors' opinions on the financial statements and
         internal accounting control and compliance reports.

    The Department of the Treasury provided comments on a draft of this
    report.  These comments are presented in the Agency Comments section
    and are reprinted in appendix II.

    --------------------
    \1 Under the Federal Financing Bank Act of 1973, FFB is subject to
    the budget and audit provisions of the act, as amended.  The act
    requires covered corporations to obtain financial statement audits in
    accordance with generally accepted government auditing standards.

       FFB ACCUMULATED DEFICIT REMAINS
       AT
       $2 BILLION
    ------------------------------------------------------------ Letter :3

    From 1985 to 1988, several FFB borrowers prepaid high interest rate
    loans made to them during 1980 and 1981 by FFB.  While some of these
    borrowers prepaid their loans at the current Treasury market values,
    as required by FFB policy, specific legislation allowed others to
    prepay their loans at less than the current Treasury market value.
    As a result of accepting these loan prepayments at book rather than
    market value, FFB accumulated a deficit of $2 billion.

    A loan's current Treasury market value, as defined by FFB, is
    determined by calculating the net present value of the future stream
    of principal and interest payments the government gives up when FFB
    accepts the prepayment of a loan.  When determining the current
    Treasury market value, FFB uses the current interest rate for a
    Treasury security with a comparable maturity.  When a loan is prepaid
    by a borrower at its current Treasury market value, FFB experiences
    neither an economic gain nor a cost on the prepayment.  In other
    words, FFB is no worse off by allowing a borrower to prepay its loan
    than if FFB held the loan to its original term and no loan default
    occurred.

    Under specific legislation, FFB was required to accept the prepayment
    of certain loans at the book value\2 rather than the current Treasury
    market value.  As a result, FFB incurred a cost of about $2
    billion--the difference between the current Treasury market value and
    the book value of the prepaid loans.  The legislation requiring FFB
    to accept certain loan prepayments at book value rather than market
    value did not change the prepayment terms of FFB's loan agreements
    with its borrowers and, consequently, the terms of FFB's borrowing
    agreement with Treasury.  Therefore, FFB remains obligated to
    Treasury for the $2 billion difference between the current Treasury
    market value of the prepaid loans and the prepayment amounts FFB
    received.  This $2 billion cost is currently reported as a deficit in
    FFB's financial statements.

    We previously reviewed the cost of the loan prepayments and, in a
    1989 report, suggested that, when requiring FFB to accept prepayments
    at book value, the Congress consider providing appropriations to the
    affected programming agencies or FFB to cover their cost.\3 We
    observed that if the Congress were to make appropriations to the
    affected program agencies, the costs of the prepayments would be
    reflected in the respective agencies' program budgets.

    However, since our previous report, several significant provisions
    affecting the budget and appropriations process have been enacted.
    In particular, the Budget Enforcement Act of 1990 contains a
    provision placing discretionary spending caps on budget authority,
    allowing little or no growth in nominal dollar spending.  These caps
    will become increasingly binding over the next several years, placing
    severe constraints on future appropriations, requiring consideration
    of other alternatives to eliminate FFB's prepayment liability.

    While FFB has made payments to Treasury against the prepayment
    liability, interest has been accruing on the unpaid balance
    ($2,074,429,000 and $2,062,779,000 at September 30, 1993 and 1992)
    since the prepayment occurred in 1988.  FFB's independent auditors
    indicated that it is unlikely that FFB's net interest income at its
    current rate will be sufficient to liquidate the prepayment
    liability.  Without some mechanism to eliminate its debt, FFB is
    likely to carry its deficit indefinitely.  In addition, Treasury is
    likely to carry its related receivable indefinitely.

    --------------------
    \2 A loan's book value is the unpaid principal balance plus accrued
    interest on the loan.

    \3 Federal Financing Bank:  The Government Incurred a Cost of $2
    Billion on Loan Prepayments (GAO/AFMD-89-59, August 22, 1989).

       FFB MADE FEW IMPROVEMENTS TO
       REPORTED INTERNAL CONTROL
       WEAKNESSES
    ------------------------------------------------------------ Letter :4

    The FFB's independent certified public accountants' (IPA) internal
    control reports stated that while FFB has made some improvements in
    addressing specific internal control weaknesses, material weaknesses
    still exist in FFB's overall internal control structure.  When we
    audited FFB's fiscal year 1988 financial statements, we reported
    material weaknesses in FFB's internal control structure, including
    deficiencies in reconciliations of accounting information and lack of
    maintenance of subsidiary ledgers for loans.  Similarly, from fiscal
    years 1989 through 1992, the IPA who performed the financial
    statement audits reported material weaknesses regarding the inability
    of FFB to maintain subsidiary ledgers.  And the IPA who performed the
    fiscal year 1993 audit again reported problems with reconciliations
    and maintenance of subsidiary ledgers.  The IPA concluded that these
    material weaknesses in FFB's internal controls were caused by the
    lack of an effective core financial accounting system and problems in
    FFB's overall organizational structure.

    FFB has been in the process of implementing a fully integrated
    accounting system for several years.  While the new system is
    operational, the information in this system has not been reconciled
    with information in the existing accounting system.  As a result,
    according to the IPA who performed FFB's 1993 audit, the new system
    is not used as FFB's core accounting system.  Instead, two separate
    accounting systems are maintained by the administrative and credit
    accounting branches of FFB, resulting in duplication of effort in the
    preparation of financial information.  In addition, because of a lack
    of clear accountability within the organizational structure, no steps
    are being taken to reconcile differences between the two systems.

    The IPA recommended that Treasury give one individual the
    responsibility and authority to oversee both the credit accounting
    and administrative side of FFB to resolve the long-standing issues
    related to the new accounting system.  We agree that this approach
    could mitigate some of the complications caused by FFB's fragmented
    structure.  In response to the internal control letter, FFB officials
    indicated that they generally concurred with the IPA's findings.  As
    of September 1, 1994, no corrective action had been taken by Treasury
    or FFB officials.

       IPA OPINIONS ON THE FINANCIAL
       STATEMENTS
    ------------------------------------------------------------ Letter :5

    In the opinion of the IPAs, FFB's financial statements present fairly
    its financial position as of September 30, 1993 and 1992, the results
    of its operations, and the changes in its cash flows for the years
    then ended, in conformity with generally accepted accounting
    principles.  The fiscal year 1993 report included a paragraph
    indicating that FFB will likely require appropriations and/or an
    increased interest rate margin charged to borrowers to finance its
    deficit caused by the waiver of $2 billion in prepayments.

    In the IPA's fiscal year 1993 report on FFB's internal control
    structure, it reported two material weaknesses similar to those that
    other auditors had reported in previous years.  The IPA for fiscal
    year 1993 also noted in its report on FFB's compliance with laws and
    regulations that FFB did not report these material weaknesses in its
    most recent FMFIA report, dated December 22, 1992.\4 Subsequent to
    the date of the IPA's opinion, FFB filed a management report for
    fiscal year 1993 disclosing these internal control weaknesses.

    During our review, we found nothing to indicate that the IPAs'
    opinions on FFB's fiscal years 1993 and 1992 financial statements and
    reports on compliance with laws and regulations and internal controls
    are inappropriate or cannot be relied on.

    During the course of their audits, the IPAs also identified several
    matters that, although not material to the financial statements, were
    communicated for FFB's consideration in a separate management letter.

    We believe that the financial statements, together with the IPAs'
    opinions and our review of that work, provide the Congress with a
    dependable basis for evaluating FFB's financial position.  This
    report presents FFB's financial statements and the auditors' opinions
    thereon.  The independent auditors' reports on FFB's internal
    accounting controls and compliance with laws and regulations are also
    provided.

    --------------------
    \4 In commenting on this report, Treasury stated that FFB, as a
    government corporation and instrumentality of the United States, is
    not, strictly speaking, required to prepare and submit an FMFIA
    report.  However, Treasury did recognize that the Government
    Corporation Control Act, as amended by the Chief Financial Officers
    Act of 1990, requires covered corporations to issue annual management
    reports.  This report includes a statement on internal accounting and
    administrative control systems consistent with the requirements for
    agency statements on such systems under the Federal Managers'
    Financial Integrity Act of 1982.

       RECOMMENDATIONS
    ------------------------------------------------------------ Letter :6

    Because of the long-standing internal control weaknesses reported by
    the IPAs and previously by us, we support the IPA's recommendation
    that the Secretary of the Treasury appoint an individual with the
    responsibility and authority to oversee both the credit accounting
    and administrative functions of FFB.

    Since FFB will not be able to repay its liability to Treasury
    associated with loan prepayments under its current operating
    scenario, Treasury should consider actions to eliminate this
    liability as well as the related account receivable on its books,
    including, if necessary, requesting appropriate legislation.

       AGENCY COMMENTS
    ------------------------------------------------------------ Letter :7

    In its written comments on a draft of this report, the Department of
    the Treasury generally agreed with our recommendations.
    Specifically, Treasury said it will continue to explore means to
    resolve the prepayment liability and is reviewing FFB's current
    structure to determine the most effective means of resolving the
    long-standing internal control issues.  Treasury's written comments
    are included in appendix III.

    ---------------------------------------------------------- Letter :7.1

    We are sending copies of this report to the Chairmen of the Senate
    Committee on Governmental Affairs and the House Government Operations
    Committee, the Director of the Office of Management and Budget, the
    Secretary of the Treasury, and the Board of Directors of the Federal
    Financing Bank.  Copies will also be made available to others upon
    request.

    Please contact me at (202) 512-9406 if you or staff have any
    questions about this report.

    Robert W.  Gramling
    Director, Corporate Financial Audits

    INDEPENDENT AUDITOR'S REPORT FOR
    FISCAL YEAR 1993
    =========================================================== Appendix I

       Auditor's Opinion

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

       Auditor's Report on Internal
       Control Structure

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

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       edition.)

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       edition.)

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       edition.)

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       edition.)

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       edition.)

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       edition.)

       (See figure in printed
       edition.)

       Auditor's Report on Compliance
       With Laws and Regulations

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

       Financial Statements

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

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       edition.)

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       edition.)

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       edition.)

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       edition.)

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       edition.)

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

    INDEPENDENT AUDITOR'S REPORT FOR
    FISCAL YEAR 1992
    ========================================================== Appendix II

       Auditor's Opinion

       (See figure in printed
       edition.)

       Financial Statements

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

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       edition.)

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       edition.)

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       edition.)

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

       Auditor's Report on Internal
       Control Structure

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

       Auditor's Report on Compliance
       With Laws and Regulations

       (See figure in printed
       edition.)

       (See figure in printed
       edition.)

    (See figure in printed edition.)Appendix III
    COMMENTS FROM THE DEPARTMENT OF
    THE TREASURY
    ========================================================== Appendix II

    (See figure in printed edition.)

    The following is GAO's comment on the Department of the Treasury's
    letter dated November 8, 1994.

    GAO COMMENTS

    1.  We have considered Treasury's views and have revised the draft
    accordingly.

    *** End of document. ***