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Inspector General

Report on Summarization of Head Start Grantee Audit Findings (A-07-91-00425)

Jo Anne B. Assistant Secretary for

Children and Families

The attached management advisory report on the Head Startprogram is provided for the purpose of alerting you andyour staff to the issues and concerns that have beenidentified by audits at Head Start grantees. Trainingand technical assistance as well as fiscal and programoversight would be helpful to correct persistentdeficiencies in grantee internal controls and reportingsystems.

The report includes a summary of over 4,000 Head Startprogram audit findings identified in some 1,200 auditreports issued between October 1, 1987, and August 30,

The audit reports issued by the Office ofInspector General were performed by certified publicaccountants and other nonfederal auditors to satisfy themandated Head Start program audit requirements. Findingsand recommendations in these reports were previouslysubmitted to the Office of Human Development Services forresolution under the Departments' audit resolutionprocess. In some instances, we noted recurring problemswere reported over several years by the nonfederalauditors. This indicates a need to reevaluate the auditresolution procedures of the Administration for Childrenand Families (ACF).

The major management control problems related toaccountability over grant funds. Accountability findingsencompassed the adequacy of the internal control systems,recordkeeping systems and procedures, financial andprogram reporting and cash management controls. Weidentified concerns with accountability over programfunds at 530 grantees. This represents about 71 percentof the grantees that were audited and 51 percent of thetotal findings identified. Strengthening internalcontrols at the grantee level provides opportunities forbetter use of program funds as well as enhancement to thefiscal integrity of the grantee program system.

- Jo Anne B.

The reports disclosed the following types of specificproblems:

o Head Start funds were not being placed interest bearing accounts as required by Federalregulations;

o Head Start funds were loaned to other granteeprograms:

o financial reports contained inaccurate/incompleteinformation;

0 matching requirements were not met: and

0 weaknesses existed in student eligibility or enrollment procedures.

The summarization of audit findings along with oursupplemental analyses reemphasizes the need for theACF to continue strengthening its monitoring andoversight efforts over its some 1,300 grantees chargedwith the responsibility for administering the Head Startprogram.

We are recommending that ACF reevaluate all importantaspects of financial management and accountabilityincluding technical assistance, financial reporting,tracking audit reports and audit resolution. Inaddition, due to the anticipated expansion in the numberof grantees, for all new grantees ACF should considerprior to the issuance of the grant award performing afinancial management capability review. This review isdesigned to assess the strengths and weaknesses of thefinancial management systems established to controlFederal funds and to detect and correct deficienciesduring the early stages of the grant award process. Weare not making any further recommendations relating tomonitoring and oversight since action is already underwaythrough the Federal Managers' Financial Integrity Actprocess to improve monitoring and oversight activities.

We believe that this document will provide some insightsand will be helpful as ACF implements its Head Startexpansion program.

Comments to our draft report indicate that the ACF is ingeneral agreement with the recommendations contained inthe report. The comments also indicate that the ACF has

implementation of most of theserecommendations. A copy of these comments have beenincorporated to the report as Appendix I.

Jo Anne B.

If you have any please call me or have yourstaff contact John A. Ferris, Assistant Inspector Generalfor Human, Family and Departmental Services Audits, at(202) 619-1175. .

Attachment

D e p a r t m e n t o f H e a l t h a n d H u m a n S e r v i c e s

CIN: A-07-91-00425

SUMMARY

This management advisory report presents the results ofour study and analysis of Head Start grantee findingsidentified in 1,262 audits performed by certified publicaccountants and other nonfederal auditors generally tosatisfy Federal program audit requirements. Theobjectives of our review were to categorize and summarizeinstances of noncompliance and internal control weaknesscontained in reports and identify target areas ofpotential risk for the program.

The report summarizes problem areas relating toaccounting and management control systems at the programgrantee level that require fiscal and program oversightefforts to ensure that the Head Start grantees haveadequate management systems and controls in place toprotect the integrity and stewardship of Federal programfunds. Appendix A contains an identification of thetypes of findings reported by the nonfederal auditors andthe total number of findings reported for each category.

The problems identified can be categorized into thefollowing three generalized areas of concern.

ACCOUNTABILITY These findings encompassed thestructure of the internal control systems, recordkeeping systems and procedures, and financialreporting. Accountability problems relate to suchmatters as policies and procedures being incompleteand/or not being followed; accounting records notcontaining up-to-date information: travel expenseswere not documented: and financial reports weresubmitted untimely and information contained in thesubmitted financial reports to Federal officials wasinaccurate.

GRANT MANAGEMENT These findings relate tocompliance with Federal rules and regulations-inadequate files to support the eligibility ofchildren to participate in the program, dailyattendance requirements were not met, grantee didnot meet the mandatory matching requirements andcenters were not in full compliance with the State'slicensing requirements.

CASH MANAGEMENT Problems related to the adequacyof the systems used to safeguard cash. Thefollowing types of problems were noted: programfunds not being kept in interest bearing accounts asrequired, interest earned on grant funds not beingreturned to the Federal Government on a timely

basis, Head Start funds were loaned to otherprograms and to the unrestricted accounts throughinterfund transfers, grant funds were deposited inunsecured bank accounts with balances that exceededFederal Deposit Insurance Corporation (FDIC) limits,drawdowns from the Department's Payment ManagementSystem (PMS) were untimely or the cash on handexceeded the cash needed and unobligated fundbalances were not reprogrammed or returned on atimely basis.

Officials should already be aware of the issues inthis report, because the issues have been includedin individual nonfederal audit reports on thegrantees and the reports have been throughAdministration for Children and Families (ACF) auditresolution process. However, this report presents aprogramwide picture of grantee problems whichrequire ACF reevaluation of all important aspects ofmanagement and accountability including technicalassistance, financial reporting, tracking auditreports and audit resolution.

The processes or action steps that can be taken by ACF toimprove the fiscal accountability of Head Start granteefunds are as follows:

--increase training and technical assistance tograntees;

--continue strengthening its monitoring proceduresto improve grantee accountability;

--implement the new audit requirement for nonprofitorganizations administering Federal programsmandated by Office of Management and Budget (OMB)Circular A-133;

--strengthen procedures to ensure all grantees useinterest bearing accounts and properly refundinterest income;

--develop procedures to detect grantees withinterfund transfers;

--reevaluate procedures to ensure excess cash is notdrawn and obtain evidence that legitimate balancesin excess of the FDIC limit are collaterallysecured when awarding grants;

--reemphasize to grantees' that the nonfederal matchis to be properly documented and met;

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--require evidence during the grant applicationprocess of current licensing or compliance withall of the facility standards; and

--emphasize the possibility of savings to the HeadStart program through use of sales tax exemptionsand timely deposits of tax refunds.

In the comments to our draft report, the ACF generallyagreed with our recommendations. A summary of comments and the related Office of Inspector General(OIG) response is included after each recommendation.The full text of comments have been incorporated tothis report as Appendix I.

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TABLE OF CONTENTS

Summary i

Introduction

Background 1

Scope 1

Findings and Recommendations

Accountability 3Recommendation 6

Nonprofit Financial Statements 79Recommendation

Interest Bearing Accounts 10Recommendation 11

Interfund Transfers 11Recommendation 12

FDIC Limits 12Recommendation 13

Matching Requirements 14Recommendation 14

Grant Management 14Recommendation 16

Facilities 16Recommendation 17

Sales Tax 17Recommendation 18

Appendices

Findings Identified in Nonfederal Audit ReportsGeographical Distribution of Review StatisticsGeographical Distribution of Finding CategoriesGeographical Distribution of Accountability FindingsDistribution of Review Statistics by Type of GranteeDistribution of Findings by Type of GranteeDistribution of Accountability Findings by Type of

c -

GranteeTime Lapse Comparison Nonfederal Head Start auditsACF Response

INTRODUCTION

BACKGROUND

Head Start is a national program providing comprehensivechild development services. The overall goal of HeadStart is to bring about a greater degree of socialcompetence in children who may be economicallydisadvantaged or have special education or service needs.Social competence is defined as a child's everydayeffectiveness in dealing with their environment and laterresponsibilities in school and life.

Head Start is administered by the Commissioner,Administration for Children, Youth and Families withinthe Administration for Children and Families (ACF). HeadStart is the largest federally funded child developmentprogram, and it is 1 of the few large programs in theDepartment funded directly to local grantees through the10 regional offices. Congressional appropriations forthe 3 Fiscal Years 1988, 1989 and 1990 represented in thereview were approximately $3.83 billion with children served during that time frame.

Grantees include local governments, school boards,community action agencies and single purpose nonprofitorganizations. Grantees are required to contribute ormatch at least 20 percent of the cost of the program eachgrant year. Grantees submit grant applications which arereviewed and approved by the ACF regional and/orheadquarter office. Except for headquarters administeredgrants, the regions are responsible for monitoringgrantees and resolving audit findings identified innonfederal audits.

To ensure the safety and well being of the children aswell as promote the educational process, Head Startfacilities must meet facility standards and/or obtainlocal licenses. Compliance with standards is a conditionof funding.

SCOPE

To review Head Start findings in nonfederal auditreports, we started with the Audit Inspections ManagementSystem (AIMS), an OIG management information data base,for the period October 1, 1987 through August 30, 1990.A total of 2,776 of the 10,125 nonfederal audit reportsin AIMS indicated that Head Start funding was included

and 1,262 reports from 719 grantees were identified ascontaining Head Start findings. Findings related tothese reports were as follows:

Number ofReports Findings

Nonfederal Audit Reports in AIMS 10,125 20,929Reports With Head Start Funding 2,776 5,616Reports With Head Start Findings 1,262 4,027

We obtained a brief description of the finding, theamount of Head Start expenditures, and total expendituresfor the 4,027 Head Start findings from the regional OIGoffices. The identifying information from all regionswas analyzed and findings were assigned codes designatingspecific problems and type of grantee. The 1,262 reportscontained Head Start expenditures of $1.4 billion. Themajority of the Head Start grantees submitting these1,262 reports with findings were either Community ActionAgencies (27 percent) or other nonprofit organizations(56 percent).

This report is based on our analysis of findings in theAIMS data base, with two exceptions. First, we selected30 organization-wide nonprofit audit reports which hadnot yet been processed through AIMS to determine whetherthe financial statements were consistent in theirpresentation of the grantees' financial conditions.These 30 audit reports were selected because they wereeasily identified as organization-wide audits, as havingdirect Head Start funding, and as having total Head Startexpenditures of $500,000 or more. Second, we used twononprofit audit reports which were not in AIMS toillustrate problems with interfund transfers. These tworeports were easily identified because they werecurrently being processed by us.

Our report includes nine appendices. Appendix A containsa detailed listing of findings that were identified inthe nonfederal audit reports. Appendices B and E containHead Start statistics broken out by Federal region and bytype of grantee, respectively. Appendices C and Fcontain our review findings broken out by Federal regionand by type of grantee, respectively. Appendices D and Gcontain details on the accountability problems broken outby Federal region and by type of grantee, respectively,and Appendix H contains a comparison of the timeliness ofaudit information between the Head Start program annualrequirement and the new OMB mandated audit requirementsfor nonprofit organizations. Appendix I incorporates

comments to a draft of this report.

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Our analysis was performed in Kansas City, Missouri andWashington, District of Columbia during the periodOctober 15, 1990 to June 15, 1991.

FINDINGS AND RECOMMENDATIONS

ACCOUNTABILITY

Accounting is defined as the process of recordingtransactions and events affecting the grantee andcommunicating this information to external decisionmakers.

Issues related to accounting and the system ofaccountability comprised 51 percent of the totalinstances of noncompliance reported by the auditors.At first, we believed that the noncompliance resultedbecause grantees were small and lacked sufficientlytrained staff to properly account for the funds.However, we found that 62 percent of the reports withaccounting problems related to grantees with over$1 million in total expenditures.

Most accounting texts identify reliability,comparability, and relevance as the characteristics thatmake information useful for decision making. We usedthese characteristics to evaluate accountability.

Reliability is the quality that assures informationis reasonably free from error and bias and iscorrectly represented. Maintaining accurate, timelyrecords is the foundation of financial accountingand the basis for reliability. To be reliable,information must be verifiable.

We believe Head Start financial information is notalways verifiable because of the lack of soundaccounting standards and practices in granteeaccounting systems. Accounting procedures wereidentified as inadequate or not implemented in 314instances, including 45 for lack of segregation ofduties. There were 632 instances that related toinaccurate general ledgers, accounting records,bank statement reconciliations, monthly financialstatements, grantee records, and other keeping errors.

Inadequate documentation, inaccurate records, andlack of segregation of duties were also problemareas for cash controls. These deficienciesresulted in 352 instances of problems such asunauthorized disbursements, untimely recording of

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deposits and checks, and cash receipts anddisbursements not segregated or not recordedproperly.

Inadequate recordkeeping also affected fixed assetmanagement and travel with 223 weaknesses concerninginventories not taken or inaccurate fixed assetrecord management and 74 instances related to traveldocumentation.

We believe these weaknesses indicate that granteesare not managing the accounting process in anaccurate and timely manner. Therefore, financialinformation is not totally reliable for use by HeadStart program decision makers.

is the quality of accountinginformation that enables users to identifysimilarities in and differences between two sets ofdata. Because of their detachment from the grantee,external users cannot directly obtain specificinformation from the grantee, and therefore, mustrely on the financial statements. We determinedthat the financial information displayed innonfederal audit reports of nonprofit organizationswas not consistent or comparable for Federalfinancial management, because Generally AcceptedAccounting Principles (GAAP) for nonprofits were notwell defined. (This issue is discussed later in thereport. See Nonprofit Financial Statements.)

Relevance relates specific items of information to aparticular grantee and is a function ofpredictability, timeliness and feedback.

--To be relevant to a decision concerning fundingfor a grantee, accounting information shouldpredict cash flows and measure the risk associatedwith grantee activities.

The application process for Head Start fundingrequires the submission of a budget for the fiscalperiod to be funded. A grant award constitutesprior approval for the expenditure of funds forspecific items included in that budget. Granteesmay make revisions between and among most budgetcategories to meet unanticipated requirements,provided that grant funds will be used forpurposes consistent with Federal regulations orpolicies governing the program. Grant budgetrevisions exceeding Federal flexibility guidelines

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and requiring prior approval from Head Startprogram officials are explicit.

--Timeliness is essential for information to berelevant because information obtained too latecannot be useful to a decision maker.

Head Start grantees are required to submitFinancial Status Reports (FSR) to report grantawards and program expenditures. These reportsare submitted quarterly or semiannually, due 30days after the end of the first period and yearly90 days after the end of the budget period. TheFSR identifies program outlays and income on thesame accounting basis used in the granteeaccounting system. Information reported must bereconcilable to the grantee books. Up to 90 daysof Federal funding for a new grant period willhave transpired before a review of the prior yearperformance can be made.

--To be relevant to the decision maker, users mustbe able to obtain feedback from the information toconfirm or correct prior expectations.

Head Start grantees receive cash drawdowns fromPMS. After grant awards are approved, the amountsare recorded in the PMS system. The PMS requiresthe recipient to submit the Federal CashTransaction Report 15 days after the end of thequarter to report Federal cash disbursements andthe cash balance. The PMS does not have anyinformation to verify amounts submitted on thereport. Through the use of computer controls,total drawdowns are limited to total awards.

With the exception of on-site visits, programofficials do not receive information on theaccuracy of the Cash Transaction Report and theFSR until the audit report is submitted. Onlyduring the independent audit is it determinedwhether these reports were correctly prepared fromthe accounting system. Generally, the auditreport is the only means available to the programofficials to reconcile grant drawdowns, grantawards and expenditures.

In 85 instances, the auditors reported inadequate budgetcontrols or unapproved budget revisions. In 109instances, required reports were not timely. In 273instances, the required reports were inaccurate.

We believe that problems with accountability,particularly timeliness, will increase in future years.For nonprofit audits of fiscal years that begin on orafter January 1, 1990, OMB Circular A-133 will allowaudits to be performed every 2 years rather thanannually. The grantee is allowed 13 months after the endof the period to complete and submit the audit.Therefore, information on the first year's expenditureswill be over 2 years old and for the second year will be13 months old before the granting agency is informedabout the accuracy of the FSR. Program officials will beawarding new funding before an evaluation can be made ofprior financial performance. See Appendix H for the timelapse comparison for nonfederal audits between the priorannual program audit and the new OMB audit requirement.Alternative methods and approaches will need to bedeveloped by ACF to ensure timely closeout of grantsusing the nonfederal audit reports as a check on theaccuracy of the closeout process as opposed to totalreliance on audit reports for closeout.

Recommendation

We recommend that the ACF:

--continue strengthening its monitoring proceduresto improve grantee accountability;

--develop alternative procedures for timely closeoutof grants, placing less reliance on the nonfederalaudit reports; and

--focus the technical training workshops towardsdeveloping model systems, techniques and methodsto improve grantee accountability.

ACF Comments

The ACF stated in their written response that they sharedour concerns that the provisions of OMB Circular A-133will not permit the program to assure timely closeout ofgrants. However, they believe that appropriatenonfederal audit procedures are the correct method fortimely closeout of grants. The comments indicated thatfor Head Start, the financial audit is an essentialinformational tool for managers in making decisions, suchas grant closeout. Finally, ACF indicated that they will

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continue to explore alternatives which will provide themwith the information to provide necessary oversight ofHead Start grantee financial management.

OIG Response

The ACF comments did not address their current practiceof grant closeout using the grantees final FSR in lieu ofreceiving the audit report. This practice has beenfollowed since the Head Start program audit guide wasphased out in the early and the requirements forState and local governments of an annual program auditwhere changed in 1984 (OMB Circular A-128). In addition,the ACF is currently refunding grantees under the skipyear concept (Final FSR for Fiscal Year 1 will be used toadjust funding for Fiscal Year with or without theaudit report for the corresponding Fiscal Year.Therefore, we believe that ACF should develop alternativeprocedures for the timely closeout of grants using thenonfederal audit reports as a check on the accuracy ofthe process.

NONPROFIT FINANCIAL STATEMENTS

As a part of this review, we made a comparison of thefinancial statements of 30 organization-wide nonprofitaudits covering Head Start funds. This comparison wasperformed to determine if there were any trends thatcould be used to evaluate financial performance andpredict potential problems. However, we were unable toidentify trends because numerous bases of accounting andreporting formats were being used.

While the financial statements in the audit reports werepresented in accordance with GAAP, this presentation didnot signify comparability. Currently, GAAP allowsalternative treatments for like items. Statements can beprepared on a full accrual, modified accrual, or modifiedcash basis and still comply with GAAP.

In our review we identified 28 grantees which did notpresent a Statement on Changes in Financial Position.The Statement of Changes in Financial Position providesinformation with regard to investing and financingactivities, financial risk and future financial resourceflows. More specifically, the statement aids users inanswering financial questions such as:

--Does the decreasing trend in internal financingindicate serious future problems?

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--Does the source of financing indicate that therisk due to the use of debt is too high?

We noted that the guide for Voluntary Health and WelfareOrganizations prepared by the American Institute ofCertified Public Accountants (AICPA) does not require thepresentation of a Statement of Changes in FinancialPosition. Further, research indicated that four auditand accounting guides prepared by the AICPA for nonprofitgrantees describe a total of seven different financialstatements, of which, only three or four are required,depending on the grantee.

The fundamental purpose of accounting is to communicatefinancial information to assist in the evaluation ofprior performance, display current financial position aid in the planning of future actions. Although acertain degree of flexibility in format and financialstatement classifications is generally considereddesirable to allow the presentation of specialsituations, we believe there must be a reasonable degreeof uniformity. The use of inconsistent and uniqueclassifications can conceal waste and inefficiency andprevent Federal resources from being allocated in areasonable manner. Our review of the 30 audit reportsindicated that the financial statements did not clearlypresent the grantees' assets and liabilities.

For example, in a report not included in the 30 mentionedpreviously, assets of 1 grantee were seized by theInternal Revenue Service for failure to pay withholdingtax. Apparently, Head Start program officials wereunaware of these debts because the debts never appearedon the financial statements. Without the use ofaccruals, there was no clear indication of debtstructure, and it was not possible to assess the abilityof the grantee to meet future obligations or judge theability of the grantee to continue as a going concern.

According to Government Auditing Standards, the FinancialAccounting Standards Board (FASB) will establishaccounting principles for nongovernment grantees. Sincethe inception of the FASB in 1973, the majority of thestandards set have pertained to profit orientedbusinesses. A set of GAAP for nonprofit organizationshas not been established by the FASB. Instead, variousindustry groups have developed uniform accountingprinciples applicable to their type of nonprofitorganizations. Also, the AICPA has issued audit guidescovering certain types of organizations, and a Statementof Position covering all other nonprofit organizationsnot covered by the audit guides. Accordingly, financial

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information has been presented under different bases ofaccounting and in various formats all of which arecurrently considered "Generally Accepted." Generallyaccepted auditing standards allow the auditor to relyupon industry practice in determining generally acceptedaccounting practice.

In December 1988 the AICPA issued a report to the FASB onfinancial presentation that proposed recommendations forpossible solutions to the format and classificationvariances of nonprofit organizations. Since that time,the FASB has not taken any decisive action and haspostponed deliberations on the issue. According to thelatest schedule, a draft exposure statement is notexpected to be issued until the fourth quarter of 1991and public hearings cannot be considered until sometimein 1992. The FASB has not scheduled a date for adoptionof a final statement. However, based on normalpractices, a.final statement cannot be expected before1993.

Issuance of OMB Circular A-133 will intensify the needfor a consistent definition of nonprofit GAAP for fiscalyears that begin on or after January 1, 1990. For OMBCircular A-128, OMB mandated a specific set of financialstatements for State and local governments which theAICPA and others helped develop. The same action isexpected for OMB Circular A-133.

Recommendation


--closely observe the progress being made bythe AICPA and the OMB in formulating requiredfinancial statements for nonprofit organizationsproviding guidance to its grantees when literatureis available.

--implement the new audit requirement, OMB CircularA-133, as this will improve the consistency ofaudited financial statements.

ACF Comments

The ACF concurred with our recommendation that theyclosely observe the progress being made by the AICPA andthe OMB in formulating required financial statements fornonprofit organizations and providing guidance to itsgrantees when literature is available. The ACF statedthat they recognize the value of a consistent definitionof GAAP for nonprofit organizations and that their grants

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office will be asked to monitor this important activityand keep programs abreast of progress. However, in theircomments, the ACF did not fully agree as to the futureusefulness of nonfederal audits of nonprofitorganizations as mandated by OMB Circular A-133. The ACFis very concerned that the new provision of A-133, whichdoes not require an audit to be completed until 13 monthsafter the end of the budget period, willconsiderably reduce the value of the audit as amanagement tool. In addition, ACF stated that prior toOMB Circular A-133, Head Start audits were due annually,no later than 120 days from the end of the budget period,allowing adequate time to review the audit and to discusswith the grantee any compliance issues prior torefunding. Finally, the ACF would also like to look intothe possibility of using the flexibility provided in theCircular to require annual program rather thaninstitutional audits of Head Start grantees, whereappropriate.

OIG Response

We do not agree with the ACF statement that theimplementation of OMB Circular A-133 could reduce thevalue of audits as a management tool. The ACF responsedid not clearly address the current lack of consistencyamong nonprofit financial statements. As previouslystated in the report, this lack of consistency precludescomparisons to determine if any trends exist that couldbe used to evaluate financial performance and predictpotential problems. We believe that implementing theprovisions of the Circular will provide ACF with abetter, more comparable management tool than previousnonprofit financial statements. In addition, the ACFmust understand that implementation of OMB CircularA-133 is mandatory and not optional.

INTEREST BEARING ACCOUNTS

Federal regulations require nonprofit organizations tomaintain Federal funds in interest bearing accounts andremit earnings in excess of $100 annually to the FederalGovernment on a quarterly basis. In 124 instances,auditors reported that grant funds had not been depositedin interest bearing accounts or the grantee had notremitted interest earned. For eight grantees, failure todeposit program funds in interest bearing accounts or toremit interest earned on Federal funds was a recurringproblem, continuing for 2 or more years.

Federal income is reduced when grantees earn interest onadvances, but do not remit the proceeds to the Federal

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Government. Federal regulations dictate the method ofrepaying interest earned on advances of grant funds.When grantees do not deposit program funds in interestbearing accounts or remit interest earned, potentialFederal income is lost.

Because the issue represents potential monetary loss tothe Federal Government, we believe that monitoringprocedures related to interest income should bestrengthened.

Recommendation


--strengthen procedures to ensure all grantees useinterest bearing accounts and properly earn andrefund interest income.

ACF Comments

The ACF concurred with our recommendation.

INTERFUND TRANSFERS

Requesting funds which are not necessary for the HeadStart program and transferring these funds to otherprograms is contrary to Federal regulations. Theregulations specifically state that grantees may notrequest advances in excess of the Federal share ofprojected outlays. Further, grant funds may only be usedfor allowable costs of activities for which the grant wasawarded and may not be transferred to other programs.In 109 instances funds were transferred between programsin nonprofit grantees to cover cash flow needs.Approximately $967,000 in Head Start funds had beenloaned to other programs.

Analysis showed that 16 grantees had recurring interfundtransfers. For example, one grantee loaned moniesbetween programs to meet short-term cash needs for 2years and had interfund receivables/payables outstandingat the end of the grant year, while another granteetransferred monies to pay the expenditures of otherprograms for 3 consecutive years.

Transferring or loaning these funds to other programs mayalso result in Head Start deficits. Further, we believeunauthorized lending and borrowing of grant funds canresult in increased interest cost to the FederalGovernment and the risk of loss due to misappropriation.

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Two audit reports not yet entered into AIMS at the timeof our review further illustrate the interfund transferproblem. One grantee transferred a deficit of $176,681from the unrestricted fund balance to the Head Start fundwith the approval of regional Head Start officials. Thedeficit was caused by an over expenditure in the prioryear when Head Start funds were transferred to coverexpenditures applicable to an expected Social Servicesgrant that was never approved. Another granteetransferred Head Start funds to other programs and toanother corporation. The grantee used Head Start fundsfor purposes not related to the program and had no HeadStart expenditures for the last 2 years.

Recommendation


--develop procedures to detect grantees withinterfund transfers. The starting point may be adetailed analyses of the financial statements.

ACF Comments


FDIC LIMITS

Federal regulations require that grantees make provisionsto ensure amounts in excess of the FDIC limit arecollaterally secured. Uncollateralized deposits inexcess of FDIC limits could be lost if banks becomeinsolvent. According to the Wall Street Journal,January 17, 1991, 31 nonprofits recently lost money dueto the failure of a New York bank. Further, a large losscould also result in inability to operate the program orinsolvency of the grantee.

We identified 20 instances where the bank accountbalances in excess of the $100,000 FDIC limit were notcollaterally secured. Two of the grantees had recurringfindings.

Large cash balances could result from poor cashmanagement. There were 106 instances where drawdownswere untimely or exceeded the cash needed to operate theprogram. Further, in 13 of the 20 instances wherebalances exceeded the FDIC limit, total annual expensesof the Head Start program were less than $1.2 million andequal monthly drawdowns would not have exceeded $100,000.However, balances at these grantees still exceeded the

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$100,000 insurance limit. Therefore, an excessive cashbalance was being maintained.

With a personal computer and a modem, grantees canrequest funds as frequently as daily from the PMS. Fundsrequested via computer or by mail are electronicallytransferred to a local bank. Therefore, most granteesshould be able to prevent balances in excess of thelimit.

Grantees with large grants could legitimately haveindividual drawdowns that exceed the FDIC limit due tothe size of the program. If large balances areunavoidable, the excessive balance over the FDIC limitshould be collateralized to eliminate the risk of loss.

Due to the increasing frequency of bank failures, strictadherence to cash management regulations should berequired.

Recommendation


--strengthen procedures to ensure excess cash is notdrawn and obtain evidence that legitimate balancesin excess of the FDIC limit are collaterallysecured when awarding grants.

ACF Comments

The ACF did not concur with our recommendation to obtainevidence that legitimate balances in excess of the FDIClimit are collaterally secured when awarding grants. Intheir written comments, the ACF stated that this findingand recommendation in the report illustrates misrepresentation of the rules on FDIC limits, and addedthat "current rules require Federal fiscal officers toinsure that legitimate balances in excess of FDIC limitsare collaterally secured, however, we know of no suchrequirement for grantees in either law or Federal

OIG Response

The ACF stated in its response that they do not know ofany current requirements to insure legitimate balances inexcess of FDIC limits other than those for Federal fiscalofficers. The aforementioned requirement is contained inattachment A of OMB Circular A-110 (Grants and Agreementswith Institutions of Higher Education, Hospitals, andother Nonprofit Organizations) and applies, by

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definition, to all Head Start grantees that are nonprofitorganizations. There is no possible misrepresentation ofthis fact. Therefore, we do not agree with the ACFstatement and believe that this requirement must befulfilled.

MATCHING REQUIREMENTS

Each grantee is required to contribute 20 percent of thetotal cost of the Head Start program. This contributionmay be in cash, in-kind services and equipment, orallowable costs borne by nonfederal grants. When thismatching requirement is not met, the grantee must obtainapproval from Head Start program officials for a smallermatch or return grant funds not matched. When a HeadStart grantee must return Federal funds because the matchis not met, the ability of the grantee to provideservices may be restricted and ultimately the childrenmay not receive a level of service that was expected whenthe grant funds were awarded.

In 233 instances, grantees did not comply with variousaspects of the Federal regulations regarding the matchingrequirements. In 81 of these cases, the required 20percent match was not met. About $6.8 million in Federalfunds were identified as not having the required matchingcontribution.

Inadequate or inaccurate documentation of matching wasidentified in 100 instances. In 52 other cases, impropervaluation of in-kind contributions was a problem.Federal regulations dictate the method of valuation formany types of property and services. Records must showhow the value placed on in-kind contributions wascalculated.

Recommendation


--reemphasize to grantees that the nonfederal matchis to be properly documented and met.

ACF Comments


GRANT MANAGEMENT

There were 1,000 instances of weaknesses andnoncompliance that we categorized as grant managementproblems. These instances related to eligibility,

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attendance, salaries and fringe benefits, fund balances,expenditures in excess of budget, indirect costs, biddingregulations, prior approval and other cost issues.

--In 254 cases, eligibility or enrollmentrequirements were not met, including 145 relatedto inaccurate or inadequate documentation and 109related to inadequate procedures for enrollment.Family income must be verified by the granteebefore a child is determined eligible toparticipate in the program. Verification ofincome must be documented in the file.

-In 78 cases, attendance expectations were not metor were inadequate. According to the programgoals, Head Start grantees are expected tomaintain a minimum average daily attendance rateof 85 percent of their funded level of enrollment.Grantees are expected to analyze the causes ofabsenteeism and develop strategies to improvetheir attendance rate if it dips below 85 percent.Follow-up support services are expected to beprovided to families when a child has 3 or moredays of unexcused absence.

-- 102 cases, salaries and fringe benefits were unallowable, or incorrect or related procedures were deficient. Of the 102 cases, 9 related to unallowable employee bonuses, 46 related to unallowable employee fringe benefits and 47 encompassed diverse salary issues such as inaccurate payroll tax calculation, no segregation of payroll duties, and inadequate payroll documentation.

--In 78 cases, unobligated fund balances were aproblem. Generally, the problem occurred becauseunobligated balances were not returned orreprogrammed in a timely manner as required. Innine cases, the unobligated balance related to agrantee whose funding was discontinued.

--In 73 cases, grantee expenditures exceeded thegrant award. We believe these instances may haveresulted from poor management of the budget.

--In 48 cases, indirect cost rates were notapproved, developed, or correctly utilized.

--In 39 cases, bidding regulations for purchaseswere not followed.

15

--In 38 cases, prior approval requirements forproperty were not met. Prior approval from HeadStart program officials is required for equipmentpurchases and for transfer of property.

--In 290 cases, other cost issues were identified.Included were 247 unauthorized programexpenditures, 6 related party transactions and 37cases where costs were allocated to improper grantperiods.

We believe these issues demonstrate a need for bettermonitoring of grant management.

Recommendation


--place emphasis during the technical trainingworkshops on the types of reoccurring programcompliance issues being reported by the nonfederalauditors.

ACF Comments


FACILITIES

To be eligible to participate in the program, facilitiesmust comply with Head Start standards. Standardsapplicable to the facilities require that centers meet 13fire, health and safety requirements. Meeting State orlocal licensing requirements serves as evidence that acenter is in compliance with all requirements.

In 58 cases, audits identified violations of Head Startfacility regulations or safety standards. Facilitysafety standards were not met in 43 instances at 30grantees. These cases may affect the safety and well-being of the children. At nine of the grantees,recurring violations were reported.

Of the deficiencies identified, 10 resulted from expiredor nonexistent licenses and 33 were violations of fire,health and safety performance standards. Thesedeficiencies included an unsafe and ineffective heatingsystem, hazardous paint on-site, and lack of a workingfire extinguisher, emergency lighting, or playgroundfencing.

16

Compliance with facility standards is a condition ofFederal funding. However, we found that grantees not incompliance with standards continued to receive grantfunds. Noncompliance with facility standards increasesthe risk that the safety and well-being of children maybe jeopardized.

Because of the possible seriousness of the issue, webelieve that, as a condition of continued funding,grantees should provide evidence of licensing orcompliance with all of the facility standards.

Recommendation


--require evidence during the grant applicationprocess of current licensing or compliance withall of the facility standards.

ACF Comments


SALES TAX

We identified six cases of noncompliance where granteesdid not use sales tax exemptions or did not return salestax refunds. Sales tax exemptions can reduce costs ofthe program. Failure to take advantage of theseexemptions would result in an unallowable cost underFederal cost principles.

Five of the six noncompliance cases related to granteesin the Atlanta, Georgia regional office. Discussionswith Head Start program officials in Atlanta indicatedthat information on sales tax exemptions was emphasizedand included in training sessions for both grantees andauditors. Since the issue was not reported in most otherregions, it is possible that other regions do not have aproblem with sales tax noncompliance. It is alsopossible that grantees and auditors are not aware of thepotential savings.

We contacted 21 States with sales tax and determined that76 percent allowed some form of exemption for nonprofitsand governments. Although our information in this areais rather limited, there may be a potential for savingsto the program.

17

Recommendation:


--emphasize the possibility of savings to the HeadStart program through use of sales tax exemptionsand timely deposits of tax refunds.

ACF Comments


18

APPENDICES

Appendix A

Findings Identified in Nonfederal Audit Reports

Appendix APage 1 of 6

FINDINGS IDENTIFIED IN NONFEDERAL AUDIT REPORTS

Number ofFindinqs

ACCOUNTABILITY

--PROCEDURES

269 Accounting policies and procedures were inadequateor not implemented, the basis of accounting wasinadequate or grantee policy and procedure manualswere not developed.

There was no segregation of the accounting duties. 314 Sub-total

98

111 Accounting records were inaccurate or inadequate.

--RECORDS

General ledgers were inaccurate, entries were notposted, or a general ledger was not used.

57 The bank statement was not reconciled or notreconciled monthly.

18 Monthly financial statements were inaccurate,untimely, or not prepared.

55

22

41

45

49

Inadequate employee records or employee files.

Grantee records were inaccurate or inadequate orboard minutes were not recorded.

Other accounting related findings that did notappear frequently and did not fall under the othercategories.

Cash control findings that did not appear frequentlyand did not fall under another category.

Program expenditures were inadequately documented.

Records and reporting findings that did not appearfrequently and did not fall under any othercategory.

632 Sub-total



Number ofFindinqs

--CASH MANAGEMENT

102 Inadequate documentation of cash receipts,disbursements, purchase orders, or vouchers.

85 Inaccurate cash receipt or disbursement records.

41 Disbursements were not properly authorized bygrantee officials.

66 There was no segregation of cash receipt anddisbursement duties.

Checks did not have two signatures, the checking account was overdrawn, or other checking account related problems.

352 Sub-total

--FIXED ASSETS

86 Physical inventories of fixed assets were inadequateor untimely.

104 Asset records or inventory listings were inaccurate.

3 3 Fixed asset findings which did not appearfrequently and did not fall under another category.

223 Sub-total

--TRAVEL

Documentation of travel expenses or approvals were inadequate or inaccurate and repayments of travel advances were untimely.

74 Sub-total

--PREDICTABILITY

Budget controls were inaccurate and the budget or specific line items were overspent.

85 Sub-total

--TIMELINESS

Federal financial reports were late.109 Sub-total



Number ofFindinqs

2 7 3

2 , 0 6 2

4 6

2 0

8 1

5 2

9 5

--FEEDBACK

Federal financial reports were inaccurate.

Total - Accountability

INTEREST BEARING ACCOUNTS

Grant funds were not kept in interest bearingaccounts.

Interest earned on grant funds was not remittedt i m e l y .

Total - Interest Bearing Accounts

INTERFUND TRANSFERS

Grant funds were being transferred betweenprograms.

Total - Interfund Transfers

FDIC LIMITS

Grant funds were deposited in unsecured bank accounts with balances that exceeded FDIC limits.

Drawdowns from PMS were untimely or the cash onhand exceeded the cash needed.

Total - FDIC Limits

MATCHING REQUIREMENTS

Grantee did not meet the 20 percent matching requirement.

In-kind contributions were inaccurately valued.

Matching documentation was inaccurate or inadequate.



Number ofFindinqs

Matching findings which did not appear frequently

58

49

2

41

254

69

78

47

9

102

49

and did not fall under another category.

Matching RequirementsTotal -

GRANT MANAGEMENT

-- ELIGIBILITY OR ENROLLMENT

Enrollment procedures were inadequate.

Income eligibility verification procedures wereinadequate.

Eligibility findings which did not appear frequentlyand did not fall under another category.

Eligibility of families was inadequately documented.

Student records, student status documentation orfamilies files were inadequate or inaccurate.

Sub-total

-- ATTENDANCE

Daily attendant-e requirement was not met.

Attendance records were inadequate.Sub-total

-- SALARIES AND FRINGE BENEFITS

Miscellaneous salary findings.

Unallowable employee bonuses were paid.

Miscellaneous fringe benefit findings.Sub-total

-- UNOBLIGATED FUND BALANCES

Unobligated fund balances were not reprogrammed orreturned timely.



Number ofFindinqs

9 Unobligated fund balances were not returned when thegrantees ceased program participation.

Other fund balance findings which did not appearfrequently and did not fall under another category.

78 Sub-total

-- BUDGET EXCEEDED

Grantee expenditures exceeded the grant award.73 Sub-total

-- INDIRECT COSTS

-- SALARIES AND FRINGE BENEFITS

48 Indirect cost rates were not approved, developed,or correctly utilized.

48 Sub-total

-- BIDDING

Bidding regulations for purchases were notfollowed.

39 Sub-total

-- PRIOR APPROVAL

38 Required prior approval was not obtained forproperty expenditures.

38 Sub-total

-- OTHER COST ISSUES

247 Program expenditures unauthorized or other costfindings which did not appear frequently and did notfall under another category.

37 Program costs were allocated to an improper grantperiod.

Related party transactions occurred.Sub-total

Total - Grant Manaaement

pendix APage 6 of 6


Number ofFindings

FACILITIES

38 Centers were not meeting State or local licensingrequirements or were not in compliance with thefire, health and safety performance standards.

Instances of facility noncompliance includeinadequate insurance coverage and no priorapproval for renovation expenditures.

Total Facilities

SALES TAX

Sales tax exemptions were not used or refunds wereremitted untimely.

6 Total Sales Tax=

OTHER

Compliance findings which did not appearfrequently and did not fall under another category.

309 Total Other-

4,027 TOTAL FINDINGS REVIEWED

Appendix B

Geographical Distribution of Review Statistics

Appendix BPage 1 of 2

Appendix BPage 2 of 2

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Geographical Distribution of Accountability Findings

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Appendix E

Distribution of Review Statistics by Type of Grantee

Appendix E

Appendix F

Distribution of Findings by Type of Grantee

Appendix F

Appendix G

Distribution of Accountability Findings by Type of Grantee

Appendix G

- -

Appendix H

Time Lapse Comparison - Nonfederal Head Start Audits

Appendix H

Appendix I

ACF Response

DEPARTMENT HEALTH HUMAN SERVICES

FOR CHILDREN AND

Office of the Assistant Secretary, Suite

370 Promenade, S.W.

W ashington, D.C. 20447

October 8, 1991

TO: Richard P. KusserowInspector GeneralDepartment of Health and Human Services

FROM: Jo Anne B. Assistant Secretary45 "

for Children and

SUBJECT: Comments on OIG Draft Management Advisory Report--'\ f"

Summarization of Head Start Grantee Audit Findings(A-07-91-00425)

This memorandum transmits the Administration for Children andFamilies' comments on your draft report on Head Start auditfindings.

We are in agreement with nine of the twelve recommendations presented in your report concerning the need to increase training and technical assistance to grantees, specifically in the area of financial management, and the need to continuously upgrade our capacity to effectively monitor grantees. We are fully committed to improving the financial management systems and accountability of Head Start grantees. We have concerns, discussed later in our comments, about three recommendations: 1) developing alternative procedures for timely grant closeout, 2) implementing OMB Circular A-133, and 3) procedures to ensure amounts in excess of FDIC limits.

We have provided specific comments on each of the report'srecommendations. We have grouped the recommendations andcomments by subject matter and, since this does not always followthe order in which they appear in the report, we have providedthe page number on which each recommendation is made.

Thank you again for the opportunity to respond to the concernsraised in the report. As noted above, we are in generalagreement with the report's recommendations, and we expect to seeconsiderable progress over the next several months inimplementing most of these recommendations. If I can be offurther assistance in this regard, please let me know.

Attachment

Comments

We concur with these recommendations. On August 6-10, 1991, aHead Start Management Institute was conducted in Washington, DC.The Institute was attended by 1,574 Head Start Directors fromlocal programs across the country, as well as 82 Regional Officestaff and 40 Head Start Bureau staff. The agenda included atotal of 99 workshops, nine of which were devoted exclusively tofinancial management.

Phase II of the Management Institute is now underway. In thisphase each Regional Office, in conjunction with its training andtechnical assistance Regional Resource Center, is responsible forconducting a Management Institute follow-up conference whichfocuses on those management issues determined at the AugustInstitute as being most critical. Input Surveys completed at theconclusion of the Institute indicated that financial managementwas identified as the first priority for the follow-upconferences. Regions will be advised to include such topics asnon-Federal share, cash management (including interest income)sales tax exemptions, and interfund borrowing.

The Head Start Resource Centers are also responsible forconducting training conferences for grantees in their respectiveRegions annually. These conferences will also provide anopportunity to address the compliance issues cited in yourreport.

On page 3, 6, the report notes that grantee information is not always verifiable because of the lack of soundaccounting standards and practices..." This identifies one ofthe most critical deficiencies that we believe exist in a numberof programs. There is a requirement that Head Start agenciesmust have written procedures for the operation of their financialmanagement system which prescribe the necessary steps to beundertaken, the timetable/cycle for completion, the personresponsible, and the checks and balances of the system. One ofour goals is to explore the feasibility of developing a modelfinancial management procedures manual which will assist granteestaff in developing and improving their own systems manuals, andwhich will make clear the importance of maintaining use of themanual on a day-to-day basis.

Approximately 60 new Head Start agencies have been added as aresult of the 1990 and 1991 expansions. There is an obviousneed, therefore, to focus our training and technical assistanceefforts on these new agencies. In this regard, we have begun theprocess of updating the Head Start Policies Manual, which first issued in 1984. The Manual is a compilation ofregulations, policies, Transmittal Notices, Information Memoranda

and Collaborative Agreements applicable to the Head Startprogram. In addition to updating the contents of the Manual, theformat will be changed to facilitate its use. Plans are toreissue the new Manual within the next several months.

In addition, discussions are being held regarding the developmentof a technical assistance manual which will assist Head StartDirectors, especially those new to the program, in understandinggrants management and understanding and applying Head Startregulations and policies.

These issues will be thoroughly addressed during the next semi-annual meeting of the Resource Centers scheduled forDecember 9-11, 1991.

Recommendation

We recommend that the ACF require evidence during the grantapplication process of current licensing or compliance with allof the facility standards.

Comment

We concur with this recommendation. We will work with theRegional Offices in developing procedures to assure that all HeadStart centers are fully licensed and meet all State and locallicensing standards.

The Administration on Children, Youth and Families has proposedrevised grant application instructions for Head Start grantees.Interim instructions were issued on September 10, 1991, pendingapproval of the final instructions by the Office of Managementand Budget (OMB). The new instructions will improve the programnarrative statement and will provide more budget detail than isallowed by the eight budget categories included in the StandardForm Part Once approved, the instructions will requiregrantees to provide information on progress made in meetingprogram requirements and on plans for improving the managementand delivery of services; including specific needsidentified through audits, fiscal reports, self-assessmentsmonitoring reports, cost analysis data, Program Information'Report data, and correspondence from the Regional Office. TheHead Start requirements for facilities contained in Part must be addressed, along with all other Performance Standardrequirements.

Recommendation

We recommend that the ACF closely observe the progress being madeby the American Institute of Certified Public Accountants and theOMB in formulating required financial statements for nonprofitorganizations providing guidance to its grantees when literatureis available. (p.9)

Comment

We concur with this recommendation. We recognize the value of aconsistent definition of Generally Accepted Accounting Principlesfor nonprofit organizations. The ACF Grants Office will be askedto monitor this important activity and keep programs abreast ofprogress.

Recommendations


- strengthen procedures to ensure all grantees use interest bearing accounts and properly earn and refund interest income.

- develop procedures to detect grantees with interfundtransfers. The starting point may be a detailed analysesof the financial statements.

reemphasize to grantees that the non-Federal match is to beproperly documented and met. (p.12)

- emphasize the possibility of savings to the Head Startprogram through use of sales tax exemptions and timelydeposits of tax refunds. (p.15)

Comments

We concur with these recommendations. Regional Offices have hadaudit citations concerning the issue of Head Start funds notbeing placed in interest bearing accounts as required by Federalregulations and the related issue of grantees not remitting aproportionate share of interest income earned back to the PaymentManagement System. Corrective action taken by one RegionalOffice was the establishment of an audit trail to look forinterest income once the grantee has been identified in an auditor through local monitoring.

Grants Management Information Letters, presentations at clusterand statewide fiscal seminars and program instruction to HeadStart grantees are examples of other means being used by theRegional Offices to bring to the attention of grantees, theactions necessary to correct weaknesses in financial management

areas; i.e., the correct procedures with respect to on-hand cashbalances, repayment of interfund loans, interest bearing checkingaccounts, sales tax exemption permits, nonfederal match andtimely correction of audit findings.

We are concerned about the recurrence of compliance issues suchas those cited in the above recommendations, especially amonggrantees with many years of experience. Therefore, the aboveissues will be included on the agenda of the next meeting of theRegional Office of Fiscal Operations Directors.

Recommendation

We recommend that the ACF strengthen procedures to ensure excesscash is not drawn and obtain evidence that legitimate balances inexcess of the FDIC limit are collaterally secured when awardinggrants.

Comment

We do not concur with this recommendation. This finding andrecommendation in the report illustrates misrepresentationof the rules on FDIC limits. Current rules require Federalfiscal officers to insure that legitimate balances in excess ofFDIC limits are collaterally secured, however, we know of no suchrequirement for grantees in either law or Federal regulations.

Recommendations


-develop alternative procedures for timely closeout ofgrants, placing less reliance on the nonfederal auditreports.

-implement the new audit requirement, OMB Circular A-133, asthis will improve the consistency of audited financialstatements.

Comments

We are not in full agreement with your recommendations regardingthe future usefulness of non-Federal audits and the developmentof alternative procedures, other than audits, for timely closeoutof grants.

Prior to OMB Circular A-133, Head Start audits were due annually,no later than 120 days from the end of the budget period. Thisallowed adequate time to review the audit and to discuss with thegrantee any compliance issues prior to refunding. We are veryconcerned that the new provision of A-133, which does not require

an audit to be completed until 13 months after the end of thetwo-year budget period, will considerably reduce the value of theaudit to us as a management tool. We believe that appropriatenon-Federal audit procedures are the correct method for timelycloseout of grants. At a minimum, we support a special 120 daytime limit on the submission of Head Start audits.

We would also like to look into the possibility of using theflexibility provided in the Circular to require annual programrather than institutional audits of Head Start grantees, whereappropriate. We believe separate audit rules regarding HeadStart grantees are justified by the unique nature of Head Startwhich makes necessary some degree of flexibility in theimplementation of A-133. To our knowledge, Head Start is theonly non-competing continuation discretionary grant program ofits kind within the Federal government.

Other discretionary grant programs with specific project periods,usually not longer than three years, may be amenable to the lessstringent audit procedures prescribed in the Circular. For HeadStart, however, the financial audit is an essential informationaltool for managers in making decisions, not only for grantcloseout but also for the disposition and reallocation of fundbalances, managing the refunding process, focusing monitoringactivities and designing technical assistance.

We share your concerns that the provisions of A-133 will notpermit Head Start to assure timely grant close-out nor assureproper use of Federal funds. We will continue to explorealternatives which will provide us the information to providenecessary oversight of Head Start grantee financial management.

Technical Comment

In the Introduction on page 1, 2, we suggest that thefollowing statement be added: Head Start program also fundsIndian Tribes and Migrant Organizations through grants issuedfrom the Headquarters Grants Office."

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