U.S. DEPARTMENT OF ENERGY
                 OFFICE OF INSPECTOR GENERAL
                              
                              
                              
                              
                      MANAGEMENT REPORT
             AUDIT OF THE DEPARTMENT OF ENERGY'S
              CONSOLIDATED FINANCIAL STATEMENTS
                    FOR FISCAL YEAR 1996
                              
                              
                              
                              
                              
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Report Number:  CR-FS-97-02
Capital Regional Audit Office
Date of Issue:  May 1, 1997
Germantown, MD 20874
 
 
 
                      MANAGEMENT REPORT
             AUDIT OF THE DEPARTMENT OF ENERGY'S
              CONSOLIDATED FINANCIAL STATEMENTS
                    FOR FISCAL YEAR 1996
                              
                              
                      TABLE OF CONTENTS
                                                            
                                                            
 
                                                            
                                                       Page
                                                        
         SUMMARY................................        1
        
        
        
PART I - APPROACH AND OVERVIEW........................  3
        
         Introduction.................................  3
        
         Scope and                                        
        Methodology...................................  3
        
        
        Observations..................................  4
        
PART II - AUDIT RESULTS...............................  6
        
        Finding 1:  Performance Measure Reporting.....  6
         
        Finding 2:  Nuclear Materials Management Safeguards 
                     System...........................  6
         
         Finding 3:  Repair and Maintenance Expenses....10
        
         Finding 4:  Environmental, Safety and Health    
                       Liability........................11
        
         Other Matters..................................12
 
 
                 U. S. DEPARTMENT OF ENERGY
                 OFFICE OF INSPECTOR GENERAL
                  OFFICE OF AUDIT SERVICES
                              
                      MANAGEMENT REPORT
             AUDIT OF THE DEPARTMENT OF ENERGY'S
              CONSOLIDATED FINANCIAL STATEMENTS
                    FOR FISCAL YEAR 1996
                              
                              
Audit Report Number: CR-FS-97-02
 
 
                           SUMMARY
 
 
  The Government Management Reform Act of 1994 requires the
Department of Energy (Department) to submit audited
financial statements to the Office of Management and Budget
(OMB) beginning with the statements as of September 30,
1996.  We audited the Department's Consolidated Statement of
Financial Position as of September 30, 1996, and the related
Consolidated Statement of Operations and Changes in Net
Position for the year then ended, to determine whether they
presented fairly, in all material respects, the Department's
financial position and results of operations.  As part of
this Departmentwide effort, we examined internal controls,
assessed compliance with applicable laws and regulations,
and tested selected account balances at Headquarters and at
a number of field activities.  The results of our audit are
included in Audit Report No. IG-FS-97-01, dated February 24,
l997.  Additional management level reports addressing local
issues are being issued to field elements.
 
  This report addresses managerial-level issues that fall
within the purview of the Chief Financial Officer and
selected Headquarters program officials.  Some performance
measure data included in the Overview of the Consolidated
Financial Statements was not consistently reported,
contained inaccurate information, and was not always
adequately supported.  System documentation related to the
Nuclear Materials Management Safeguards System was not
complete and reports were not distributed in a timely
manner.  Field sites were not specifically accounting for
repairs and maintenance expenses.  In addition,
documentation to support management approval of costs
included in an estimated Environmental Safety and Health
compliance activities related liability was not provided.
Also, certain other issues discovered during the prior
year's audit had not been completely resolved.
 
  Management generally concurred with the findings and
recommendations and acknowledged that corrective actions
were needed.  In some instances, the required actions have
already been completed.  Part II of this report discusses
the results and management's comments.
 
                              ______(Signed)________
                              Office of Inspector General
 
                           PART I
                              
                    APPROACH AND OVERVIEW
                              
                              
INTRODUCTION
 
  The Government Management Reform Act of 1994 significantly
expanded the provisions of the Chief Financial Officers Act
of 1990 to require that audited financial statements
covering all accounts and associated activities of the
Department be submitted to OMB annually.  In compliance with
this requirement, we audited the Department's Consolidated
Statement of Financial Position as of September 30, 1996,
and the related Consolidated Statement of Operations and
Changes in Net Position for the year then ended.  We
examined internal controls, assessed compliance with laws
and regulations, and tested selected account balances at
various Departmental facilities.
 
  The objective of the Departmentwide audit was to determine
whether the Consolidated Statement of Financial Position as
of September 30, l996, and the related Consolidated
Statement of Operations and Changes in Net Position for the
year then ended, presented fairly, in all material respects,
the Department's financial position and results of
operations.  Departmentwide issues developed during our
audit are addressed in Audit Report No. IG-FS-97-01.
Additional management level reports are being issued to
various field activities.
 
  The purpose of this report is to inform the Chief
Financial Officer of matters that came to the attention of
the Office of Inspector General (OIG) during the audit
related to policy issues and other field element issues that
fall within the purview of the Chief Financial Officer and
selected Headquarters program officials.  The findings and
recommendations included in this report did not impact the
overall opinion on the Department's consolidated financial
statements and have not been included in other audit
reports.  They are, however, matters that need to be
addressed and should strengthen the Department's internal
control structure or result in operating efficiencies.
 
 
SCOPE AND METHODOLOGY
 
  Field work was conducted from April through December 1996
at various Headquarters components of the Office of Chief
Financial Officer (CFO).  Those components included the
Office of Headquarters Accounting Operations and the
Departmental Accounting and Analysis Division.  Audit work
at the Department's field elements was also substantially
completed during the same period and included both
Departmental and contractor accounting entities.  As a part
of this effort, we obtained an understanding of the internal
control structure, performed tests of control procedures,
assessed compliance with applicable laws and regulations,
and tested selected account balances as necessary to achieve
the Departmentwide audit objectives.
 
  Audit work was performed in accordance with generally
accepted Government auditing standards for financial audits.
Since we relied on computer-generated data, we evaluated the
general control environment of certain systems and evaluated
the reliability of the data on a test basis.
 
  Because the audit was limited, it would not necessarily
disclose all the internal control weaknesses that exist.
Furthermore, because of inherent limitations in any internal
control structure, errors or irregularities may nevertheless
occur and not be detected.  Issues addressed in this report
represent our observations of activities through the end of
field work.  Projection 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.
 
  The Office of Chief Financial Officer waived an exit
conference.
 
 
OBSERVATIONS
 
  During our audit we found problems involving issues that
fall within the purview of the Chief Financial Officer and
selected Headquarters program officials.  These issues
related to performance measure reporting, the Nuclear
Materials Management Safeguards System (NMMSS), accounting
for repair and maintenance expenses, and the Environmental,
Safety and Health (ES&H) liability for noncompliance.  Also,
certain other issues discovered during the prior year's
audit had not been completely resolved.
 
  Some of the performance measure data included in the
Overview was not consistently reported, contained inaccurate
information, and was not always adequately supported.  For
example, claimed staffing reductions were inconsistent with
other sources; dollar savings for staffing reductions were
calculated inconsistently with claimed reductions;
performance measures did not consistently include all
Departmental elements; and no support was provided for some
performance measures.
 
  System documentation related to the NMMSS was not complete
and reports were not distributed in a timely manner.  Due to
the lack of complete documentation, NMMSS had not received
formal approval from the Department, despite being in
operation since September 1995.  In addition, due to data
submission deadlines placed on reporting entities and other
factors, significant time lags occurred between the date of
data submission and the date final reports were received.
 
  Field sites were not specifically accounting for repair
and maintenance expenses.  Rocky Flats Field Office, Kaiser-
Hill, Chicago Operations Office, Westinghouse Hanford
Company, Westinghouse Savannah River Company, and Lockheed
Idaho Technologies Company were among the field entities
that could not readily account for repair and maintenance
expense.
 
  Officials in the Office of Environment, Safety and Health
(EH) were not able to provide documentation to support
management's approval of costs of activities estimated to be
liabilities.  In accruing the liability for the costs of
activities related to ES&H noncompliance, EH estimated the
amount and provided it to the CFO.  Officials in EH were
unable to provide copies of the original Activity Data
Sheets to demonstrate whether management approved the costs
of these activities.
 
  In addition, as reported in the prior year's audit, the
Department had not completely resolved issues related to
application of overhead expenses to purchased assets and use
of standard service lives for capitalized assets.
 
  Management generally concurred with the findings and
recommendations and acknowledged that corrective actions
were needed.  In some instances, the required actions have
already been completed.  Part II of this report provides
additional details concerning the audit results and
management's comments.
                           PART II
                              
                        AUDIT RESULTS
 
 
Finding 1:  Performance Measure Reporting
 
 
Background
 
  In accordance with OMB guidance, each annual financial
statement should include a narrative overview of the
reporting entity.  This overview should provide a clear and
concise description of the reporting entity, its mission,
activities, accomplishments, and overall financial results
and condition.  It should also include information on
whether and how the mission of the reporting entity is being
accomplished.  This communication should include the use of
explicit measures of program performance (performance
measures).
 
 
Details of Finding 1
 
  OMB Bulletin No. 94-01 requires the Department to clearly
set forth performance measures in the overview and maintain
adequate supporting documentation in a form suitable for
review and audit.  In contrast, some of the performance
measure data included in the Department's Overview to the
financial statements was not consistently reported,
contained inaccurate information, and was not always
adequately supported.  For example:
 
  o  The power marketing administrations and the Federal
     Energy Regulatory Commission were not consistently included
     or excluded from measures, while the financial statements
     and accompanying notes included data for all Departmental
     elements.
  
  o  Dollar savings associated with staffing reductions were
     calculated using different staffing reductions than those
     reported in the Overview, resulting in at least a
     $10 million overstatement of savings.
  
  o  Amounts concerning staffing reductions were
     inconsistent with amounts claimed elsewhere in the Overview
     and with data obtained from the Department's payroll and
     personnel system.
  
  o  Savings of $6 million initially claimed in draft
     versions of the Overview from streamlining the National
     Environmental Policy Act (NEPA) program were unsupported.
     When Departmental representatives were contacted for
     support, they acknowledged that these savings could not be
     supported.  In the final version of the Overview, the
     Department reported that while no accounting data existed
     specifically for NEPA compliance activities, it estimated
     that the goal ($6 million in savings) had been met.
  
  o  No support was provided for a measure concerning the
     development of Strategic Diversity Plans.  Support was not
     provided by the responsible program despite repeated
     requests.
 
  These problems occurred because the Department's internal
control structure for ensuring accurate and timely reporting
of performance measure data in the Overview was not
sufficient.  Specifically, formalized data collection
procedures were not in place, reported results were not well
documented, and validation of supporting data was not
accomplished.  As a result, the Department risks reporting
information in the Overview that does not present an
accurate and up-to-date picture of how it is accomplishing
its mission.
 
 
Recommendation
 
  We recommend that the Office of Chief Financial Officer,
in conjunction with the Office of Policy and International
Affairs (PO), strengthen its internal control structure for
reporting performance measures, including providing program
offices specific guidance on maintaining adequate support.
 
 
Management Comments
 
  Management generally concurred with the finding and
recommendation and plans certain corrective actions.  The
CFO asserted that the existing internal control structure
for reporting performance measures consisted of several
coordinated processes conducted within the PO, the CFO, the
program offices, and the OIG.  The performance reporting
process established by PO emphasizes the importance of
ensuring that information provided was accurate and
complete.  In response to guidance and training by the CFO,
Heads of Departmental Elements also provided representations
indicating an awareness of their responsibility for
performance measure data and for completing the necessary
validation and support documentation to ensure its accuracy
and reliability.  Management also asserted that an
additional element of the internal control is the OIG's
audit of the financial statements, which provides an
independent confirmation on the accuracy of performance
measure information.
 
  Management recognized that improvements could be made to
the process and proposed that PO lead efforts to strengthen
and formalize the existing internal control structure, in
partnership with the CFO and the OIG, to ensure the accurate
reporting of performance results and the maintenance of
adequate support documentation.  As part of these efforts,
the CFO will issue guidance and offer training to program
offices to clearly delineate their specific roles and
responsibilities in the preparation of the financial
statements and related program performance reporting.
Management believes that each program office is responsible
for its performance data and that the OIG should make
program offices responsible for reported deficiencies aware
of problems encountered and suggest improvements needed to
further improve accountability for future reporting.
 
 
Auditor Comments
 
Although management's proposed actions may be beneficial,
they are not completely responsive to our recommendation.
Management plans to reemphasize existing requirements, but
has not provided specific plans for validating or verifying
the accuracy of reported performance data.  As part of its
effort to strengthen and formalize the existing internal
control structure, management should develop consistent
standards to be applied by all program elements to ensure
that data used to support reported performance measure
results are valid and accurate, consistent, and readily
verifiable.  While programmatic representations should
remain an essential part of the internal control structure
in this area, they are not, in and of themselves, sufficient
to ensure that reported data is properly documented or
supported.
 
We do not agree with the Department's proposal to rely on
the OIG to provide independent confirmation of performance
measure information rather than including data validation
procedures as an integral part of its internal control
structure.  While the OIG is more than willing to assist
management by providing input on the design and
implementation of an internal control structure, the
ultimate responsibility for good internal controls rests
with management.  Management's system of internal controls
in this area must stand alone and not rely on the results of
audit.  The OIG's independent audit function generally
enhances the internal control structure of the Department
but may not be directly substituted for sound internal
control policies and procedures.
 
 
Finding 2:  Nuclear Materials Management Safeguards System
 
Background
 
  NMMSS is the nationwide system used to track and record
all movements of nuclear materials.  All Departmental sites
with nuclear materials are required to reconcile inventory
quantities per site accountability systems to NMMSS on a
periodic basis.  In addition, certain sites use applicable
NMMSS reports to value nuclear materials.
 
  In 1994, Lawrence Livermore National Laboratory (LLNL) was
tasked with updating the NMMSS from a mainframe system to a
more user friendly and reliable microcomputer-based network
system.  Upon receiving this task, LLNL subcontracted the
work to the Nuclear Assurance Corporation in Norcross,
Georgia.  After significant system design work,  Nuclear
Assurance Corporation began sole operation and maintenance
of NMMSS on September 1, 1995.
 
 
Details of Finding 2
 
  Maintenance of complete system documentation and
timeliness of report distribution are among the critical
success factors for any computer system.  However, system
documentation relating to NMMSS was not complete, and report
distribution was not timely.  Despite being in operation
since September 1995, the NMMSS had not received formal
approval from LLNL or the Department because of the lack of
complete systems documentation.  Much of the system
knowledge that needed to be documented resided with one of
only two programmers.  In addition, due to data submission
deadlines placed on reporting entities and Nuclear Assurance
Corporation's manual review of reports for security,
significant time lags occurred between the date of data
submission and the date final reports were distributed to
users.  As a result of these issues, the long-term viability
of the system was a concern, and delayed reconciliation
procedures increased the potential for incorrect information
submissions to Headquarters.
 
     
Recommendations
 
  We recommend that the Office of Chief Financial Officer
work with the Office of Nonproliferation and National
Security to:
 
     Ensure that Nuclear Assurance Corporation completes all
     system documentation and obtains formal system approval from
     LLNL and the Department as soon as possible;
  
     Ensure the Nuclear Assurance Corporation has followed
     through with its intentions to hire additional programmers
     to enhance system development and operation; and
  
     Work with NMMSS users to modify current user reporting
     deadlines or Nuclear Assurance Corporation procedures to
     provide for more timely report distribution.
  
  
Management Comments
 
  Management concurred with the finding and recommendations
and has taken or plans to take corrective action to improve
system documentation and timeliness of report distribution,
including hiring two additional programmers and conducting
onsite training by NMMSS project staff.
 
 
Auditor Comments
 
  Management's proposed and completed actions are responsive
to the recommendations.
     
     
Finding 3:  Repair and Maintenance Expenses
 
Background
 
  According to the Department's Accounting Handbook, costs
for normal maintenance and repair, such as repairing roads,
painting buildings, or cleaning structures, are expensed
unless the maintenance and repair results in an addition,
replacement, or betterment.  If the repair costs do result
in an addition, replacement, or betterment, the policy
requires capitalization of the costs.
 
  For periods beginning after September 30, 1997, Statement
of Federal Financial Accounting Standards Number 6,
"Accounting for Property, Plant, and Equipment," will
require disclosures related to the condition and estimated
cost to remedy deferred maintenance of property, plant and
equipment.  The minimum disclosure required by the Standards
must include the method used to measure, and an estimate of
deferred maintenance for each major class of property, plant
and equipment.  If the Department chooses to use the total
life-cycle cost method, it must present information on the
dollar amount of maintenance actually performed.
 
 
Details of Finding 3:
 
  To meet upcoming standards requirements and to aid in
proper classification of repair and maintenance expenses,
Departmental field sites should specifically account for
these types of costs.  However, Departmental field sites
like Rocky Flats Field Office, Kaiser-Hill, Chicago
Operations Office, Westinghouse Hanford Company,
Westinghouse Savannah River Company, and Lockheed Idaho
Technologies Company did not specifically account for repair
and maintenance expenses.  For example, Lockheed Idaho
Technologies Company could determine the costs for repairs
and maintenance completed with indirect funding, but was not
readily able to determine direct funded repair and
maintenance costs.  This condition exists because neither
the Department's Accounting Handbook nor the prior
Departmental Order required that repair and maintenance
costs be recorded in a specific expense account.  Without
such an account, it is difficult for field sites to evaluate
whether required repair and maintenance costs are being
properly categorized.  In addition, it will be difficult for
the Department to comply with the new Statement of Federal
Financial Accounting Standards Number 6 if field sites do
not classify, record, and report repair and maintenance
expenses in specifically identifiable accounts.
     
     
Recommendations
 
  We recommend that the Office of Chief Financial Officer:
     
     Develop policy guidance requiring reporting entities to
     classify, record, and report repair and maintenance expense
     in specific accounts; and
  
     Establish any other accounts and accounting procedures
     that will be needed for the Department to comply with
     deferred maintenance disclosure requirements beginning in
     Fiscal Year 1998.
 
 
Management Comments
 
  Management is in the process of analyzing the applicable
Federal Accounting Standards Advisory Board recommended
requirements that are effective beginning in Fiscal Year
1998 to determine the appropriate actions that must be taken
to establish compliance.  While there is no specific
requirement to establish "accounts" to achieve compliance
with the referenced deferred maintenance disclosure
requirements, the CFO will consider this as well as other
options during this analytical process.
     
     
Auditor Comments
 
  Management's planned analysis is responsive to the finding
and recommendations.  Identification and implementation of
alternative actions that can be taken to meet accounting
standards and aid proper classification of costs would be
acceptable.
  
  
Finding 4:  Environmental, Safety and Health Liability
 
 
Background
 
  The Department accrued a $1.2 billion estimated liability
in Fiscal Year 1996 for those activities necessary to bring
its facilities and operations into compliance with existing
ES&H laws and regulations.  In accruing the liability for
the costs of activities related to ES&H noncompliance, EH
estimated the amount and provided it to the CFO.
 
 
Details of Finding 4:
 
  As a component of its overall internal control structure,
the Department is responsible for establishing a system of
controls to provide reasonable assurance that estimates
supporting accrual of liabilities are complete and readily
verifiable.  However, officials in EH were not able to
provide copies of the original signed Activity Data Sheets
used in the ES&H liability estimate to demonstrate whether
management approved the costs of the activities.  This
occurred because the EH database system used to accumulate
cost data was not designed to utilize hard copies of
Activity Data Sheets, as information was converted to
computer form in remote locations.  As a result, there was
an incomplete audit trail for the ES&H liability estimate
and a greater likelihood of the introduction of errors to
the estimate.
 
 
Recommendation
 
  We recommend that the Office of Chief Financial Officer
work with EH to ensure adoption of a system in which staff
responsible for calculating the estimated liability receive
up-to-date copies of approved Activity Data Sheets in a
timely manner.
 
 
Management Comments
 
  The CFO concurred with the finding and recommendation and
agreed to work with EH to improve the process of receiving
data and calculating the estimated ES&H liability.
     
     
Auditor Comments
 
  Management's proposed actions are responsive to the
recommendation.
 
 
 
Other Matters
 
  In our Fiscal Year 1995 report on the internal control
structure, we reported that the Department's internal
control system to prevent or detect the inconsistent or
misapplication of accounting policies, principles, and
procedures was not entirely effective.  In relation to this
finding, the Department had not completely resolved, during
Fiscal Year 1996, issues related to the application of
overhead expenses to purchased assets and the use of
standard service lives for capitalized assets.
 
     Certain general and administrative costs were
  inappropriately included in the cost of capitalized assets.
  Westinghouse Savannah River Site incorrectly added a
  surcharge of 20 to 30 percent to the cost capitalized for
  property, plant and equipment purchases.  The surcharge is
  an allocation of certain overhead costs including purchasing
  and accounts payable.  The CFO stated that its policy in the
  area of allocation of general and administrative expenses
  was under formulation and would be transmitted to field
  offices upon completion.
 
     Standard service lives specified by accounting guidance
  were not always used for capitalized assets.  Westinghouse
  Hanford Company was using service lives for certain capital
  assets that were not consistent with Departmental Standard
  Service Lives established by the CFO.  Westinghouse Hanford
  Company utilized at least two standard service lives lists.
  One list was consistent with the Department standard, while
  another inconsistent list dated back to 1963.
 
The specific instances cited above are being reported
locally in separate management reports to the cognizant
Departmental field elements.  No additional recommendations
to remedy these conditions are being made, as the
recommendations from last year's audit are being tracked by
the Department.
 
                            IG Report No.__CR-FS-97-02_
                                                       
                                                       
                              
                              
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