United States General Accounting Office 

GAO Report to Congressional Requesters 

October 2003 COMPACT OF FREE 

ASSOCIATION 

Single Audits 

Demonstrate 

Accountability 

Problems over 

Compact Funds 

GAO-04-7


a
Highlights of GAO-04-7, a report to 

congressional requesters 

In 1986, the United States entered 

into a Compact of Free Association 

(Compact) that provided about 

$2.1 billion in U.S. assistance from 

1987 through 2003 to the Pacific 

Island nations of the Federated 

States of Micronesia (FSM) and the 

Republic of the Marshall Islands 

(RMI). GAO has issued a number 

of reports raising concerns about 

the effectiveness of this assistance. 

GAO was asked to review possible 

FSM and RMI misuse of Compact 

funds. We reviewed single audits 

for 1996 through 2000 and this 

report summarizes the audit 

results. 

GAO recommends that the 

Secretary of the Interior delegate 

responsibility to and hold the 

Office of Insular Affairs 

accountable for monitoring and 

reporting on FSM and RMI actions 

to address Compact-related single 

audit findings and initiating 

appropriate actions when the FSM 

or the RMI do not implement 

appropriate and adequate actions 

to correct Compact-related single 

audit findings in a timely manner. 

In commenting on this report, the 

Office of Insular Affairs of the 

Department of the Interior, FSM, 

and RMI agreed with our findings 

or conclusions and 

recommendations. They also cited 

the amended Compacts as 

mechanisms that should result in 

improved financial management 

over Compact assistance. 

www.gao.gov/cgi-bin/getrpt?GAO-04-7. 

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact McCoy 

October 2003 

COMPACT OF FREE ASSOCIATION 

Single Audits Demonstrate Accountability 

Problems over Compact Funds 

GAO’s review of 30 single audit reports for the FSM, 4 FSM states, and the 

RMI for the years 1996 through 2000 identified pervasive and persistent 

noncompliance with Compact requirements and financial statement-related 

audit findings. These single audit reports identified 458 audit findings 

relevant to the Compact. Significant numbers of these audit findings 

occurred during each year of the 5-year period and at each of the auditees. 

In addition, successive single audits identified recurring audit findings over 

the 5-year period despite corrective action plans prepared by the auditees. 

While none of the audit findings specifically discussed misuse of Compact 

funds, they did describe noncompliance with Compact requirements and 

financial management problems in areas that GAO considers highly 

susceptible to misuse, such as poor control over cash and equipment. When 

considered in conjunction with the qualified opinions or disclaimers of 

opinion on the financial statements in all 30 reports and for 60 percent of the 

Schedules of Expenditure of Federal Awards required by the Single Audit 

Act, the audit findings reveal one thing: overall poor accountability of 

Compact funds. 

In responding to GAO’s previous reviews of the original Compact, Interior 

officials expressed concerns about the U.S. government’s limited ability to 

enforce accountability over Compact funds due to certain provisions of the 

Compact and the related fiscal procedures agreement (FPA). Recently, an 

Interior official noted that departmental officials have been frustrated with 

the lack of tools to administer or track federal assistance in a manner that 

could reasonably ensure that such assistance is having its intended effect. 

GAO found that the amended Compacts and related FPAs, which are 

scheduled to become effective upon legislative approval in the three 

countries, include many strengthened reporting and monitoring measures 

that could improve accountability, if diligently implemented. For example, 

funds could be withheld for noncompliance with Compact terms and 

conditions. In addition, joint economic committees and an Interior oversight 

team will focus on monitoring and overseeing Compact funds. 

Percentage of 1996 through 2000 Single Audit Findings That Recurred 3 or More Years 

FSM 

Pohnpei 

Yap 

Chuuk 

Kosrae 

RMI 

Williams at (202) 512-6906 or 0 10 20 30 40 50 60 70 

Percentage of findings williamsm1@gao.gov or Susan Westin at Source: GAO analysis of single audit reports. 

(202) 512-4128 or westins@gao.gov. 
Contents


Letter


Results in Brief 


Background 


Objectives, Scope, and Methodology 


Pervasive Audit Findings Demonstrate Poor Accountability over 


Compact Funds 

Amended Compact Agreements Contain Improved Accountability 

Measures 

Conclusions 

Recommendations for Executive Action 

Government and Agency Comments and Our Evaluation 

1 

3 

5 

7 

8 

16 

19 

19 

20 

Appendixes 

Appendix I: 

Appendix II: 

Appendix III: 

Appendix IV: 

Comments from the Federated States of Micronesia 

Comments from the Republic of the Marshall Islands 

Comments from the Department of the Interior 

GAO Contacts and Staff Acknowledgments 

GAO Contacts 

Acknowledgments 

22 

24 

27 

28 

28 

28 

Figures Figure 1: Number of Audit Findings Reported Annually from 1996 

through 2000 9 

Figure 2: Auditee Findings as a Percentage of Total Findings 10 

Figure 3: Percentage of Corrective Action Plans Developed for 

Audit Findings 11 

Figure 4: Percentage of 1996 through 2000 Single Audit Findings 

That Recurred 3 or More Years 12 

Page i GAO-04-7 Compact of Free Association 
Contents 

Abbreviations 

CAP corrective action plan


FPA fiscal procedures agreement


FSM Federated States of Micronesia


OMB Office of Management and Budget


RMI Republic of the Marshall Islands


U.N. United Nations


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Page ii GAO-04-7 Compact of Free Association 
Page 1 GAO-04-7 Compact of Free Association 

A

United States General Accounting Office 

Washington, D.C. 20548 

October 7, 2003


The Honorable Tom Lantos


Ranking Minority Member


Committee on International Relations


House of Representatives


The Honorable James A. Leach


Chairman


The Honorable Eni Faleomaveaga


Ranking Minority Member


Subcommittee on Asia and the Pacific


Committee on International Relations


House of Representatives


The Honorable Doug Bereuter


House of Representatives


In 1986, the United States entered into a Compact of Free Association 


(Compact) with the Pacific Island nations of the Federated States of 


Micronesia (FSM) and the Republic of the Marshall Islands (RMI). Through 


the Compact, the United States has provided about $2.1 billion in 


assistance to these nations in the form of direct funding and federal 


services and programs. Further, the Compact established U.S. defense 


rights and obligations in the region and allowed for migration from both 


nations to the United States. The Compact provisions that address 


economic assistance were scheduled to expire in 2001; however, they 


remained in effect while the United States negotiated amended Compacts 


with each nation. 


Page 1 GAO-04-7 Compact of Free Association 
Over the last several years, we issued reports that raised concerns about 

the effectiveness of the FSM and the RMI use of and accountability over 

U.S. assistance provided under the Compact.1 In commenting on the 

accountability issues raised in our 2000 report, officials at the Department 

of the Interior, the agency responsible for overseeing the assistance 

program, pointed out the limited ability of the United States to enforce 

accountability over Compact funds because basic elements of federal grant 

management were lacking. They also noted that additional personnel and 

funding could have been committed to Compact oversight, but the United 

States would still have had almost no ability to influence fiscal decisions 

made by the FSM and the RMI. In recent testimony, an official from the 

Office of Insular Affairs, Department of the Interior, noted that the 

department was hampered by the fact that the Compact provided for large, 

loosely defined grants with no express enforcement mechanisms to ensure 

the efficient and effective expenditure of funds. This official also stated 

that departmental officials “have been greatly frustrated with the lack of 

tools to properly administer or track Federal assistance in a manner that 

could reasonably ensure that such assistance is having its intended effect.”

2 

In conjunction with our monitoring and reporting on Compact 

renegotiation efforts, you asked us to review possible FSM or RMI misuse 

of Compact funds. The annual single audits of the FSM and the RMI, which 

are required by the fiscal procedures agreement (FPA) for implementing 

the Compact, are a potential source of this information.3 While the single 

audit reports do not specifically use the phrase “misuse of Compact funds,” 

many of the problems they identify are in areas that are susceptible to the 

misuse of funds. 

1

 U.S. General Accounting Office, Foreign Assistance: Effectiveness and Accountability 

Problems Common in U.S. Programs to Assist Two Micronesian Nations, GAO-02-70 

(Washington, D.C.: Jan. 22, 2002); Foreign Assistance: U.S. Funds to Two Micronesian 

Nations Had Little Impact on Economic Development, GAO/NSIAD-00-216 (Washington, 

D.C.: Sept. 22, 2000); and Foreign Relations: Better Accountability Needed Over U.S. 

Assistance to Micronesia and the Marshall Islands, GAO/RCED-00-67 (Washington, D.C.: 

May 31, 2000). 

2

 Statement of David B. Cohen, Deputy Assistant Secretary of the Interior for Insular Affairs, 

before the Subcommittee on Asia and the Pacific, House Committee on International 

Relations, June 18, 2003. 

3

 The FPA provides for a financial and compliance audit within the meaning of the Single 

Audit Act. See 31 U.S.C. Chapter 75. 

Page 2 GAO-04-7 Compact of Free Association 
We obtained the 30 single audit reports for the years 1996 through 2000 for 

the national government of the FSM; the FSM state governments of Chuuk, 

Kosrae, Pohnpei, and Yap; and the national government of the RMI. We 

reviewed and summarized the audit findings contained in these reports, the 

most recently completed reports available at the start of our review, to 

identify instances of possible misuse of Compact funds. On February 12, 

March 12, and March 13, 2003, we briefed your staffs on our results. This 

report summarizes our briefing results regarding the single audit reports. 

In addition, it provides information on the enhanced accountability 

measures that are built into the amended or renegotiated Compacts. The 

amended Compacts4

 and related FPAs, which are scheduled to become 

effective upon legislative approval in the United States, the FSM, and the 

RMI, include many strengthened reporting and monitoring measures that 

could improve accountability, if diligently implemented.5 (Further details 

on our scope and methodology are provided later in this report.) 

Results in Brief	 Single audits are intended to promote sound financial management, 

including effective internal control over federal awards. Our review of 30 

single audit reports for the FSM, the four FSM states, and the RMI for the 

years 1996 through 2000 identified pervasive and persistent complianceand financial statement-related audit findings. More specifically, the audit 

reports contained about 90 audit findings for each year of the 5-year period 

that we reviewed and a significant number of audit findings for each of the 

auditees. In total, they contained 458 audit findings. Further, these reports 

showed recurring audit findings over the 5-year period despite the fact that 

the corrective action plans prepared by the FSM, the four FSM states, and 

the RMI indicated more timely completion of actions to address these 

findings. 

4

 According to a Department of State official, while the original Compact was one document 

that applied to both the FSM and the RMI, an amended Compact has been prepared for each 

nation. 

5

 Although the three governments have signed the amended Compacts, the Compacts have 

not been approved by the legislature of any country. Therefore, in this report, we describe 

the amended Compacts’ requirements and potential impact conditionally, recognizing that 

the Compacts have not yet been enacted. The total possible cost to renew expiring 

assistance in fiscal year 2004 U.S. dollars would be $3.8 billion on the basis of the 

Congressional Budget Office’s forecasted inflation rate. 

Page 3 GAO-04-7 Compact of Free Association 
None of the audit report discussions of the 458 audit findings specifically 

cited misuse of Compact funds. However, they did discuss noncompliance 

with Compact requirements and financial management problems in areas 

that we consider highly susceptible to such misuse. For example, one 

finding noted that differences between the cash balance shown in the 

entity’s financial records and the bank records amounted to over $150,000. 

Further, the independent auditors issued qualified opinions or disclaimers 

of opinion on the entitywide financial statements in all 30 reports and for 

about 60 percent of the Schedules of Expenditures of Federal Awards 

required by the Single Audit Act.6 These opinions were frequently issued 

because the audited entity did not provide the auditor with all required 

financial reports and/or other financial records. Taken together, the audit 

findings of and the financial statement opinions rendered by the auditors 

demonstrate that the FSM, the 4 FSM states, and the RMI did not provide 

reasonable accountability over Compact funds and assurance that these 

funds were used as intended. 

The amended Compacts and related FPAs, which are scheduled to become 

effective upon legislative approval in all three countries, include many 

accountability provisions that would strengthen reporting and monitoring, 

if diligently implemented. If so implemented, they would address most of 

the recommendations that we made in past reports regarding assistance 

accountability, fiscal control and accounting procedures, and standards for 

financial management systems. For example, under the amended 

Compacts, the annual reporting and consultation requirements would be 

expanded; funds could be withheld for noncompliance with Compact terms 

and conditions; and the FPAs call for the establishment of a joint economic 

management committee for each nation. These committees will consist of 

three members appointed by the United States, including the chairman, and 

two members appointed by FSM or RMI and will have significant oversight 

and monitoring responsibilities. In addition, Interior officials have stated 

that they are in the process of assembling a Compact oversight team of fulltime employees that will focus exclusively on monitoring and oversight of 

Compact financial assistance. The successful implementation of these 

strengthened reporting and monitoring measures will require a sustained 

commitment and appropriate resources from the United States, the FSM 

and the RMI. 

6

 An audit of these schedules as part of the single audit is required by the Single Audit Act, as 

amended, 31 U.S.C. 7502(e)(2). 

Page 4 GAO-04-7 Compact of Free Association 
To help promote compliance with Compact requirements and sound 

financial management, we are recommending that the Secretary of the 

Interior delegate this responsibility to the Office of Insular Affairs and hold 

appropriate officials in that office accountable for (1) ensuring the 

adequacy of staff dedicated to Compact oversight and monitoring 

activities, (2) monitoring FSM and RMI progress in correcting Compactrelated single audit report findings, (3) reporting on the FSM and the RMI 

actions to address Compact-related compliance and financial statement 

findings identified in single audit reports to the Secretary of the Interior or 

other appropriate high-level Interior official, (4) initiating appropriate 

actions if the FSM or the RMI do not implement timely and adequate 

actions to correct Compact-related single audit findings, and 

(5) investigating single audit findings that indicate possible violations of 

grant conditions or misuse of funds and taking appropriate actions when 

such problems are verified. 

The Department of the Interior and the RMI concurred with the findings 

cited. The FSM noted that the report was constructive and useful as it 

continues to prepare for the implementation of the amended Compact and 

its related agreements. The FSM and RMI also provided technical 

comments and other information on current actions to address the 

financial management issues that the report raised. 

Background	 In 1947, the United Nations (U.N.) created the Trust Territory of the Pacific 

Islands. The United States entered into a trusteeship with the U.N. Security 

Council and became the administering authority of the current islands of 

the FSM and the RMI. The United States administered the islands under 

this trusteeship until 1986, when it entered into a Compact of Free 

Association with the FSM and the RMI, both of which are located in the 

Pacific Ocean. 

The original Compact represented both a continuation of U.S. rights and 

obligations first embodied in the U.N. trusteeship agreement and a new 

phase in the unique and special relationship that had existed between the 

United States and these island nations. It also provided a framework for 

the United States to work toward achieving its three main goals of 

(1) securing self-government for the FSM and the RMI,7

 (2) assisting the 

7

 The FSM and RMI are now independent nations and are members of international 

organizations such as the U.N. 

Page 5 GAO-04-7 Compact of Free Association 
FSM and the RMI in their efforts to advance economic development and 

self-sufficiency, and (3) ensuring certain national security rights for all of 

the parties. 

The Department of the Interior’s Office of Insular Affairs was responsible 

for disbursing and monitoring Compact funds. For the 15-year period from 

1987 through 2001, it provided funding at levels that decreased every 5 

years. For 2002 and 2003, while negotiations to renew the expiring 

Compact provisions were ongoing, funding levels increased to equal an 

average of the funding provided during the previous 15 years. For 1987 

through 2003, total U.S. assistance to the FSM and the RMI to support 

economic development is estimated, based on Interior data, to be about 

$2.1 billion. 

In addition, the Compact identified several services that U.S. agencies 

would supply to the FSM and the RMI and further stated that these 

agencies could provide direct program assistance as authorized by the 

Congress. This assistance included grants, loans, and technical assistance 

that, for fiscal years 1987 through 2001, totaled about $700 million from 19 

U.S. agencies. The Department of the Interior was responsible for 

supervising, coordinating, and monitoring program assistance, while the 

Department of State was responsible for directing and coordinating all U.S. 

government employees in foreign countries, except those under the 

command of U.S. area military commanders. 

In 2000, we reported that one tool that should be used for ensuring 

accountability over Compact assistance was the annual audits required by 

the Compact. FPAs for implementing the Compact required that financial 

and compliance audits be conducted in accordance with the provisions of 

the Single Audit Act.8 This act is intended to, among other things, promote 

sound financial management, including effective internal controls, with 

respect to the use of federal awards. Entities that expend $300,000 or more 

in federal awards in a year are required to comply with act’s requirements. 

Further, the act requires entities to (1) maintain internal control over 

federal programs, (2) comply with laws, regulations, and the provisions of 

contracts or grant agreements, (3) prepare appropriate financial 

statements, including a Schedule of Expenditures of Federal Awards, 

(4) ensure that the required audits are properly performed and submitted 

8

 The Single Audit Act of 1984 was substantially amended by the Single Audit Act 

Amendments of 1996, which is codified in Chapter 75 of Title 31, United States Code. 

Page 6 GAO-04-7 Compact of Free Association 
when due, and (5) follow up and take corrective actions on audit findings. 

Deloitte Touche Tohmatsu, an independent public accounting firm, 

conducted the 30 single audits that we reviewed for the FSM; the 4 FSM 

states of Chuuk, Kosrae, Pohnpei, and Yap; and the RMI. 

Objectives, Scope, and 

Methodology 

Our objective was to review possible FSM and RMI misuse of Compact 

funds. One source of this type of information is the annual single audits 

that the fiscal procedures agreement for the implementation of the 

Compact requires the FSM and the RMI to obtain. 

We obtained the single audit reports for the years 1996 through 2000, the 

most recent single audit reports available at the time of our review, for the 

national government of the FSM; the FSM state governments of Chuuk, 

Kosrae, Pohnpei and Yap; and the national government of the RMI. In total, 

this amounted to 30 single audit reports representing 5 years, a period that 

we considered sufficient for identifying misuse of funds and common or 

persistent compliance and financial management problems involving 

Compact funds. While these reports did not specifically identify any 

findings as instances of misuse of Compact funds, they did identify 

problems that could leave Compact funds susceptible to misuse, including 

poor control over cash and equipment. 

We reviewed each report to identify and categorize the audit findings 

relevant to the Compact, paying particular attention to those involving 

assets or other financial accounts (i.e., cash and equipment) that we 

considered particularly susceptible to misuse. (We did not independently 

assess the quality of these audits or the reliability of the audit finding 

information. However, based on the fact that the audited entities 

developed corrective action plans for about 93 percent of the findings 

contained in the audit reports, we concluded that the audit findings provide 

an accurate representation of the problems reported.) We also reviewed 

the reports to identify auditee responses to the audit findings and their 

corrective action plans. These plans indicate auditee agreement or 

disagreement with the audit findings and the actions they planned to take 

or had taken to fix the findings. In addition, we reviewed the audit findings 

to determine if they recurred in successive single audits over the 5-year 

period. We completed our review of each single audit report by identifying 

and categorizing the auditor’s opinions on the financial statements and the 

Schedules of Expenditures of Federal Awards. 

Page 7 GAO-04-7 Compact of Free Association 
In responding to our previous review of the Compact program, Interior 

officials expressed concerns about the U.S. government’s limited ability to 

enforce accountability over Compact funds due to certain provisions of the 

original Compact and the related FPA. In light of these concerns, we 

reviewed the amended Compacts and related FPAs to determine if they 

included measures that could increase accountability over Compact funds. 

In addition, we supplemented our review of these documents with a 

discussion about the amended Compacts with Interior officials to 

determine if the new provisions addressed their prior concerns about 

limited actions available to them for holding the FSM and the RMI 

accountable. 

Interior’s Compact-related expenditures represented about 80 percent of 

the total expenditures of U.S. assistance made by the FSM, the 4 FSM 

states, and the RMI during the 5-year period. Because of the relatively 

small amount of funding from other federal agencies at these recipients, we 

did not discuss finding resolution with representatives of those agencies. 

We conducted our audit from August 2002 through May 2003 in accordance 

with generally accepted government auditing standards. We requested 

written comments on a draft of this report from the governments of the 

FSM and the RMI and the Secretary of the Interior. Their comments are 

discussed in the section entitled Government and Agency Comments and 

Our Evaluation and are reprinted in appendixes I, II, and III. Further, we 

considered all comments and made changes to the report, as appropriate. 

Pervasive Audit 

Findings Demonstrate 

Poor Accountability 

over Compact Funds 

Single audits of the FSM, the four FSM states, and the RMI identified 

pervasive audit findings involving noncompliance with Compact 

requirements and financial statement problems in areas that we consider 

highly susceptible to misuse. In addition, the independent auditor 

performing the single audits issued qualified opinions or disclaimers of 

opinion on the financial statements in all 30 single audit reports reviewed 

and for 60 percent of the Schedules of Expenditures of Federal Awards. 

Taken together, these findings and opinions demonstrate that the FSM, the 

four FSM states, and the RMI did not provide reasonable accountability 

over Compact funds and assurance that these funds were used for their 

intended purposes. 

Page 8 GAO-04-7 Compact of Free Association 
Single Audit Reports 

Identify Pervasive Audit 

Findings Involving Compact 

Funds 

The 30 single audit reports that we examined contained about 90 audit 

findings for each year of the 5-year period covered by our review. In total, 

they contained 458 audit findings relevant to Compact funds and significant 

numbers of findings for each of the auditees for which we reviewed single 

audit reports. Further, successive single audits during the 5-year period 

contained recurring audit findings despite corrective action time frames 

established by the auditees and our conclusion that few of the findings 

involved significant issues, such as implementing an accounting system, 

that could be expected to require more than 2 years to correct. 

Figure 1 shows the number of audit findings reported annually from 1996 

through 2000. It demonstrates that the auditors performing the 30 single 

audits in our review identified a significant number of audit findings both in 

total and in each year of the 5-year period of our review. 

Figure 1: Number of Audit Findings Reported Annually from 1996 through 2000 

120 Number of findings 

100 

80 

60 

40 

20 

0 1996 1997 1998 1999 2000 

Source: GAO analysis of single audit reports. 

In addition, the 30 audit reports identified a significant number of audit 

findings for each of the auditees. Figure 2 shows the percentages of the 458 

audit findings related to Compact funds for each auditee. 

Page 9 GAO-04-7 Compact of Free Association 
Figure 2: Auditee Findings as a Percentage of Total Findings 

11% 

28% 

18% 

16 

13% 

14% 

Source: GAO analysis of single audit reports. 

RMI 

FSM 

Kosrae 

Pohnpei 

Yap 

Chuuk 

Office of Management and Budget (OMB) Circular No. A-133, Audits of 

States, Local Governments, and Non-Profit Organizations, establishes 

policies for federal agency use in implementing the Single Audit Act, as 

amended, and provides an administrative foundation for consistent and 

uniform audit requirements for nonfederal entities that administer federal 

awards. In part, the circular requires the auditee to follow up and take 

corrective actions on audit findings identified by the single audits. It 

clarifies this requirement by stating that, at the completion of the single 

audit, the auditee shall prepare a corrective action plan (CAP) to address 

each audit finding included in the current year auditor’s report. If the 

auditee does not agree with the audit findings or believes corrective action 

is not required, the CAP is to include an explanation of and justification for 

this position. Based on our review of the audit reports, the FSM, the four 

FSM states, and the RMI generally fulfilled their responsibility to either 

prepare a CAP or indicate their disagreement with the audit finding and 

provide reasons for their disagreement. As figure 3 shows, they prepared 

CAPs for 93 percent of the audit findings identified by the single audits in 

our review and indicated their disagreement and reasons for this 

disagreement for 5 percent of the findings. 

Page 10 GAO-04-7 Compact of Free Association 
Figure 3: Percentage of Corrective Action Plans Developed for Audit Findings 

1% 

1% 

5% 

93% 

Corrected finding 

No CAP prepared 

Disagree with finding 

CAP prepared 

Source: GAO analysis of single audit reports. 

Our review of these CAPs showed that about 33 percent (138) included 

anticipated completion dates, and, of these plans, only 4 percent (16) 

indicated that the planned corrective actions would require more than 2 

years to complete. Based on a review of the CAPs that did not include 

anticipated completion dates (287), we concluded that, with a few 

exceptions,9 the problems addressed by these plans could be corrected 

within a year. For example, Financial Status Reports submitted to the 

grantor agencies for fiscal year 2000 were not available during the single 

audit of the RMI. The auditors recommended that an adequate filing 

system, including the maintenance of Financial Status Reports, be 

maintained for all federal awards. The CAP called for the Ministry of 

Finance to ensure that an adequate filing system was in place and to review 

status reports periodically. 

Further analysis of the findings revealed that successive single audits 

identified recurring audit findings over the 5-year period despite the time 

frames identified in the auditee-prepared CAPs or our estimate of the 

9

 We identified 11 CAPs that we believe could require significant amounts of time to correct. 

For example, 3 CAPs called for accounting system upgrades and another 2 called for 

accounting systems. In another 2 instances, FSM states prepared plans that required legal 

opinions from the FSM national government in order to resolve the problems. 

Page 11 GAO-04-7 Compact of Free Association 
amount of time corrective action should take. As figure 4 shows, many 

audit findings that were identified in more than one single audit report 

recurred in 3 or more years over the 5-year period. The percentage of each 

auditee’s single audit findings that recurred 3 or more years over the 5-year 

period of our review ranged from RMI’s high of 69 percent to a low of 17 

percent for the FSM. 

Figure 4: Percentage of 1996 through 2000 Single Audit Findings That Recurred 3 or 

More Years 

FSM 

Pohnpei 

Yap 

Chuuk 

Kosrae 

RMI 

Compliance and Financial 

Statement Problems 

Persisted over Compact 

Funds 

The auditors categorized the audit findings related to the Compact into 

three areas—federal award findings, local findings, and financial statement 

findings. Upon further review, we determined that 117 audit findings that 

the auditors categorized as federal award findings or local findings 

discussed problems related to compliance with Compact requirements, and 

the remaining 341 discussed financial statement problems. The auditors 

who performed these single audits qualified or disclaimed their opinion on 

all of the financial statements and about 60 percent of the Schedules of 

Expenditures of Federal Awards generally because the auditees did not 

provide them with all needed financial statements or documentation to 

0 10 20 30 40 50 60 

Percentage of findings 

Source: GAO analysis of single audit reports. 

Page 12 GAO-04-7 Compact of Free Association 

70 
support transactions recorded in their books. Taken together, the 

compliance and financial statement findings and audit opinions 

demonstrate poor accountability over Compact funds and an inability on 

the part of the entities involved to provide assurances that all program 

funds are used as intended. They highlight the need for a stronger control 

environment and greater efforts to implement control activities that 

strengthen accountability and help ensure that Compact funds are used for 

program purposes. 

Compliance requirements for federal assistance set forth what is to be 

done, who is to do it, the purpose to be achieved, the population to be 

served, and how much can be spent in certain areas. OMB’s Single Audit 

Act guidance includes 15 compliance categories10 used by auditors to 

report on compliance-related findings. Our analysis of the compliance 

categories the auditors cited for the Compact-related audit findings showed 

that over half of the audit findings related to two categories—allowable 

costs/cost principles and equipment and real property management. The 

first category, allowable costs/cost principles, specifies the allowability of 

costs under federal awards. For example, expenditures for 17 types of 

projects or activities were allowable under the original Compact capital 

account, including construction or major repair of capital infrastructure, 

public and private sector projects, training activities, and debt service. 

The second category, equipment and real property management, specifies 

how federal award recipients should use, manage, and dispose of 

equipment and real property. 

The following examples illustrate the types of audit findings that the 

auditors categorized into the 15 areas. 

•	 Kosrae advanced $93,000 in Compact Health and Medical Program funds 

to off-island health providers for medical referrals. The advances were 

immediately expensed without reference to the specific medical 

expenses actually incurred. This is an example of a compliance finding 

related to allowable costs/cost principles. 

10 The 15 areas are (1) activities allowed or unallowed, (2) allowable costs/cost principles, 

(3) cash management, (4) Davis-Bacon Act, (5) eligibility, (6) equipment and real property 

management, (7) matching, level of effort, and earmarking, (8) period of availability of 

federal funds, (9) procurement, (10) program income, (11) real property acquisition and 

relocation assistance, (12) reporting, (13) subrecipient monitoring, (14) special tests and 

provisions, and (15) none. 

Page 13 GAO-04-7 Compact of Free Association 
•	 Kosrae incurred over $274,000 in expenditures of Compact Capital funds 

that lacked proper supporting vendor’s invoices. This is an example of a 

compliance finding related to allowable costs/cost principles. 

•	 Chuuk transferred about $169,000 in Compact Capital funds to entities 

(subrecipients) that have not been audited or reviewed for compliance 

with Compact requirements. This is an example of a compliance finding 

related to subrecipient monitoring. 

As mentioned earlier, the auditors performing the single audits also 

categorized findings as financial statement findings. The audit findings for 

this category related to the reliability of financial reporting and involved 

recording, processing, summarizing, and reporting financial data. Unlike 

the findings that related to compliance with Compact requirements, the 

auditors did not tie the financial statement findings to the categories 

contained in the Single Audit Act guidance. Our review of these findings 

identified 101 financial statement findings involving problems with assets 

or accounts that we consider susceptible to misuse. The following 

examples illustrate financial statement findings related to assets or 

accounts that we consider susceptible to misuse. 

•	 Yap’s three major bank accounts (general checking, savings, and 

payroll) were not reconciled to bank records at the end of fiscal year 

1999. Differences between the amounts shown for these cash accounts 

in Yap’s books and the bank records amounted to over $150,000. The 

auditors identified this lack of bank reconciliations as an internal 

control weakness in Yap’s single audit reports for the years 1995 through 

1999. A record being out of balance is a risk factor auditors use to 

identify the possibility of fraud. This is an example of a cash problem. 

•	 The RMI had not conducted a physical inventory or updated property 

records for equipment and real property. As of September 30, 2000, RMI 

reported that its equipment was worth about $11 million, but the auditor 

could not substantiate this amount due to inadequate records. The 

auditor identified a lack of updated property records for the General 

Fixed Asset Group in single audit reports for the years 1988 through 

2000. Missing documents, such as the property records for equipment in 

this example, are a risk factor used by auditors to identify the possibility 

of fraud. This is an example of an equipment problem. 

The 30 single audit reports included auditor opinions or disclaimers of 

opinion on the financial statements and Schedules of Expenditures of 

Page 14 GAO-04-7 Compact of Free Association 
Federal Awards for the FSM, the four FSM states, and the RMI. The 

financial statements reflect a federal award recipient’s financial position, 

results of operations or changes in net assets, and, where appropriate, cash 

flows for the year. The Schedules of Expenditures of Federal Awards show 

the amount of expenditures for each federal award program during the 

year. If the auditors are not able to perform all of the procedures necessary 

to complete an audit, they consider the audit scope to be limited or 

restricted. Scope limitations may result from the timing of the audit work, 

the inability to obtain sufficient evidence, or inadequate accounting 

records. If the audit scope is limited, the auditors must make a 

professional judgment about whether to qualify or disclaim an opinion. A 

qualified opinion states that, except for the matter to which the 

qualification relates, the financial statements are fairly presented in 

accordance with generally accepted accounting principles. In a disclaimer 

of opinion, the scope limitation is serious enough that the auditor does not 

express an opinion. 

The auditor’s opinions on the financial statements and Schedules of 

Expenditures of Federal Awards for the 30 single audits in our review 

reveal overall poor financial management. The auditors performing these 

single audits qualified or disclaimed their opinions on all of the financial 

statements and about 60 percent of the Schedules of Expenditures of 

Federal Awards generally because they were unable to obtain sufficient 

evidence or adequate accounting records. For example, the auditor 

qualified its opinion on the FSM’s financial statements for the year 2000 

because of the auditor’s inability to ensure the propriety of receivables 

from other governments and missing financial statements for a component 

unit. In another example, the auditor did not express an opinion on 

Chuuk’s financial statements for the year 1999 because of inadequacies in 

the accounting records and internal controls, incomplete financial 

statements for component units, and its inability to obtain audited financial 

statements supporting investments. 

The significant number of audit findings involving FSM and RMI 

noncompliance with Compact requirements and weaknesses in their 

financial management systems, along with auditor qualified opinions or 

disclaimers of opinion on financial statements, echo the control and 

accountability issues that we identified in our earlier reports on Compact 

assistance. Further, the pervasive and recurring nature of the compliance 

and financial statement problems highlights (1) the need for stronger 

control environments that will help ensure that Compact funds are used for 

program purposes and (2) the limited progress made during the 5-year 

Page 15 GAO-04-7 Compact of Free Association 
period of our review in establishing accountability in the FSM, the four 

FSM states, and the RMI that would provide reasonable assurance that 

Compact funds are used for their intended purposes. 

Amended Compact 

Agreements Contain 

Improved 

Accountability 

Measures 

In responding to our previous reviews of the original Compact program, 

Interior officials expressed concerns about the U.S. government’s limited 

ability to enforce accountability over Compact funds due to certain 

provisions of the original Compact and the related FPA. According to these 

officials, administrators have been reluctant to commit oversight resources 

to the Compact when no enforcement mechanisms exist due to these 

provisions. The United States and the FSM signed an amended Compact in 

May 2003. The United States and the RMI signed an amended Compact in 

April 2003. These amended Compacts are awaiting legislative approval in 

the United States, the FSM, and the RMI. They contain strengthened 

reporting and monitoring measures over the original Compact that could 

improve accountability over Compact assistance, if diligently implemented. 

According to Interior officials, the FPA in effect during the period of our 

review created a financial management regimen unique in federal practice. 

They explained that it was negotiated to give the FSM and the RMI 

governments clear control over Compact funding and to limit the U.S. 

government’s authority to intervene in spending decisions and, most 

important, to withhold payments if the terms and conditions of funding 

were violated. More specifically, these officials explained that the expiring 

FPAs lacked basic elements of federal grant management practice similar 

to those in OMB Circular A-102, Grants and Cooperative Agreements with 

State and Local Governments, which requires standard procurement 

practices and cost principles. They elaborated that, when coupled with the 

full faith and credit provisions of the Compact,11 this lack of standards 

limited the U.S. government’s response to mismanagement. In summing 

up, they stated that while additional personnel and funding could have 

been committed to Compact oversight, the United States would still have 

had almost no ability to influence fiscal decisions made by the FSM or the 

RMI. 

11 “Except as otherwise provided, approval of the Compact by the Government of the United 

States shall constitute a pledge of the full faith and credit of the United States for the full 

payment of the sums and amounts specified in Articles I and III of this Title. The obligations 

of the United States under Article I and III of this Title shall be enforceable in the United 

States Claims Court.” Compact of Free Association, section 236 (Jan. 14, 1986). 

Page 16 GAO-04-7 Compact of Free Association 
The amended Compacts could potentially cost the U.S. government about 

$6.6 billion in new assistance. Of this amount, $3.5 billion would cover 

payments over a 20-year period (2004-23), while $3.1 billion represents 

payments for U.S. military access to the Kwajalein Atoll in the RMI for the 

years 2024 through 2086. The amended Compacts contain strengthened 

reporting and monitoring measures that could improve accountability over 

Compact assistance, if diligently implemented. In addition, the Department 

of the Interior has taken actions to increase resources dedicated to 

monitoring and oversight of Compact funds. 

The following are amended Compact and related FPA measures that 

represent changes from the prior Compact and FPAs. 

•	 In 2000, we reported that Compact funds were placed in a general 

government fund and commingled with other revenues and, therefore, 

could not be further tracked. In addition, some Compact assistance was 

only traced at a high level with few details readily available regarding 

final use. The amended Compacts and FPAs include requirements that 

should address these accountability concerns. Specifically, they require 

fiscal control and accounting procedures sufficient to permit 

(1) preparation of required reports and (2) tracing of funds to a level of 

expenditures adequate to establish that such funds have been used in 

compliance with applicable requirements. Further, the amended 

Compacts specify standards for the financial management systems used 

by the FSM and the RMI. For example, these systems should maintain 

effective controls to safeguard assets and ensure that they are used 

solely for authorized purposes. 

•	 The new FPAs would establish a joint economic management 

committee for the FSM and the RMI that would meet at least once a 

year. The committee would be composed of three U.S. appointed 

members, including the chairman, and two members appointed, as 

appropriate, by either the FSM or the RMI. The committee’s duties 

would include (1) reviewing planning documents and evaluating island 

government progress to foster economic advancement and budgetary 

self-reliance, (2) consulting with program and service providers and 

other bilateral and multilateral partners to coordinate or monitor the 

use of development assistance, (3) reviewing audits, (4) reviewing 

performance outcomes in relation to the previous year’s grant funding 

level, terms, and conditions, and (5) reviewing and approving grant 

allocations (which would be binding) and performance objectives for 

the upcoming year. 

Page 17 GAO-04-7 Compact of Free Association 
•	 Grant conditions normally applicable to U.S. state and local 

governments would apply to each grant. General terms and conditions 

for the grants would include conformance to plans, strategies, budgets, 

project specifications, architectural and engineering specifications, and 

performance standards. Specific postaward requirements address 

financial administration by establishing, for example, (1) improved 

financial reporting, accounting records, internal controls, and budget 

controls, (2) appropriate use of real property and equipment, and 

(3) competitive and well-documented procurement. 

•	 The United States could withhold payments if either the FSM or the RMI 

fails to comply with grant terms and conditions. The amount withheld 

would be proportional to the breach of the term or condition. In 

addition, funds could be withheld if the FSM or RMI governments do not 

cooperate in U.S. investigations of whether Compact funds have been 

used for purposes other than those set forth in the amended Compacts. 

•	 The new FPAs include numerous reporting requirements for the two 

countries. For example, each country must prepare strategic planning 

documents that are updated regularly, annual budgets that propose 

sector expenditures and performance measures, annual reports to the 

U.S. President regarding the use of assistance, quarterly and annual 

financial reports, and quarterly grant performance reports. 

The successful implementation of the new accountability provisions will 

require a sustained commitment by the three governments to fulfilling their 

new roles and responsibilities. Appropriate resources from the United 

States, the FSM, and the RMI represent one form of this commitment. 

While the amended Compacts do not address staffing issues, officials from 

Interior’s Office of Insular Affairs have informed us that they intend to post 

six staff in a new Honolulu office: a health grant specialist, an education 

grant specialist, an accountant, an economist, an auditor, and an office 

assistant. Interior can also contract with the Army Corps of Engineers for 

engineering assistance, when necessary. These Honolulu-based staff may 

spend about half of their time in the FSM and the RMI. Further, an Interior 

official noted that his office has brought one new staff member on board in 

Washington, D.C. and intends to post one person to work in the RMI (one 

staff member already works in the FSM). We have not conducted an 

assessment of Interior’s staffing plan and rationale and cannot comment on 

the adequacy of the plan or whether it represents sufficient resources in the 

right locations. 

Page 18 GAO-04-7 Compact of Free Association 
Conclusions	 The 30 single audit reports demonstrate a lack of or poor accountability 

over U.S. Compact assistance that has totaled an estimated $2.1 billion 

since 1987. The large number and recurring nature of the findings involving 

noncompliance with Compact requirements or financial management 

weaknesses, along with the preponderance of auditor’s qualified opinions 

or disclaimers of opinion on FSM and RMI financial statements, clearly 

indicate the need for improved FSM and RMI management of U.S. 

assistance and greater U.S. oversight and monitoring of the use of this 

assistance. Changes are needed especially considering the fact that the 

amended Compacts with these nations could potentially cost the U.S. 

government about $3.5 billion in new assistance over the next 20 years. 

Under the original Compact, the Department of the Interior was 

responsible for supervising, coordinating, and monitoring the program 

assistance provided. Interior officials expressed frustration with the lack 

of tools available to them to administer or track this assistance in a manner 

that could reasonably ensure that such assistance was having its intended 

effect. The amended Compacts strengthen reporting and monitoring 

measures that could improve accountability over assistance, if diligently 

implemented. These measures include strengthened fiscal control and 

accounting procedures requirements, expanded annual reporting and 

consultation requirements, and the ability to withhold funds for 

noncompliance with grant terms and conditions. The successful 

implementation of the new accountability provisions will require 

appropriate resources and sustained commitment from the United States, 

the FSM, and the RMI. The joint economic committees called for in the 

Compact with each nation and Interior’s planned increase in staff 

associated with Compact oversight and monitoring functions should play 

key roles in improving accountability over Compact funds. 

Recommendations for 

Executive Action 

To help promote compliance with Compact requirements and sound 

financial management, the Secretary of the Interior should delegate 

responsibility to the Office of Insular Affairs and hold appropriate officials 

in that office accountable for 

•	 ensuring the adequacy of staff dedicated to Compact oversight and 

monitoring, 

•	 monitoring FSM and RMI progress in addressing Compact-related single 

audit report findings, 

Page 19 GAO-04-7 Compact of Free Association 
•	 reporting on the FSM and RMI actions to correct Compact-related 

compliance and financial management findings identified in single audit 

reports to the Secretary of the Interior or other appropriate high-level 

Interior official, 

•	 initiating appropriate actions when the FSM or the RMI do not 

undertake adequate actions to address Compact-related single audit 

findings in a timely manner, and 

•	 investigating single audit findings that indicate possible violations of 

grant conditions or misuse of funds and taking appropriate actions 

when such problems are verified. 

Government and 

Agency Comments and 

Our Evaluation 

In commenting on this report, the Office of Insular Affairs of the 

Department of the Interior, FSM, and RMI agreed with our findings or 

conclusions and recommendations. They also cited the amended 

Compacts as mechanisms that should result in improved financial 

management over Compact assistance. The FSM and RMI also provided 

technical comments and information on current actions to address 

financial management issues. We considered all comments and made 

changes to the report, as appropriate. 

The FSM comments noted that it found the report constructive and useful 

as it continues to prepare for the implementation of the amended Compact 

and its related agreements. The comments (reprinted in app. I) recognized 

that, although FSM has worked hard to develop a consistent approach to 

satisfy the Compact and FPA requirements, significant work remains to be 

done to improve and strengthen accountability in all aspects throughout 

the nation. Further, FSM agreed that it must continue to improve internal 

financial control through upgrading the current financial management 

system, providing for capacity building, and retaining its most productive 

and experienced employees. Finally, it noted that the amended Compact 

and related fiscal procedures agreement include requirements that will 

address all of the accountability concerns expressed in the report. 

RMI’s comments (reprinted in app. II) stated that it concurred with the 

report’s findings and noted that the report will be useful since it gives a 

summary of the financial and management situation of the RMI between 

1996 and 2000. RMI noted that its problems stem partly from the fact that it 

has not had a global system for following up on audits that would apply 

throughout all ministries of the government as well as other entities that 

Page 20 GAO-04-7 Compact of Free Association 
receive Compact grant assistance. RMI stated that it has made progress 

recently by upgrading its information system and strengthening its internal 

control procedures and noted that it will add personnel to the budget, 

procurement, and supply areas. 

In its comments (reprinted in app. III), the Office of Insular Affairs of the 

Department of the Interior agreed with the conclusions and 

recommendations in the report. The Office also noted that it looks forward 

to discharging its responsibilities under the amended Compacts and that it 

is confident that it will now have the tools needed to properly protect the 

American taxpayer’s investment in the freely associated states. 

As agreed with your offices, unless you publicly announce its contents 


earlier, we will not distribute this report until 30 days after its date. At that 


time, we will send copies to the Secretary of the Interior, the President of 


the Federated States of Micronesia, the President of the Republic of the 


Marshall Islands, and appropriate congressional committees. Copies will 


also be made available to others on request. This report will also be 


available at no charge on GAO’s Web site at http://www.gao.gov. 


For future contacts regarding this report, please call McCoy Williams at 


(202) 512-6906 or Susan S. Westin at (202) 512-4128. Staff contacts and 


other key contributors to this report are listed in appendix IV. 


McCoy Williams


Director


Financial Management and Assurance


Susan S. Westin


Managing Director


International Affairs and Trade


Page 21 GAO-04-7 Compact of Free Association 
Appendix I 

Comments from the Federated States of 

Micronesia 

Page 22 GAO-04-7 Compact of Free Association 
Appendix I


Comments from the Federated States of 


Micronesia


Page 23 GAO-04-7 Compact of Free Association 
Appendix II 

Comments from the Republic of the Marshall 

Islands 

Page 24 GAO-04-7 Compact of Free Association 
Appendix II


Comments from the Republic of the Marshall 


Islands


Page 25 GAO-04-7 Compact of Free Association 
Appendix II


Comments from the Republic of the Marshall 


Islands


Page 26 GAO-04-7 Compact of Free Association 
Appendix III 

Comments from the Department of the 

Interior 

Page 27 GAO-04-7 Compact of Free Association 
Appendix IV 

GAO Contacts and Staff Acknowledgments


GAO Contacts	 Tom Broderick, (202) 512-8705 or broderickt@gao.gov 

Emil Friberg, Jr., (202) 512-8990 or friberge@gao.gov 

Acknowledgments	 In addition to the contacts named above, Perry Datwyler and Leslie Holen 

made key contributions to this report. 

(195008) Page 28 GAO-04-7 Compact of Free Association 
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