June 25, 1997
 
 
MEMORANDUM FOR THE SECRETARY
 
FROM:            John C. Layton
                 Inspector General
 
SUBJECT:         INFORMATION:  Report on "Audit of
                 the Western Area Power Administration's Contract
                 with Basin Electric Power Cooperative"
 
BACKGROUND:
 
At the request of the Western Area Power Administration
(Western), we conducted an audit of charges to Western made by
Basin Electric Power Cooperative (Basin), under Contract No. DE-
MP65-82WP-19001.  The contract for Westernms purchase of electric
power from Basin was entered into on April 15, 1982, and was in
effect from January 1, 1986, through October 31, 1990.  Western 
identified 17 areas where overcharges might have occurred.  The 
purpose of the audit was to determine whether Western had been 
charged costs in excess of those permitted by the contract for the 
17 areas identified.
 
DISCUSSION:
 
We found that Basin overcharged Western approximately $23.8
million.  These overcharges occurred because Basin:  (1) did not
recognize or amortize as gain its overestimate of completion and
correction costs for Antelope Valley Station (AVS) Unit 2;
(2) did not amortize the gain on the sale/leaseback of AVS Unit 2
as an offset to lease costs; (3) billed Western prematurely for
lease and interest costs; (4) overcharged for the cost of coal by
including administrative and general expenses and profit, as well
as incorrectly calculating discounts, royalty payments, and
imputed interest costs; (5) made faulty calculations of
amortization rates for deferred costs; (6) used a shorter
depreciation period for AVS common facilities than it had used
for other power plants; (7) retained tax benefit transfers; and
(8) charged Western for interest and depreciation that had been
paid by others.
 
In addition to the $23.8 million in overcharges, we estimated
interest accrued on the overcharges through December 31, 1996, to
be approximately $22.1 million, resulting in a total of $45.9
million due Western.
 
We recommended that Western seek a refund from Basin in the
amount of $23,843,592, plus accrued interest.  Western management
agreed with the findings and recommendation.
 
Attachment
 
cc:  Deputy Secretary
     Under Secretary
 
                                
                    U.S. DEPARTMENT OF ENERGY
                   OFFICE OF INSPECTOR GENERAL
                                
                                
                                
                                
                            AUDIT OF
 
             THE WESTERN AREA POWER ADMINISTRATION'S
 
         CONTRACT WITH BASIN ELECTRIC POWER COOPERATIVE
 
                                
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Report Number:  DOE/IG-0409     Western Regional Audit Office
Date of Issue:  June 25, 1997   Albuquerque, New Mexico 87185
                            
                            
                            
                            AUDIT OF
             THE WESTERN AREA POWER ADMINISTRATION'S
         CONTRACT WITH BASIN ELECTRIC POWER COOPERATIVE
                                
 
                        TABLE OF CONTENTS
                                
                                                             Page
                                
         SUMMARY ........................................     1
                                                             
PART I  -APPROACH AND OVERVIEW ..........................     2
                                                             
         Introduction ...................................     2
                                                             
         Scope and Methodology ..........................     2
                                                             
         Background .....................................     3
                                                             
PART II -FINDINGS AND RECOMMENDATION ....................     5
                                                             
         1.  Completion and Correction Fund .............     5
                                                             
         2.  Gain on Sale of AVS Unit 2 .................     5
                                                             
         3.  Lease Payment Intervals ....................     6
                                                             
         4.  Coal Quantity Discount and Meridian 
             Royalties...................................     6
                                                             
         5.  Deferred Cost of Freedom Mine Development...     6
                                                             
         6.  Amortization Periods for Common Facilities...    7
                                                             
         7.  Basin's Cost Allocation System ..............    7
                                                             
         8.  Cost Sharing with Basin Subsidiaries ........    8
                                                             
         Summary of Overcharges to Western ...............    9
                                                             
         Recommendation ..................................   10
                                                             
PART III - MANAGEMENT AND AUDITOR COMMENTS ...............   11
 
                                                             
PART IV -APPENDICES                                          
                                                             
            
         A. Summary of Areas Audited                         
                                                             
         B. Total Amount Due Western (Including Interest     
            through 12/31/96)
                                                             
            
            
            
                                
                                
                    U.S. DEPARTMENT OF ENERGY
                   OFFICE OF INSPECTOR GENERAL
                    OFFICE OF AUDIT SERVICES
                                
                            AUDIT OF
             THE WESTERN AREA POWER ADMINISTRATION'S
         CONTRACT WITH BASIN ELECTRIC POWER COOPERATIVE
 
Audit Report Number:  DOE/IG-0409
 
                             SUMMARY
 
     At the request of the Western Area Power Administration
(Western), we conducted an audit of 17 areas with respect to
possible overcharges on a power contract between Western and
Basin Electric Power Cooperative (Basin), Contract No. DE-MP65-
82WP-19001.  The contract for Western's purchase of electric
power from Basin was entered into on April 15, 1982, and was in
effect from January 1, 1986, through October 31, 1990.  During
this 58-month period, Basin billed Western approximately $197.6
million.
 
     Overall, we found that Basin overcharged Western
approximately $23.8 million.  These overcharges occurred because
Basin:  (1) did not recognize or amortize as gain its
overestimate of completion and correction costs for Antelope
Valley Station (AVS) Unit 2; (2) did not amortize the gain on the
sale/leaseback of AVS Unit 2 as an offset to lease costs; (3)
billed Western prematurely for lease and interest costs; (4)
overcharged for the cost of coal by including administrative and
general expenses and profit, as well as incorrectly calculating
discounts, royalty payments, and imputed interest costs; (5) made
faulty calculations of amortization rates for deferred costs; (6)
used a shorter depreciation period for AVS common facilities than
it had used for other power plants; (7) retained tax benefit
transfers; and (8) charged Western for interest and depreciation
that had been paid by others.
 
     In addition to the $23.8 million in overcharges, we
estimated interest accrued on the overcharges through December
31, 1996, to be approximately $22.1 million, resulting in a total
of $45.9 million due Western.
 
 
 
 
______________(Signed)___________________
Office of Inspector General
                             
                             
                             
                             PART I
                                
                      APPROACH AND OVERVIEW
                                
INTRODUCTION
 
     At the request of Western, we performed an audit of charges
to Western made by Basin under Contract No. DE-MP65-82WP-19001.
Western identified 17 areas where overcharges might have occurred
(see Appendix A).  The purpose of the audit was to determine
whether Western had been charged costs in excess of those
permitted by the contract for the 17 areas identified.
 
SCOPE AND METHODOLOGY
 
     The audit was performed primarily at Basin's headquarters in
Bismarck, North Dakota, from May 29, 1996, through August 30,
1996.  To accomplish the audit objective, we:
 
     o  reviewed Western's contract with Basin;
 
     o  analyzed Code of Federal Regulations, Title 7-Agriculture,
        Part 1767, Accounting Requirements for Rural Utilities 
        Service Electric Borrowers (7 CFR 1767);
 
     o  examined invoices and supporting documentation;
 
     o  determined which costs could be charged to Western; and,
 
     o  held discussions with Western and Basin personnel.
 
     In determining applicable criteria for costs, we looked to
the contract and to 7 CFR 1767.  Both references cited
"reasonableness" as criteria, without significant elaboration.
Therefore, we searched for further guidance.  Because the Federal
Acquisition Regulation (FAR) contained cost principles and
definitions, we used the FAR as criteria.  The FAR is
comprehensive, authoritative, has been in effect for many years,
and identifies what is generally acceptable to the Federal
Government concerning contract costs.  Although Western's
contract with Basin was not specifically covered by the FAR, we
believe application of the FAR was appropriate in situations
where cost guidance beyond that found in 7 CFR or the contract
was needed.
 
     To fulfill our audit responsibilities, we contracted with
the independent public accounting firm of KPMG Peat Marwick LLP
to conduct the audit for us, subject to our review.
 
     Except as discussed in the following two paragraphs, the
audit was conducted in accordance with generally accepted
Government auditing standards.
 
     The audit was limited to the 17 areas where overcharges
might have occurred.  Accordingly, we do not express an opinion
on the allowability of all Basin charges to Western or Basin's
internal controls.  Had we reviewed other Basin charges to
Western, other matters might have come to our attention that
would have been reported.
 
     In addition, Basin essentially limited discussion and
contacts to only two Basin personnel--Basin's Assistant General
Counsel and a Senior Financial Reporting Analyst.  Our requests
for information and documents were provided to the analyst, who
in turn would contact other Basin personnel, obtain information
and documents, and relay the information and documents to us.  As
a result, we did not have the opportunity to discuss issues in
depth with those individuals responsible for carrying out work
related to the issues being audited and who possibly could have
provided additional information on the audit issues.  We also did
not have the opportunity to obtain documents directly from those
individuals, as the documents were pre-screened prior to being
made available to us.  Consequently, because of this scope
impairment, we did not have assurance that we were provided all
information and documents pertinent to the audit issues.
 
     Except for matters described in the preceding paragraphs, we
conducted our audit in accordance with generally accepted
Government auditing standards that applied to this financial
related audit.  Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the data
and records reviewed are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the data and records reviewed.  An
audit also includes assessing the accounting principles used and
significant estimates made by the contractor.  We believe that
our audit provides a reasonable basis for our audit conclusions.
 
BACKGROUND
 
Western's Contract and Cost Guidelines
 
     Western entered into a contract with Basin on April 15,
1982, to purchase 185 megawatts (MW) of power from Basin's
Antelope Valley Station Unit 2, which was under construction at
the time.  On December 3, 1985, Basin entered into a
sale/leaseback of AVS Unit 2.  As a result, the contract was
modified on December 13, 1985, to allow Western to pay for its
share of lease costs, to establish the contract start date as
January 1, 1986, to show that the accredited rating of AVS Unit 2
was anticipated to be 450 MW, and to provide for other details
concerning various contract provisions.  Power became available
from AVS Unit 2 on January 1, 1986, and the unit became fully
operational by June 1986.  The contract ended on October 31,
1990.
 
     With respect to costs, the contract stated that Basin should
operate the facilities to the best of its ability using prudent
utility practices that were expected to accomplish results at the
lowest reasonable cost, consistent with reliability, safety, and
expedition.  The contract provided for specific allowable account
numbers from which costs were to be computed.
 
     Federal guidelines for costs for rural utility electric
borrowers are provided in 7 CFR 1767, which states, in part, that
cost is defined as the amount of money actually paid for property
or services, amounts included in the accounts shall be just and
reasonable, and electric plant is to be recorded at cost.  Basin,
a Rural Electrification Administration (now known as the Rural
Utilities Service) borrower, was required to apply 7 CFR 1767 to
its accounts.
 
Description of Basin and its Subsidiaries
 
     Founded in 1961, Basin is a consumer-owned, not-for-profit,
regional cooperative located in Bismarck, North Dakota.  Basin
generates and transmits electricity to more than 120 member rural
electric systems in eight states.  These member systems
distribute electricity to 1.5 million consumers.  Basin produces
electricity from four power plants that have a combined
generating capacity of 3,304 MW.  One of these four plants is the
AVS, located in Beulah, North Dakota, which has two units--AVS
Unit 1 and AVS Unit 2.  Each unit has a capacity of 450 MW.
Western contracted to purchase 185 MW of the 450 MW from AVS Unit
2.
 
     Basin has four major subsidiaries:
 
     o Basin Cooperative Services, incorporated in 1981, 
       is a wholly owned, not-for-profit property management 
       subsidiary.
 
     o Basin Telecommunications, Inc., is a for-profit subsidiary
       formed in 1995.  It is a network of services that includes 
       a travel agency, a dispatch center, and telecommunications 
       services such as Internet access, long-distance discounts 
       and cellular plans.
 
     o Dakota Coal Company is a wholly owned, for-profit subsidiary
       incorporated in 1988 to provide financing for the Freedom 
       Mine and to purchase the lignite coal produced there.  The 
       Freedom Mine, owned and operated by The Coteau Properties 
       Company, supplies lignite for Basin's Leland Olds and AVS 
       stations, Dakota Gasification Company's synfuels plant, and 
       United Power Association's Stanton, North Dakota Station.  
       The Coal Company has a division called Wyoming Lime Producers 
       which owns a lime kiln that began operating in 1993; it 
       produces 400 tons of lime daily for use in dry scrubbers that 
       remove sulfur dioxide from emissions at the AVS and Laramie 
       River stations and at other coal-fired power plants in the 
       region.
 
     o Dakota Gasification Company is a wholly owned, for-profit
       subsidiary incorporated in 1988 to own and operate the Great
       Plains Synfuels Plant near Beulah, North Dakota.  The plant
       produces high-BTU natural gas from lignite and byproducts, 
       such as agricultural fertilizers and chemicals from the coal
       gasification process.
 
                             PART II
                                
                   FINDINGS AND RECOMMENDATION
                                
 
     During the 58-month contract period, January 1986 through
October 1990, Basin billed Western approximately $197.6 million.
The audit disclosed that Basin had overcharged Western by $23.8
million.  The findings that follow describe the overcharges.
 
1.  Completion and Correction Fund
 
     As part of the sale/leaseback proceeds from AVS Unit 2,
Basin established (with Rural Electrification Administration
approval) a Completion and Correction Fund (Fund) of $66,311,540.
The Fund was to be used for four specific types of expenditures
related to completing and correcting AVS Unit 2.  During 1985-
1991, additions to the Fund for interest earned and other items
exceeded expenditures.  Basin overestimated the amount needed for
the completion and correction of AVS Unit 2, although the amount
needed should have been reasonably known, since AVS Unit 2 was
substantially complete at the time of the sale/leaseback.  Basin
used the Fund's ending balance, $48,917,906, to pay off AVS and
non-AVS notes.  However, paying off notes was not an authorized
type of expenditure from the Fund.
 
     According to our calculations, had Basin established the
Fund at $29,811,540, instead of $66,311,540, the Fund would have
been sufficient to meet authorized expenditures.  The difference
of $36,500,000 would have been an additional gain on the
sale/leaseback.  Amortization of this gain as a partial offset to
the lease costs Basin charged Western would have reduced lease
costs to Western by $2,410,864 over the contract's term.
Accordingly, Basin owes Western $2,410,864, plus interest.
 
     As a result of our inquiry, Basin calculated that it owed
Western $49,354.  However, as indicated above, $2,410,864, plus
interest, is owed to Western.
 
2.  Gain on Sale of AVS Unit 2
 
     Basin realized a gain (profit) of $69,299,827 on the
sale/leaseback of AVS Unit 2.  Since Western's contract with
Basin was a cost-type contract, the gain should have partially
offset the lease costs charged to Western.  However, Basin
amortized the gain to other income, and Western received no
benefit as a result of the AVS Unit 2 sale/leaseback gain.
 
     Because the FAR defines contract cost to be net of allocable
credits, Basin should have reduced the lease charges to the net
cost, which was the monthly lease payment less the amortized
gain.  Therefore, Basin should refund $4,296,502, plus interest,
to Western for the amount of the gain that should have been used
to reduce Western's charges for lease costs.
 
3.  Lease Payment Intervals
 
     Basin billed Western monthly for the AVS Unit 2 lease
payment, but Basin made semi-annual payments on the lease.  Basin
told us that they billed Western monthly because (1) they were
required under generally accepted accounting principles to post
the accrued lease obligation monthly, and (2) they were required
to bill Western the amounts in the accounts specified in the
contract.
 
     Although it is not inappropriate for Basin to post the
accruals monthly, billing Western monthly for the amounts
violated the contract, which was based on cost.  Federal
regulations defined cost as the amount of money actually paid for
property or services.  The monthly accrual of the lease
obligation did not represent an amount of money actually paid,
since the actual payment did not occur until the semi-annual
lease payment was made by Basin.
 
     As a result of Basin's premature billing of Western during
1986-1990, Basin should refund $1,040,239, plus interest, to
Western.
 
4.  Coal Quantity Discount and Meridian Royalties
 
     Basin overcharged Western $700,477 for coal costs during
1986-1987 because Basin inappropriately applied a quantity
discount to coal consumed by both AVS Units 1 and 2.  Because the
Joint Coal Supply Agreement based the quantity discount on coal
consumed by AVS Unit 2, the entire discount should have been
applied as a reduction of AVS Unit 2's costs.
 
     Basin overcharged Western an additional $21,767 for coal
costs in November 1986 when Basin recorded royalties to Meridian
Minerals Company for the period December 1985 through October
1986.  The overcharge resulted because Basin did not consider the
differences in quantities of coal burned by AVS Units 1 and 2 and
because the royalties were based partly on a time period (March
1986 through July 1986) for which Western was not billed for any
energy charges.
 
     Basin should refund $722,244, plus interest, to Western for
the above overcharges for coal costs.
 
5.  Deferred Cost of Freedom Mine Development
 
     Basin's calculations of 1986, 1987, and 1990 amortization
rates for the deferred costs of developing the Freedom Mine were
faulty and resulted in excessive charges to Western of $801,398.
This occurred for three reasons.  First, Basin did not use a
consistent amortization period.  In 1988, Basin changed from a 32-
year period to amortize the costs to 20 years.  Second, Basin
included projected additional loans to be made by Basin in the
amortization rates, but the loans were never made.  Third,
Basin's estimate of the amount of coal to be purchased was low
and resulted in a higher cost per ton of coal each year.
 
     Our recalculation of amortization rates, based on the above,
showed that an additional $1,075,272 of interest would have been
deferred during 1986-1990.  This would have reduced interest
charged to Western by $442,056.
 
     Basin should refund $1,243,454, plus interest, to Western
for the above overcharges.
 
6.  Amortization Periods for Common Facilities
 
     Basin overcharged Western $2,769,180 for interest and
$828,781 for depreciation during June 1986 through October 1990.
This occurred because Basin amortized deferred expenses for the
AVS Common Facilities over 10 years rather than 20 years,
although Basin had previously used a 20-year time period for
common facilities relating to its other power plants.  Basin
reverted to the 20-year amortization period for AVS in 1991--
after the contract with Western ended.
 
     Basin overcharged Western an additional $477,827 for
interest and $83,005 for depreciation because Basin early
amortized deferred interest and depreciation during June 1988
through September 1989, but did not adjust monthly amortization
charges to Western.  The early amortizations should have resulted
in reduced monthly charges to Western, but Basin continued to
charge Western on the basis of a straight-line amortization of
the June 1, 1986, balance of deferred charges, the balance prior
to the early amortizations.
 
     Basin should refund the above total overcharges of
$4,158,793, plus interest, to Western.
 
7.  Basin's Cost Allocation System
 
     We tested Basin's billings to Western for 5 different months
of the 58-month contract period during 1986-1990 (1 month from
each of the 5 years) and found that billing records matched the
records at Western, billings were mathematically accurate, and
capacity and energy costs on the billings generally agreed with
Basin's supporting computerized records.  We also found that
account and cost center charges appeared to be allowable and
allocable, except for the following:
 
     a.  Basin received tax benefits based on tax benefit
transfers on the AVS Common Facilities, but retained the benefits
as Other Income rather than offsetting related costs.  This
resulted in overcharges of $1,174,674 to Western.
 
     b.  Basin overcharged Western $768,847 for the cost of coal
during November 1988 through October 1990 because administrative
and general expenses and profit margins were included in the
costs.  Western's contract with Basin did not allow such charges.
 
     c.  Basin billed Western monthly for interest costs that
were paid quarterly and semi-annually.  As a result, Western lost
$114,068 in interest income due to the premature billing by
Basin.
 
     Based on the above three exceptions, Basin should refund
$2,057,589, plus interest, to Western.
 
8.  Cost Sharing with Basin Subsidiaries
 
     Basin overcharged Western $7,913,907 during 1986-1990 for
interest and depreciation on the Common Facilities.  This
occurred because the costs had already been paid by the ANG Coal
Gasification Company (ANG) and by ANG's successor company--the
Dakota Gasification Company (DGC).
 
     Basin had agreements requiring ANG/DGC to pay Basin for
sharing the use of five Common Facilities for which Western was
also being charged.  Two of the facilities, Water Transportation
and Railroad Spur, required ANG/DGC to pay 100 percent of related
interest and depreciation expenses.  However, Western was also
billed for those costs, which resulted in Basin collecting costs
that had already been paid.
 
     Basin should refund $7,913,907, plus interest, to Western
for the overcharges.
 
SUMMARY OF OVERCHARGES TO WESTERN
 
                Reason for Overcharge            Amount
                                                 Overcharged
                                                 
   1. Basin did not recognize $36,500,000 of     $ 2,410,864
      the Completion and Correction Fund monies
      as a gain, which should have been
      amortized as an offset to lease costs.
                                                 
   2. Basin recorded a $69,299,827 gain            4,296,502
     (profit) from the sale/ leaseback of AVS
      Unit 2 that should have been amortized as
      an offset to lease costs billed to
      Western.
                                                 
   3. Basin billed Western monthly for lease       1,040,239
      costs, but only made lease payments semi-
      annually.
                                                 
   4. Basin overcharged the cost of coal due to      722,244
      inappropriate application of discounts
      and calculation of royalties.
                                                 
   5. Basin's calculations of amortization         1,243,454
      rates for deferred costs were faulty, and
      additional interest should have been
      deferred.
                                                 
   6. Basin amortized deferred costs for AVS       4,158,793
      Common Facilities over 10 years rather
      than its customary 20 years, and Basin
      did not adjust monthly charges to Western
      when early amortizations occurred.
                                                 
   7. Basin retained tax benefits rather than       2,057,589
      offsetting related costs ($1,174,674),
      included administrative and general
      expenses and profit margins in the cost
      of coal ($768,847), and billed Western
      monthly for interest costs but paid the
      interest quarterly and semi-annually
      ($114,068).
                                                 
   8. Basin charged Western for two Common          7,913,907
      Facilities costs that it had already
      collected 100 percent of the costs from
      others.
                                                 
            Total Overcharges                     $23,843,592
                                                 
            Interest on Overcharges (1/1/86-       22,073,411
            12/31/96) (See Appendix B)
                                                 
            Total Overcharges and Interest        $45,917,003
            (through 12/31/96)
 
 
 
 
RECOMMENDATION
 
     We recommend that Western seek a refund from Basin in the
amount of $23,843,592, plus interest accrued from January 1,
1986, to the date such refund is received.
                            
                            
                            PART III
                                
                 MANAGEMENT AND AUDITOR COMMENTS
 
     In responding to our initial draft version of this report,
the Western Administrator concurred with the information (facts
presented, findings and recommendation, and reasonableness of the
estimated monetary impact) contained in the report.  The
Administrator further stated that Western was working to reach
closure on the issue of overcharges made by Basin.
 
Auditor Comments
 
     Management's comments are responsive to the recommendation.
 
                             PART IV
                                
                           APPENDICES
                                             APPENDIX A                  
                                             Page 1 of 1
                    
                    
                    
                    Summary of Areas Audited
 
1.   Leveraged Lease Transaction
 
2.   Completion and Correction Fund - (See Finding No. 1)
 
3.   Gain on Sale of Antelope Valley Station Unit 2 - (See
     Finding No. 2)
 
4.   Lease Payment Intervals - (See Finding No. 3)
 
5.   Coal Quantity Discount and Meridian Royalties - (See 
     Finding No. 4)
 
6.   Coal Sales Agreement - (See Finding No. 7)
 
7.   Royalties Paid on Development of Freedom Mine
 
8.   Imputed Interest on Development of Freedom Mine - (See
     Finding No. 5)
 
9.   Loan Advance to Construct Secondary Crusher
 
10.  Non-refundable Down Payment for Dragline C
 
11.  Change in Depreciable Assets
 
12.  Deferred Depreciation and Interest on Common Facilities -
     (See Finding No. 6)
 
13.  Amortization Periods and Revisions for Common Facilities -
     (See Finding No. 6)
 
14.  August 1987 Change in Amortization of Facilities
 
15.  Basin's Cost Allocation System - (See Finding No. 7)
 
16.  Administrative/General and Indirect Costs - (See Finding No.
     7)
 
17.  Cost Sharing with Basin Subsidiaries - (See Finding No. 8)
 
                                               APPENDIX B
              
              
              (APPENDIX B IS NOT AVAILABLE ON THE INTERNET
               COPIES CAN BE OBTAINED BY CALLING THE OIG
               REPORTS REQUEST LINE AT (202) 586-2744)
 
 
 
Report No.   DOE/IG-0409
 
 
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