Public Power Auditing and Governance Update American Public Power Association Savannah, Georgia September 15, 2009

Public Power Auditing and Governance Update

American Public Power AssociationSavannah, Georgia

September 15, 2009

Public Power Auditing and Governance UpdatePage 2

Today’s agenda

► Yellow Book and Related SAS 115 Update► American Recovery and Reinvestment Act (ARRA)► Recent Market Events:

Accounting and reporting considerations

► Sarbanes-Oxley Act Impact in the Public Power Sector

Yellow Book and Related SAS 115 Update


► Review of Government Auditing Standards► Changes to Government Auditing Standards due to July

2007 Revision► Review of SAS Number 115► Impact of SAS 115 on:

► GAS audits► A-133 audits


When GAS applies

► The financial statement audit of an entity is performed in accordance with GAS when subject to the requirements of:► OMB Circular A-133► Or other laws, contracts, regulations or agreements


Additional GAS requirements

► We assume certain responsibilities beyond those of audits performed in accordance with AICPA Standards

► GAS includes the following standards:► General ► AICPA fieldwork and reporting standards ► Additional fieldwork and reporting standards

► Additional report on internal control over financial reporting and on compliance and other matters


What GAS does not require

► An opinion on internal control over financial reporting ► Tests of internal control over financial reporting► An opinion on compliance


Additional GAS standards

► Continuing professional education► Quality control and assurance► Independence ► Auditor communication


Additional GAS standards

► Consideration of the results of previous audits and attestation engagements

► Developing elements of a finding ► Guidance on abuse► Reporting

► Restatements


General standards

Quality control and assurance► Auditor requested to provide most recent external quality

control review report and any letter of comments to the party contracting for the audit.


Auditor required communication

► Communication with management of the audited entity, those charged with governance, the individuals contracting for or requesting audit services, and the audit committee regarding the nature, timing, and extent of planned testing and reporting and the level of assurance provided.► Performed annually during planning


Abuse-a notion unique to GAS

► Distinct from fraud, illegal acts and violations of provisions of contracts or grant agreements.

► No law, regulation or grant agreement is violated. ► Involves behavior that is deficient or improper when compared

with behavior that a prudent person would consider reasonable and necessary business practice given the facts and circumstances


Additional guidance on abuse

► Auditors should be alert for situations or transactions that could be indicative of abuse.

► When information comes to the auditors attention that abuse may have occurred, ► May have to extend audit procedures in certain circumstances► Example – Travel and Entertainment market


Restatements – increased transparency – NEW for July 2007 Revision

► In response to frequent restatements of federal and other governmental financial statements

► Goes beyond AICPA standards► Auditors should advise management to make appropriate

disclosures when they believe it is likely that previously-issued financial statements are misstated and the misstatement is or reasonably could be material


Restatements – additional GAS requirements

► Evaluate the timeliness and appropriateness of management’s disclosure and actions to determine and correct misstatements in the previously-issued financial statements

► Report on restated financial statements► Report directly to appropriate officials when the audited

entity does not take the necessary steps


Restatements – evaluating management’s disclosure and actions

► Auditors should evaluate the timeliness and appropriateness of:► Management’s disclosures to those likely to rely on the financial

statements► Management’s actions to determine and correct misstatements in

previously-issued financial statements


Restatements – evaluation responsibilities

► Auditors should also evaluate whether management► Acted in an appropriate time frame after new information was

available► Disclosed the nature and extent of the known or likely material

misstatements► Disclosed whether specified information was in the entity’s

restated financial statements


Restatements – report on restated financial statements

► Explanatory paragraph includes► Disclosure that the previously-issued financial statements have

been restated► Statement that previously issued report should not be relied on

and is replaced by a revised report► Reference to the notes that discuss the restatement► If applicable, reference to the report on internal control


Restatements – direct reporting

► Auditors should notify those charged with governance:► If entity management does not act in an appropriate timeframe► Does not restate with reasonable timeliness► To take necessary steps to prevent further reliance on the

auditor’s report and advise them to notify oversight bodies and funding organizations

► If users not notified, auditors should make the notification


SAS No. 115, Communicating Internal Control Related Matters Identified in an Audit

► Effective for periods ending after 12/15/09► Ernst & Young has early implemented

► Supersedes SAS No. 112 of same title► To conform definitions of control deficiency (CD), significant

deficiency (SD), and material weakness (MW) to more closely align to AS 5


Main changes in internal control definitions

► No real change to CD or MW definition► SD’s

► Matters that merit the attention of those charged with governance


Material weakness

► A material weakness is a deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented or detected on a timely basis► Based on FASB 5 definition of “reasonably possible”► Lack of a material misstatement does not mean that you do not

have a material weakness


Significant deficiency

► A deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important to merit attention by those charged with governance


SAS 115 indicators

► No longer includes a list of deficiencies that ordinarily would be considered at least significant deficiencies

► Revises the list of deficiencies in internal control that are indicators of material weaknesses► Fraud by senior management► Restatements► Auditor found material adjustments► Ineffective oversight by governance


SAS 115 impact on GAS audits

► GAO has issued guidance allowing use of new SAS 115 definitions in the GAS report on internal control over financial reporting and on compliance and other matters


SAS 115 impact on A-133 audits

► Do not use the new SAS 115 definitions in A-133 internal control and compliance reports► Until such time as the OMB approves the new definitions and

AICPA adapts them for internal control over compliance


SAS 115 impact on A-133 audits

► Depending on timing of OMB approval:► Could have different definitions of CD, SD and MW in the GAS

internal control report and the A-133 internal control and compliance report within the same reporting package!

American Recovery and Reinvestment Act (ARRA)


American Recovery and Reinvestment Act (ARRA)

► Signed by President Obama in February of 2009► Goals of the Recovery Act

► To preserve and create jobs and promote economic recovery► To assist those most impacted by the recession► To provide investments needed to increase economic efficiency by

spurring technological advances in science, technology and health► To invest in transportation, environmental protection and other

infrastructure that will provide long-term economic benefits


Facts about ARRA

► No republicans in the House of Representatives voted for it

► Only two current republican senators voted for it► Spending and accountability for funds likely to be politically

charged

► Vice president in charge of Recovery Act aspects► Governors have to certify with respect to the propriety of

its spending


ARRA Impact

► Total cost of spending is $787 billion► 300 billion in grants

► Federal government is funneling billion of dollars to state and local governments (including public power entities), much of which will be subject to single audit► Significant increase in Department of Transportation funding► Environmental Protection Agency funding tripled


ARRA Impact

► 70 billion has been obligated by the federal government so far► 18 to 20 billion so far► 70% of grant funding expected to be disbursed by the end of the

summer of 09

► Speed of awarding funds► Many entities not subject to OMB Circular A-133 in the

past may now be subject to it


ARRA oversight and transparency

► Unprecedented oversight and transparency mandated► www.Recovery.gov ( announcements, agreements, program

managers, governors, mayors)

► Formation of the Recovery Act Accountability and Transparent Board► Created to review management of recovery dollars and to provide

early warning of problems► Seven member board includes federal agency inspector generals

and federal deputy cabinet secretaries► Coordinating and conducting oversight of federal spending under

the ARRA

http://www.recovery.gov/



► The GAO and the federal agency inspector generals have been provided additional funds and access for reviews of the act funds and spending

► The Recovery Act tasks GAO with a range of responsibilities to help promote accountability and transparency and ensure that these funds are used as specified


GAO Recovery Act Activities

► Conducting on site bi-monthly reviews on how funds are used by 16 states and the District of Columbia which contain 65% of the grant funds available through the Recovery Act► Review specific areas such as trade, education, small business

and health care► Commenting on reports filed by fund recipients

► GAO’s oversight work on the Recovery Act will be published on its web site at http://www.gao.gov/recovery/



► A-133 audit is an important part of the Recovery Act’s accountability mechanisms► Significant federal scrutiny via Quality Control Reviews (QCR’s) of

A-133 audits performed on entities receiving Recovery Act money (primarily in 2010-2011 time frame)► Results of QCR’s to be placed on recovery.gov► A-133 audit reporting packages to be made available at the federal

audit clearinghouse web site


ARRA Oversight and Transparency

► Federal OIG’s will use risk assessment techniques where data is available to identify high risk programs and non-federal entities to be targeted for priority audits and investigations with faster turnarounds► A-133 audits not performed until nine months after the end of the

recipient’s fiscal year


ARRA Implementation Guidance

► Initial implementing guidance issued on February 18, 2009 at http:www.recovery.gov/files/initial%20Recovery%20Act%20Implementing%20Guidance.pdf

► Follow-up implementing guidance issued on April 3, 2009 at http://www.recovery.gov/sites/default/files/m09-15.pdf


ARRA Compliance Requirements

► As required by section 1512, each direct recipient federal funds under ARRA must report the following information 10 days after each calendar quarter beginning on July 10, 2009► Total amount of recovery funds received from each federal agency► Amount of funds received that were obligated (encumbered) and

expended to projects or activities


ARRA Reporting Elements ( cont.)

► A detailed list of all projects or activities for which recovery funds were obligated and expended including:

► The name of the project or activity► A description of the project or activity► An evaluation of the project status of the project or activity► An estimate of the number of jobs created and the

number of jobs created and the number of jobs retained by the project or activity


ARRA Reporting Elements ( cont.)

► For infrastructure investments made by state and local governments, the purpose, total cost, justification for use of ARRA funds, and the name of a contact person

► Detailed information on any subcontracts or sub-grants awarded by the recipient, including the data elements required to comply with the Federal Funding Accountability and Transparency act of 2006 (P.L. 109-282), allowing aggregate reporting on awards below $25,000 or to individuals.


Other ARRA Reporting Issues

► Subrecipients may need to report information to enable direct recipients to report up to recovery.gov

► Accounting system capabilities► Resources

► Act provides no funding for recipients to administer the awards


Recovery Act Risks

► Many entities spending federal funds who have never gotten them before► Do they have the internal controls to properly expend these funds

► Many programs will significantly increase the amount of the federal funding they expend

► Are these entities equipped for such an increase in funding?► Staffing and controls


Recovery Act Risks

► A-133 audits are not due until nine months after year end► Thus for the fiscal year ending June 30, 2010, the A-133 audit is

not due until March 30, 2011► Half of the states are also late with their reports

► This timing may not result in timely accountability for Recovery Act Funds


Addressing Recovery Act Risks-Timing of A-133 Audits-Potential Solutions

► Reduce the deadline from nine months after year end► Quarterly recovery act compliance audits► Internal control reviews of entities spending Recovery Act

funds in a timely fashion after their receipt of recovery act funds

► Potential solutions applicable to all entities spending recovery act funds including second and third tier subrecipients


Recovery Act-Impact on All Programs

► Separate CFDA numbers for ARRA funding► Including separate CFDA numbers for ARRA funding that

supplements pre-existing programs

► Pass-through entities must provide this CFDA number to each entity they pass funds through


Recovery Act Impact on OMB Circular A-133 Audit

► Use of A-133 audit for risk assessment► Use for monitoring program

► Assignment of separate ARRA CFDA► Evaluate high risk programs and grantees► Separate reporting on SEFA and data collection form► Federal audit clearinghouse to display all ARRA findings


Recovery Act Impact on OMB Circular A-133 Compliance Supplement

► The 2009 OMB Circular A-133 Compliance Supplement includes a high level Appendix on the ARRA

► The OMB will issue interim updates to the Compliance Supplement to keep ARRA requirements current

► Stay plugged in on upcoming updates to the Compliance Supplement

► OIG’s will also provide training on ARRA requirements


Other A-133 audit impacts due to ARRA

► The A-133 reporting package will be publicly available in the federal audit clearinghouse for fiscal years ending on or after June 30, 2009► This includes the financial statements► Does not matter if the entity did not spend ARRA funds

► Keep social security numbers, check routing numbers and individual’s names out of the findings and corrective action plans to avoid privacy violations


Impact of Recovery Act Going Forward

► Some June 30, 2009 audits impacted► Bigger impact on June 30, 2010, audits► Changes that could impact major program determination

process► Non-static Compliance Supplement► Watch communications for further updates and

developments


Recovery Act Internal Control Considerations

► Consider whether control procedures in place over federal expenditures are appropriate, working properly, and designed to prevent unallowable expenditures

► Consider whether additional controls and system requirements will be needed to ensure that Recovery Act funds are able to be separately identified and tracked

► If applicable consider whether new controls are needed to meet the stringent reporting requirements back to federal agencies


Recovery Act Internal Control Considerations

► If Recovery Act funds will be passed down to subrecipients, controls should be in place to ensure appropriate subrecipient monitoring and also whether any new controls will need to be established related to new subrecipient reporting responsibilities

Recent market events:Accounting and reporting considerations


Overall economic conditions

► Steep adjustments in real estate values► Restricted criteria for obtaining capital► Liquidity concerns of financial institutions► Deterioration in consumer spending

These conditions create challenges for many companies, including public power organizations


Internal control

Issue: Maintaining effective internal control► Are existing controls sufficient:

► New material risks to operations, financial reporting, compliance or new fraud risk

► Changes in significance of risks


Valuation of investments

Issue: Measuring fair value of assets► Fair value is intended to convey the current value of an

asset or liability and not the potential value at some future date

► Understand sources of valuation► Quoted prices in active markets► Broker quotes► Methods and inputs used

► Are market participant assumptions used


Derivatives

Issue: Impact of counterparty creditworthiness► Severe deterioration could indicate a hedge is no longer

“highly effective” = loss of hedge accounting► Credit deterioration and bankruptcy could terminate a

derivative = receivable or payable on balance sheet► Possible ineffectiveness for continuing hedges;

particularly fair value hedges


Postretirement benefits

Issue: Plan assets valuation and assumptions► Fair value of plan assets affected by market conditions

► Hard to value assets (e.g., alternative investments)

► Discount rates used to measure the benefit obligation at the measurement date should be based on high quality fixed income instruments► Not investments that have been downgraded as a result of the credit crisis

below the “high-quality” rating level► Customized portfolios and use of spot curves require analysis

► Assumed returns on plan assets for next year should reflect current expectations of asset returns

► Recognition of an underfunded plan may have implications for debt covenant compliance


Debt

Issue: Debt covenants and financing concerns► Review for compliance with all provisions and covenants

(financial and non-financial)► Covenants that were met solely by amendment► Ability to comply in next 12 months► Waivers must be for at least 1 year plus 1 day

► Intent and demonstrated ability to refinance maturing debt long term should be documented to classify long term

► Lender concessions may be a troubled debt restructuring► Debt service securities may need to be replaced.► Subjective acceleration clauses may impact classification


Going concern

Issue: Declining operations and liquidity concerns could affect an organization’s ability to continue as a going concern►Evaluate conditions or events that may cast significant doubt on an organization’s ability to continue as a going concern►Management evaluates its sources of financing and liquidity

► Circumstances may impact management’s plans and assumptions regarding refinancing, rolling over existing debt, and other credit arrangements

►Management develops plan to mitigate going concern risk (e.g. improving operating results, financing strategies, increasing balance sheet liquidity)


Disclosures

Issue: What to disclose► Take a fresh look at financial statement disclosures

addressing risks, uncertainties and concentration of risks► Evaluate the sufficiency of MD&A, including liquidity plans

and how a rating change and/or increased funding costs might affect future earnings, the ability to enter into new business, ability to fund collateral calls or repurchase requests, etc.

► Challenge whether previously disclosed market risks should be updated to reflect current conditions

Sarbanes-Oxley Act Impact on the Public Power Sector


Objectives

► Review the S-O requirements► Learn what various industry and professional

organizations are doing► What are public sector organizations and municipal

utilities doing?► Auditor responses


The Act - Highlights

► Title II – Auditor Independence► Prohibition from certain non-audit services► Rotate lead and ind. partners every five years► Report various matters to the audit committee► Rules related to hiring from CPA firm► GAO to study mandatory rotation of firms

► Issued November 2003


The Act - Highlights

► Title III► Audit committee appoints/compensates auditor► Independent audit committee members► CEO/CFO certifications

► Title IV► Reporting on internal control (404)► Disclosures about code of ethics► At least one AC member is a financial expert


Industry Activities

► GAO – ► Mandatory Rotation Study► June 2003 Yellow Book introduction references S-O► Various comment letters to PCAOB► Testimony in support of SOX (SEC, PCAOB)


Industry Activities

► AICPA A&A Guide► Audit risk alert covers S-O briefly

► AICPA Government Audit Quality Center► Audit Committee Best Practices

► Example charters► Qualifications► Meeting guidelines


Industry Activities

► GFOA – Recommended Practices► “Enhancing Management Involvement with Internal Control (2004)

► Information and training of finance managers► Documentation of IC procedures► Periodic evaluations of controls


Industry Activities

► GFOA – Recommended Practices (cont.)► “Establishment of Audit Committees”

► Not new, but updated► Formally established (appropriate legal means)► Expertise and experience► Selected from outside the government► Oversee the independent audit► Selection of audit firm► Written reports to governing board


Industry Activities

► Ratings agency questions around governance► Risk management organizations (e.g., ERM initiatives –

especially in utilities)► Underwriters expectations


Marketplace Responses to S-O

► Improvements to existing audit committees► New/amended charters► Ensuring financial expertise

► Formation of audit committees► Changes in reporting of internal audit



► Adoption of code of ethics► Whistle-blower mechanism► CEO/CFO certification► Requests for auditor to review selected processes



► Establish/out-source internal audit function► Use of IA to implement 404-like internal review► ERM – linking risk management with governance


E&Y Response

► More audit committee disclosure, particularly about accounting policies► Discuss estimates and related assets and liabilities► Discuss firm QCR processes

► Recommendations to:► Establish/strengthen audit committees► Adopt ethics policies► Establish/reorganize internal audit► CEO/CFO certifications► Periodic IC evaluations by management


Thank you!

Thank you for attending this learning session.

Documents

Public Power Auditing and Governance Update American Public Power Association Savannah, Georgia September 15, 2009