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Accountability Problems over Compact Funds' which was released on 
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Report to Congressional Requesters:

October 2003:

COMPACT OF FREE ASSOCIATION:

Single Audits Demonstrate Accountability Problems over Compact Funds:

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-7] GAO-04-7:

GAO Highlights:

Highlights of GAO-04-7, a report to congressional requesters

Why GAO Did This Study:

In 1986, the United States entered into a Compact of Free Association 
(Compact) that provided about $2.1 billion in U.S. assistance from 
1987 through 2003 to the Pacific Island nations of the Federated 
States of Micronesia (FSM) and the Republic of the Marshall Islands 
(RMI). GAO has issued a number of reports raising concerns about the 
effectiveness of this assistance. GAO was asked to review possible FSM 
and RMI misuse of Compact funds. We reviewed single audits for 1996 
through 2000 and this report summarizes the audit results. 

What GAO Found:

GAO’s review of 30 single audit reports for the FSM, 4 FSM states, and 
the RMI for the years 1996 through 2000 identified pervasive and 
persistent noncompliance with Compact requirements and financial 
statement-related audit findings. These single audit reports 
identified 458 audit findings relevant to the Compact. Significant 
numbers of these audit findings occurred during each year of the 5-
year period and at each of the auditees. In addition, successive 
single audits identified recurring audit findings over the 5-year 
period despite corrective action plans prepared by the auditees. While 
none of the audit findings specifically discussed misuse of Compact 
funds, they did describe noncompliance with Compact requirements and 
financial management problems in areas that GAO considers highly 
susceptible to misuse, such as poor control over cash and equipment. 
When considered in conjunction with the qualified opinions or 
disclaimers of opinion on the financial statements in all 30 reports 
and for 60 percent of the Schedules of Expenditure of Federal Awards 
required by the Single Audit Act, the audit findings reveal one thing: 
overall poor accountability of Compact funds. 

In responding to GAO’s previous reviews of the original Compact, 
Interior officials expressed concerns about the U.S. gGovernment’s 
limited ability to enforce accountability over Compact funds due to 
certain provisions of the Compact and the related fiscal procedures 
agreement (FPA). Recently, an Interior official noted that 
departmental officials have been frustrated with the lack of tools to 
administer or track federal assistance in a manner that could 
reasonably ensure that such assistance is having its intended effect. 
GAO found that the amended Compacts and related FPAs, which are 
scheduled to become effective upon legislative approval in the three 
countries, include many strengthened reporting and monitoring measures 
that could improve accountability, if diligently implemented. For 
example, funds could be withheld for noncompliance with Compact terms 
and conditions. In addition, joint economic management committees and 
an Interior oversight team will focus on monitoring and overseeing 
Compact funds.

What GAO Recommends:

GAO recommends that the Secretary of the Interior delegate 
responsibility to and hold the Office of Insular Affairs accountable 
responsiblefor monitoring and reporting on FSM and RMI actions to 
address Compact-related single audit findings and initiating 
appropriate actions , such as withholding U.S. assistance when the FSM 
FMI or the RMI FSM do not implement appropriate and adequate actions 
to correct Compact-related single audit findings in a timely manner.

In commenting on this report, the Office of Insular Affairs of the 
Department of the Interior, FSM, and RMI agreed with our findings or 
conclusions and recommendations. They also cited the amended Compacts 
as mechanisms that should result in improved financial management over 
Compact assistance. 

www.gao.gov/cgi-bin/getrpt?GAO-04-7.

To view the full product, including the scope and methodology, click 
on the link above. For more information, contact McCoy Williams at 
(202) 512-6906 or williamsm1@gao.gov or Susan Westin at (202) 512-4128 
or westins@gao.gov.

[End of section]

Contents:

Letter: 

Results in Brief: 

Background: 

Objectives, Scope, and Methodology: 

Pervasive Audit Findings Demonstrate Poor Accountability over Compact 
Funds: 

Amended Compact Agreements Contain Improved Accountability Measures: 

Conclusions: 

Recommendations for Executive Action: 

Government and Agency Comments and Our Evaluation: 

Appendixes:

Appendix I: Comments from the Federated States of Micronesia: 

Appendix II: Comments from the Republic of the Marshall Islands: 

Appendix III: Comments from the Department of the Interior: 

Appendix IV: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Acknowledgments: 

Figures: 

Figure 1: Number of Audit Findings Reported Annually from 1996 through 
2000: 

Figure 2: Auditee Findings as a Percentage of Total Findings: 

Figure 3: Percentage of Corrective Action Plans Developed for Audit 
Findings: 

Figure 4: Percentage of 1996 through 2000 Single Audit Findings That 
Recurred 3 or More Years: 

Abbreviations: 

CAP: corrective action plan:

FPA: fiscal procedures agreement:

FSM: Federated States of Micronesia:

OMB: Office of Management and Budget:

RMI: Republic of the Marshall Islands:

U.N.: United Nations:

Letter October 7, 2003:

The Honorable Tom Lantos: 
Ranking Minority Member: 
Committee on International Relations: 
House of Representatives:

The Honorable James A. Leach: 
Chairman: 
The Honorable Eni Faleomaveaga: 
Ranking Minority Member: 
Subcommittee on Asia and the Pacific: 
Committee on International Relations: 
House of Representatives:

The Honorable Doug Bereuter: 
House of Representatives:

In 1986, the United States entered into a Compact of Free Association 
(Compact) with the Pacific Island nations of the Federated States of 
Micronesia (FSM) and the Republic of the Marshall Islands (RMI). 
Through the Compact, the United States has provided about $2.1 billion 
in assistance to these nations in the form of direct funding and 
federal services and programs. Further, the Compact established U.S. 
defense rights and obligations in the region and allowed for migration 
from both nations to the United States. The Compact provisions that 
address economic assistance were scheduled to expire in 2001; however, 
they remained in effect while the United States negotiated amended 
Compacts with each nation.

Over the last several years, we issued reports that raised concerns 
about the effectiveness of the FSM and the RMI use of and 
accountability over U.S. assistance provided under the 
Compact.[Footnote 1] In commenting on the accountability issues raised 
in our 2000 report, officials at the Department of the Interior, the 
agency responsible for overseeing the assistance program, pointed out 
the limited ability of the United States to enforce accountability over 
Compact funds because basic elements of federal grant management were 
lacking. They also noted that additional personnel and funding could 
have been committed to Compact oversight, but the United States would 
still have had almost no ability to influence fiscal decisions made by 
the FSM and the RMI. In recent testimony, an official from the Office 
of Insular Affairs, Department of the Interior, noted that the 
department was hampered by the fact that the Compact provided for 
large, loosely defined grants with no express enforcement mechanisms to 
ensure the efficient and effective expenditure of funds. This official 
also stated that departmental officials "have been greatly frustrated 
with the lack of tools to properly administer or track Federal 
assistance in a manner that could reasonably ensure that such 
assistance is having its intended effect."[Footnote 2]

In conjunction with our monitoring and reporting on Compact 
renegotiation efforts, you asked us to review possible FSM or RMI 
misuse of Compact funds. The annual single audits of the FSM and the 
RMI, which are required by the fiscal procedures agreement (FPA) for 
implementing the Compact, are a potential source of this 
information.[Footnote 3] While the single audit reports do not 
specifically use the phrase "misuse of Compact funds," many of the 
problems they identify are in areas that are susceptible to the misuse 
of funds.

We obtained the 30 single audit reports for the years 1996 through 2000 
for the national government of the FSM; the FSM state governments of 
Chuuk, Kosrae, Pohnpei, and Yap; and the national government of the 
RMI. We reviewed and summarized the audit findings contained in these 
reports, the most recently completed reports available at the start of 
our review, to identify instances of possible misuse of Compact funds. 
On February 12, March 12, and March 13, 2003, we briefed your staffs on 
our results. This report summarizes our briefing results regarding the 
single audit reports. In addition, it provides information on the 
enhanced accountability measures that are built into the amended or 
renegotiated Compacts. The amended Compacts[Footnote 4] and related 
FPAs, which are scheduled to become effective upon legislative approval 
in the United States, the FSM, and the RMI, include many strengthened 
reporting and monitoring measures that could improve accountability, if 
diligently implemented.[Footnote 5] (Further details on our scope and 
methodology are provided later in this report.):

Results in Brief:

Single audits are intended to promote sound financial management, 
including effective internal control over federal awards. Our review of 
30 single audit reports for the FSM, the four FSM states, and the RMI 
for the years 1996 through 2000 identified pervasive and persistent 
compliance-and financial statement-related audit findings. More 
specifically, the audit reports contained about 90 audit findings for 
each year of the 5-year period that we reviewed and a significant 
number of audit findings for each of the auditees. In total, they 
contained 458 audit findings. Further, these reports showed recurring 
audit findings over the 5-year period despite the fact that the 
corrective action plans prepared by the FSM, the four FSM states, and 
the RMI indicated more timely completion of actions to address these 
findings.

None of the audit report discussions of the 458 audit findings 
specifically cited misuse of Compact funds. However, they did discuss 
noncompliance with Compact requirements and financial management 
problems in areas that we consider highly susceptible to such misuse. 
For example, one finding noted that differences between the cash 
balance shown in the entity's financial records and the bank records 
amounted to over $150,000. Further, the independent auditors issued 
qualified opinions or disclaimers of opinion on the entitywide 
financial statements in all 30 reports and for about 60 percent of the 
Schedules of Expenditures of Federal Awards required by the Single 
Audit Act.[Footnote 6] These opinions were frequently issued because 
the audited entity did not provide the auditor with all required 
financial reports and/or other financial records. Taken together, the 
audit findings of and the financial statement opinions rendered by the 
auditors demonstrate that the FSM, the 4 FSM states, and the RMI did 
not provide reasonable accountability over Compact funds and assurance 
that these funds were used as intended.

The amended Compacts and related FPAs, which are scheduled to become 
effective upon legislative approval in all three countries, include 
many accountability provisions that would strengthen reporting and 
monitoring, if diligently implemented. If so implemented, they would 
address most of the recommendations that we made in past reports 
regarding assistance accountability, fiscal control and accounting 
procedures, and standards for financial management systems. For 
example, under the amended Compacts, the annual reporting and 
consultation requirements would be expanded; funds could be withheld 
for noncompliance with Compact terms and conditions; and the FPAs call 
for the establishment of a joint economic management committee for each 
nation. These committees will consist of three members appointed by the 
United States, including the chairman, and two members appointed by FSM 
or RMI and will have significant oversight and monitoring 
responsibilities. In addition, Interior officials have stated that they 
are in the process of assembling a Compact oversight team of full-time 
employees that will focus exclusively on monitoring and oversight of 
Compact financial assistance. The successful implementation of these 
strengthened reporting and monitoring measures will require a sustained 
commitment and appropriate resources from the United States, the FSM 
and the RMI.

To help promote compliance with Compact requirements and sound 
financial management, we are recommending that the Secretary of the 
Interior delegate this responsibility to the Office of Insular Affairs 
and hold appropriate officials in that office accountable for (1) 
ensuring the adequacy of staff dedicated to Compact oversight and 
monitoring activities, (2) monitoring FSM and RMI progress in 
correcting Compact-related single audit report findings, (3) reporting 
on the FSM and the RMI actions to address Compact-related compliance 
and financial statement findings identified in single audit reports to 
the Secretary of the Interior or other appropriate high-level Interior 
official, (4) initiating appropriate actions if the FSM or the RMI do 
not implement timely and adequate actions to correct Compact-related 
single audit findings, and (5) investigating single audit findings that 
indicate possible violations of grant conditions or misuse of funds and 
taking appropriate actions when such problems are verified.

The Department of the Interior and the RMI concurred with the findings 
cited. The FSM noted that the report was constructive and useful as it 
continues to prepare for the implementation of the amended Compact and 
its related agreements. The FSM and RMI also provided technical 
comments and other information on current actions to address the 
financial management issues that the report raised.

Background:

In 1947, the United Nations (U.N.) created the Trust Territory of the 
Pacific Islands. The United States entered into a trusteeship with the 
U.N. Security Council and became the administering authority of the 
current islands of the FSM and the RMI. The United States administered 
the islands under this trusteeship until 1986, when it entered into a 
Compact of Free Association with the FSM and the RMI, both of which are 
located in the Pacific Ocean.

The original Compact represented both a continuation of U.S. rights and 
obligations first embodied in the U.N. trusteeship agreement and a new 
phase in the unique and special relationship that had existed between 
the United States and these island nations. It also provided a 
framework for the United States to work toward achieving its three main 
goals of (1) securing self-government for the FSM and the RMI,[Footnote 
7] (2) assisting the FSM and the RMI in their efforts to advance 
economic development and self-sufficiency, and (3) ensuring certain 
national security rights for all of the parties.

The Department of the Interior's Office of Insular Affairs was 
responsible for disbursing and monitoring Compact funds. For the 15-
year period from 1987 through 2001, it provided funding at levels that 
decreased every 5 years. For 2002 and 2003, while negotiations to renew 
the expiring Compact provisions were ongoing, funding levels increased 
to equal an average of the funding provided during the previous 15 
years. For 1987 through 2003, total U.S. assistance to the FSM and the 
RMI to support economic development is estimated, based on Interior 
data, to be about $2.1 billion.

In addition, the Compact identified several services that U.S. agencies 
would supply to the FSM and the RMI and further stated that these 
agencies could provide direct program assistance as authorized by the 
Congress. This assistance included grants, loans, and technical 
assistance that, for fiscal years 1987 through 2001, totaled about $700 
million from 19 U.S. agencies. The Department of the Interior was 
responsible for supervising, coordinating, and monitoring program 
assistance, while the Department of State was responsible for directing 
and coordinating all U.S. government employees in foreign countries, 
except those under the command of U.S. area military commanders.

In 2000, we reported that one tool that should be used for ensuring 
accountability over Compact assistance was the annual audits required 
by the Compact. FPAs for implementing the Compact required that 
financial and compliance audits be conducted in accordance with the 
provisions of the Single Audit Act.[Footnote 8] This act is intended 
to, among other things, promote sound financial management, including 
effective internal controls, with respect to the use of federal awards. 
Entities that expend $300,000 or more in federal awards in a year are 
required to comply with act's requirements. Further, the act requires 
entities to (1) maintain internal control over federal programs, (2) 
comply with laws, regulations, and the provisions of contracts or grant 
agreements, (3) prepare appropriate financial statements, including a 
Schedule of Expenditures of Federal Awards, (4) ensure that the 
required audits are properly performed and submitted when due, and (5) 
follow up and take corrective actions on audit findings. Deloitte 
Touche Tohmatsu, an independent public accounting firm, conducted the 
30 single audits that we reviewed for the FSM; the 4 FSM states of 
Chuuk, Kosrae, Pohnpei, and Yap; and the RMI.

Objectives, Scope, and Methodology:

Our objective was to review possible FSM and RMI misuse of Compact 
funds. One source of this type of information is the annual single 
audits that the fiscal procedures agreement for the implementation of 
the Compact requires the FSM and the RMI to obtain.

We obtained the single audit reports for the years 1996 through 2000, 
the most recent single audit reports available at the time of our 
review, for the national government of the FSM; the FSM state 
governments of Chuuk, Kosrae, Pohnpei and Yap; and the national 
government of the RMI. In total, this amounted to 30 single audit 
reports representing 5 years, a period that we considered sufficient 
for identifying misuse of funds and common or persistent compliance and 
financial management problems involving Compact funds. While these 
reports did not specifically identify any findings as instances of 
misuse of Compact funds, they did identify problems that could leave 
Compact funds susceptible to misuse, including poor control over cash 
and equipment.

We reviewed each report to identify and categorize the audit findings 
relevant to the Compact, paying particular attention to those involving 
assets or other financial accounts (i.e., cash and equipment) that we 
considered particularly susceptible to misuse. (We did not 
independently assess the quality of these audits or the reliability of 
the audit finding information. However, based on the fact that the 
audited entities developed corrective action plans for about 93 percent 
of the findings contained in the audit reports, we concluded that the 
audit findings provide an accurate representation of the problems 
reported.) We also reviewed the reports to identify auditee responses 
to the audit findings and their corrective action plans. These plans 
indicate auditee agreement or disagreement with the audit findings and 
the actions they planned to take or had taken to fix the findings. In 
addition, we reviewed the audit findings to determine if they recurred 
in successive single audits over the 5-year period. We completed our 
review of each single audit report by identifying and categorizing the 
auditor's opinions on the financial statements and the Schedules of 
Expenditures of Federal Awards.

In responding to our previous review of the Compact program, Interior 
officials expressed concerns about the U.S. government's limited 
ability to enforce accountability over Compact funds due to certain 
provisions of the original Compact and the related FPA. In light of 
these concerns, we reviewed the amended Compacts and related FPAs to 
determine if they included measures that could increase accountability 
over Compact funds. In addition, we supplemented our review of these 
documents with a discussion about the amended Compacts with Interior 
officials to determine if the new provisions addressed their prior 
concerns about limited actions available to them for holding the FSM 
and the RMI accountable.

Interior's Compact-related expenditures represented about 80 percent of 
the total expenditures of U.S. assistance made by the FSM, the 4 FSM 
states, and the RMI during the 5-year period. Because of the relatively 
small amount of funding from other federal agencies at these 
recipients, we did not discuss finding resolution with representatives 
of those agencies.

We conducted our audit from August 2002 through May 2003 in accordance 
with generally accepted government auditing standards. We requested 
written comments on a draft of this report from the governments of the 
FSM and the RMI and the Secretary of the Interior. Their comments are 
discussed in the section entitled Government and Agency Comments and 
Our Evaluation and are reprinted in appendixes I, II, and III. Further, 
we considered all comments and made changes to the report, as 
appropriate.

Pervasive Audit Findings Demonstrate Poor Accountability over Compact 
Funds:

Single audits of the FSM, the four FSM states, and the RMI identified 
pervasive audit findings involving noncompliance with Compact 
requirements and financial statement problems in areas that we consider 
highly susceptible to misuse. In addition, the independent auditor 
performing the single audits issued qualified opinions or disclaimers 
of opinion on the financial statements in all 30 single audit reports 
reviewed and for 60 percent of the Schedules of Expenditures of Federal 
Awards. Taken together, these findings and opinions demonstrate that 
the FSM, the four FSM states, and the RMI did not provide reasonable 
accountability over Compact funds and assurance that these funds were 
used for their intended purposes.

Single Audit Reports Identify Pervasive Audit Findings Involving 
Compact Funds:

The 30 single audit reports that we examined contained about 90 audit 
findings for each year of the 5-year period covered by our review. In 
total, they contained 458 audit findings relevant to Compact funds and 
significant numbers of findings for each of the auditees for which we 
reviewed single audit reports. Further, successive single audits during 
the 5-year period contained recurring audit findings despite corrective 
action time frames established by the auditees and our conclusion that 
few of the findings involved significant issues, such as implementing 
an accounting system, that could be expected to require more than 2 
years to correct.

Figure 1 shows the number of audit findings reported annually from 1996 
through 2000. It demonstrates that the auditors performing the 30 
single audits in our review identified a significant number of audit 
findings both in total and in each year of the 5-year period of our 
review.

Figure 1: Number of Audit Findings Reported Annually from 1996 through 
2000:

[See PDF for image]

[End of figure]

In addition, the 30 audit reports identified a significant number of 
audit findings for each of the auditees. Figure 2 shows the percentages 
of the 458 audit findings related to Compact funds for each auditee.

Figure 2: Auditee Findings as a Percentage of Total Findings:

[See PDF for image]

[End of figure]

Office of Management and Budget (OMB) Circular No. A-133, Audits of 
States, Local Governments, and Non-Profit Organizations, establishes 
policies for federal agency use in implementing the Single Audit Act, 
as amended, and provides an administrative foundation for consistent 
and uniform audit requirements for nonfederal entities that administer 
federal awards. In part, the circular requires the auditee to follow up 
and take corrective actions on audit findings identified by the single 
audits. It clarifies this requirement by stating that, at the 
completion of the single audit, the auditee shall prepare a corrective 
action plan (CAP) to address each audit finding included in the current 
year auditor's report. If the auditee does not agree with the audit 
findings or believes corrective action is not required, the CAP is to 
include an explanation of and justification for this position. Based on 
our review of the audit reports, the FSM, the four FSM states, and the 
RMI generally fulfilled their responsibility to either prepare a CAP or 
indicate their disagreement with the audit finding and provide reasons 
for their disagreement. As figure 3 shows, they prepared CAPs for 93 
percent of the audit findings identified by the single audits in our 
review and indicated their disagreement and reasons for this 
disagreement for 5 percent of the findings.

Figure 3: Percentage of Corrective Action Plans Developed for Audit 
Findings:

[See PDF for image]

[End of figure]

Our review of these CAPs showed that about 33 percent (138) included 
anticipated completion dates, and, of these plans, only 4 percent (16) 
indicated that the planned corrective actions would require more than 2 
years to complete. Based on a review of the CAPs that did not include 
anticipated completion dates (287), we concluded that, with a few 
exceptions,[Footnote 9] the problems addressed by these plans could be 
corrected within a year. For example, Financial Status Reports 
submitted to the grantor agencies for fiscal year 2000 were not 
available during the single audit of the RMI. The auditors recommended 
that an adequate filing system, including the maintenance of Financial 
Status Reports, be maintained for all federal awards. The CAP called 
for the Ministry of Finance to ensure that an adequate filing system 
was in place and to review status reports periodically.

Further analysis of the findings revealed that successive single audits 
identified recurring audit findings over the 5-year period despite the 
time frames identified in the auditee-prepared CAPs or our estimate of 
the amount of time corrective action should take. As figure 4 shows, 
many audit findings that were identified in more than one single audit 
report recurred in 3 or more years over the 5-year period. The 
percentage of each auditee's single audit findings that recurred 3 or 
more years over the 5-year period of our review ranged from RMI's high 
of 69 percent to a low of 17 percent for the FSM.

Figure 4: Percentage of 1996 through 2000 Single Audit Findings That 
Recurred 3 or More Years:

[See PDF for image]

[End of figure]

Compliance and Financial Statement Problems Persisted over Compact 
Funds:

The auditors categorized the audit findings related to the Compact into 
three areas--federal award findings, local findings, and financial 
statement findings. Upon further review, we determined that 117 audit 
findings that the auditors categorized as federal award findings or 
local findings discussed problems related to compliance with Compact 
requirements, and the remaining 341 discussed financial statement 
problems. The auditors who performed these single audits qualified or 
disclaimed their opinion on all of the financial statements and about 
60 percent of the Schedules of Expenditures of Federal Awards generally 
because the auditees did not provide them with all needed financial 
statements or documentation to support transactions recorded in their 
books. Taken together, the compliance and financial statement findings 
and audit opinions demonstrate poor accountability over Compact funds 
and an inability on the part of the entities involved to provide 
assurances that all program funds are used as intended. They highlight 
the need for a stronger control environment and greater efforts to 
implement control activities that strengthen accountability and help 
ensure that Compact funds are used for program purposes.

Compliance requirements for federal assistance set forth what is to be 
done, who is to do it, the purpose to be achieved, the population to be 
served, and how much can be spent in certain areas. OMB's Single Audit 
Act guidance includes 15 compliance categories[Footnote 10] used by 
auditors to report on compliance-related findings. Our analysis of the 
compliance categories the auditors cited for the Compact-related audit 
findings showed that over half of the audit findings related to two 
categories--allowable costs/cost principles and equipment and real 
property management. The first category, allowable costs/cost 
principles, specifies the allowability of costs under federal awards. 
For example, expenditures for 17 types of projects or activities were 
allowable under the original Compact capital account, including 
construction or major repair of capital infrastructure, public and 
private sector projects, training activities, and debt service. The 
second category, equipment and real property management, specifies how 
federal award recipients should use, manage, and dispose of equipment 
and real property.

The following examples illustrate the types of audit findings that the 
auditors categorized into the 15 areas.

* Kosrae advanced $93,000 in Compact Health and Medical Program funds 
to off-island health providers for medical referrals. The advances were 
immediately expensed without reference to the specific medical expenses 
actually incurred. This is an example of a compliance finding related 
to allowable costs/cost principles.

* Kosrae incurred over $274,000 in expenditures of Compact Capital 
funds that lacked proper supporting vendor's invoices. This is an 
example of a compliance finding related to allowable costs/cost 
principles.

* Chuuk transferred about $169,000 in Compact Capital funds to entities 
(subrecipients) that have not been audited or reviewed for compliance 
with Compact requirements. This is an example of a compliance finding 
related to subrecipient monitoring.

As mentioned earlier, the auditors performing the single audits also 
categorized findings as financial statement findings. The audit 
findings for this category related to the reliability of financial 
reporting and involved recording, processing, summarizing, and 
reporting financial data. Unlike the findings that related to 
compliance with Compact requirements, the auditors did not tie the 
financial statement findings to the categories contained in the Single 
Audit Act guidance. Our review of these findings identified 101 
financial statement findings involving problems with assets or accounts 
that we consider susceptible to misuse. The following examples 
illustrate financial statement findings related to assets or accounts 
that we consider susceptible to misuse.

* Yap's three major bank accounts (general checking, savings, and 
payroll) were not reconciled to bank records at the end of fiscal year 
1999. Differences between the amounts shown for these cash accounts in 
Yap's books and the bank records amounted to over $150,000. The 
auditors identified this lack of bank reconciliations as an internal 
control weakness in Yap's single audit reports for the years 1995 
through 1999. A record being out of balance is a risk factor auditors 
use to identify the possibility of fraud. This is an example of a cash 
problem.

* The RMI had not conducted a physical inventory or updated property 
records for equipment and real property. As of September 30, 2000, RMI 
reported that its equipment was worth about $11 million, but the 
auditor could not substantiate this amount due to inadequate records. 
The auditor identified a lack of updated property records for the 
General Fixed Asset Group in single audit reports for the years 1988 
through 2000. Missing documents, such as the property records for 
equipment in this example, are a risk factor used by auditors to 
identify the possibility of fraud. This is an example of an equipment 
problem.

The 30 single audit reports included auditor opinions or disclaimers of 
opinion on the financial statements and Schedules of Expenditures of 
Federal Awards for the FSM, the four FSM states, and the RMI. The 
financial statements reflect a federal award recipient's financial 
position, results of operations or changes in net assets, and, where 
appropriate, cash flows for the year. The Schedules of Expenditures of 
Federal Awards show the amount of expenditures for each federal award 
program during the year. If the auditors are not able to perform all of 
the procedures necessary to complete an audit, they consider the audit 
scope to be limited or restricted. Scope limitations may result from 
the timing of the audit work, the inability to obtain sufficient 
evidence, or inadequate accounting records. If the audit scope is 
limited, the auditors must make a professional judgment about whether 
to qualify or disclaim an opinion. A qualified opinion states that, 
except for the matter to which the qualification relates, the financial 
statements are fairly presented in accordance with generally accepted 
accounting principles. In a disclaimer of opinion, the scope limitation 
is serious enough that the auditor does not express an opinion.

The auditor's opinions on the financial statements and Schedules of 
Expenditures of Federal Awards for the 30 single audits in our review 
reveal overall poor financial management. The auditors performing these 
single audits qualified or disclaimed their opinions on all of the 
financial statements and about 60 percent of the Schedules of 
Expenditures of Federal Awards generally because they were unable to 
obtain sufficient evidence or adequate accounting records. For example, 
the auditor qualified its opinion on the FSM's financial statements for 
the year 2000 because of the auditor's inability to ensure the 
propriety of receivables from other governments and missing financial 
statements for a component unit. In another example, the auditor did 
not express an opinion on Chuuk's financial statements for the year 
1999 because of inadequacies in the accounting records and internal 
controls, incomplete financial statements for component units, and its 
inability to obtain audited financial statements supporting 
investments.

The significant number of audit findings involving FSM and RMI 
noncompliance with Compact requirements and weaknesses in their 
financial management systems, along with auditor qualified opinions or 
disclaimers of opinion on financial statements, echo the control and 
accountability issues that we identified in our earlier reports on 
Compact assistance. Further, the pervasive and recurring nature of the 
compliance and financial statement problems highlights (1) the need for 
stronger control environments that will help ensure that Compact funds 
are used for program purposes and (2) the limited progress made during 
the 5-year period of our review in establishing accountability in the 
FSM, the four FSM states, and the RMI that would provide reasonable 
assurance that Compact funds are used for their intended purposes.

Amended Compact Agreements Contain Improved Accountability Measures:

In responding to our previous reviews of the original Compact program, 
Interior officials expressed concerns about the U.S. government's 
limited ability to enforce accountability over Compact funds due to 
certain provisions of the original Compact and the related FPA. 
According to these officials, administrators have been reluctant to 
commit oversight resources to the Compact when no enforcement 
mechanisms exist due to these provisions. The United States and the FSM 
signed an amended Compact in May 2003. The United States and the RMI 
signed an amended Compact in April 2003. These amended Compacts are 
awaiting legislative approval in the United States, the FSM, and the 
RMI. They contain strengthened reporting and monitoring measures over 
the original Compact that could improve accountability over Compact 
assistance, if diligently implemented.

According to Interior officials, the FPA in effect during the period of 
our review created a financial management regimen unique in federal 
practice. They explained that it was negotiated to give the FSM and the 
RMI governments clear control over Compact funding and to limit the 
U.S. government's authority to intervene in spending decisions and, 
most important, to withhold payments if the terms and conditions of 
funding were violated. More specifically, these officials explained 
that the expiring FPAs lacked basic elements of federal grant 
management practice similar to those in OMB Circular A-102, Grants and 
Cooperative Agreements with State and Local Governments, which requires 
standard procurement practices and cost principles. They elaborated 
that, when coupled with the full faith and credit provisions of the 
Compact,[Footnote 11] this lack of standards limited the U.S. 
government's response to mismanagement. In summing up, they stated that 
while additional personnel and funding could have been committed to 
Compact oversight, the United States would still have had almost no 
ability to influence fiscal decisions made by the FSM or the RMI.

The amended Compacts could potentially cost the U.S. government about 
$6.6 billion in new assistance. Of this amount, $3.5 billion would 
cover payments over a 20-year period (2004-23), while $3.1 billion 
represents payments for U.S. military access to the Kwajalein Atoll in 
the RMI for the years 2024 through 2086. The amended Compacts contain 
strengthened reporting and monitoring measures that could improve 
accountability over Compact assistance, if diligently implemented. In 
addition, the Department of the Interior has taken actions to increase 
resources dedicated to monitoring and oversight of Compact funds.

The following are amended Compact and related FPA measures that 
represent changes from the prior Compact and FPAs.

* In 2000, we reported that Compact funds were placed in a general 
government fund and commingled with other revenues and, therefore, 
could not be further tracked. In addition, some Compact assistance was 
only traced at a high level with few details readily available 
regarding final use. The amended Compacts and FPAs include requirements 
that should address these accountability concerns. Specifically, they 
require fiscal control and accounting procedures sufficient to permit 
(1) preparation of required reports and (2) tracing of funds to a level 
of expenditures adequate to establish that such funds have been used in 
compliance with applicable requirements. Further, the amended Compacts 
specify standards for the financial management systems used by the FSM 
and the RMI. For example, these systems should maintain effective 
controls to safeguard assets and ensure that they are used solely for 
authorized purposes.

* The new FPAs would establish a joint economic management committee 
for the FSM and the RMI that would meet at least once a year. The 
committee would be composed of three U.S. appointed members, including 
the chairman, and two members appointed, as appropriate, by either the 
FSM or the RMI. The committee's duties would include (1) reviewing 
planning documents and evaluating island government progress to foster 
economic advancement and budgetary self-reliance, (2) consulting with 
program and service providers and other bilateral and multilateral 
partners to coordinate or monitor the use of development assistance, 
(3) reviewing audits, (4) reviewing performance outcomes in relation to 
the previous year's grant funding level, terms, and conditions, and (5) 
reviewing and approving grant allocations (which would be binding) and 
performance objectives for the upcoming year.

* Grant conditions normally applicable to U.S. state and local 
governments would apply to each grant. General terms and conditions for 
the grants would include conformance to plans, strategies, budgets, 
project specifications, architectural and engineering specifications, 
and performance standards. Specific postaward requirements address 
financial administration by establishing, for example, (1) improved 
financial reporting, accounting records, internal controls, and budget 
controls, (2) appropriate use of real property and equipment, and (3) 
competitive and well-documented procurement.

* The United States could withhold payments if either the FSM or the 
RMI fails to comply with grant terms and conditions. The amount 
withheld would be proportional to the breach of the term or condition. 
In addition, funds could be withheld if the FSM or RMI governments do 
not cooperate in U.S. investigations of whether Compact funds have been 
used for purposes other than those set forth in the amended Compacts.

* The new FPAs include numerous reporting requirements for the two 
countries. For example, each country must prepare strategic planning 
documents that are updated regularly, annual budgets that propose 
sector expenditures and performance measures, annual reports to the 
U.S. President regarding the use of assistance, quarterly and annual 
financial reports, and quarterly grant performance reports.

The successful implementation of the new accountability provisions will 
require a sustained commitment by the three governments to fulfilling 
their new roles and responsibilities. Appropriate resources from the 
United States, the FSM, and the RMI represent one form of this 
commitment. While the amended Compacts do not address staffing issues, 
officials from Interior's Office of Insular Affairs have informed us 
that they intend to post six staff in a new Honolulu office: a health 
grant specialist, an education grant specialist, an accountant, an 
economist, an auditor, and an office assistant. Interior can also 
contract with the Army Corps of Engineers for engineering assistance, 
when necessary. These Honolulu-based staff may spend about half of 
their time in the FSM and the RMI. Further, an Interior official noted 
that his office has brought one new staff member on board in 
Washington, D.C. and intends to post one person to work in the RMI (one 
staff member already works in the FSM). We have not conducted an 
assessment of Interior's staffing plan and rationale and cannot comment 
on the adequacy of the plan or whether it represents sufficient 
resources in the right locations.

Conclusions:

The 30 single audit reports demonstrate a lack of or poor 
accountability over U.S. Compact assistance that has totaled an 
estimated $2.1 billion since 1987. The large number and recurring 
nature of the findings involving noncompliance with Compact 
requirements or financial management weaknesses, along with the 
preponderance of auditor's qualified opinions or disclaimers of opinion 
on FSM and RMI financial statements, clearly indicate the need for 
improved FSM and RMI management of U.S. assistance and greater U.S. 
oversight and monitoring of the use of this assistance. Changes are 
needed especially considering the fact that the amended Compacts with 
these nations could potentially cost the U.S. government about $3.5 
billion in new assistance over the next 20 years.

Under the original Compact, the Department of the Interior was 
responsible for supervising, coordinating, and monitoring the program 
assistance provided. Interior officials expressed frustration with the 
lack of tools available to them to administer or track this assistance 
in a manner that could reasonably ensure that such assistance was 
having its intended effect. The amended Compacts strengthen reporting 
and monitoring measures that could improve accountability over 
assistance, if diligently implemented. These measures include 
strengthened fiscal control and accounting procedures requirements, 
expanded annual reporting and consultation requirements, and the 
ability to withhold funds for noncompliance with grant terms and 
conditions. The successful implementation of the new accountability 
provisions will require appropriate resources and sustained commitment 
from the United States, the FSM, and the RMI. The joint economic 
committees called for in the Compact with each nation and Interior's 
planned increase in staff associated with Compact oversight and 
monitoring functions should play key roles in improving accountability 
over Compact funds.

Recommendations for Executive Action:

To help promote compliance with Compact requirements and sound 
financial management, the Secretary of the Interior should delegate 
responsibility to the Office of Insular Affairs and hold appropriate 
officials in that office accountable for:

* ensuring the adequacy of staff dedicated to Compact oversight and 
monitoring,

* monitoring FSM and RMI progress in addressing Compact-related single 
audit report findings,

* reporting on the FSM and RMI actions to correct Compact-related 
compliance and financial management findings identified in single audit 
reports to the Secretary of the Interior or other appropriate high-
level Interior official,

* initiating appropriate actions when the FSM or the RMI do not 
undertake adequate actions to address Compact-related single audit 
findings in a timely manner, and:

* investigating single audit findings that indicate possible violations 
of grant conditions or misuse of funds and taking appropriate actions 
when such problems are verified.

Government and Agency Comments and Our Evaluation:

In commenting on this report, the Office of Insular Affairs of the 
Department of the Interior, FSM, and RMI agreed with our findings or 
conclusions and recommendations. They also cited the amended Compacts 
as mechanisms that should result in improved financial management over 
Compact assistance. The FSM and RMI also provided technical comments 
and information on current actions to address financial management 
issues. We considered all comments and made changes to the report, as 
appropriate.

The FSM comments noted that it found the report constructive and useful 
as it continues to prepare for the implementation of the amended 
Compact and its related agreements. The comments (reprinted in app. I) 
recognized that, although FSM has worked hard to develop a consistent 
approach to satisfy the Compact and FPA requirements, significant work 
remains to be done to improve and strengthen accountability in all 
aspects throughout the nation. Further, FSM agreed that it must 
continue to improve internal financial control through upgrading the 
current financial management system, providing for capacity building, 
and retaining its most productive and experienced employees. Finally, 
it noted that the amended Compact and related fiscal procedures 
agreement include requirements that will address all of the 
accountability concerns expressed in the report.

RMI's comments (reprinted in app. II) stated that it concurred with the 
report's findings and noted that the report will be useful since it 
gives a summary of the financial and management situation of the RMI 
between 1996 and 2000. RMI noted that its problems stem partly from the 
fact that it has not had a global system for following up on audits 
that would apply throughout all ministries of the government as well as 
other entities that receive Compact grant assistance. RMI stated that 
it has made progress recently by upgrading its information system and 
strengthening its internal control procedures and noted that it will 
add personnel to the budget, procurement, and supply areas.

In its comments (reprinted in app. III), the Office of Insular Affairs 
of the Department of the Interior agreed with the conclusions and 
recommendations in the report. The Office also noted that it looks 
forward to discharging its responsibilities under the amended Compacts 
and that it is confident that it will now have the tools needed to 
properly protect the American taxpayer's investment in the freely 
associated states.

:

As agreed with your offices, unless you publicly announce its contents 
earlier, we will not distribute this report until 30 days after its 
date. At that time, we will send copies to the Secretary of the 
Interior, the President of the Federated States of Micronesia, the 
President of the Republic of the Marshall Islands, and appropriate 
congressional committees. Copies will also be made available to others 
on request. This report will also be available at no charge on GAO's 
Web site at [Hyperlink, http://www.gao.gov] http://www.gao.gov.

For future contacts regarding this report, please call McCoy Williams 
at (202) 512-6906 or Susan S. Westin at (202) 512-4128. Staff contacts 
and other key contributors to this report are listed in appendix IV.

McCoy Williams: 
Director: 
Financial Management and Assurance:

Susan S. Westin: 
Managing Director: 
International Affairs and Trade:

Signed by McCoy Williams and Susan S. Westin: 

[End of section]

Appendixes: 

Appendix I: Comments from the Federated States of Micronesia:

[See PDF for image]

[End of figure]

[End of section]

Appendix II: Comments from the Republic of the Marshall Islands:

EMBASSY OF THE REPUBLIC OF THE MARSHALL ISLANDS 
2433 Massachusetts Avenue, N.W, 
Washington, D.C. 20008 
Tel. # (202) 234-5414 Fax # (202) 232-3236:

October 2, 2003:

Mr. McCoy Williams:

Director, Financial Management and Assurance: 
U.S. General Accounting Office, Room 5089 
441 G Street, NW:
Washington, D.C. 20548-0001:

Dear Mr. Williams:

First, thank you for the opportunity to comment on the drafts of your 
reports. On behalf of the Government of the Republic of the Marshall 
Islands (RMI), I am pleased to forward to you comments on your most 
recent draft report entitled Compact of Free Association: Single Audits 
Demonstrate Accountability Problems Over Compact Funds.

I hope you will take time to consider the reactions of the RMI 
Government in the final version of your report. If you have any 
questions about the content of the RMI Government's response, please 
feel free to contact me at anytime.

With Best Regards: 

Signed by: 

Banny deBrum:

Ambassador to the United States:

RMI RESPONSE TO DRAFT GAO REPORT ENTITLED "COMPACT OF FREE ASSOCIATION: 
SINGLE AUDITS DEMONSTRATE ACCOUNTABLITIY PROBLEMS OVER COMPACT FUNDS":

The RMI government has reviewed the draft GAO report on the findings of 
possible misuse of federal grants allocated to the RMI under the 
Compact of Free Association. Funding from the U.S. government is 
authorized and implemented under Section 211 of the Compact of Free 
Association, approved under U.S. Public Law 99-239.

The RMI is committed to being accountable to its constituency in the 
spirit of good governance. It is the desire of the RMI government to 
serve as a model democratic nation, with accountability and 
transparency as its underlying principles.

The RMI concurs with the findings of the GAO in respect to problems 
resulting from a lack of follow-up on audit findings for government 
operations over the period 1996-2000. This problem stems partly from 
the fact that the RMI has not had a "global" system for following up on 
audits that would apply throughout all ministries of the government as 
well as other entities that receive Compact grant assistance. As a 
result, certain ministries, instrumentalities of the government, and 
other entities receiving Compact assistance have made substantial 
efforts to respond to and correct problems revealed by audits, while 
others have done little or nothing in the past.

In addition, there has been little or no sanction under either domestic 
or the original Compact provisions for not correcting audit 
deficiencies after such deficiencies have been reported. This problem 
is now being affirmatively addressed in the RMI's Appropriation act for 
FY 2004, which will provide that entities that have been determined by 
the Auditor General to be "unauditable" will not be permitted to 
receive funding until such problems are remedied. Although only a first 
step, this measure is independent of anything required in the Compact, 
as Amended, or the new Fiscal Procedures Agreement.

While the Compact, as Amended, provides for closer monitoring of the 
use of Compact grant funds than has been done in the past, the RMI 
believes that domestic revenues must also be brought under stricter 
accountability requirements so we do not end up with two different 
systems and accountability standards for Compact funding and other 
revenues of the RMI Government.

In the Compact, as Amended, both the RMI and the U.S. have agreed to 
detailed financial and management procedures and consultations that 
will assist the RMI in being more accountable to its people. These 
mechanisms can be found in the Fiscal Procedures Agreement (FPA), and 
they include the Medium Term Budget and Investment Framework (MTBIF) 
and the Joint Economic Management and Financial Accountability 
Committee (JEMFAC) that will review audit findings in the future.

The GAO report states that the RMI does not comply with the quarterly 
reports requirement of its federal programs. The RMI would point out 
that this is an overly broad 
statement and that it has been able to make timely reports for most, 
but not all federal programs in accordance with those programs 
requirements.

The GAO notes that one improvement that will improve the accountability 
situation in the RMI is the Ministry of Finance (MOF) implementing a 
new filing system to keep better track of the government's documents. 
This is just one new mechanism that MOF has put into place, and there 
are other new measures that the GAO fails to mention.

Much progress has been made recently, specifically the upgrading of the 
information system and strengthening of the internal control 
procedures, which will address most of the on-going audit findings. 
Furthermore, additional personnel (budget, procurement and supply) will 
soon be added to better monitor and ensure internal and external 
compliance.

The RMI is also exploring other avenues to improve its accountability 
capacity. The RMI is committed to upgrade its fiscal operation and work 
closely with its DOI partners. From time to time, the RMI seeks the 
assistance of DOI, particularly the Technical Assistance Division, to 
resolve remaining audit findings. Thus the task ahead should be 
mutually beneficial for the RMI and the U.S. governments in combined 
efforts to achieve greater transparency and accountability.

The RMI appreciates the fact that the GAO conducted this study. This 
study will be useful to the RMI as it gives it a summary of the 
financial and management situation of the RMI between 1996 and 2000.



[End of section]

Appendix III: Comments from the Department of the Interior:

United States Department of the Interior:

OFFICE OF INSULAR AFFAIRS 
1849 C Street, NW Washington, D.C. 20240:

Deputy Assistant Secretary:

Mr. McCoy Williams:

Director, Financial Management and Assurance United States General 
Accounting Office Washington, DC 20548:

Dear Mr. Williams:

I have reviewed the draft report entitled "Compact Of Free Association: 
Single Audits Demonstrate Accountability Problems over Compact Funds", 
dated October 2003. I agree with the conclusions and recommendations of 
the report.

The report found that the proposed amendments to the Compacts of Free 
Association and the related fiscal procedures agreements should, if 
implemented properly, address the need to properly administer and 
oversee federal assistance. The Department of the Interior's extensive 
preparations to implement the amended Compact are already well 
underway, even though the amendments have yet to be approved as of this 
writing. We look forward to discharging our responsibilities under the 
amended Compacts, and are confident that we will finally have the tools 
that we need to properly protect the American taxpayer's investment in 
the freely associated states.

Thank you for the opportunity to comment on the above report.

Sincerely: 

Signed by: 

David B. Cohen: 

[End of section]

Appendix IV: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Tom Broderick, (202) 512-8705 or [Hyperlink, broderickt@gao.gov] 
broderickt@gao.gov Emil Friberg, Jr., (202) 512-8990 or [Hyperlink, 
friberge@gao.gov] friberge@gao.gov:

Acknowledgments:

In addition to the contacts named above, Perry Datwyler and Leslie 
Holen made key contributions to this report.

(195008):

FOOTNOTES

[1] U.S. General Accounting Office, Foreign Assistance: Effectiveness 
and Accountability Problems Common in U.S. Programs to Assist Two 
Micronesian Nations, GAO-02-70 (Washington, D.C.: Jan. 22, 2002); 
Foreign Assistance: U.S. Funds to Two Micronesian Nations Had Little 
Impact on Economic Development, GAO/NSIAD-00-216 (Washington, D.C.: 
Sept. 22, 2000); and Foreign Relations: Better Accountability Needed 
Over U.S. Assistance to Micronesia and the Marshall Islands, GAO/RCED-
00-67 (Washington, D.C.: May 31, 2000). 

[2] Statement of David B. Cohen, Deputy Assistant Secretary of the 
Interior for Insular Affairs, before the Subcommittee on Asia and the 
Pacific, House Committee on International Relations, June 18, 2003.

[3] The FPA provides for a financial and compliance audit within the 
meaning of the Single Audit Act. See 31 U.S.C. Chapter 75.

[4] According to a Department of State official, while the original 
Compact was one document that applied to both the FSM and the RMI, an 
amended Compact has been prepared for each nation. 

[5] Although the three governments have signed the amended Compacts, 
the Compacts have not been approved by the legislature of any country. 
Therefore, in this report, we describe the amended Compacts' 
requirements and potential impact conditionally, recognizing that the 
Compacts have not yet been enacted. The total possible cost to renew 
expiring assistance in fiscal year 2004 U.S. dollars would be $3.8 
billion on the basis of the Congressional Budget Office's forecasted 
inflation rate. 

[6] An audit of these schedules as part of the single audit is required 
by the Single Audit Act, as amended, 31 U.S.C. 7502(e)(2).

[7] The FSM and RMI are now independent nations and are members of 
international organizations such as the U.N.

[8] The Single Audit Act of 1984 was substantially amended by the 
Single Audit Act Amendments of 1996, which is codified in Chapter 75 of 
Title 31, United States Code. 

[9] We identified 11 CAPs that we believe could require significant 
amounts of time to correct. For example, 3 CAPs called for accounting 
system upgrades and another 2 called for accounting systems. In another 
2 instances, FSM states prepared plans that required legal opinions 
from the FSM national government in order to resolve the problems.

[10] The 15 areas are (1) activities allowed or unallowed, (2) 
allowable costs/cost principles, (3) cash management, (4) Davis-Bacon 
Act, (5) eligibility, (6) equipment and real property management, (7) 
matching, level of effort, and earmarking, (8) period of availability 
of federal funds, (9) procurement, (10) program income, (11) real 
property acquisition and relocation assistance, (12) reporting, (13) 
subrecipient monitoring, (14) special tests and provisions, and (15) 
none.

[11] "Except as otherwise provided, approval of the Compact by the 
Government of the United States shall constitute a pledge of the full 
faith and credit of the United States for the full payment of the sums 
and amounts specified in Articles I and III of this Title. The 
obligations of the United States under Article I and III of this Title 
shall be enforceable in the United States Claims Court." Compact of 
Free Association, section 236 (Jan. 14, 1986). 

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