[Final Audit Report on the Working Capital Fund, Bureau of Reclamation]
[From the U.S. Government Printing Office, www.gpo.gov]

Report No. 96-I-644

Title: Final Audit Report on the Working Capital Fund, Bureau of
       Reclamation

Date: March 29, 1996

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To:  The Secretary

From:     Wilma A. Lewis
     Inspector General

Attached for your information is a copy of the subject final audit report.
We concluded that the Bureau of Reclamation had not fully complied with the legislation
that established the Working Capital Fund in that the Fund was not fully recovering its
costs and Fund management had not. established adequate procedures for controlling
operational costs or identifying funds that may be surplus to verifiable Fund needs. In
addition, the Fund's internal control structure did not provide reasonable assurance that
transactions were recorded properly. As a result, depreciation costs of $25.3 million
were not recovered; accrued annual leave of $9.7 million was not funded; and customers
were overcharged $15.6 million for operational expenses. The Bureau concurred with
four of our seven recommendations and has taken action to implement those four
recommendations. However, the Bureau did not concur with our recommendations to
require: (1) Working Capital Fund activities to establish billing rates that will recover full
costs, including depreciation and accrued annual leave; (2) applicable activities of the
Fund to return, to their customers through reduced future billings, the $15.6 million
overrecovery; and (3) funds that were transferred to the Office of Aircraft Services,
Office of the Secretary, to be taken from the Capital Reserves account. We have
requested the Assistant Secretary for Water and Science to reconsider these
recommendations.

If you have questions concerning this matter, please contact me or Ms. Judy Harrison,
Assistant Inspector General for Audits, at (202) 208-5745.

U.S. Department of the Interior
Office of Inspector General

AUDIT REPORT

WORKING CAPITAL FUND,
BUREAU OF RECLAMATION

REPORT NO. 96-I-644
MARCH 1996

C-IN-BOR-O02-95
United States Department of the Interior

OFFICE OF THE INSPECTOR GENERAL
 Washington, D.C. 20240

AUDIT REPORT

Memorandum

Subject: Final Audit Report on the Working Capital Fund, Bureau of Reclamation (No. 96-I-644)
        
INTRODUCTION

This report presents the results of our audit of the Working Capital Fund. The
objective of the audit was to determine whether: (1) the Fund was being operated
in accordance with the United States Code, the Treasury Financial Manual, Office
of Management and Budget Circulars and Bulletins, and Reclamation Instructions;
(2) the Fund was being operated effectively and was fully recovering costs; and (3)
the Fund's internal control structure provided reasonable assurance that transactions
were properly recorded and accounted for to permit the preparation of reliable
financial statements and to maintain accountability over assets.

BACKGROUND

The Bureau's Working Capital Fund was established on December 3, 1985, by Public
Law 99-141 (43 U.S.C. 1472). The objective of the Fund is to finance, in an efficient
manner, support services and equipment for Bureau programs, other Federal entities,
and non-Federal entities. The Fund is an intragovernmental revolving fund and, as
such, is intended to operate entirely within its own resources rather than from an
annual appropriation from the Congress.

Public Law 99-141 requires the Working Capital Fund to fully recover its costs,
including depreciation and accrued annual leave. Furthermore, the Energy and
Water Development Appropriation Bill of 1986 states:

The Committee recommends bill language, the same that was included in
the budget request, to establish a Working Capital Fund in order to help

 
provide for more efficient financing and financial management of certain
activities of the Bureau of Reclamation . . . . The Committee hopes that
establishment of such funds would slightly reduce the annual appropriations
requirement since full costs would be recovered from users. [Emphasis
added.]

Consequently, the Working Capital Fund is required to collect from benefiting
entities the full cost of services provided in order to continue operations without
additional appropriations. The billing rates to benefiting entities are essentially made
up of two components. The first component is made up of operational costs such
as salaries, accrued annual leave, supplies, materials, and overhead. The billing rates
for these charges are generally determined in advance and based on budgets and are
to be adjusted periodically to ensure that customers are not overcharged or
undercharged. Accordingly, any excess funds accumulating as a result of these
charges would be offset in subsequent billing rates. The second component is made
up of charges for depreciation expenses plus an additional amount to compensate for
inflation to replace equipment and other capital assets. The funds resulting from
these charges are set aside in reserve for equipment replacement and other planned
capital improvements and changes. The funds accumulated in this reserve that are
in excess of the planned capital reinvestment purposes are to be identified as surplus
and returned to the U.S. Treasury.

The legislation establishing the Working Capital Fund provides that the Fund will
be available for expenses such as acquisition, replacement, and operation of a central
computer and related automated data processing equipment; engineering services;
payroll and other management services; and acquisition and replacement of
equipment and facilities. The Working Capital Fund is currently composed of 27
activities (see Appendix 2), which provide regional or Bureauwide services such as
finance, accounting, cost recovery, technical support, and equipment. Other activities
can be added or existing activities can be expanded as needed to provide services in
support of the Bureau's mission.

The management and administration of the Working Capital Fund were transferred
in July 1994 from the Bureau's Division of Program Coordination and Budget to the
Denver Service Center's Management Services Office, which is responsible for
establishing the policies and procedures necessary to ensure effective operation of
the Fund.

SCOPE OF AUDIT

Our audit included a review and analysis of financial statements and reports, budgets,
cost recovery rate calculation work sheets, and accounting records pertaining to the
Working Capital Fund for fiscal years 1993 through 1995. We also reviewed
documentation for fiscal years prior to 1993 to compare Working Capital Fund
budgeted costs with actual costs to determine how overrecoveries or underrecoveries
of capital reserves occurred.

 
Our audit was made in accordance with the "Government Auditing Standards," issued
by the Comptroller General of the United States. Accordingly, we included such
tests of records and other auditing procedures that were considered necessary under
the circumstances. The audit was conducted at the Bureau's Management Services
Office and Administrative Service Center in Denver, Colorado, and we contacted the
Bureau's regional offices to obtain documentation and information regarding specific
Working Capital Fund activities. We also reviewed the operating policies and
procedures of the Department of Justice's Working Capital Fund and the U.S. Army
Corps of Engineers Revolving Fund, and we discussed Bureau procedures regarding
cost recovery with officials from the Office of Management and Budget.

In addition, we reviewed the Secretary's Annual Statement and Report to the
President and the Congress for fiscal year 1994, required by the Federal Managers'
Financial Integrity Act of 1982, to determine whether any reported weaknesses were
within the objective and scope of our audit. We determined that none of the
reported weaknesses were directly related to the objective and scope of our audit.

PRIOR AUDIT COVERAGE

Neither the Office of Inspector General nor the General Accounting Office has
issued any audit reports on the Bureau's Working Capital Fund. However, the
Office of Inspector General has issued two audit reports within the past 5 years on
components of the Working Capital Fund as follows:

- Our June 1994 report "Operation of the Federal Financial System, Denver
Administrative Service Center, Bureau of Reclamation" (No. 94-1-609) stated that
users of the Federal Financial System were not being provided specific information
on the costs of the services provided. We found that the Administrative Service
Center had implemented a System Resource Units method to provide its users with
information on costs and system utilization.

- Our October 1994 report "Accounting for Fiscal Year 1993 Reimbursable
Expenditures of Environmental Protection Agency Superfund Money, Bureau of
Reclamation" (No. 94-1-1312) stated that the Bureau should reimburse the Working
Capital Fund for the unallowable expenditures in the indirect cost pool and
recalculate the year-end overrecoveries or underrecoveries. The report also stated
that Bureau management should review, analyze, and recommend improvements to
all rate-setting and cost-allocation procedures to ensure the integrity of the Working
Capital Fund. The Bureau did not agree with the first recommendation. However,
in a subsequent memorandum from the Assistant Secretary for Water and Science
to the Office of Inspector General, the Assistant Secretary agreed that unallowable
expenditures should not be charged to the Working Capital Fund. Consequently, the
Bureau's Finance and Accounting Services issued a directive to all regional
coordinators of the Working Capital Fund that reiterated the requirements to review
rates and expenses transferred through cost allocation to ensure that the expenses
are properly charged to customers.

 
RESULTS OF AUDIT

Based on our audit, we concluded that: (1) the Bureau had not fully complied with
the legislation establishing the Working Capital Fund; (2) the Fund was not being
operated effectively and fully recovering its costs; and (3) the Fund's internal control
structure provided reasonable assurance that transactions were recorded properly,
except for the internal control weaknesses related to the conditions noted and as
discussed below.

The legislation that established the Fund requires the Bureau to recover the cost of
operations, including depreciation and accrued annual leave, and to return any
surplus funds derived from accumulated depreciation charges to the U.S. Treasury.
However, the Bureau did not comply with this requirement in that it did not
adequately monitor and enforce cost recovery. Instead, individual activity managers
developed their own methodologies for establishing billing rates and for using funds.
As a result, depreciation costs of $25.3 million were not recovered; accrued annual
leave of $9.7 million was not funded; and customers were overcharged $15.6 million
for operational expenses. In addition, the Bureau was using funds derived from the
overcharges to subsidize non-Fund-related activities. Furthermore, the Bureau had
not established a multiyear capital reinvestment plan to support the need for the
Fund's reported capital reserve of $69.3 million. Therefore, it was not possible to
determine whether any portion of the capital reserve should have been returned to
the Treasury, as required by law.

Recovery of Depreciation Expenses

We found that activity managers were not consistent in setting billing rates, which
resulted in certain activities not recovering their full cost of the capital investment.
Specifically, some activities did not include or included only a portion of their
depreciation expenses in their billing rates. As a result, we estimated that as of
September 30, 1994, the Fund had not recovered $25.3 million of depreciation
expenses.  The activities with the most significant underrecoveries were the
Administrative Service Center, Computer Aided Design and Drafting, and Drilling
Operations.

Inconsistencies in recovering capital investment costs occurred because the Bureau
had not enforced its policy regarding full cost recovery. Consequently, each activity
established its own policy as the policy benefited the needs of the individual activity.
For example, Administrative Service Center officials stated that the Center did not
fully charge for depreciation because, in their opinion, it did not need to recover its
original capital investment for future use, since the cost of computer equipment was
decreasing and its customers would not agree to the higher rates that would result
from including depreciation costs.

Drilling Operations did not include the full amount of depreciation expenses in its
billing rates. Specifically, 91 percent of its $2.7 million underrecovery of capital

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investment as of September 30, 1994, was accounted for by the following regions: the
Pacific Northwest Region - $664,000; the Lower Colorado Region - $945,000; and the
Great Plains Region - $857,000. Regional Drilling Operations managers said that
they had "unilaterally" decided not to include the full cost of depreciation in their
cost recovery rates because they did not need to recover the full amount of the
Drilling Operations capital investment and because the regions wanted to keep the
rates charged to their customers "competitive." In addition, Drilling Operations had
used its capital reserves to subsidize its operations and maintenance costs in attempts
to keep its rates low. As a result of these actions, additional funding will be needed
to continue activities of Drilling Operations unless cost controls are initiated, rates
are increased, or services are discontinued.

The legislation that established the Fund requires full cost recovery, including
depreciation, and the Bureau's policy also requires the recovery of depreciation.
Accordingly, the Bureau should require each activity to fully recover its depreciation
expense regardless of individual activity needs for the resultant accumulated funds.

Management of Capital Reserves

The Bureau had not developed a budgetary process to determine whether the
Fund's Capital Reserves were needed for replacement of equipment and
enhancement of Fund activities or whether they were surplus and should have been
returned to the Treasury, as required by law. The legislation establishing the Fund
states, "Funds that are not necessary to carry out the activities to be financed by the
fund, as determined by the Secretary, shall be covered into miscellaneous receipts
of the Treasury." We found that the Bureau did not have adequate budgetary
controls, such as a multiyear capital reinvestment plan, that would detail and
compare individual activity reinvestment requirements and overall Fund reinvestment
requirements to available funds.  For example, the Working Capital Fund's
Management Services Office did not approve individual activity fund capital
reinvestment plans and did not incorporate all activity plans into an integrated
overall Fund reinvestment plan. As a result, we could not determine whether any
portion of the reported $69.3 million of Capital Reserves was surplus to verifiable
needs and, as such, should have been returned to the Treasury.

Consequently, the Bureau needs to develop budgetary procedures for its Capital
Reserves in order to meet the overall reinvestment needs of the Fund and to
determine whether funds are surplus. Specifically, each activity should prepare a
multiyear capital reinvestment plan that details the capital reinvestment requirements
of the particular activity as compared with activity funds available. Approval of
individual activity fund plans should be contingent on the incorporation of all plans
into an integrated overall Fund reinvestment plan that would prioritize all
reinvestment needs. Any reserves not needed to meet the purposes of the overall
plan should be declared surplus and returned to the Treasury.

 
Funding Accrued Annual Leave

The Bureau did not include the costs of accrued annual leave in the billing rates for
Fund activities because, according to Fund managers, administration of funded
accrued annual leave would be "difficult" and the current method of funding the costs
of current year leave is sufficient. Currently, annual leave is funded when the leave
is taken instead of when it is earned. However, legislation establishing the Fund
requires cost recovery, and this would require that the annual leave be funded when
it is earned or accrued. Because the costs of accrued annual leave were not included
in the billing rates, the Fund reported $7.8 million of accrued annual leave as
unfunded at September 30, 1994. This balance had increased by $1.9 million, to $9.7
million, as of August 31, 1995. Three activities accounted for $8.5 million, or 87
percent, of the $9.7 million balance.  These activities were the Indirect Cost
Recovery activity -$3.7 million; the Administrative Service Center -$1.3 million; and
the Technical Service Center - $3.5 million. In our opinion, because the Fund is
intended to operate within its own resources, unlike Government-appropriated
activities, the costs of the annual leave should be included in the billing rates when
the leave is earned instead of when it is taken.

Overrecovery of Operational Costs

Some Fund activities were not adjusting their billing rates to compensate for the
overrecovery of costs. The activities based their billing rates on budgeted amounts.
However, when actual costs became known, subsequent rates were not adjusted to
reflect the difference between budgeted and actual amounts. For example, the
Bureau did not adjust the fiscal year 1995 billing rates for 1994 overrecoveries that
totaled approximately $15.6 million. The Indirect Cost Recovery activity accounted
for $6.2 million of the total overrecovery.

The overrecovery occurred because the regions did not have adequate budget
information available to develop their indirect cost rates, did not adequately monitor
the indirect cost rates to ensure that revenues equaled expenses, and did not adjust
indirect cost rates by year-end overrecoveries and underrecoveries. For example, the
Mid-Pacific Region could not provide us with the budget information to support its
indirect cost rate without having to reconstruct it and could not provide us with
budget information to support its area offices' indirect cost rates. The Lower
Colorado Region's indirect cost budget did not provide a breakdown of budgeted
cost components so that budgeted and actual costs by object class category could be
compared. This basic budgetary information was necessary for the Bureau to
monitor the indirect cost rates on a periodic basis to prevent overrecoveries or
underrecoveries. Because there was no comparison of budgeted and actual costs,
activity managers were able to maintain the indirect cost overrecoveries as a reserve
to be used as a "cushion" or as a source of funding.

The regional offices said that revenues for the Indirect Cost Recovery activity,
recovered through an indirect cost charge, were monitored on a monthly basis and

6

 
that indirect cost rates were adjusted to ensure that revenues approximated costs.
However, our testing disclosed that the Indirect Cost Recovery activity was not
adequately monitored and that overrecoveries were not used to reduce billing rates.

The conditions regarding indirect cost controls, budgets, and overrecoveries and
underrecoveries are long-standing. For example, the Bureau's 1991 update to the
1989 report "Total Cost of Doing Business Report" stated to Bureau management
that there were no cost standards or consistencies in the types of costs treated as
indirect; there was a lack of budget information for developing indirect cost rates;
indirect accounts were used as a "convenient means" of distributing costs rather than
costs being distributed based on benefit or equity; indirect costs were considered by
many as a source of funding; "arbitrary assessments" were made to indirect accounts
for the purpose of building reserves or to offset expenses of unrelated activities; and
indirect cost rates were overstated.  The 1991 update recommended the
establishment of "budgets and controls for Reclamation's indirect costs accounts."
The team that developed the report considered this recommendation as one of the
highest priorities assigned for implementation. However, we found that the Bureau
had not taken all the corrective actions needed to resolve the recommendation. We
agree that the Bureau should issue and enforce standardized procedures regarding
the establishment and adjustment of these cost recovery rates.

Overrecoveries Used to Subsidize Other Activities

Surplus funds generated by overcharges to customers were used to fund other
activities, including activities occurring outside the Fund. For example, in fiscal year
1994, the Pacific Northwest Region provided the overrecovery of its Indirect Cost
Recovery activity to the Office of the Secretary's Office of Aircraft Services to
purchase a $1.1 million aircraft. The Region submitted an Office of Management
and Budget Circular A-76 ("Performance of Commercial Activities") review to the
Department and received approval from the Department to purchase the aircraft.
However, in our opinion, the Region's procedure for the purchase was inadequate
because the use of surplus funds from the Indirect Cost Recovery activity removed
the purchase from the budgetary review process of the Office of Management and
Budget and the Congress. Also, the source of funds used to purchase the aircraft
was inconsistent with the Fund's requirements and the overall purpose of the Fund.
Specifically, a capital asset was acquired using operational cost overrecoveries instead
of capital reserves. In addition, the aircraft, which is being leased from the Office
of Aircraft Services, is not being used in support of the Fund's activities that
provided the funding used to purchase it.

Management Actions

The Management Services Office has begun to take action to correct some of the
long-standing deficiencies affecting the Fund. Specifically, Services Office officials
have revised the "Working Capital Fund Guidebook," which provides Fund policies
and procedures to address the accounting for revenues, equipment purchases, and

7

 
capital reserves; budgeting; and the preparation of financial reports. The guidebook
addresses procedures for accounting for inter-Fund loans and repayments,
capitalizing software development, transferring capital assets, and setting rates for
Fund activities. Services Office officials issued the draft guidebook in November
1995 and plan to issue the final guidebook by September 30, 1996. During fiscal year
1995, the Services Office initiated procedures that were incorporated into the revised
guidebook, such as requiring the regions to submit budgets to the Services Office.

We do not believe that the changes to the guidebook, particularly those pertaining
to the preparation, submission, and review of activity budgets, will correct the
deficiencies noted. Specifically, in our opinion, the contemplated budgetary review
process is insufficient to ensure adequate control over the Fund's Capital Reserves.
We believe that Fund management needs to provide more direct control by reviewing
and approving the methods used to recover costs, set billing rates, prepare budgets,
and plan capital reinvestment of the various activity funds to ensure that the overall
goals of the Fund are accomplished, including the identification of any surplus funds
and their subsequent return to the Treasury.

Recommendations

We recommend that the Commissioner, Bureau of Reclamation:

1. Require that Working Capital Fund activities establish billing rates that will
recover full costs, including depreciation and accrued annual leave.

2. Require individual activities of the Working Capital Fund to prepare and
approve multiyear capital investment plans. In addition, an overall Working Capital
Fund multiyear capital investment plan should be prepared that integrates and
prioritizes the investment needs of both the various activities and the overall
Working Capital Fund.

3. Revise Working Capital Fund procedures to ensure that an accurate and
supportable determination can be made as to when the Fund has a surplus and to
ensure that the surplus funds from the reserves are returned to the Treasury.

4. Require the Management Services Office to monitor the financial performance
of the various activities to control and ensure compliance with the requirements
regarding cost recovery, capital investment plans, rate setting, and use of funds that
are overrecovered.

5. Revise the policies and procedures for management of the Fund's indirect
costs to ensure the following:

  - That regions prepare and submit indirect cost budgets for each indirect cost
rate.

 
  - That regions periodically, and not less than annually, monitor indirect cost
revenues and expenditures to ensure that the Indirect Cost Recovery activity does
not have a surplus or a deficit and records no more than a nominal overrecovery or
underrecovery at fiscal year-end.

  - That regions annually adjust billing rates by the amounts of the prior
overrecoveries and underrecoveries.

  - That regional directors review regional indirect cost accounts to ensure that
the regions are not maintaining reserves.

  - That regions are aware that the overrecoveries should not be used for
unbudgeted expenses or to subsidize other activities.

  - That regions include only costs in the Indirect Cost Recovery activity that are
administrative and overhead in nature, that are not incurred in support of specific
activities, and that cannot practically be identified and charged to specific activities.

6. Require the applicable activities of the Fund to return to their customers,
through reduced future billings, the $15.6 million overrecovery.

7. Require that the funds which were transferred to the Office of Aircraft
Services, Office of the Secretary, be taken from the Capital Reserves account.

Bureau of Reclamation Response and Office of Inspector General Reply

In its March 7, 1996, response (Appendix 3) to the draft report, the Bureau of
Reclamation concurred with Recommendations 1, 2, 3, 4, and 5 and did not concur
with Recommendations 6 and 7. Based on the response, Recommendations 2, 3, 4,
and 5 are considered resolved but not implemented. Accordingly, the resolved but
unimplemented recommendations will be referred to the Assistant Secretary for
Policy, Management and Budget for tracking of implementation. Even though the
Bureau concurred with Recommendation 1, this recommendation is considered
unresolved because of the extent to which the Bureau qualified its concurrence.
Therefore, the Bureau is requested to reconsider its response to Recommendation
1 and to Recommendations 6 and 7, which are also unresolved (see Appendix 4).

Recommendation 1. Concurrence.

Bureau Response.  The Bureau stated that it will issue its revised Fund
Guidebook "that will require full cost recovery, including depreciation and accrued
annual leave through the billing rates." The Bureau further stated that "as long as
the decision is properly documented," the full recovery of depreciation can be
foregone when warranted by "economic conditions or technological obsolescence."

9

 
Office of Inspector Reply.  We are not aware of any provision in the Fund
legislation that allows for management discretion regarding full cost recovery.
Accordingly, without a Solicitor's opinion or other statutory authority to support the
Bureau's position that it can ''exercise management discretion" with regard to not
recovering full costs, reconsider the recommendation unresolved and request that
the Bureau reconsider its response.

Recommendation. Nonconcurrence.

Bureau Response. The Bureau disagreed with the recommendation, stating that
it "does not subscribe to the two-component principle" presented in our report or
to the related computations of overrecoveries and underrecoveries. The Bureau
further stated, "In cases where overcharges of all activity costs were made--regardless
of component breakout--and where there is no planned use for these funds to benefit
the customers from which they were obtained, the activity manager will refund these
excesses through reduced rates."

Office of Inspector General Reply. Regardless of whether or not it subscribes to
the two-component principle, the Bureau must set the prices for its goods and
services to recover both capital and operating costs (two-component principle). With
regard to capital costs, the Bureau's annual Fund budget justifications for fiscal years
1988 through 1991 established a clear distinction between operating and capital costs.
Specifically, the Bureau's budget justifications stated, "The fund will accumulate
funds from charges for depreciation to be used for replacement of assets." In our
opinion, the budget justifications clearly indicate that funds (capital reserves) will be
accumulated from depreciation charges and, as such, that the depreciation
component must be readily identifiable. Also, since the legislation establishing the
Fund requires that funds (derived from depreciation charges) not necessary to carry
out the activities of the Fund be returned to the Treasury, the Bureau must use the
two-component principle to readily separate the operating charges from depreciation
charges that might become available to be returned to the Treasury.

With regard to operating costs, the Fund legislation states, "Charges to users will be
at rates approximately equal to the costs." As such, operational costs included in
billing rates should approximate actual costs and be adjusted to ensure that
customers are not overcharged or undercharged. The legislation does not provide
for a "profit" for the Bureau to use at its discretion. In addition, the Energy and
Water Development Appropriation Bill of 1986 states, "The Committee recommends
bill language, . . . to establish a Working Capital Fund . . . This is similar to the
revolving fund of the Corps of Engineers." We compared the Bureau's Fund
procedures with those of the Army Corps of Engineers and found that the Corps
Revolving Fund clearly distinguishes between operating and capital costs.

We also believe that the Bureau, in wanting to use overcharges for operating costs
for whatever purpose it deems necessary, will permit the continuation of "cushions."
We do not believe that this policy is in keeping with either the enabling legislation

10

 
or the overall purpose of the Fund. Accordingly, we request that the Bureau
reconsider its response to the recommendation.

Recommendation 7. Nonconcurrence.

Bureau Response. The Bureau disagreed with the recommendation, stating that
it does not maintain "unique activity accounts to distinguish between capital
equipment used for indirect purposes and other indirect costs incurred." The Bureau
further stated that "little would be accomplished by refunding money to these
customers only to turn around and ask them to fund the airplane purchase."

Office of Inspector General Reply. We concluded that the accounting treatment
used by the Fund for the purchase of the airplane was inconsistent with Fund
accounting principles and the overall purpose of the Fund. Specifically, a capital
asset was acquired using operational cost overrecoveries instead of capital reserves.
Accordingly, implementation of our recommendation will provide for proper
accounting treatment and adjustment to the capital reserve account. Once the
Bureau recognizes the two-component principle for recovering capital and operating
costs, the recommendation can be implemented by an accounting entry to transfer
the airplane purchase costs from the operating costs surplus to the capital reserve
surplus. Thus, the Bureau will not have to recover the funds from its customers
"only to turn around and ask them to fund the airplane purchase." Therefore, we
request that the Bureau reconsider its response to this recommendation.

Additional Comments

Bureau Response. The Bureau disagreed with our conclusion that it had not fully
complied with Working Capital Fund legislation, that it had internal control
weaknesses pertaining to adequately monitoring and enforcing cost recovery, and that
it had not developed budgetary procedures to determine whether the Fund's capital
reserves were needed or whether they were surplus and should have been returned
to the Treasury. The Bureau also disagreed with our computation of lost revenues.
The Bureau stated that it is not convinced that the $9.7 million historical balance for
accrued leave cited in the report is the full responsibility of the Fund because many
employees with significant leave balances transferred into the Fund from other
appropriated activities and thus only a portion of the historical accrued leave balance
will have to be funded by customers of the Fund.

Office of Inspector General Reply. Regarding compliance with Working Capital
Fund legislation, our report stated that the Bureau had not complied with the
legislation because it did not have adequate controls to ensure that costs were fully
recovered and that it had not developed budgetary control procedures to determine
whether capital reserve funds were surplus to verifiable needs. Specifically, we found
that the Bureau relied primarily on its Fund activity managers to carry out policy and
ensure compliance. However, we believe that our report supports the conclusion

11

 
that this strategy did not succeed because of a lack of sufficient controls and
oversight.

We believe that the Bureau's position to allow its Fund activity managers to set and
implement policies is clearly contrary to legislative requirements and Working
Capital Fund polices. We agree that Fund management must have the ability to
control the billing activities of its various activity funds. However, management must
also ensure compliance with the cost recovery requirements. Furthermore, the
Bureau, in order to identify any surplus funds, should be able to identify, at any time,
what its capital reserves are and what they should be and to what purposes those
funds are going to be applied.

The $35 million of lost revenues represents $25.3 million for the underrecovery of
depreciation expenses and $9.7 million for accrued annual leave that the Bureau had
not included in its billing rates to its customers. The $25.3 million underrecovery is
based on methodology provided by the Bureau's prior Working Capital Fund
Coordinator, which we reviewed, tested, and determined to be a sound basis for
computing overrecoveries and underrecoveries. Although the Bureau's Management
Services Office did not agree with this methodology, the Services Office had not
developed an alternative methodology. The $9.7 million of accrued annual leave is
based on amounts from the Bureau's general ledgers. We disagree with the Bureau's
suggestion that the $35 million of undercharges identified in our report as lost
revenues should be offset by the $15.6 million identified in our report as overcharges.
Under the two-component principle, the undercharges were made in the capital costs
component, while the overcharges were made in the operating costs component.
Since these two components must remain separate and distinct, an overrecovery in
one component cannot be used to offset an underrecovery in the other component.

With regard to the Bureau's statement that it is responsible for only a portion of the
historical accrued leave balance because employees with significant leave balances
transferred into the Fund from other appropriated activities, we agree. However, it
should be noted that we obtained the $9.7 million for accrued annual leave from the
Fund's financial statements, where it is recognized as a liability. If the Bureau
believes that the Fund is not responsible for the entire $9.7 million historical amount,
it should take appropriate action to determine the amount for which the Fund is
liable and make the appropriate adjustment to the Fund's financial statements.

In accordance with the Departmental Manual (360DM 5.3), we are requesting a
written response to the report by June 28, 1996. The response should provide the
information requested in Appendix 4.

The legislation, as amended, creating the Office of Inspector General requires
semiannual reporting to the Congress on all audit reports issued, the monetary
impact of audit findings (Appendix 1), actions taken to implement audit

              .
recommendations, and identification of each significant recommendation
corrective action has not been taken.

on which

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                     APPENDIX 1
CLASSIFICATION OF MONETARY AMOUNTS

Finding Area

Underrecovery of Depreciation Expenses
Accrued Annual Leave
   Total

Lost Revenues
(In millions)

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APPENDIX 2
Page 1 of 3

  BUREAU OF RECLAMATION
WORKING CAPITAL FUND ACTIVITIES

               FUND                       FY 1995
               CODE   ACTIVITY DESCRIPTION         BUDGET
Central Computer Site             Provides for the management, operation,    $900,000
                    and maintenance of central computer
                    capability for all Bureau activities.
Indirect Costs           K12     Provides for indirect or overhead costs that    111,235,000
                    cannot be directly charged to a project or
                    beneficiary. Costs are charged through an
                    indirect cost recovery rate applied to each
                    dollar of direct labor. Indirect cost rates are
                    established for each office.
Minicomputer Systems Fund      K13     Provides minicomputer systems for central     3,774,000
                    computer capability to each of the regional
                    offices, as well as Bureauwide.
Transportation Vehicles       K14     Provides transportation of vehicles for use     1,004,000
                    by  the  Denver Office, regional offices, or
                    project personnel.
Capitalized Movable Property     K15     Provides for all movable capitalized property    250,000
                    benefiting more than one project, but
                    excludes property specifically accounted for
                    in other Working Capital Fund activities.
Comprehensive Construction Training  K16     Provides construction training for         10,000
Program                  construction inspectors both in the Bureau
                    and other entities.
Aircraft Operations         K17     Provides for operation and maintenance      1,828,000
                    costs of aircraft used by regional personnel.
Drilling Operations         K18     Provides for costs of drill crews and their     5,644.000
                    drilling equipment that are billed to
                    projects.
Centralized Finance         K19     Provides Bureauwide financial management    6,500,000
                    and accounting services, including finance
                    policy, systems support, fund control, and
                    cost accounting.
Soil and Water Quality Laboratories   K21     Provides for centralized soil and water      1,633,000
                    quality analysis facilities for projects and
                    studies in the regional offices.
Data Communications        K22     Provides for management of Bureauwide     3.712,000
                    data communications network, including
                    installation and maintenance of data
                    communication services used primarily for
                    accessing information resource systems.
Computer Aided Design and Drafting  K23     Provides hardware, software, and technical   4,000,000
                    personnel for Bureauwide computer-aided
                    design capabilities and communications.

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               FUND                       FY 1995
ACTIVITY            CODE   ACTIVITY DESCRIPTION         BUDGET
Cooperative Administrative Support   K24     Provides administrative services for the       155,000
Unit(CASU)-Mid-Pacific Region         Department and other agencies in the
                    Sacramento area.
Denver Office Research and Lab    K25     Provides laboratory services for chemistry,        o
Service                   concrete testing, soils testing, synthetic
                    materials testing, and hydraulics testing.
Engineering Workstation Operations   K26     Provides decision support and advanced      970,000
and Maintenance               computer technology for integrated analysis
                    and graphical display of technical problems
                    in water and power.
Geographic Information System    K27     Provides Geographic Information System      600,000
                    hardware and software designed to collect,
                    manage, and analyze spatially-referenced
                    data.
Hydrographic Survey Equipment    K28     Provides hydrographic surveys of Bureau      30,000
                    reservoirs and rivers to define water storage
                    space available for reservoir management.
Personal Computer Lab       K29     Provides for financial management of the     1,200,000
                    Denver Office PC Lab function.
Training Aid for Dam Safety     K30     Provides self-instructional training program      30,000
                    in various aspects of dam safety.
ADP Software Applications      K31     Provides funding for development and      6,800,000
                    maintenance of approved Bureauwide
                    software applications and information
                    systems.
ADP Capital Investment       K33     Provides central management of Bureauwide    2.609.000
                    capital investments. Also provides
                    centralized source of financing for major
                    information resources.
Bend, Oregon, Construction Office   K35     Provides for distribution of administrative      93,000
                    costs for the Bend, Oregon, Construction
                    Office, which services various construction
                    and operation and maintenance projects and
                    other Governmental agencies.
Pacific Northwest Regional Activity   K36     Provides for the operation, maintenance,      463,000
                    and cost recovery of the Accessibility Data
                    Management System (ADMS). ADMS is a
                    Governmentwide data base for evaluating
                    and tracking the accessibility, mandated by
                    the Rehabilitation Act of 1973, of
                    Government programs, policies, and
                    facilities.

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Page 3 of 3

               FUND                       FY 1995
ACTIVITY            CODE   ACTIVITY DESCRIPTION         BUDGET
Administrative Service Center     K41     Provides services, including computer      31,928,000
                    operations, the Federal Financial System,
                    the Payroll/Personnel System, and the
                    Federal Personnel Payroll Program, to
                    customers within the Department of the
                    Interior, including the Bureau, and to
                    customers outside the Department.
Denver Office Common Supply    K47     Provides for common services such as      7,225,000
Activities                  personnel and facilities management to
                    Denver Office organizations.
Technological Service Center     K88     Provides engineering and technical support    69,423,000
                    to the Bureau's regional and project offices.

Leave Account          K90     Provides for funding of costs of actual leave    52,725,000
                    taken. This fund is credited with a leave
                    additive, which is charged to employees'
                    salaries and expensed when employees take
                    leave.
                    TOTAL FY 1995 BUDGET        $314,741,000

16

 
IN REPLY
REFER TO:
  D-501O
  ADM-8.00

MEMORANDUM

To:    Office of Inspector General
     Attention: Acting Assistant Inspector General for Audits

Subject:  Response to Draft Audit Report on Working Capital Fund, Bureau of
    Reclamation (Report No. C-IN-BOR-002-95)

The Bureau of Reclamation appreciates the opportunity to comment on the subject
report. We are concerned, however, with some aspects of the report that suggest
Reclamation is not taking adequate steps to improve its Working Capital Fund (Fund)
business practices.

Reclamation recognized in its 1989 internal "Total Cost of Business" report the need
for more accurate accounting of indirect costs. In 1992, we issued an internal
management control report in which we documented Fund-related problems and
recommended corrective actions. Since that time, significant progress has been made,
including the assignment of the Fund's administration to the Management Services
Office in Denver, and the issuance of improved policy guidance with the revision of
the Fund's guidebook in 1993. In 1995, before the audit was announced, Reclamation
began to take even more aggressive steps in establishing greater organizational control
over, and introducing more sound business practices to the Fund. We believe these
actions will ensure the Fund's continued viability into the future and establish
confidence that we are complying with all aspects of the law.

The audit report draws a clear distinction between recovering operating and capital
costs. We agree that all costs should be recovered but find no clear guidance that
requires recovery be by component. Some of the Fund activities are a hybrid mixture
of capital and operating services (e.g., the Administrative Service Center (ASC)). We
believe that as long as the total costs of providing the service for each activity are
fully recovered, individual cost components notwithstanding (i.e., equipment, labor,
printing, etc.), the objective and legislative direction of the Fund has been satisfied.
With this in mind, we believe the over-recovery and under-recovery amounts detailed

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2

in the report distort the true financial position of the activities in question. For
example, activities such as the ASC are not only financially solvent but have adequate
fund reserves for capital replacement. Moreover, we question the report's finding that
there was $35 million in "lost revenue." When offset by the $15.6 million of
supposed "overcharges" identified in the report, the characterization of the $35 million
amount as "lost revenues" appears to be misleading. In fact, as detailed below, we not
only question the validity of these amounts, but have fundamental differences as to
what they represent.

The audit report also states that Reclamation has not complied with the legislative
requirement of the Fund to return any surpluses back to the Treasury. We agree that
unneeded Fund surpluses must be returned to the Treasury. The Fund was established
to provide Reclamation-wide flexibility to fund service-type capital purchases and
activities in support of Reclamation's mission. When Reclamation proposed the
language authorizing the Fund, we intended, and believe the legislation supports, that
the Fund as a whole is the ongoing economic entity upon which we must assess
whether a surplus exists. We do not believe that the viability of unique activities,
which were established as an administrative convenience within the Fund, should be
the test of whether a surplus exists for return to the Treasury. We believe that when
one activity ceases to exist or provide benefit, its reserve or unobligated balance
becomes available for Reclamation to use within the Fund for some other authorized
purpose--once again, to fulfill the objective of utilizing cost effective business
practices to accomplish Reclamation's mission.

Since the Fund's inception, Reclamation has been aware of its reserve balance and
made plans for its appropriate use, whether to replace Fund equipment or pursue a
legitimate Fund activity. It is Reclamation's position that there has not been any
surplus available to return to the Treasury (including any portion of the $69.3 million
unobligated reserve as of 1994). In this matter, we believe we have fully complied
with the requirements of the legislation.

The report goes on to identify under-recovery of depreciation as an internal control
issue. We do not agree that this is an internal control issue as much as it is a matter
of management policy. Management discretion is a key factor in making capital
investment decisions based on changing business conditions that result from improved
efficiencies, technological advances, economies-of-scale, and changing economic or
market conditions which, in some cases, may be driven by legislative mandate. For
example, technological advances in the computer and computer-related areas continue
to provide improved productivity, while sometimes rendering existing equipment
technologically obsolete before exhausting its useful life. Also, mandated downsizing,
cuts in Federal programs, and a shrinking customer base require Reclamation to
continuously monitor and evaluate the viability of the services it provides. Investment
write-offs are a necessary outcome of either situation, without which the existing
customers would be unduly penalized. We maintain that in these instances,

18

 
APPENDIX 3
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3



Reclamation must have the ability to exercise management discretion, provided
accountability is well documented, to forego equipment (or software development)
recovery even when doing so may result in temporary losses.

We note that the report also indicates that Reclamation must recover all accrued
annual leave associated with the Fund, including the August 1995 balance of
$9.7 million. Reclamation agrees that current year accrued leave costs in the Fund
must be recovered. We are not convinced, however, that the $9.7 million historical
balance cited in the report is the full responsibility of the Fund. We note that the

organic act permits transfers into the Fund "less any liabilities. " Because many
employees with significant leave balances transferred into the Fund from other
appropriated activities, we believe only a portion of the historical accrued leave
balance will have to be funded by the customers of the Fund.

Reclamation offers the following comments in response to the recommendations
subject audit report.


We recommend that the Commissioner, Bureau of Reclamation:

Recommendation 1

on the

Require that Working Capital Fund activities establish billing rates that will recover
full costs, including depreciation and accrued annual leave.

  Response: Concur. Reclamation will issue its revised Fund Guidebook that
  will require full cost recovery, including depreciation and accrued annual leave
  through the billing rates. We believe management also reserves the right, so
  long as the decision is properly documented, to forego the full recovery of
  depreciation when economic conditions or technological obsolescence warrant
  such action.

  The responsible official is the Leader, Finance and Accounting Services. The
  target date for issuing the revised Fund Guidebook is September 30, 1996.

Recommendation 2

Require individual activities of the Working Capital Fund to prepare and approve
multi-year capital investment plans. In addition, an overall Working Capital Fund
multi-year capital investment plan should be prepared that integrates and prioritizes the
investment needs of both the various activities and the overall Working Capital Fund.

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4

Response: Concur. Since the Fund's inception, planned capital equipment
purchases have been identified in annual budget submissions to Reclamation's
Washington Office. Plans will be provided and summarized consistent with the
Fund's customer base.

The responsible officials for preparing multi-year capital investment plans are
the Fund activity managers, while the responsible official for summarizing the
Reclamation-wide data is the Leader, Finance and Accounting Services. The
target date for summarizing capital investment plans is September 30, 1996.

Recommendation 3

Revise Working Capital Fund procedures to ensure that an accurate and supportable
determination can be made as to when the Fund has a surplus and to ensure that the
surplus funds from the reserves are returned to the Treasury.

Response: Concur. This will be accomplished through the revised Fund
Guidebook.

The responsible official is the Leader, Finance and Accounting Services . The
target date for issuing the revised Fund Guidebook is September 30, 1996.

Recommendation 4

Require the Management Services Office to monitor the financial performance of the
various activities to control and ensure compliance with the requirements regarding
cost recovery, capital investment plans, rate setting, and the use of funds that are over-
recovered.

Response: Complied. The Management Services Office will monitor activities
and performance of the Fund, as well as exchange information with Fund
activity managers, to enable them to assert necessary controls over local
activities and ensure compliance with Reclamation-wide Fund policies.
Reclamation believes that the revised Fund Guidebook with its reporting and
documentation requirements, a more engaged central management of the Fund,
and an improved understanding of both the operational and management
requirements of the activities will implement the objective of this
recommendation.

Recommendation 5

Revise the policies and procedures for management of the Fund's indirect costs to
ensure the following:

20

 


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5

- That regions prepare and submit indirect cost budgets for each indirect cost
rate.

- That regions periodically, and not less than annually, monitor indirect cost
revenues and expenditures to ensure that the Indirect Cost Recovery activity
does not have a surplus or a deficit and records no more than a nominal over-
recovery or under-recovery at fiscal year-end.

- That regions annually adjust billing rates by the amounts of the prior over-
recoveries and under-recoveries.

- That regional directors review regional indirect costs accounts to ensure that
the regions are not maintaining reserves.

- That regions are aware that over-recoveries should not be used for
unbudgeted expenses or to subsidize other activities.

- That regions include only costs in the Indirect Cost Recovery activity that are
administrative and overhead in nature, that are not incurred in support of
specific activities. and cannot practically be identified and charged to specific
activities.

Response: Concur. This will be accomplished through the revised Fund
Guidebook.

The responsible official is the Leader, Finance and Accounting Services . The
target date for issuing the revised Fund Guidebook is September 30, 1996.

Recommendation 6

Require the applicable activities of the Fund to return to their customers, through
reduced future billings, the $15.6 million over-recovery.

Response: Non-concur. As indicated above, Reclamation does not subscribe to
the two-component principle espoused in the audit report nor the related over-
and under-recovery computations. In cases where overcharges of all activity
costs were made--regardless of component breakout--and where there is no
planned use for these funds to benefit the customers from which they were
obtained, the activity manager will refund these excesses through reduced rates.

21

 


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6

Recommendation 7

Require the funds that were transferred to the Office of Aircraft Services, Office of the
Secretary, be taken from the Capital Reserves account.

Response: Non-concur. Reclamation's Pacific Northwest Region does not
maintain unique activity accounts to distinguish between capital equipment
used for indirect purposes and other indirect costs incurred. The airplane
purchase was made from depreciation reserves generated from other indirect
equipment and refunds received from vendors who supply the indirect cost
activity. This funding pool was not generated from intentional surcharge
assessments. The decision to use these funds for the plane's acquisition was
predicated on the customer base being the same as the indirect cost account
customers, and that these customers benefit from the plane's use in the same
proportion as customers of other indirect services in the region. Reclamation
believes little would be accomplished by refunding money to these customers
only to turn around and ask them to fund the airplane purchase.

We welcome the opportunity to discuss our response with you if necessary. If you
have any questions or require additional information, please contact Luis Maez at
(303) 236-3289, extension 245.

cc:  Assistant Secretary - Water and Science, Attention: Margaret Carpenter
  Office of Financial Management, Attention: Wayne Howard

22

 
APPENDIX 4

STATUS OF AUDIT REPORT RECOMMENDATIONS

Finding/Recommendation
    Reference          Status         Action Required

2, 3, 4, and 5     Resolved; not  No further response to the Office of
          implemented.   Inspector General is required. The
                       recommendations will be referred to
                 the Assistant Secretary for Policy,
                  Management  and Budget for
                 tracking of implementation.

1, 6, and 7

Unresolved.    Reconsider each recommendation,
        and provide action plans that include
        target dates and titles of officials
       responsible for implementation.

23

 
ILLEGAL OR WASTEFUL ACTIVITIES
  SHOULD BE REPORTED TO
THE OFFICE OF INSPECTOR GENERAL BY:

Sending written documents to:           calling:

     Within the Continental United States

U.S. Department of the Interior        Our 24-hour
Office of Inspector General          Telephone HOTLINE
1550 Wilson Boulevard            1-800-424-5081 or
Suite 402                (703) 235-9399
Arlington, Virginia 22210
                TDD for hearing impaired
                   (703) 235-9403 or
                   1-800-354-0996

     Outside the Continental United States

         Caribbean Region
U.S. Department of the Interior
Office of Inspector General
Eastern Division - Investigations
1550 Wilson Boulevard
Suite 410
Arlington, Virginia 22209

         North Pacific Region
U.S. Department of the Interior
Office of Inspector General
North Pacific Region
238 Archbishop F.C. FIores Street
Suite 807, PDN Building
Agana, Guam 96910

(703) 235-9221

(700) 550-7279 or
COMM 9-011-671-472-7279