ARCHIVED INFORMATION -- Annual Accountability Report Fiscal Year 1996

Report on Internal Controls

To the Inspector General
U.S. Department of Education

We were engaged to audit the consolidated financial statements of the U.S. Department of Education (Education) as of and for the year ended September 30, 1995, and have issued our report thereon dated June 4, 1996. In that report we disclaimed an opinion on the consolidated financial statements because certain amounts reported in Education's consolidated financial statements could not be supported by sufficient and reliable accounting information and certain differences between financial statement amounts and underlying accounting records could not be adequately explained.

The management of Education is responsible for establishing and maintaining an internal control structure. In fulfilling this responsibility, estimates and judgments are required to assess the expected benefits and related costs of internal control policies and procedures. The objectives of an internal control structure are to provide management with reasonable, but not absolute, assurance that: (1) transactions are properly recorded and accounted for to permit the preparation of reliable financial statements and to maintain accountability over assets; (2) funds, property, and other assets are safeguarded from loss from unauthorized use or disposition; and (3) transactions, including those related to obligations and costs, are executed in compliance with laws and regulations that could have a direct and material effect on the financial statements. Because of inherent limitations in any internal control structure, errors or irregularities may nevertheless occur and not be detected. Also, projections of any evaluation of the structure to future periods is subject to the risk that procedures may become inadequate because of changes in conditions or that the effectiveness of the design and operation of policies and procedures may deteriorate.

We noted certain matters in the internal control structure and its operation that we consider to be reportable conditions under standards established by the American Institute of Certified Public Accountants. Reportable conditions involve matters coming to our attention relating to significant deficiencies in the design or operation of the internal control structure that, in our judgment, could adversely affect the entity's ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements.

Certain reportable conditions are also considered to be material weaknesses. A material weakness is a reportable condition in which the design or operation of one or more elements of the internal control structure does not sufficiently reduce the risk of material errors and irregularities occurring and not being timely detected. Material errors or irregularities are those that, in the judgment of independent accountants, might cause a large dollar impact in the financial statements being audited, or might be qualitatively important to a reasonable person relying on those financial statements.

Overview of Weaknesses

Fiscal year 1995 was the first year an audit was conducted of Education's consolidated financial statements. In prior years, separate audits were performed of the Federal Family Education Loan (FFEL) Program and the William D. Ford Federal Direct Loan (Direct Loan) program, as required by the Chief Financial Officers (CFO) Act of 1990. Pursuant to the Government Management Reform Act (GMRA) of 1994, financial statement audits will be required for all of Education's operations, beginning with fiscal year 1996. Education elected to begin the process a year ahead of time.

Most of the control weaknesses discussed in this report have been previously identified during prior audits performed by the Office of Inspector General and General Accounting Office, or in Education's report prepared pursuant to the Federal Managers' Financial Integrity Act. For most of these weaknesses Education has initiated corrective action plans. However, as of the completion of our audit, we found that the corrective actions were not sufficiently completed such that the control weaknesses could be considered corrected. Thus, we have continued to report the control weaknesses as material weaknesses or reportable conditions.

Presented in Exhibit 1 is a summary of the material weaknesses and reportable conditions that we noted in performing our audit. These weaknesses are discussed in detail in the balance of this report.

Exhibit 1: Summary of Control Issues
Issue Area Summary of Control Issues
FFEL Program -- Liability Estimate for Loan Guarantees (Material Weakness) Education is in the process of implementing its National Student Loan Data System (NSLDS) to augment data available in managing the FFEL Program, including the development of the estimated liability for loan guarantees. However, this new system is not yet populated with sufficient years of data; nor has system data been tested by Education to ensure the data is reliable. Because of these limitations in the NSLDS data, we are unable to conclude whether Education's liability estimate for fiscal year 1995 is materially correct.
FFEL Program -- Guaranty Agency Oversight (Material Weakness) Education needs to finalize and issue improved audit guidance so that audits of guaranty agencies (GA) are more effective in ensuring the reasonableness of the $2.8 billion in cash outflows and $2.0 billion in cash inflows to Education.

Education is unable to reconcile its loans receivable portfolio held by the GAs with GA records. An unexplained difference of $888 million has accumulated over many years of the program's operation.

Education needs to improve control over its $1.8 billion in cash-basis reserves held by the GAs.

FFEL Program -- Lender Oversight (Material Weakness) Education has issued improved audit guidance to help ensure the reasonableness of lender billings to Education; however, a system to ensure that the lender audits are performed has not yet been implemented. These billings total $2.8 billion in cash outflows and $1.1 billion in cash inflows annually.
Cash -- Timely Reconciliations (Material Weakness) Education needs to develop a better process of reconciling its cash balances and activity with Treasury. An unexplained difference of $183 million, more than Treasury, existed as of September 30, 1995.
Pell and Federal Work-Study Grants -- Institutional Audits (Reportable Condition) Education does not have a system in place to ensure that the external audits required of postsecondary educational institutions are performed. These institutions receive $6.9 billion annually in Pell and Federal Work Study Grants.

Education needs to timely follow-up on questioned costs and internal control weaknesses identified in external audit reports and through its own reviews of postsecondary institutions.

PAS/PMS Systems -- Disaster Recovery and Security Concerns (Reportable Condition) PAS and PMS are Education's two key financial systems. Disaster recovery plans are lacking for these systems that would ensure that Education could quickly resume processing in the event of disaster at the primary data centers.

Improved security over the PMS system is required. Software capable of improving security is available, and it should be implemented as soon as possible.

Our consideration of the internal control structure would not necessarily disclose all matters in the structure that might be reportable conditions and, accordingly, would not necessarily disclose all reportable conditions that are also considered to be material weaknesses as defined above. We also noted certain other matters involving the internal control structure that we will report to the management of Education in a separate letter.

This report is intended for the information of the Office of the Inspector General, the management of the Department of Education, and Congress. However, this report is a matter of public record and its distribution is not limited.

Price Waterhouse LLP
Washington, D.C.
June 4, 1996

[Report on Compliance with Laws and Regulations] [Table of Contents] [FFEL Program - Liability Estimate for Loan Guarantees]