BATTELLE MEMORIAL INSTITUTE AND SUBSIDIARIES

OMB Circular A-B3 Single Audit Report

September 30, 2006

(With Independent Auditors' Reports Thereon)

BATTELLE MEMORIAL INSTITUTE AND SUBSIDIARIES

OMB Circular A-133 Single Audit Report

September 30, 2006

Table of Contents

Independent Auditors' Report on Internal Control Over Financial Reporting and on Complianceand Other Matters Based on an Audit of Financial Statements Performed in AccordanceWith Government Auditing Standards

Independent Auditors' Report on Compliance With Requirements Applicable toEach Major Program and on Internal Control Over Compliance in AccordanceWith OMB Circular A-133

Schedule of Expenditures of Federal Awards

Notes to Schedule of Expenditures of Federal Awards

Schedule of Findings and Questioned Costs

Page

2-3

4-8

9

10-11

KPMG LLPSuite 500191West NationwideBoulevardColumbus.OH43215-2568

Telephone 614 249 2300Fax 6142492348

Internet www.us.kpmg.com

Independent Auditors' Report on Internal Control Over Financial Reportingand on Compliance and Other Matters Based on an Audit of Financial Statements

Performed in Accordance With GovernmentAuditing Standards

Battelle Memorial InstituteThe Board of Directors:

We have audited the consolidated financial statements of Battelle Memorial Institute and subsidiaries (Battelle) as ofand for the year ended September 30, 2006, and have issued our report thereon dated December 15, 2006. Weconducted our audit in accordance with auditing standards generally accepted in the United States of America and thestandards applicable to financial audits contained in Government Auditing Standards, issued by the ComptrollerGeneral of the United States.

Internal Control Over Financial Reporting

In planning and performingour audit, we considered Battelle's internal control over financial reporting in order todetermineour auditing proceduresfor the purposeof expressingour opinionon the consolidatedfinancialstatementsand not to provide an opinion on the internal control over financial reporting. Our consideration of the internalcontrol over financial reporting would not necessarily disclose all matters in the internal control that might bematerial weaknesses.A materialweakness is a reportablecondition in which the design or operation of one or moreof the internal control componentsdoes not reduce to a relatively low level the risk that misstatementscaused byerror or fraud in amountsthat would be material in relationto the consolidatedfinancialstatementsbeing audited mayoccur and not be detected within a timely period by employees in the normal course of performing their assignedfunctions. We noted no matters involving the internal control over financial reporting and its operation that weconsider to be materialweaknesses.

Compliance and Other Matters

As part of obtaining reasonable assurance about whether Battelle's consolidated financial statements are free ofmaterial misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts,and grant agreements, noncompliance with which could have a direct and material effect on the determination ofconsolidated financial statement amounts. However, providing an opinion on compliance with those provisions wasnot an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosedno instances of noncompliance or other matters that are required to be reported under Government AuditingStandards.

We noted certain matters that we report to management of Battelle in a separate letter.

This report is intended solely for the information and use of the audit committee, management, federal awardingagencies and pass-through entities, and is not intended to be and should not be used by anyone other than thesespecified parties.

Columbus, OhioDecember 15, 2006

KPMGLLP.a u.s. limited liabilitypartnership. is the U.S.member firm of KPMG International. a Swiss cooperative.

KPMG LLPSuite 500191 West Nationwide BoulevardColumbus. OH 43215-2568

Telephone 6142492300Fax 614 249 2348

Internet www.us.kpmg.com

Independent Auditors' Report on Compliance With RequirementsApplicable to Each Major Program and on Internal Control Over

Compliance in Accordance With OMB Circular A-133

Battelle Memorial InstituteThe Board of Directors:

Compliance

We have audited the compliance of Battelle Memorial Institute and subsidiaries (Battelle) with the types ofcompliance requirements described in the US. Office oj Management and Budget (OMB) CircularA-J33 Compliance Supplement that are applicable to its major federal program for the year endedSeptember 30, 2006. Battelle's major federal program is identified in the summary of auditors' resultssection of the accompanying schedule of findings and questioned costs. Compliance with the requirementsof laws, regulations, contracts, and grants applicable to its major federal program is the responsibility ofBattelle's management. Our responsibility is to express an opinion on Battelle's compliance based on ouraudit.

We conducted our audit of compliance in accordance with auditing standards generally accepted in theUnited States of America; the standards applicable to financial audits contained in Government AuditingStandards, issued by the Comptroller General of the United States; and OMB Circular A-133, Audits ojStates, Local Governments, and Non-Profit Organizations. Those standards and OMB Circular A-I33require that we plan and perform the audit to obtain reasonable assurance about whether noncompliancewith the types of compliance requirements referred to above that could have a direct and material effect ona major federal program occurred. An audit includes examining, on a test basis, evidence about Battelle'scompliance with those requirements and performing such other procedures as we considered necessary inthe circumstances. We believe that our audit provides a reasonable basis for our opinion. Our audit doesnot provide a legal determination on Battelle's compliance with those requirements.

In our opinion, Battelle complied, in all material respects, with the requirements referred to above that areapplicable to its major federal program for the year ended September 30, 2006. However, the results of ourauditing procedures disclosed instances of potential noncompliance with those requirements, which arerequired to be reported in accordance with OMB Circular A-133 and which are described in theaccompanying schedule of findings and questioned costs as Finding 06-0 I.

Internal Control Over Compliance

The management of Battelle is responsible for establishing and maintaining effective internal control overcompliance with requirements of laws, regulations, contracts, and grants applicable to federal programs. Inplanning and performing our audit, we considered Battelle's internal control over compliance withrequirements that could have a direct and material effect on a major federal program in order to determineour auditing procedures for the purpose of expressing our opinion on compliance and to test and report onthe internal control over compliance in accordance with OMB Circular A-133.

2

KPMGLLP.a u.s. limIted liabilitypartnership. is the U.S.member firm of KPMGInternational. a Swiss cooperative.

We noted certain matters involving the internal control over compliance and its operation that we considerto be reportable conditions. Reportable conditions involve matters coming to our attention relating tosignificant deficiencies in the design or operation of the internal control over compliance that, in ourjudgment, could adversely affect Battelle's ability to administer a major federal program in accordancewith the applicable requirements of laws, regulations, contracts, and grants. Reportable conditions aredescribed in the accompany schedule of findings and questioned costs as Finding 06-01.

Our consideration of the internal control over compliance would not necessarily disclose all matters in theinternal control that might be material weaknesses. A material weakness is a reportable condition in whichthe design or operation of one or more of the internal control components does not reduce to a relativelylow level the risk that noncompliance with applicable requirements of laws, regulations, contracts, andgrants caused by error or fraud that would be material in relation to a major federal program being auditedmay occur and not be detected within a timely period by employees in the normal course of performingtheir assigned functions. We noted no matters involving the internal control over compliance and itsoperation that we consider to be material weaknesses.

Schedule of Expenditures of Federal Awards

We have audited the consolidated financial statements of Battelle as of and for the year endedSeptember 30, 2006, and have issued our report thereon dated December 15, 2006. Our audit wasperformed for the purpose of forming an opinion on the consolidated financial statements taken as a whole.The accompanying schedule of expenditures of federal awards is presented for purposes of additionalanalysis as required by OMB Circular A-l33 and is not a required part of the consolidated financialstatements. Such information has been subjected to the auditing procedures applied in the audit of theconsolidated financial statements and, in our opinion, is fairly stated, in all material respects, in relation tothe consolidated financial statements taken as a whole.

This report is intended solely for the information and use of Battelle Board of Directors, Battellemanagement, and federal awarding agencies and pass-through entities, and is not intended to be and shouldnot be used by anyone other than these specified parties.

Columbus, OhioMay 8, 2007

except as to paragraph 7,which is as of December 15, 2006

3

BATTEllE MEMORIAL IN~'TI11ITE ANU StJBSlUlARIES

Schedule Jf.Iq'C:~IUrc:t uffed«8I A",..dtSepu:mber M. 2006

I. DitKtFlIRdinc

)'I8Jor s.." ACftK'YII't-otr_ nd~

Ccilicr for S~ Coastal o.:..n Rcxvch Cv81&a1o.:..n Pfutram

AuFon:c:

Arm)'tl.,")'D"DOIlwr

AVlMlOIIR_n:h Granb

federal Hllhwar AdmllUllnltOfiDOT OlIwr

Cnmpul8f MIdInfnm..l1 ScWMCMd EnalflCmfll

&lnl'OflfllCfllll Protecnon.Cofllnhd8ted ReSC8l'dl

ScieMe To AchlCYCRcswts (STAR) Rele8lCh Pruwram

Office of R8_fCh _ Dc-velopmOlllCon.oIMI8tcd RHe~IrJT,.inu..EPA N.boMIllomeland Secwiry ~h CenterEPA Con.ubdiliod R_n:h

EPA N.tt0n81 EKJ'OSUI'CRelnRh lAbEPA N.b0n81 R..* Mlflllcmeni Re.8'da t...bMatofYEPA Office ofScICflUCoordiMUntI.t PolicyEPAOtbcT

Office o(Scic_ FIRUlCiIlA.-tLll'Ic:e Pm,ram

ConIel'\.aII(Ift Rca8fCh Iftd UcvckJpmentFonil EMfJY R,.Vth 8nd Dc-velopmcntDOE 00..

Menlll Health Re~h Grants

Oc<:tIpIIIKtnIIiSlfoty UId H-.ltb Propm

Akohol RclclR:h ProJram.DN, AbMc and Addtction Rnc.fCh Proarun.

Centcn rOf Oi__ Control_ PJ.v'nboll_lnvcMlpttontlDd Tochrucal A.-1I8I\(,NuninlRcllClI'Chea.-. Contrul

ChIld "Cllth IDd Human Oe\'dtlplMnl Extramural Re8C8fd\AJi",R_rehCn_ (OfDi CofttrnI

Federal DNa AdnllNllr8l1onNltional c-r IMtlMcN8Iion8i IntblulcofwifDflfllml8ltcaltb sac-

NlllOft8IlnMllul8 of AlIClJM:' A IntocbolD 01__NllinnallnMllulc nfHealr.hDHHS01hcr

TI8llIp(\I1IbOIISeclfnry Admlnltlf8bOll

HoMICllDdSeocunryOdtcr

......".R.&D ft4nal

07 00 V" omu ofNaliona! Urnl ConlJOl Poltey

I. RD V" DoJ*Unen1ofAlneul!urc:

" '" V" Dop.rtmmIU( c...nmcI'U00 V" DopartmenlofComnwn:.

U RD V.. Dopll1monlo(Odlrft118V" Ucp8l'U1lCalof[)CflrMCV.. J>c,pu1mcnlof O&-lcli:ICV.. DcJ8f1l'Mn1:ufO&-k_

.. RD Va Dcj8tmm1 ofHl>\lSlfIIand Urban J>c,\-clupmonl

IS 00 V.. [)cp8l'UMnloflnr

16 00 V.. Ikp8C1menl of Ju..Ii

11 RD V" Depw1rnenl of Labor

20 "" V.. OcjWIrnml of TfIIMJ'OfWIOIIRD V.. UcpenmentofTfllftlPt'lUbOll

V.. O&-ptII1mmCofTraMflUlVtiOCl

ZI RD V" J>c,partmeutuft/w TfNJIUY

42 RD Va Lat.nry of Co"lrc:.

., RD V" N.llunIIAeTOfIAulinASpKc Admuulltf8liUfl

47 7. V" N.llnnII ScllrftU Foundaboe.

RD Va

.. SOO Va &lVll'ONM'nWf"MIecllonAacnc:y"" V.. &lviNnmcntal Pruk\;hua A,cnc:y'" V" &lvirorvnental Prowcli..... )'00 Va &I\'m Prakeltnct Aacnq'

V.. bVIJUlWnellul PruWChOtlAlmeyV.. Envlfonmalw PmIKtiua "'me)'Va EnvIrOIlCDCllWPma.:ctintllAleat).Va Environmental PmIed.iM Alene)'Va EnvlNNIWnuI PMn:boll Aamc;,..

71 RD Va Nuclear Resulatory Commi-'oa

" 04. V" Oep.rtmcnlofbcrr.-'... V" [)op8nnMn1 of EnertY

... V" Dopartmcnl of EnertYRD V" Der-trnenlofEaorJy

I) 00 V" FN.:raJw.err.QlCYMllRllaMntAJeMY

., '" V" lJcp8ftmcnCorUcallh Ind lIuman Service,,., V" Ocp.tmcalorJk8ltlaandH_ Servie..'" Va Der-unonlofHlrllithInCIHumanService.,,. V" I>cp8rtmcnlonkalthMIlHUmIIIService.'" Va Depwlmentoffklltla 8RdHumIft800-__)6' Va Ocr-nmonlof HealthandHumlt!Scr\'K81399 Va Dcp.tmoqlofflollith8tIdHumans.,.'1COI.., Va DcpIrtntmtof HealthandHUmaIISm'KeS... V.. Deplf1mOrttIIf Heallh and Human Sen'",..RD Va Dep8l'UMnl of He.Ch 1M Humaa Sc"'tcft

Va DeparblM:MofHeallh and Humlll Scn'KQVa DDputmcnt of Health and Humlt! SeI'\'tcnVa MofHcllith_Hu_Scr\-_.Va lofHellith_HulI'I8AScr\'K"Va UcpllfttucfICofHellith MIdHunlan Sc"'lCnVa DepartlnenlofHealth_HIIlIWISe",acu

'7 00 Va Dep.,!meM of Homcland Sec1ll11".Va DeJllrtnM:MofHomelud SocunlY

Tot" Diired FundlR(

T.... SQbeoalnd....t:s Dull...

Sl.04O.08J ""'.699

$16.166

361,217 177.041

2.202.1\64 2)6.576$41.\,617

24.949.524 9.1)).012

70.911.676 25,151.586

72.134.'J1IO 15,51MI4

ISoI.IWO,55) 2O,S49.926$.\21542.7).1 $71.747.938

1270.4111

$1.11.\.956 S6lU75

$1.165.960

513,6)1 57,695

S,Ul2

6,645.817 .1.2S1.249

5,412,679 715.54)

512.113.2Q $3,966,792

"',.

$4.627,6048 51.313,702

$6.906,0)6 $2,497,949

J.MS

$11.2J3

1.J71.041 76.636

lJ6,067 ..113,m

4,174,456 ....297

1,1174.471.351 1.991,954

1,244,322 0108.549

4.on.3D 2..\S2.9-W

5.909.116 3J1,M9$29..\27.650 55,672,4113

$404,129 $70,])9

155.352500.703

2.4&&.267 951,472

J,6JUM J05,I74

$1.264,.\.46

512.495,150 5J.16UM

2.061944 1.010.497

3,251696,434 17,110O

91.794

-12,17)274,71S 5S,9St47.239 I"')

2.0.11.150 4,2.\031.597 <,000

24,116,7)2 171.574

2.161.024 6JU21

2,424.011 326....16,861

11.451.89230..\21.114 4"0]2

6.122.310 91J.056

SII6.010.255 54.105,712

29.4S1.502 13.111.42726,500.151 5,277,526

$11,451.953

$544,436,045 $114.225,764

1-'

BATTELLE MEMORIAL INSTI11lTE AHIJS1JBSIUlARJES

Scheduk ofbpendilurc,ofFedo:ra! Award,ScpICmbclJO.2006

1. Indilttt FwwUnt (Bandt is Suit r«ipimtlSubcnnlnctor)

F profitOrpniuti,,118Kansas Slate Uftlvers;t)'

Texas AJ:nculturai Expcnment SIaIIOII

PrimelUplWr TWr ContrKtor

F",.pmfit OrpftlUlions

Lower Columbia River Utuary PartncnlupSUJi! Rn.-crWatcnbcd CtMmCil

JlSAOiSMA Chmate Imf*LS Group. UnluNlty of WuhinilonScripps IndilUtion of()uanoaraphy. UCSDNorth cst Moriume Center

Kit.\8pCoontySlaIcScICntc&' TochllOlo,rlnSlilulc

Uftlvcrsi~.olMelne

Fnr-pmfit Orpniul8onsJohns Hopkins Uni\.cnity - Applied Physic, Lab

Linculntlni\'cnityofMiaouril.o&J~csMaNllemcfltl",ututcNational En\1ronmenl8l Eduution &.TllUmns

N.tional In:ditutc for Buildina ScieocesCenlnl W-"inlton University

OfC'OftSlatcUni'\.nsity

Univcm~'o!OR,o)nScience Application, InlCnllbonai Corporation (SAIC)

Bo\VJinl Grcon SI8tc Um\.cniryPcnnsylvaniaStatcUni\'enily

Rut,e"Uni\'ersitySaudi c.roIlNI Reseereh AutnontySRJ Inlcmatiooal

UnivcDityo!Miuouri-RoIi.Universit)" of Utah

F.x-pro6tOr)'NUbons

FncoprofitOr)aNutJons

University of VcmwntUOIvcrsii}.o! Aluka.Fa.irbt.nb

For-rrofitOrpniutiunsNYPO -Offi" ofMeNl,emcnl Analysis &.PtannIO'

Fur-profirQrr:.niulions

Intcfl\lltioual Atomic EnOfJYAfcncy

T....E'lpenditurn

41,.13"66.944

'.5<14

$117.782

126.151134.1170

61.652

1.09151..\2.110."'577.4411

'.027

S406""Ji9

66.757103.675.150

104.11127.5117

IRI7125.832

243,362".S12

542.41811,67952.78133.95120.7::1(1.40)

'"(207)<",..)

171.455$105.830.570

$22.521

98.258

J,06450,061

$151..18.1

(13.229)

17.444

S6UiS

S2.4X,"025

$70,381

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:m30-USDA Phalli:II

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I. RD Y.. DeplU1mo::nlOf A,r1o;ultun:Departmenl or AancuhuR:Department or A,ncullUre

11 RD Y.. Department ofCommcll:cY.. Depoutmcn1of CommeR:eY.. [)qNutment "f CommeR:eY.. Department ofCommt:rceY.. DepartmentofCommereeY.. Depwtment "fCummcll:eY.. Department "fComrnc-n:eY.. Derat1ment ofCommel'tC

12 630 Y.. I>cpMrtmcntof Dcfel\5CRD Y.. DepantntntofDefenso::

Y.. Department "f DdemeY.. Dcputmc:nt "fDefclUCY" Department ofDefeMeY.. DepartmenlofDcfenlCY.. Department of Dcfc\1lCY.. Dcp8rtInentofDefeTIICY.. DepartmentofDcfen!ICY.. Oepurtmcnt "f DcnxY.. Departmen1 <IfDefen"t:Y.. I>cpMtmcnt of DefeTIICY.. Dcpwtmmt "f Ddel_Y.. Depoutmenlo)(1)den''t:Y.. Dcputment ofDcfellSOY.. DepartmcnlofDcfenscY.. Dcpaltmcnt "fDcfemcy" Dcpartrnent"fDcfelUC

14 RD Y.. Dcp.rtment of ""u:U1I&and Urban Development

IS RD Y.. Dcpar1mcflloflMlnknorY.. Dep.rtmenl of 1M InteriorY.. Dct-tmenloflM Interi\lr

16 RD Y..

y" Dcputmentof JUSbtc

17 RD Y.. De1ofLabor

19 RD Y.. DcpartmentOfStaIc

BATTELLE MEMORIAL INSTITIJTE AND SIJBSIDIARlE.<;

Schedule ofEICpCnd1lur.:sufFederal A",...dsScptcmher 30. 2006

Pri",elUPPCf Tkr <:onC...c.....

FtH'-proIiIOra.niz.auons

Amcn.:.an AHU.:I.ti,>nufSl.lk Hi,hWIIY. Tf8I1!1p>r't8llOnOflici.a11UNVC'rI1r.oflow.

UNvcnrtyofMu;:hlpn Tf8I1spor1a1lO1'1Rcsearch InSlllulCGrralcfCIC\clandOIt R~ TninsilAUlhunty

Nalumal c rerab\'C IIi,:hWIIYRC5C.8rchPro@:raJDWest Vlfllnia U"".Crslt)i

F<>r-p'0litOrprul.lbOnS

Oren Wood Libnry UfConllR'$:S

Fnr-profllOr)anizallons

IndianaUni\'crsityUnivcrsil)'of Ulllh

HcnbaeCallcacUNvCISII)'ofC8Iifom... SUI Dtc:ao

Univcnityof MlchipnOhioAerolplCelnstilulcUni"crsil)'ofMarylancf

Univcrsity DfMaryland -BaitimoR'Coullty

Ohio SIIIIeUNvcuilY

FOf"JIfUlitOrpniz.atiuni

University or Wasbin&tonUni..'ersil}' ofC8Iifomia obscr\'.alMcsSrnilhc,jlele

Juhn Hopkins Sl:OO,,1Oil'Pub!;c;Health

F profrIOrpnizabuDS

JamellOwnSKlallamTnbc:

FOC"profilOrpnizabuns

lowcr c,jurnbia Rivcr Estuary PartntrshipN.llona! Ceftkr fOf En"ronntental Rcscarcll

Ohio SIIIIeUniversity School of Public HcalthUnivcrsicyufArizona

Univcrsi~'ofCilKlnlUlb

UniversilyofC.lifl'lm18

f<>r-profIIOrl8nizabons

Drexel Univcnity

fOf'.profilO!J.nizauoI\IWashlllJlonStalcUnivcml)'

CmlmcR'ial Vchidc Safety Alli.necLower Columbia River Estuary Partnenhip

Ohio Board of RClcnbIowa Stale University .Iowa Ene,.)' Cenler

Univnsil)'ofMichipnUnivenil)" ofCbiCII,o. [)j\'ision ofchc Bioloaical Sc:icnc.osMontana Sl.Itc Uni"crsity

Bro"''U UniversityFuturrC'ocnIndustrial Alli.ancc.lnc

Ohio Dcplrtmcnl of Coal DevclopmenlMidwcstRcse.an:hlnsbtuteSMStuilcr

for-profit Orpnizations

Vi"ini. Pnlykchnic; ID!ltirutea. SI.IIeUni\'enily

T"~

Elporndicura

3.646.65599.<134

14475,652

(192)21.33629.011

SJ,a7i.047

$1.220,249

SI94,213

1.126.081

211,67610,450

1.19669,~550,143

470,0S419.602

31,144SI.~

12.92653.95730,912

."11.265~

SII5.160

$11.016

61808

121,11439,96A69.137

92.459

<"71.362

1.221

S4""S9.064

$9.745

77,93323.360,511

2.948511,746

109,S64Jl645411,171

5,015125.962116.855

92,6574.336.166

9,715JOJ.B79

2,201,956$30.190.170

3.83933.S43

s37.3i2

Suht:ontracWd

""".nnJ.3119

Contract Rd,SUBCONTRACT NO. S512521SSDAGREEMENT

AGREEMENT NO, OPJI979DTNH22..oI-l).07009 PO 4000090624 PHASE I ro 4000090631 PHASE "

SUBCONTRACT FOl5i5iSCRA SUBCONTRACT 9g..(1()Q45

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S325,176

(SHU5H) 2:\0141

$1(5.206 RQ OWLlOOW026

_HII, 161 _100i92

10411-('1119

1221119

43911I02J3662FOliS99

199.554 NNCOSAAO.1ASUBAWARD NOJroOOOOOOJ2761Al.'CT NO 00002Jt9

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SUBCONTRACT NO. 6072.()4..007

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GRANT AGREEMENT NO ~99-16

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BOO PROPOSAL NO. CP0566IgCR 1961S-42S443

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Code CfDA RAD Ff'Ckrai Alfttn.---y;;- l>epurtmomturTf8I1sportDbon

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21 RD V.. Dcpl1ltmcntoflMTr.:uurv

42 on V.. ltbnryOfCungrcS5

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47 04' V.. NIotioMISc)cnu Foundah(>nRD V.. N8liomalSctenc:eFoundlltiOfl

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60 RD V.. Smilluiooi.nllUitilulion

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77 on V.. Nocl", Rc:,uJ.lOry Col1lmilSlon

II 04' V" Dcputmcnl uf EnCIJRD V.. Dcp8lttncnlofEneflY

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SATTEllEMEMORIAL INSTITIJTE ANO SUBSIDIARIES

Schedule o(hpendllUrC'lo(Federai Award.Seplcmbe,)(I.2006

PriM~lUppef T1et C::-h'8c1nr

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N8INlnaIAtIOCiation orCollnh'''' Cily Hellilh Qtlicial.S)T8CIdIIUnlvenllVTOPtCftorColum UN\,,,,.1yThe Molecullf Sciencq In'lIllllo:

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BOARD OF REGENTS OF mE VNIV OF NEBRASKACOLUMBtI!! Olf HEALTit DEPT

1lJ..INOIS ClEAN COAL INSTITUTEMONTANA DEPARTMENT OF TRANSPORTA TI(JNNY DEYTOF ENVIRONMENTAL CONSERVATION

OH DEPT OF DEVElOPMENTOil DEPT OF DEVELOPMENTOil DEPTOF JOB" FAMILY SERVICES

OH OFFICE OF INFORMATION TECHNOlOOY011 OFFICE OF INFORMATION TECHNOLOGY

STATE OF CONNECTICUTSTATE OF CONNECTIarrWA DEP'TOF TRANSPORTATION

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~UW L'ONTRACT NO 1311992

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BATTELLE MEMORIAL INSTITUTE

Notes to Schedule of Expenditures of Federal Awards

September 30, 2006

(1) Basis of Presentation

The accompanying schedule of expenditures of federal awards (the Schedule) summarizes the expendituresof Battelle Memorial Institute and subsidiaries (Battelle) under programs funded by the federal governmentfor the year ended September 30, 2006. The Schedule has been prepared on the accrual basis ofaccounting.

For purposes of the Schedule, federal awards include all grants and contracts entered into directly betweenBattelle and agencies and departments of the federal government, as well as federal funds passed throughto Battelle by other recipients. The awards are classified as a major program in accordance with therequirements of Office of Management and Budget (OMB) Circular A-133, Audits of States, LocalGovernments, and Non-Profit Organizations. The Schedule includes only federal funds and other federalassistance received by Battelle and denotes the federal agency that is the source of those funds. As requiredby OMB Circular A-133, the Schedule does not include amounts received to operate government-owned,contractor-operated facilities.

Battelle's fiscal year 2006 major program is the research and development cluster. It includes those awardsthat are for technology-based research and development activities and for research training. OMB CircularA-133 defines research and development as follows: research is a systematic study directed toward fullerscientific knowledge or understanding of the subject studied; development is the systematic use ofknowledge and understanding gained from research directed toward the production of useful materials,devices, systems, or methods, including design and development of prototypes and processes.

(2) Summary of Significant Accounting Policies for Federal Program Expenditures

Expenditures consist of direct and indirect costs. Direct costs are those that can be easily identified with anindividual federally sponsored project. The salary cost of a Lead Scientist or Technical Specialist and thematerials consumed by the project are examples of direct costs.

Battelle uses indirect cost rates to charge indirect costs to individual federally sponsored projects. Indirectcosts are the costs of services and resources that benefit both federally sponsored and nonsponsoredprojects. The rate is the result of a number of complex cost allocation procedures that Battelle uses toallocate its indirect costs to both federally sponsored and nonsponsored activities. The indirect costsallocated to federally sponsored projects are divided by the direct costs of federally sponsored projects toarrive at a rate. Before the rates are used, the Defense Contract Audit Agency must approve them.

(3) Classified Information

Due to the nature of the Research and Development that Battelle performs on behalf of the FederalGovernment, various contracts and project information is considered either "Top Secret", "Secret", or"Confidential". As a result, the Schedule reflects summarized data by agency in order to properlysafeguard various information as required by the Federal Government.

(4) Relationship to Consolidated Financial Statements

Federal awards in the amount of $712,472,753 are reported as a portion of total project revenue inBattelle's consolidated financial statements as revenue from operations.

9

.h. ... ....

BATTELLE MEMORIAL INSTITUTE

Schedule of Findings and Questioned Costs

September 30, 2006

(1) Summary of Auditors' Results:

(a) The type of report issued on the consolidated financial statements: Unqualified Opinion

(b) Reportable conditions in internal control were disclosed by the audit of the consolidated financialstatements: None reportedMaterial weaknesses: No

(c) Noncompliance which is material to the consolidated financial statements: No

(d) Reportable conditions in internal control over major program: YesMaterial weaknesses: No

(e) The type of report issued on compliance for major program: Unqualified Opinion

(t) Any audit findings which are required to reported under section. 5IO(a}of OMS CircularA-133: Yes

(g) Major Program: Research and Development Cluster

(h) Dollar threshold used to distinguish between Type A and Type S programs: $3,000,000

(i) Auditee qualified as a low-risk auditee under section. 530 of OMS Circular A-I33: No

(2) Findings Relating to the Consolidated Financial Statements Reported in Accordance withGovernment Auditing Standards: None

10

BATTELLE MEMORIAL INSTITUTE

Schedule of Findings and Questioned Costs

September 30, 2006

(3) Findings and Questioned Costs relating to Federal Awards:

Findine: 06-01

Federal Program - Researchand DevelopmentCluster

CFDA No. - Research and Development Cluster

Federal Grantor - Various

Federal Contract Numbers - Various

Compliance Requirement - Allowable Costs/Cost Principles

Battelle Memorial Institute (Battelle) is exempt !Tom OMB Circular A-122 but is required to follow theFederal Acquisition Regulation (FAR). According to the FAR 31.201-2 (48 CFR Part 31), Battelle isrequired to have an adequate labor charging system.

Condition Found - Management of Battelle informed us that the Defense Contract Audit Agency(DCAA), Battelle's cognizant audit agency, reported that Pacific Northwest National Laboratory's(PNNL's) labor accounting system was "inadequate in part" for the period of October 2005 throughDecember 2006. The DCAA noted the following which they contend are significant deficiencies: I)Battelle does not account for uncompensated overtime; 2) when uncompensated overtime hours areworked, employees may use discretion to determine the number of hours recorded in a day and the costobjectives to which they are charged; and 3) employees change prior period timesheets to reflect workperformed in subsequent periods without maintaining documentation. DCAA contends the deficienciesnoted could result in an overstatement or an understatement of overhead rates charged by PNNL and non-compliance with Cost Accounting Standard (CAS) 418-40(c)(I). We have reviewed correspondencebetween PNNL and the DCAA and note that the final CAS non-compliance report is pending resolution.Approximately $39 million in federal awards were received and expended by PNNL for the fiscal yearended September 30, 2006. Of the $39 million, approximately $13 million represents labor charges fromexempt employees for these awards during the fiscal year.

Questioned Costs - No specific questioned costs were noted by the DCAA.

Effect - DCAA contends the deficiencies are significant and could result in non-compliance with theAllowable Costs/Cost Principles compliance requirement, as well as Cost Accounting Standards.

Recommendation - Battelle needs to establish a labor policy to ensure compliance with the AllowableCosts/Cost Principles compliance requirement and ensure that their labor charging system is adequate toprovide that costs claimed and reimbursed are allowable and allocable.

View of Responsible Official - Battelle expects the issue to be resolved in the next few months by thePacific Northwest Site Office DOE Contracting Officer (CO) making a written determination that PNNL'slabor system is adequate pending select changes in its time recording policy. There is precedent for thisoutcome as the last time DCAA raised this issue at PNNL (over a decade ago), the then CO made adetermination of compliance based on legal interpretation of cost accounting standards thereby resolvingthe issue over the objections ofDCAA.

II