Federal Reserve Banks: Inaccurate Reporting of Currency at the Los
Angeles Branch (Letter Report, 09/30/96, GAO/AIMD-96-146).
The October, November, and December 1995 monthly currency activity
reports of the Los Angeles Federal Reserve Bank were prepared and
reported incorrectly. The reported receipts from currency deposited in
the Los Angeles Bank by depository institutions were not taken from the
Bank's cash inventory records but rather "forced" to ensure that the
currency activity report agreed with the daily balance sheet for the
last day of the month. For example, the December 1995 report had a
forced amount of more than $3.7 billion for receipts from circulation to
ensure that the ending balance for cash on hand would equal $6.7 billion
as reported in the daily balance sheet at the end of December. These
problems in currency reporting are linked to limitations in the design
of the underlying cash inventory system. The Los Angeles Bank's
inability to precisely summarize currency activity from its cash
inventory records raises serious questions about the integrity of its
accounting and internal controls and may signal problems in the other
Federal Reserve Banks that use this same system. Considering the large
sums of cash that the Los Angeles Bank deals with and the problems
identified in GAO's limited audit work, more detailed reviews of the Los
Angeles Bank's operations are warranted.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: AIMD-96-146
TITLE: Federal Reserve Banks: Inaccurate Reporting of Currency at
the Los Angeles Branch
DATE: 09/30/96
SUBJECT: Federal reserve banks
Cash management
Internal controls
Financial management systems
Bank management
Financial records
Accounting procedures
Accounting systems
Bank examination
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Cover
================================================================ COVER
Report to the Ranking Minority Member, Committee on Banking and
Financial Services, House of Representatives
September 1996
FEDERAL RESERVE BANKS - INACCURATE
REPORTING OF CURRENCY AT THE LOS
ANGELES BRANCH
GAO/AIMD-96-146
Federal Reserve Banks
(901713)
Abbreviations
=============================================================== ABBREV
BEP - Bureau of Engraving and Printing
CAS - Cash Automation System
FRAS - Federal Reserve Accounting System
FRB - Federal Reserve Bank
GAAS - generally accepted auditing standards
Letter
=============================================================== LETTER
B-274060
September 30, 1996
The Honorable Henry B. Gonzalez
Ranking Minority Member
Committee on Banking and Financial Services
House of Representatives
Dear Mr. Gonzalez:
This letter responds to your request that we review reports on
currency activities prepared for the Federal Reserve Board of
Governors by the Los Angeles Federal Reserve Bank, a branch bank of
the San Francisco District Bank. You expressed concern that
management at the L.A. Bank had directed staff to report inaccurate
numbers in such reports to ensure that they balanced with other
reports generated from the Bank's accounting data base. You asked us
to (1) determine the nature of problems that may have occurred in
reporting currency activity for Federal Reserve note receipts,
payments, and amount on hand and (2) review and comment on corrective
actions planned or taken by the Federal Reserve to resolve those
problems. We focused on the reports for the months of October
through December 1995 because those had been identified by your staff
and the Federal Reserve as months in which the reports were prepared
incorrectly.
BACKGROUND
------------------------------------------------------------ Letter :1
Each of the 37 banks (12 district and 25 branches) in the Federal
Reserve System prepares monthly currency activity reports, known as
the FR 160 reports. The monthly currency activity reports are
transmitted to the Board of Governors to document movement of
currency through the banks and to summarize the total currency on
hand in the respective banks' vaults. These reports and the
underlying systems that they are generated from constitute the
Federal Reserve's only detailed records of currency transactions
throughout the Federal Reserve System and the respective ending
balances by denomination. Thus, information on monthly currency
movement in and out of Federal Reserve Banks provided to Federal
Reserve management (including the Board of Governors), the Congress,
and other external users of this information would be based on data
from the monthly currency activity reports.
According to the Board of Governors, the uses of this report are
four-fold:
-- "to provide an inventory of collateralized Federal Reserve
notes,
-- to monitor payout patterns,
-- to assess the currency stock needs of the various districts, and
-- to generate a variety of ongoing and ad hoc reports for the
Board, Reserve Banks, other government entities, and the
public."\1
In addition, each Federal Reserve Bank (FRB) prepares a daily balance
sheet (the FR 34 report) that shows all of the assets, liabilities,
and equity for the bank. In particular, the daily balance sheet
shows the balance of currency in the respective bank's vault at the
end of each day. At the end of each month, to ensure agreement, the
reported vault cash balance in the last daily balance sheet of the
month is compared to the ending balance reported in the month-end
currency activity reports.
The L.A. Bank manages over $80 billion a year in currency, second
only to the New York FRB. The L.A. Bank uses an electronic cash
inventory system to manage this currency, but not every FRB uses the
same system or even an electronic one. A Board of Governors official
stated that the Philadelphia and Atlanta Federal Reserve District
Banks, including their respective branch banks, also use the same
cash inventory system as the San Francisco District Bank and its
branches, including the L.A. Bank. The official stated that the New
York and Dallas District Banks have other electronic information
systems to account for their detailed cash transactions. Board
officials also said that systems in the Kansas City, Minneapolis,
Chicago, Cleveland, and Richmond District Banks are housed in a
personal computer-based local area network. The two remaining
district banks, Boston and St. Louis, manually account for these
transactions and inventory of cash on hand.
--------------------
\1 Board of Governors of the Federal Reserve System, Division of
Information Resources Management, Technical Memorandum No. 91,
"Processing Procedures for the CASH Series," November 9, 1994.
OBJECTIVES, SCOPE, AND
METHODOLOGY
------------------------------------------------------------ Letter :2
The objectives of our review at the L.A. Bank were to
-- determine the nature of the problems that may have occurred in
reporting currency activity for Federal Reserve note receipts,
payments, and amount on hand and
-- review and comment on corrective actions planned or taken by the
Federal Reserve to resolve those problems.
We conducted our review in three parts. First, we examined the use
and preparation of the monthly currency activity report. To
accomplish this, we (1) reviewed the L.A. Branch and San Francisco
District Bank's policies and procedures for preparing this report,
(2) met with officials at the Board of Governors and examined
official policies to determine the uses of the report, and (3)
interviewed analysts and managers at the L.A. Bank to determine how
staff were told to prepare the currency activity report and what
controls were in place to ensure that the numbers reported were
accurate.
In the second part of our review--determining the nature of the
reporting problems--we attempted to perform a comprehensive
assessment of the L.A. Bank's accounting practices and internal
controls over currency. However, our efforts were restricted by the
lack of readily available historical data maintained by the L.A.
Bank. For example, L.A. Bank officials stated that they could not
readily provide the detailed general ledger transactions that had
been recorded for the currency in their account. L.A. Bank
officials stated that the information was not stored in a format that
would allow for detailed analysis of transactions and that conversion
to such a format would take a significant amount of time.
For 6 judgmentally selected days in the October through December 1995
period, we attempted to perform limited reviews of the L.A. Bank's
reconciliations. These reconciliations compare the Bank's general
ledger balances (which are used to prepare the daily balance sheet)
to its cash inventory system (which contains the physical inventory
file). However, our efforts to perform limited reviews of these 6
days were hindered because the L.A. Bank could not locate some of
the requested data. For instance, the L.A. Bank could not locate
the report containing the ending balance of the amount of currency in
the vault as reported in its cash inventory system for one of the
days selected in our review. To enhance our understanding of the
Bank's reconciliation process, we also did a walkthrough of 1-day's
reconciliation efforts with bank employees in June 1996.
In addition, for October through December 1995, we examined
transactions in general ledger accounts that were used to account for
reconciling differences found that were either written off or were
temporarily held aside for further research and disposition. We
gathered information on Bank procedures for resolving out-of-balance
situations and differences between amounts reported and actually
received from banks. Because the L.A. Bank could not provide the
general ledger transaction history for its cash accounts, we could
not determine whether the accounts and activity provided to us by the
Bank represented the universe of cash activity. Thus, we only tested
the transactions provided to us. Further, we did not perform a
review of (1) the L.A. Bank's computer security controls for
preventing unauthorized access to its general ledger and cash
inventory system or (2) its physical access controls for ensuring
that the money it manages is protected from theft and
misappropriation.
In the third part of our review, we interviewed Bank officials and
reviewed the new procedures for preparing the currency activity
reports and the revised reports to determine if their efforts to
comply with their policy for preparing these reports were effective
in resolving the problems identified.
We conducted our work at the Federal Reserve Bank in San Francisco
and its branch bank in Los Angeles between June 1996 and August 1996
in accordance with generally accepted government auditing standards.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :3
We found that the October, November, and December 1995 monthly
currency activity reports of the L.A. Bank were prepared and
reported incorrectly. We confirmed that the reported receipts from
currency deposited in the L.A. Bank by depository institutions
(receipts from circulation) were not taken from the L.A. Bank's cash
inventory records (in other words, independently determined) but
rather "forced" to ensure that the currency activity report agreed
with the daily balance sheet for the last day of the month. For
example, the report filed for December 1995 had a forced amount of
$3.771 billion for receipts from circulation to ensure that the
ending balance for cash on hand would equal $6.7 billion as reported
in the daily balance sheet at the end of December. In contrast, when
the L.A. Bank recently attempted to independently determine receipts
from circulation for December 1995 (as it should have done at the
time it prepared the monthly currency activity report), it calculated
this amount at $3.882 billion, a difference of $111 million from the
forced amount on its original monthly currency report for December.
As discussed further on page 10, the $111 million is a net figure and
represents a number of errors that were initially obscured because of
the L.A. Bank's practice of forcing the receipts from circulation in
preparing the monthly currency activity report.
These reports were prepared incorrectly at the direction of the L.A.
Bank's management. L.A. Bank officials stated that the practice of
forcing the reports to agree had been in place for some time. This
practice, however, is not consistent with guidance on preparing the
monthly currency activity report issued by the Board of Governors,
which, in essence, calls for the amounts to be independently
determined and reconciled. This guidance calls for comparing the
calculated ending balance (the beginning balance plus receipts less
expenditures equals the calculated ending balance) on the monthly
currency activity report to the amount in the vault on the last day
of the month, as reported in the daily balance sheet, to ensure that
they agree. These amounts should agree, and, if they do not,
differences that are greater than the allowed $3 million tolerance
for errors, or for amounts less than the tolerance if requested,
should be researched and corrected or explained. The L.A. Bank's
practice of forcing certain amounts made ending cash balances of the
two reports agree when they actually did not.
The L.A. Bank has made efforts to revise the currency activity
reports that were filed incorrectly, back to October 1995. However,
revised reports were not transmitted to the Board of Governors.
According to L.A. Bank officials, the Board requested that they
receive the revised reports all at once and only for those months
that had substantive revisions. Officials stated that the revised
currency activity reports were reconciled to within the net, plus or
minus, $3 million tolerance allowed for in the Board of Governors'
policy. However, the ending balance for the revised currency
activity report and the reported vault cash balance in the daily
balance sheet still do not equal. Thus, one or both of the reports
are incorrect.
We found that the problems in currency reporting are linked to the
limitations in the design of the underlying cash inventory system. A
key limitation is the inability to link the detailed transactions
posted in the stand-alone inventory transaction files to the postings
in the inventory file, which shows cash in the vault by denomination.
Thus, these problems may also have occurred in the San Francisco
District Bank and its other branches and the other two FRB districts
and their related branches that use this system.
The L.A. Bank's inability to precisely summarize currency activity
from its cash inventory records raises serious questions about the
integrity of its accounting and internal controls. A comprehensive
review of these controls and accounting is needed. In addition, the
Federal Reserve Board needs to take appropriate steps to assure
itself that such problems do not exist in the accounting and internal
controls at other FRBs.
CURRENCY ACTIVITY REPORTS WERE
PREPARED AND REPORTED
INCORRECTLY
------------------------------------------------------------ Letter :4
The monthly currency activity reports are required to be prepared in
accordance with guidance in the Board of Governors' Technical
Memorandum No. 91 "Processing Procedures for the CASH Series." This
guidance states that the calculated ending balance in the monthly
currency activity report should be compared to the reported
end-of-the-month balance for cash in the vault on the Bank's daily
balance sheet and that corrective actions should be taken to resolve
any substantial differences. This guidance also underscores that, if
requested, explanations must be provided for any differences (other
than rounding) between the month-end balance sheet amount and the
ending balance on the currency activity report for cash in the vault.
This guidance does not state how the amounts reported in the currency
activity report are to be determined. However, to complete the
report in a meaningful way, each reported amount, except the ending
balance for cash in the vault, which is calculated as noted above,
would need to be independently determined.
Table 1 shows excerpts from the L.A. Bank's spreadsheet used to
prepare the monthly currency activity report for December 1995.\2
Table 2 provides excerpts from the revised spreadsheet on currency
activity for December 1995--the revision was not transmitted to the
Board of Governors. As noted on page 9, inaccuracies in amounts
reported on the monthly currency activity reports for the fourth
quarter of 1995 were discovered during a compliance review. As a
result of this review, the revised spreadsheet was developed by the
L.A. Bank.
Table 1
Excerpt From December 1995 Currency
Activity Spreadsheet as Filed
(Dollars in thousands)
$1 $2 $5 $10 $20 $50 $100 Total
--------------- ------ ------ ------ ------ ------ ------ ------ -------
On hand at the 96,017 4,411 143,12 181,31 3,912, 1,187, 2,719, 8,244,5
beginning of 9 4 998 041 633 43
the month:
Rec from 79,305 349 82,980 95,692 1,751, 321,36 1,440, 3,770,8
circulation 078 4 102 70
Rec from BEP 0 0 0 0 0 0 0 0
Rec from other 35,400 0 0 0 0 0 0 35,400
FR offices
Total currency 210,72 4,760 226,10 277,00 5,664, 1,508, 4,159, 12,050,
available 2 9 6 076 405 735 813
Paid into 91,114 974 94,215 86,174 1,808, 385,43 978,35 3,444,4
circulation 230 5 0 92
during month:
Forwarded for 36,290 311 30,549 28,968 311,17 80,392 1,383, 1,871,3
redemption 0 707 86
Returned to BEP 0 0 0 0 0 0 0 0
Shipped to 0 0 0 0 0 0 0 0
other FR
offices
Total currency 127,40 1,285 124,76 115,14 2,119, 465,82 2,362, 5,315,8
expended 4 3 2 400 7 057 78
On hand at end
of the month:
FR 34 total 83,318 3,475 101,34 161,86 3,544, 1,042, 1,797, 6,734,9
6 4 676 578 678 35
================================================================================
Total 83,318 3,475 101,34 161,86 3,544, 1,042, 1,797, 6,734,9
(calculated) 6 4 676 578 678 35
Difference 0 0 0 0 0 0 0 0
--------------------------------------------------------------------------------
Note: This excerpt only includes most summary items for the L.A.
Bank and excludes items containing zeros.
Legend: Rec stands for received; FR stands for Federal Reserve; and
BEP stands for Bureau of Engraving and Printing.
Table 2
Excerpt From December 1995 Currency
Activity Spreadsheet as Revised
(Dollars in thousands)
$1 $2 $5 $10 $20 $50 $100 Total
--------------- ------ ------ ------ ------ ------ ------ ------ -------
On hand at the 96,017 4,411 143,12 181,31 3,912, 1,187, 2,719, 8,244,5
beginning of 9 4 998 041 633 43
month:
Rec from 76,597 353 83,034 95,942 1,769, 417,06 1,439, 3,882,5
circulation 661 6 923\a 76
Rec from BEP 28,160 0 0 0 0 0 0 28,160
\b
Rec from other 10,000 0 0 0 0 0 0 10,000
FR offices \b
Total currency 210,77 4,764 226,16 277,25 5,682, 1,604, 4,159, 12,165,
available 4 3 6 659 107 556 279
Paid into 91,114 974 94,215 86,174 1,826, 385,43 978,35 3,462,4
circulation 212\c 5 0 74
during month:
Forwarded for 36,290 311 30,549 28,968 311,17 80,392 1,383, 1,871,3
redemption 0 707 86
Returned to BEP 0 0 0 0 0 0 0 0
Shipped to 0 0 0 0 0 96,000 0 96,000
other FR \d
offices
Total currency 127,40 1,285 124,76 115,14 2,137, 561,82 2,362, 5,429,8
expended 4 4 2 382 7 057 60
On hand at end
of the month:
FR 34 total 83,318 3,475 101,34 161,86 3,544, 1,042, 1,797, 6,734,9
6 4 676 578 678 35
================================================================================
Total 83,370 3,479 101,39 162,11 3,545, 1,042, 1,797, 6,735,4
(calculated) 9 4 277 280 499 19
Difference -52 -4 -53 -250 -601 298 179 -484
--------------------------------------------------------------------------------
Note: This excerpt only includes summary items for the L.A. Bank
and excludes most items containing zeros.
\a New calculated amounts for receipts from circulation, instead of
forced amounts on original report.
\b $28,160,000 was misclassified as received from another Federal
Reserve office instead of from the Bureau of Engraving and Printing
(BEP). $2,240,000 in coins were deleted from the currency report but
had been included in the original report. $5,000,000 received from
the Federal Reserve Bank of New York was added, which was missing
from the original report.
$35,400,000 Original amount shown as received from other Federal
Reserve offices
- 28,160,000 Received from BEP
- 2,240,000 Coins which were originally included on the currency
report
+ 5,000,000 Received from Federal Reserve Bank of New York, missing
from original
report
$10,000,000 Amount shown on revised report as received from other
Federal Reserve offices
\c This figure increased by $17,982,000 paid to circulation that were
manually recorded transactions, which were missing from the original
report.
\d $96,000,000 shipped to the Federal Reserve Branch Bank in Seattle,
which was missing from the original report.
Legend: Rec stands for received; FR stands for Federal Reserve; and
BEP stands for Bureau of Engraving and Printing.
As can be seen from comparing the L.A. Bank's spreadsheet for the
filed currency activity report for December 1995 (table 1) to the
revised spreadsheet (table 2), the forced amounts for receipts from
circulation changed after the L.A. Bank conducted a compliance
review and identified inaccuracies. The practice of forcing the
receipts from circulation amount in the monthly currency activity
report, as opposed to independently determining the amount, is not
consistent with the Board of Governors' guidance for validating the
accuracy of the currency activity report. Federal Reserve officials
stated that it is a common practice for FRBs to adjust the receipts
from circulation line to balance the monthly currency activity report
ending total to the balance sheet if it is within the plus or minus
$3 million tolerance established by the Board of Governors. However,
at least for October through December 1995, the L.A. Bank did not
determine that the forced amount was within the $3 million tolerance.
Forcing receipts from circulation allowed errors to occur that were
neither reported nor explained. In fact, this practice obscures any
other differences that might exist between the two reports.
Had these amounts been determined using appropriate procedures, the
ending balance of cash on hand, which is intended to be the
calculated amount in the monthly currency activity report, would have
been at variance with the daily balance sheet. Consequently, the
differences would have been researched and corrected or explained.
L.A. Bank internal correspondence confirmed that the Bank's problems
preparing and reporting the monthly currency activity report were
initially found by an analyst who was responsible for preparing the
report. The analyst stated that queries made from the cash inventory
system to identify receipts from circulation for the report showed
substantial differences from the amount that was forced in the
report. Bank management officials in the L.A. Bank and its San
Francisco district bank confirmed that analysts were instructed to
force the amount in the report for receipts from circulation and that
this practice had been in place for several years.
L.A. Bank officials stated that the discrepancies reported in the
monthly currency activity reports for the fourth quarter of 1995 were
brought to their attention as a result of a planned compliance
review. They stated that through the review, performed under the
direction of Bank management and completed in January 1996, the
compliance analyst discovered and communicated to Bank management
that incorrect amounts appeared to be reported on the monthly
currency activity reports for the fourth quarter of 1995.
As part of this review, the compliance analyst found that the
preparer of the reports had identified discrepancies between the
preparer's efforts to independently calculate receipts from
circulation and the forced amount. Using data obtained through
queries to the cash inventory system combined with manual records,
the compliance analyst initially recalculated the receipts from
circulation. The analyst determined that receipts from circulation
in October should have been $5.8 million more than what was
originally reported; in November, $61.8 million less; and, in
December, $111 million more. In addition to the errors identified
for receipts from circulation, we confirmed that other errors had
been obscured as a result of the L.A. Bank's practice of forcing the
receipts from circulation.
-- The December 1995 currency activity report contained errors in
the aggregate of about $121 million, which resulted in the above
noted $111 million understatement in reported receipts from
circulation. Specifically, it failed to include $96 million
shipped to the branch bank in Seattle because a clerk did not
include the transaction on the manual log used to record
shipments of currency between FRBs. Another $5 million received
from the New York FRB was excluded from the report because it
too was not in the manual log. The report preparer also did not
include most of the manual transactions for the month, which was
about $18 million paid into circulation. Finally, the report
preparer incorrectly included about $2 million in coin receipts
on the currency report.
-- The October 1995 currency activity report had a $2.7 million
error. While preparing the report, the report preparer
mistakenly entered $300,000 for a $3,000,000 amount paid into
circulation. This error resulted in understating the amount of
currency paid into circulation by $2.7 million, which caused the
forced amount received from circulation to be understated.
We verified that the L.A. Bank's subsequent efforts to independently
determine receipts from circulation for October through December 1995
showed that the initially filed reports were incorrect. These
efforts were known by L.A. Bank officials to be incomplete because
they did not account for differences that occur due to the time lag
between receipt and processing of currency. Thus, other errors could
have existed that were not detected. Due to our time constraints and
the resulting limited nature of our work, we did not attempt to
determine what the correct amount should have been or if other errors
were made.
--------------------
\2 Tables 1 and 2 are excerpts from spreadsheets developed by the
L.A. Bank and contain the same information as the currency activity
reports. The actual report could not be duplicated here.
L.A. BANK HAS MADE SOME
PROGRESS BUT STILL FORCES
REPORTS TO BALANCE
------------------------------------------------------------ Letter :5
Officials at the L.A. Bank assumed that the data in their general
ledger as reported on the daily balance sheet were correct and have
therefore focused their efforts on correcting and improving the
preparation of the monthly currency activity reports. Officials said
that their objectives were to (1) eliminate errors, (2) independently
determine the receipts from circulation amount in the currency
activity report, and (3) ensure that the currency activity reports'
ending balances equal the daily balance sheets within the Board of
Governors' policy of plus or minus $3 million. L.A. Bank officials
stated that they were confident that implementation of their new
procedures, as applied in April 1996, would correct the reporting
inaccuracies associated with the receipts from circulation line.
After the compliance review was completed, branch analysts reviewed
several previously issued currency activity reports to identify and
research the causes of errors. In an effort to prevent data entry
errors and help ensure that all data is included in the receipts from
circulation, Bank officials said that they now require supervisory
review before the report is transmitted to the Board of Governors.
In this process, an L.A. Bank officer and supervisor are to review
the reports and the supporting documentation for each line item.
L.A. Bank officials stated that important actions were taken to
revise a series of queries to the cash inventory system in an attempt
to independently determine receipts from circulation. Officials said
that the queries of the cash inventory system are now used to collect
some of the data that were previously collected from manual logs.
For amounts not included in the cash inventory system, the Bank
continues to collect the data manually. In addition, the officials
stated that queries are used to determine differences that can occur
in the Bank's cash inventory system and general ledger due to the
time lag between receipt and processing of money--an important
problem the Bank faced in balancing the currency activity report with
the daily balance sheet that we discuss in more detail on page 15.
The new procedures were used to prepare the April through June 1996
reports. The December 1995 through March 1996 currency activity
reports were revised using the new procedures but have not yet been
submitted to the Board of Governors. According to L.A. Bank
officials, the Board requested that they receive the revised reports
all at once and only for those months that had substantive revisions.
Bank officials stated that they plan to correct other months that
were incorrectly filed back to October 1995 in both the revised
reports and the reports that were prepared using the new procedures.
Even so, the Bank has not precisely summarized currency activity.
The L.A. Bank should have done so using the new procedures because
these procedures state that receipts from circulation should be
independently determined using the same sources that post to the
general ledger. To make the monthly currency activity report balance
with the daily balance sheet, the amount reported as received from
circulation was reduced by $307,600 for January; reduced by $190,600
for February; reduced by $189,000 for March; increased by $2,074,000
for April; increased by $29,000 for May; and increased by $24,000 for
June. Each of these adjustments were within the Bank's $3 million
tolerance for error for months in 1996.\3
According to a Board official, the $3 million tolerance was
established to facilitate timely reporting to the Board of Governors.
Despite the fact that these numbers fall within the Board of
Governors' policy that allows for a $3 million tolerance for error,
the unexplained differences raise the concern that either the queries
to summarize inventory activity are still inaccurate or that there
are more fundamental problems that need to be addressed. Without the
historical general ledger data, we were unable to do the work
necessary to develop an opinion on that matter.
Two other changes have been introduced to improve preparation of
currency activity reports. First, officials said that they plan to
prepare the currency activity reports on a daily and weekly basis so
that if errors are identified, it will be easier to research the
cause of the problem. In addition, officials reported that they plan
to create a new position--reports clerk--to specialize in the
preparation of this and other reports.
--------------------
\3 When the December 1995 report was revised, it was out of balance
by $484,000.
BALANCE SHEET AND CURRENCY
ACTIVITY REPORT ENDING BALANCES
SHARE THE SAME SOURCES AND
SHOULD AGREE
------------------------------------------------------------ Letter :6
The L.A. Bank prepares the monthly currency activity report
primarily using its Cash Automation System files (its cash inventory
system, which provides a perpetual inventory file that tracks
currency by denomination); Integrated Accounting System (its general
ledger); and manual records (for transactions recorded in the general
ledger that are not recorded in the cash inventory system). These
cash inventory and general ledger systems interface in that, for the
most part, detailed transactions are entered into the cash inventory
system and posted to the general ledger. However, they are different
because the general ledger posts at a detailed level but not by
denomination, while the cash inventory system posts to multiple
files, at a summary level, and by denomination. In addition, some
transactions handled by the Bank's cashier--primarily consisting of
currency transactions with government entities and L.A. Bank
staff--are recorded directly into the general ledger and are not
recorded in the cash inventory system.
Generally, the cash inventory system consists of multiple stand-alone
files that record each type of currency transaction. For example,
one stand-alone file for receipts from circulation is called the
detailed deposit file and another stand-alone file to record monies
disbursed or "paid out" from the vault to depository institutions is
called the detailed order file. In addition to these transaction
files, the cash inventory system has a stand-alone perpetual
inventory file that is supposed to track the balance of currency and
coin in the Bank (all money in the Bank is considered for accounting
purposes to be in the vault, even though it may not be physically in
the main vault) by denomination, in total, and by location within the
Bank.
This inventory file also tracks increases and decreases to the vault
inventory but does not link the increases or decreases to the
specific type of transaction that prompted the change. Another key
file in the cash inventory system is the cash file that accumulates
the detailed transactions processed by the cash inventory system for
posting to the general ledger. The accumulated transactions are
uploaded periodically--hourly or daily--at a detailed level into the
general ledger, without distinction by denomination.
The L.A. Bank's inability to precisely summarize the detailed
activity in its cash inventory and manual records, as demonstrated by
the problems found in preparing its currency activity reports, raises
important concerns. First, data for the currency activity report and
the daily balance sheet basically come from the same sources--the
detailed cash inventory records of cash transactions and manual
records. An inability to balance the two reports without forcing the
number for receipts from circulation indicates that there could be
problems with the source data in the cash inventory system or the
summary information reported in the L.A. Bank's daily balance sheet.
ACCOUNTING PRACTICES AND
INTERNAL CONTROLS OVER CURRENCY
------------------------------------------------------------ Letter :7
We attempted to perform a comprehensive review of the L.A. Bank's
internal controls and accounting practices over the money flowing
through the Bank. Our efforts to perform a comprehensive review were
substantially limited by the L.A. Bank's inability to provide the
information needed for the review in a timely manner. While such
data availability constraints prevented an in-depth assessment, we
performed limited procedures and found other potential data integrity
and procedural problems in the L.A. Bank's efforts to account for
and report the money it manages. Based on (1) the size and nature of
the L.A. Bank's operations, which involve managing large sums of
money, (2) its inability to accurately summarize its financial
records, and (3) the problems found from our performance of limited
procedures, we believe a detailed internal control review is needed
in the L.A. Bank to provide independent assurance that these assets
are properly accounted for and controlled.
To perform a comprehensive review of the L.A. Bank's internal
controls and accounting for the money processed through the Bank
would have required us to perform extensive audit procedures. To do
this, we requested that the Bank provide us with (1) the
reconciliations it prepares for its currency accounts and (2) a
general ledger history of all of the activity in its general ledger
cash accounts for October through December 1995.
The L.A. Bank did not provide significant portions of the requested
information, and some of the requested documents were still not
available at the time we completed our review. Bank officials stated
that it would take them over 3 weeks to provide us their general
ledger history of cash transactions. According to these officials,
all of the Bank's historical accounting transaction data are stored
in such a way that makes retrieving and converting the information
into a data format very difficult. Because this information was not
readily available, we had to limit our audit approach.
To perform our review without a general ledger history of cash
transactions is comparable to trying to verify someone's personal
bank account reconciliation without having their checkbook. This
information was needed, in part, because of our concern over the L.A.
Bank's inability to precisely summarize the information in its cash
inventory system and the limitations in the system's design that
preclude readily linking the detailed transactions in its cash
inventory system to the summary postings made to its perpetual
inventory file. L.A. Bank officials stated that the Bank's cash
inventory system, by design, does not identify or retain items that
are grouped together and posted in summary from the cash inventory
system to the inventory file.
This design limitation presents two fundamental problems in
accounting for currency. First, when the general ledger is out of
balance with the cash inventory system, identifying the cause of
differences is more difficult because of the inability to readily
compare the transactions in the cash inventory system to the
transactions in the general ledger. This step would be comparable to
comparing the check and deposit activity, item by item, in a person's
checkbook (the general ledger) to the items shown on their bank
statement (the cash inventory system). Second, the ability to
specifically identify timing differences that occur between the two
systems due to the time lag between the receipt and processing of
money is also made more difficult for the same reason. This second
problem is the main reason that the receipts from circulation amounts
are difficult to determine, and Bank officials stated that this
contributed to amounts being forced instead of being independently
determined from the cash inventory system.
In addition to these limitations, our work, which focused on
identifying the problems of reporting currency activity and
corrective actions taken at the L.A. Bank, did not include two other
critical steps that would be needed to provide a comprehensive
assessment of the Bank's accounting and internal controls over
currency. These steps are a (1) general electronic data processing
review to assess the effectiveness of the computer security controls
over access to the Bank's general ledger and cash inventory systems
to ensure that unauthorized access could not occur and go undetected
or that such a risk is substantially minimized and (2) detailed
review of the effectiveness of the physical safeguarding controls for
controlling unauthorized access to the money.
Despite these limitations, we were able to perform a limited review
of the reconciliations of the L.A. Bank's currency accounts for 6
judgmentally selected days in the October through December 1995
period and a walkthrough with bank employees for 1 day in June 1996
to enhance our understanding of the Bank's reconciliation process.
As part of that review, we reviewed other management reports that
highlighted differences between the data reported in the L.A. Bank's
cash inventory and general ledger systems. Thus, we only reviewed
the propriety of differences that FRB analysts identified when they
performed their reconciliation.
Our efforts focused on assessing the propriety of how differences
identified by the L.A. Bank were resolved and disposed. The
problems identified in our review follow.
-- On November 28, 1995, the L.A. Bank received a deposit of
$432,000 from one depository institution. According to L.A.
Bank officials, the depository institution received credit for
$8,640,000 instead of the actual $432,000. Bank officials
stated that they do not know whether the depository institution
sent the wrong notification amount or whether L.A. Bank staff
used the wrong notification for comparison. The initial L.A.
Bank receiving team that counted the money knew that a
$8,208,000 difference existed, but they overrode the system
control in the cash inventory system and forwarded the money for
further processing. Although this error was corrected when the
problem was detected at the end of the day, this resulted in an
erroneous entry being made into the L.A. Bank's general ledger
for the $8,640,000 that increased the cash in the vault amount
and the depository institution's account. L.A. Bank officials
had no explanation for why this occurred.
This error, however, should have been immediately corrected when the
difference was identified by the L.A. Bank staff verifying the
deposit. This raises concerns about the effectiveness of these
physical controls even though the internal control of performing
reconciliations at the end of the day worked effectively and found
the problem. The internal control to verify the deposit and compare
the amount counted to the amount reported by the depository
institution identified this difference early in the process and
before the wrong amount was recorded in the general ledger. However,
the L.A. Bank staff that performed the count did not notify their
supervisor and the supervisor did not contact the depository
institution at that point. As a result, greater effort was required
at the end of the day to resolve the differences.
-- On October 17, 1995, there was a reconciling item that required
a correction to the general ledger. This correction was made to
increase the general ledger balance by $1,040,000 to make it
agree with the balance of the cash inventory system. The
correction was to record money returned to the vault that had
been ordered by a depository institution but that was not sent
to the institution by the end of the day. This transaction
raises a number of concerns.
The physical movement of individual customer orders for currency
cannot be tracked through the L.A. Bank's cash inventory system
because currency associated with numerous orders is tracked in an
aggregate amount as it leaves the vault and is processed by teams
preparing and shipping orders. For instance, the transfer of funds
to the armored carrier for transport to the banks leaves as an
aggregate carrier shipment amount, not as a series of single order
amounts. As a result, credits and debits to financial institutions
and associated entries to the general ledger are made at the end of
the day, rather than when they leave the bank. When an order is
cancelled, an adjustment must be made to the general ledger. At the
L.A. Bank, certain clerks have the ability to delete transactions
that would post to the general ledger at the end of the day, from the
general ledger, where they will show up as "unposted" transactions.
While the clerks are supposed to send a list of unposted transactions
to the supervisor and attach documentation, such as cancelled
shipping orders, the Bank relies heavily on the clerk to accurately
and completely report these transactions.
While it is not unusual for a depository institution or armored
carrier company to cancel an order, the manner in which these are
corrected raises concerns. These corrections do not require
documented supervisory approval as would other general ledger
adjustments. Instead, through direct intervention on the L.A.
Bank's computer system, certain L.A. Bank staff have the ability to
cause an original transaction posted to the general ledger to
subsequently be deleted. In addition, we could not find evidence
that anyone at the Bank reviewed the general ledger for unposted
transactions. Thus, certain staff could make unauthorized
adjustments that could go undetected.
-- On December 15, 1995, the L. A. Bank experienced an
out-of-balance situation of $120,000 between its cash inventory
system and its general ledger. The problem occurred because the
cash inventory system assigned the same transaction number to
two transactions and would not upload both of these transactions
to the general ledger. As a result, one of the transactions did
not post to the general ledger. A suspense item was created and
the problem was researched.
After researching the item, analysts found that a $120,000 deposit
had been entered into holdover,\4 taken out of holdover, and then
returned to holdover. One Bank official indicated that the
underlying cause of the out-of-balance condition was a systemic
defect in the cash inventory system that assigns the same transaction
numbers to deposits that are placed in holdover twice in the same
hour. Once identified, this problem was resolved. Following
inquiries by our staff, an L.A. Bank official documented and
reported the problem to the FRB in Atlanta, which is responsible for
maintaining the cash inventory system.
These are examples of the problems we found in our review. The fact
that we found problems while only attempting to review the
reconciliations for a few days increases our concerns about the
Bank's accounting practices and internal controls over currency.
--------------------
\4 Holdover includes deposits to the L.A. Bank from financial
institutions that cannot be immediately verified as to the number of
bundles and straps of currency because of processing constraints.
PROBLEMS FOUND DEMONSTRATE NEED
FOR INTERNAL CONTROL REVIEWS
------------------------------------------------------------ Letter :8
The ultimate responsibility for good internal controls rests with
management. Internal controls are an integral part of each system
that management uses to regulate and guide its operations. In this
sense, internal controls are management controls. Good internal
controls are essential to achieving the proper conduct of business
with full accountability for the resources made available. They also
facilitate the achievement of management objectives by serving as
checks and balances against undesired actions. In preventing
negative consequences from occurring, internal controls help achieve
the positive aims of managers.
As discussed previously, our findings concerning the L.A. Bank
demonstrate the need for detailed internal control reviews at the
L.A. Bank. They also raise concerns about the San Francisco
District and its other branches and the other two District banks that
use the same cash inventory system as the L.A. Bank--Philadelphia
and Atlanta--and their respective branches. Further, they may signal
concerns for the remaining banks or banks that use a less
sophisticated system--for example, a Board of Governors official
stated that two FRB banks account for their detailed cash activity
manually.
Our report\5 on our audit of the Federal Reserve Bank of Dallas, its
three branches, and the Federal Reserve Automation Services (FRAS)
identified internal control issues that we considered significant
enough to warrant management's attention. These issues included how
(1) the accounting records of the Dallas FRB and its branches are
reconciled, reviewed, maintained, and reported, (2) accountability
over assets is maintained, and (3) automated systems are utilized by
the Dallas FRB and its branches, many of which are controlled by
FRAS. Our findings were reported to officials of the Dallas FRB\6
and FRAS,\7 as applicable. In these reports, we provided suggestions
for improvements and documented the many corrective actions Dallas
FRB and FRAS officials have taken to date.
In November 1994, the Board of Governors of the Federal Reserve
System contracted for external, independent audits of the combined
financial statements of the FRBs for calendar years 1995 through
1999. During these years, the financial statements of each of the
FRBs will be audited once. In our recently issued reports,\8 we
commended the Board for taking this step and expressed our belief
that instituting regular, external independent audits will help
enhance accountability over the operations of the Federal Reserve
System. Additionally, this step would place the United States on a
par with the practices of other central banks, such as those in
France, Germany, and the United Kingdom. However, these financial
audits will not include an internal control review designed to ensure
that currency entrusted to the Federal Reserve Banks is accurately
accounted for and controlled.
--------------------
\5 Federal Reserve Banks: Internal Control, Accounting, and Auditing
Issues (GAO/AIMD-96-5,
February 9, 1996).
\6 Dallas FRB Internal Controls (GAO/AIMD-96-31R, January 18, 1996).
\7 FRAS General Controls (GAO/AIMD-96-32R, January 18, 1996).
\8 See Federal Reserve System: Current and Future Challenges Require
Systemwide Attention (GAO/GGD-96-128 June 17, 1996) and Federal
Reserve Banks: Internal Control, Accounting, and Auditing Issues
(GAO/AIMD-96-5, February 9, 1996).
CONCLUSIONS
------------------------------------------------------------ Letter :9
The problems identified in this report raise concerns over the
quality of the internal control environment and the accuracy of the
accounting for and controlling of money entrusted to the L.A. Bank
and may signal problems in the other FRB banks that use this same
system. It would be prudent for the Board of Governors to determine
whether or not similar situations exist in the remaining FRBs as
well.
The L.A. Bank has system design problems and procedures that should
be improved to ensure a more accurate accounting of and effective
control over such a liquid asset. Considering the large sums of
money the L.A. Bank is responsible for managing and the problems
identified from the limited audit procedures we performed, more
detailed reviews of the L.A. Bank's operations are warranted.
Detailed internal control reviews would provide independent assurance
that the L.A. Bank has properly accounted for and controlled the
money it manages. In this regard, to assure themselves and the
public they serve about the integrity over accounting for and
controlling the money in their possession, almost every major
financial institution in this country has its internal controls
scrutinized on a regular basis by its internal and external auditors.
Because of the system design problems and lack of discipline we
identified in the cash processing operations of the L.A. Bank, we
are concerned that the San Francisco District Bank and the other
district banks that use the same cash inventory system could be
experiencing similar problems. Such determinations were beyond the
scope of our work. The FRB needs to consider the results of the
detailed internal control reviews we believe are needed at the L.A.
Bank in ensuring that cash operations at other banks are
appropriately accounting for and controlling cash they are managing.
RECOMMENDATIONS
----------------------------------------------------------- Letter :10
We recommend that the Chairman of the Board of Governors of the
Federal Reserve System take the following actions.
-- Require that the management of the Federal Reserve Bank of Los
Angeles, working with its internal auditors, perform an
immediate internal control assessment of its cash operations and
reporting practices, including a review of the underlying
systems. Bank management should prepare a report on the results
of its assessment, including a written assertion on the
effectiveness of its internal controls to ensure that the money
it manages is appropriately accounted for, reported, and
controlled. Also, as a component of the 1996 audit of the
combined financial statements of the Federal Reserve Banks,
require that the independent external auditors examine and
provide an opinion on management's assertion about the
effectiveness of the internal controls over cash operations at
the L.A. Bank.
-- Require that the San Francisco District Bank and the other two
District Banks--Philadelphia and Atlanta--that use the same
systems as the San Francisco Bank and their branches conduct
reviews of their cash inventory systems and reporting practices
to determine whether they have problems similar to those
identified at the L.A. Bank.
-- For the remaining Federal Reserve Banks, consider conducting
internal control assessments to ensure the effectiveness of
internal controls over their cash operations.
-- Taking into account the continuing importance of proper controls
and accountability for currency, consider conducting annual
internal control assessments at all Federal Reserve Banks,
including formal reporting by management and independent
external auditor examination of management's assertion regarding
the effectiveness of internal controls.
-- To strengthen internal controls and provide for more accurate
reporting, re-examine its policy that allows for the currency
activity reports to be prepared within a plus or minus $3
million tolerance for accuracy.
AGENCY COMMENTS AND OUR
EVALUATION
----------------------------------------------------------- Letter :11
In commenting on a draft of this report, the FRB did not dispute our
conclusions that the monthly currency activity reports for October
through December 1995 were prepared incorrectly and that this was
done at the direction of the L.A. Bank's management. The FRB also
did not take issue with the fact that the L.A. Bank's management
practice of forcing the numbers in the report to agree was not
consistent with the Federal Reserve Board's policy guidance on how
the monthly currency activity reports were to be prepared. The FRB
stated that because of the issues raised in our report regarding
accounting procedures at its L.A. Bank and our concerns about the
integrity of financial accounting at the branch and at other FRBs, it
has requested its external auditors to institute a thorough audit of
this area. Also, consistent with our recommendations, the FRB stated
that it will request its external auditors to examine and provide an
opinion regarding the effectiveness of the internal controls over the
cash operations at the Philadelphia and Atlanta Reserve Banks, which
use the same cash inventory system as the L.A. Bank.
We agree with the FRB that such a thorough review is needed. It is
critical that during this review, the FRB's external auditor
comprehensively look at and test the internal controls over the
banks' cash operations. This review should ensure that effective
preventive and detection controls are in place and operating. Such
controls should ensure that approvals, reviews, and other supervisory
actions are properly documented when performed. In addition, this
review should independently assess, including testing where
appropriate, the physical safeguarding and computer security controls
as well as the commitment of the respective bank's management towards
instituting an effective internal control environment that requires
strict adherence to established FRB policies.
The FRB took exception to two major conclusions in our report.
First, it does not believe that there is a linkage between the
preparation of its monthly currency activity reports and its
financial accounting records. It stated that ". . . these reports
are used for informational purposes only and are quite distinct from
the financial accounting records of the bank." In addition, after
noting that we concluded that such a linkage does exist, the FRB
stated that ". . . GAO did not review the accuracy of the Branch's
financial accounting records and provides no substantiation for this
assertion."
We disagree with the FRB's statement that no linkage exists between
the information in the monthly currency activity reports and its
financial accounting records. We found that the cash inventory
records, which make up the FRB's cash inventory system, were used to
prepare the monthly currency activity reports we reviewed. The cash
inventory records were updated with the same information\9 used to
update the L.A. Bank's financial accounting records.
In attachment 2, page 9, of its comments on our report, the FRB
describes this linkage in stating that "the data maintained in CAS
(Cash Automation System), together with certain manual transactions,
are used in three distinct ways: as a record of inventory for
currency and coin (Inventory Files); as financial accounting records
affecting depository institutions; and as a source of statistical
information... (transaction/statistical files)." In its comments,
the FRB refers to CAS as the Bank's cash inventory system and a
source of statistical information. This is consistent with what we
found. The monthly currency activity reports and the L.A. Bank's
financial accounting records are prepared from the same source
information--its cash inventory system--and are thereby linked.
Also, the FRB stated in its comments that daily reconciliations of
its financial records to its cash inventory system are performed.
However, the L.A. Bank was unable to make the two agree on a monthly
basis for the period we reviewed and, therefore, forced the numbers
on its monthly currency activity reports. This calls into question
the effectiveness and/or completeness of the Bank's daily
reconciliation procedures. If daily reconciliations of this
information are performed, the monthly process should require nothing
more than adding the daily activity together.
In an effort to show that its financial accounting records were
correct, the FRB stated that on September 6, 1996, it performed a
100-percent cash inventory count of the L.A. Bank's cash holdings
and concluded that the branch's balance sheet accurately reflected
its currency and cash holdings. The FRB further stated that its
internal financial examiners and internal auditors performed several
internal reviews of its cash operations that determined that its
internal controls were effective. The FRB asserted that these
reviews were done in accordance with generally accepted auditing
standards.
Performing a periodic physical inventory, as the FRB did on September
6, 1996, is a good internal control but doing so and the ensuing
results are not directly relevant to the concerns identified in our
report. A physical inventory count shows what was in the bank the
day the count took place; in this case, almost a year after the
October through December 1995 period covered by our review. Also,
our review did not have as its objective and was not designed to
address whether there were cash shortages at the L.A. Bank. We,
however, identified serious internal control and reporting problems
and the L.A. Bank's inability to precisely account for the currency
flowing through the Bank from month to month.
With respect to the two internal reviews cited by the FRB in its
comment letter, the review reports had not been finalized at the time
of our review and, according to an FRB official, would not be
released in time for this report. As a result, we cannot comment on
the scope, findings, conclusion, nor quality of the work performed by
the FRB's internal examiners and internal auditors for these reports.
Also, the FRB incorrectly asserted that these reviews were done in
accordance with generally accepted auditing standards (GAAS). The
work done does not meet the independence standards of GAAS applicable
to external auditors.\10 Thus, while the financial examiners' and
internal auditors' work may be considered independent for purposes of
reporting to management, it should not be relied upon by external
auditors. Under professional audit standards, we would have to
review the internal financial examiners' and internal auditors' work
in order to comment on their findings, scope of work, or audit
quality.
The second major conclusion the FRB took exception with in commenting
on a draft of this report was our recommendation that the Board
reconsider its policy that allows for a $3 million tolerance for
errors in preparing the monthly currency activity reports. The Board
reiterated its view that the reports are for informational purposes
only and that this level of precision is sufficient for the purposes
that the reports are used. Further, it stated that the cost
associated with achieving such precision far outweighed the benefit
that would be derived from achieving it.
First, for broad informational purposes, such as calculating the
money supply or monitoring payout patterns, the level of precision
afforded by the $3 million tolerance would seem acceptable. We are
not questioning this. Our concern is that the monthly currency
activity reports are prepared from the Federal Reserve's accounting
records, which brings into question the acceptability of any
tolerance level.
Further, in our report, we express our concern over the L.A. Bank's
inability to precisely account for currency activity from its cash
inventory records when it attempted to do so. Even after L. A.
Bank officials spent several months developing procedures to attempt
to accurately account for this information, the inventory records did
not agree with the general ledger. This means that either the L.A.
Bank's new procedures for summarizing the activity in its cash
inventory system were still flawed or that its financial records may
be incorrect. This raises further concerns about the integrity of
the internal control environment. The fact that the FRB asserts that
it performs daily reconciliations of this information and cannot
readily and precisely account for this activity also raises concerns.
We reaffirm our recommendation that because of the linkage to the
accounting records, the Federal Reserve reconsider its $3 million
tolerance for accuracy.
In addition to the two major exceptions it took with our report, the
FRB also asserted that the reviews conducted by its internal
financial examiners and internal auditors concluded that (1) the
reporting errors made by the L.A. branch have not affected the
integrity of the Federal Reserve's financial statements, (2) these
errors have not affected the Federal Reserve's calculation of the
money supply, its conduct of monetary policy, or the amount of
shipments of currency and coin to or from the branch, and (3) no
money has been lost due to these errors, and no key decision-making
has been compromised. These matters were not within the scope of our
review and our report does not make any conclusions about any of
them. As previously stated, the internal reviews cited by the FRB
had not been completed and, therefore, not available for our review.
Instead, our report focuses on the serious internal control problems
found in the L.A. Bank. Notwithstanding our primary focus, we
remain concerned that, until the L.A. Bank can resolve why it cannot
reconcile the activity in its cash inventory records with the general
ledger, it does not know and cannot be certain of the accuracy of its
financial statements nor whether money has been lost.
--------------------
\9 As noted in attachment 2, page 9, of the Federal Reserve's
comments on this report, most of the information that supports the
L.A. Bank's accounting records (general ledger) and its statistical
reports comes from its cash inventory system called the cash
automation system. However, the cash inventory system and the L.A.
Bank's general ledger have to be adjusted for a "very limited number
of transactions" that are not recorded in its cash inventory system,
and thus require manual entries to update both to get a full
accounting of the Bank's cash position.
\10 See Statement on Auditing Standards No. 65 "The Auditor's
Consideration of the Internal Audit Function in an Audit of Financial
Statements."
--------------------------------------------------------- Letter :11.1
We are sending copies of this report to the Chairman of the Board of
Governors of the Federal Reserve System; the Secretary of the
Treasury; the Chairman of the House Committee on Banking and
Financial Services; the Chairman and Ranking Minority Member of the
Senate Committee on Banking, Housing, and Urban Affairs; and the
Director of the Office of Management and Budget. Copies will be made
available to others upon request.
Please contact me at (202) 512-9510 if you or your staff have any
questions. Appendix I contains comments we received from the Federal
Reserve on a draft of this report and our response to those comments.
Major contributors to this report are listed in appendix II.
Sincerely yours,
Gregory M. Holloway
Director, Governmentwide Audits
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COMMENTS FROM THE BOARD OF
GOVERNORS OF THE FEDERAL RESERVE
SYSTEM
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The following are comments on the Board of Governors of the Federal
Reserve System's letter dated September 12, 1996.
GAO COMMENTS
1. As discussed throughout this report and as described in
attachment 2, page 9, second paragraph, of the Federal Reserve's
response to this report, the basis for the information reported in
the monthly currency activity reports and the L.A. Bank's financial
accounting records is the same--its cash inventory system called the
Cash Automation System. Because this information comes from the same
source, it should agree; however, we found that the L.A. Bank could
not make the information agree without forcing numbers.
2. Because the FRB could not provide the detailed general ledger
transactions that had been recorded for the currency in its financial
accounting records, we were unable to determine whether the financial
statements and the related general ledger were accurate. However,
the FRB's inability to reconcile activity in its cash inventory
system with the general ledger without forcing numbers and the
serious internal control problems that we identified in our review
raise questions about whether the cash inventory records, the L.A.
Bank's new procedures for summarizing the information from its cash
inventory records, the general ledger, or all three are incorrect.
Beyond the concerns we raised about the integrity of its accounting
and internal controls, other potential impacts on the FRB of the
errors we identified were beyond the scope of our review. In
particular, without access to the general ledger transactions and
without performing an independent review of physical safeguarding and
computer security controls, we would be unable to determine whether
money was lost or unreasonably exposed to loss due to the problems we
found.
Further, the currency activity reports and the underlying systems
that they are generated from constitute the Federal Reserve's only
detailed records of currency transactions throughout the Federal
Reserve System. Therefore, to the extent that the information on
monthly currency movement in and out of Federal Reserve Banks is
provided to Federal Reserve management, the Congress, and other
external users of this information, it would be based on data from
the currency activity reports. The impact of errors in this
reporting on external users of this information was also beyond the
scope of our review.
3. While periodically performing physical inventory counts of the
L.A. Bank's vault is a good internal control, such a count only
shows that what was physically in the vault that day equalled what
was in its cash inventory and general ledger records the day of the
count--in this instance, September 6, 1996. This does not prove that
the coin and currency that moved through the Bank at all other times
was properly safeguarded and accounted for. Without the ability to
consistently summarize currency activity and effective internal
controls, the physical inventory of the vault, alone, is insufficient
to provide assurances that the FRB is accurately accounting for the
billions of dollars that flow through the Bank each week.
4. In the "Agency Comments and Our Evaluation" section of this
report, we noted that our review identified serious internal control
problems and pointed to the inability of the L.A. Bank to summarize
currency activity on a monthly basis. It is our view that these
issues do, in fact, raise serious concerns about the integrity of its
accounting and internal controls.
Because two other district banks and their branches use the same cash
inventory system and some of the problems in currency reporting are
linked to the limitations in the design of this system, we suggest
that problems may also have occurred in the San Francisco District
Bank and its other branches and the other two districts using the
system. It is worth noting that the gravity of the concerns raised
at the L.A. Bank appear to make it prudent to also investigate
whether there are problems in these other banks.
When we requested their general ledger transactions, we were told by
L.A. Bank officials that to provide it in hard copy would be
impractical, and they strongly discouraged producing the information,
because it would amount to reams of material. When we then requested
the records in electronic format, FRB officials stated that it would
be burdensome and very difficult and that they did not have the staff
to provide it in time for our review. It is for these reasons that
we limited the scope of our review. FRB staff also had difficulty
retrieving information we requested to support the reconciliations
for 2 of the 6 days that we reviewed. L.A. Bank officials have
still not located the report containing the ending balance of the
amount of currency in the vault as reported in its cash inventory
system for one of the days selected in our review, identified earlier
in this report, and certain other information we requested.
5. With respect to the two internal reviews cited by the FRB in its
comment letter, the review reports had not been finalized at the time
of our review and, according to an FRB official, would not be
released in time for this report. As a result, we cannot comment on
the scope, findings, conclusions, nor quality of the work performed
by the FRB's internal examiners and internal auditors related to
these reports. Also, the FRB incorrectly asserted that these reviews
were done in accordance with generally accepted auditing standards
(GAAS). The work done does not meet the independence standards of
GAAS applicable to external auditors.\1 Thus, while the financial
examiners' and internal auditors' work may be considered independent
for purposes of reporting to management, it cannot be relied upon by
external auditors. Under professional audit standards, we would have
to review the internal financial examiners' and internal auditors'
work in order to comment on their findings, scope of work, or audit
quality.
Finally, as noted in attachment 5, third paragraph, of the Federal
Reserve's response to this report, the work performed by the external
auditor was primarily based on representations made by Federal
Reserve officials and observations. The external auditor obtained
the majority of evidential matter used in its review through inquiry
and observation. It did not initiate the formal process of verifying
the various related statements and representations during its limited
review. In addition, as summarized by Federal Reserve officials in
attachment 5, the external auditors informed the Board that "they
identified no factors that would indicate the potential for
inaccuracies or misstatements of the Branch's cash position as
reported in the general ledger or in the balance sheet." They did not
say that "there was no evidence to suggest that statistical errors
affected the official records of the Bank's currency holdings."
Similar to the Board's financial examiner review, the external
auditor's report was not provided as part of the FRB's response nor
was it provided to us during our review. Thus, we cannot
specifically comment on the report's scope, findings, conclusions, or
contextual presentation.
6. See discussion in comment 5 above. The issue of independence
applies to both the San Francisco Reserve Bank's internal auditors
and its financial examiners.
7. See our responses made in the "Agency Comments and Our
Evaluation" section of this report.
8. We did not conduct a comprehensive review of procedures and
controls that are in place to ensure the accuracy of its accounting
records and associated financial statements. In particular, we did
not review the L.A. Bank's computer security controls for preventing
unauthorized access to its general ledger and cash inventory system
or its physical access controls for ensuring that the money it
manages is protected from theft and misappropriation. We agree with
FRB officials that a number of controls are in place. However, we
believe that the errors and internal control problems identified in
this report raise serious questions about the effectiveness of the
controls in place and the need for additional controls to ensure the
accuracy of its accounting and to provide assurance that the money
flowing through the Bank is safeguarded.
9. We agree that staff made a number of errors in preparing the
currency activity reports. We believe that the actions taken to
improve supervisory review and reduce the amount of data that must be
collected from manual logs will likely reduce errors in reporting.
However, we do not agree that all of the errors were due to
procedural errors made by L.A. Bank staff. In fact, the most
troublesome aspect of how the reports were prepared was that Bank
management directed staff to force the number for receipts from
circulation to ensure that the currency activity report agreed with
the daily balance sheet for the last day of the month. This is
troublesome because it showed that the Bank had difficulty
summarizing receipts from circulation independently and it also
obscured other errors in the report.
10. See our responses in the "Agency Comments and Our Evaluation"
section of this report and our responses to comments 4, 5, 6, and 8.
Further, while Bank management ultimately took actions to improve how
the currency activity reports were prepared, it was at their
direction that staff forced the number for receipts from circulation.
Further, we did not find that they were rigorous in their followup of
internal control weaknesses. The particular example cited in the
comments is one that raised our concern. In an interview with FRB
officials, we were told that a processing team intentionally overrode
the physical controls in the cash inventory system and processed a
deposit despite the fact that the amount they counted did not agree
with the amount in the depository institution's deposit notification.
We were not told that they mistakenly credited an institution, as
cited in the comments. In addition, at the time of our interview in
August 1996, Bank officials said that they did not know what caused
the out-of-balance situation that led the team to override the system
in November 1995. It would seem that tracking down the cause of such
a mistake and what impact it may have on other transactions would
have been a top management priority and it was not. Finally, while
we note in the report that the mistake was caught at the end of the
day through the reconciliation, we also state that the difference
should have been identified and corrected immediately when it was
found by staff.
11. See our response to comment 3.
12. See our response to comments 4, 5, 6, 8, and 10.
13. We stated in this report that there was no evidence that
management reviewed or approved the transactions done by unit proof
clerks to delete transactions from the general ledger. Nothing was
provided to us to show otherwise, other than L.A. Bank management
officials asserting that they did it. We reaffirm this finding.
14. See our response to comments 4 and 5.
15. See our response in the "Agency Comments and Our Evaluation"
section of this report and our response to comments 1 and 2.
16. The FRB comment addresses what it states are its new procedures
for preparing the monthly currency activity reports. However, our
report addresses the procedures used to prepare the monthly currency
activity reports for October through December 1995. These amounts
were forced and the L.A. Bank did not perform any reasonableness
check for the receipts from circulation amount to see if it was
within the $3 million tolerance--this is the line item in the report
that was and continues to be used to make the report equal the
general ledger balance. The practice of checking this amount for
reasonableness to verify that it was within the allowed tolerance was
begun as part of new procedures that were implemented in 1996.
--------------------
\1 See Statement on Auditing Standards No. 65, "The Auditor's
Consideration of the Internal Audit Function in an Audit of Financial
Statements."
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II
SAN FRANCISCO REGIONAL OFFICE
Lynne M. Pollock, Assistant Director
Karen L. Seymour, Evaluator in Charge
Julie DeVault, Evaluator
Eugene P. Buchert, Senior Evaluator
LOS ANGELES REGIONAL OFFICE
Jan M. Brock, Senior Auditor
Ted C. Hu, Auditor
Stacey C. Osborn, Auditor
*** End of document. ***