Credit Reform: Review of OMB's Credit Subsidy Model
Released: 1997-08-29T00:00:00

Letter

Background

The federal government uses direct loans and loan guarantees as tools to achieve numerous program objectives, such as assistance for housing, farming, education, small businesses, and foreign governments. Before the enactment of FCRA, credit programs—like most other programs—were recorded in budgetary accounts on a cash basis. This cash basis distorted the timing of when costs would actually be incurred and, thus, the comparability of credit program costs with other programs intended to achieve similar purposes, such as grants. For example, the cash-basis cost of a direct loan in a fiscal year was equal to the cash-basis cost of a grant. The long-term cost of a direct loan, however, may be much less than a grant because of loan repayments. Cash-basis budgetary recording also suggested a bias in favor of loan guarantees over direct loans. Loan guarantees appeared to be free because cash-basis recording did not recognize that some loan guarantees default. Furthermore, direct loans appeared to be relatively costly because the cash-basis recording did not recognize that many direct loans are repaid.

FCRA changed the treatment of credit programs beginning with fiscal year 1992 so that their costs can be compared more accurately with each other and with the costs of other federal spending. Two key principles of credit reform are (1) the definition of cost (subsidy) in terms of the net present value of cash flows over the life of a loan and (2) the requirement that budget authority to cover the subsidy cost be provided in advance before new direct loan obligations are incurred and new loan guarantee commitments are made.

FCRA defines the subsidy cost of direct loans as the present value over the loan’s life of disbursements by the government (loan disbursements and other payments) minus estimated payments to the government (repayment of principal, payments of interest, and other payments) after adjusting for projected defaults, prepayments, fees, penalties, and other recoveries. It defines the subsidy cost of loan guarantees as the present value of cash flows from estimated payments by the government (for defaults and delinquencies, interest rate subsidies, and other payments) minus estimated payments to the government (for loan origination and other fees, penalties, and recoveries). According to FCRA, the net present value is calculated by discounting the cash flows at the average interest rate on marketable Treasury securities of similar maturity to the direct or guaranteed loan when the loans are disbursed.

FCRA gave OMB oversight responsibility to ensure proper implementation of credit reform, including agency calculation of subsidy costs. To provide a consistent, common approach to calculate the present value of credit program costs, OMB developed the CSM, a computer software program that calculates a subsidy rate based on agency-generated estimates of cash flows to and from the government. The CSM also calculates the portions of the subsidy cost attributable to defaults, interest subsidies, fees, and other subsidy components.

Thus, the CSM is basically a calculator. Agency-generated cash flows are entered into the CSM by means of an electronic spreadsheet. The CSM’s basic function is to calculate the net present value of these cash flows by discounting them to the year monies are disbursed and dividing the amount of subsidy by the present value of the amount of disbursement to obtain the subsidy percentage. Agency-generated cash flows are essential for determining subsidy costs. Changing data on the cash flows, such as the expected rate of defaults, changes the subsidy calculation. Therefore, the CSM’s subsidy calculation is only as reliable as the data in agency-generated cash flows the CSM uses.

Although FCRA requires the use of present value to measure the subsidy costs of direct loans and loan guarantees for budgetary accounting and reporting, the law does not address financial statements and associated reporting. However, the Federal Accounting Standards Advisory Board (FASAB) concluded that significant benefits would result from integrating budgetary and financial accounting for federal credit programs. FASAB recommended that since budgetary resources for direct loan and loan guarantee subsidies are required to be reported on a net present value basis, financial reporting of loan activity should be on the same basis. Statement of Federal Financial Accounting Standards (SFFAS) No. 2, Accounting for Direct Loans and Loan Guarantees, was issued in 1993 to provide accounting standards for federal direct loans and loan guarantees that incorporate FCRA’s subsidy calculation requirements. With the issuance of SFFAS No. 2, subsidy calculations became important not only for budgetary accounting and reporting purposes but also for financial reporting purposes.

Scope and Methodology

To determine whether the CSM complies with applicable laws and accounting standards, provides reliable results, and is maintained and operated under a system of adequate controls, we engaged the independent public accounting firm of Ernst & Young to perform an attestation in accordance with American Institute of Certified Public Accountants (AICPA) attestation standards on OMB management’s assertions regarding the CSM’s capabilities and limitations. A complete discussion of Ernst & Young’s scope and methodology is included in its report in appendix I. To ensure that Ernst & Young complied with contract requirements and applicable auditing standards, we defined the scope of work to be completed by Ernst & Young; met periodically with Ernst & Young during the course of its evaluation and attended key meetings with them, including their initial meeting with OMB staff; reviewed Ernst & Young’s work in accordance with generally accepted performed a limited analysis of the CSM, its assumptions, and mechanics in order to better understand the results of Ernst & Young’s work; analyzed the discounting formulas used by the CSM to discount the cash flows to the time of disbursement; and developed a limited number of test cash flow spreadsheets for use with the CSM to compare its results with those calculated manually and to gain an understanding of the proper use of the CSM.

To identify supplemental audit steps that auditors should perform, we reviewed the CSM’s User’s Guide, OMB’s assertions, and Ernst & Young’s report. We also received advice and assistance from the Federal Audit Executive Council, credit agencies’ inspectors general, representatives of the Governmentwide Credit Reform Subgroup, and OMB’s credit reform staff.

Our analysis of the Ernst & Young report and related work was conducted in Washington, D.C., from April 1997 through June 1997 in accordance with generally accepted government auditing standards. We requested comments on a draft of this report from the Director of OMB or his designated representative. OMB staff responsible for credit reform suggested some technical clarifications to our report, which we have incorporated where appropriate.

CSM Calculations Comply With Definition of Credit Subsidy

FCRA and SFFAS No. 2 contain several requirements about the budgetary and financial accounting treatment of direct loans and loan guarantees. However, the primary requirement pertinent to the calculation of the subsidy is the definition of cost. FCRA and SFFAS No. 2 define the cost of a direct loan or loan guarantee as the net present value of estimated future cash flows at the time when the loan is disbursed. This calculation incorporates cash flows to and from the government, excluding administrative costs and any incidental effects on governmental receipts or outlays. The CSM’s calculation of subsidies complies with this definition in that the CSM computes a subsidy cost by calculating the net present value of agency-generated cash flows of expected payments to and from the government by discounting these cash flows to the fiscal year when they are disbursed. For loans that disburse in more than 1 year, the CSM allocates the cash flows to each disbursement year and discounts the associated cash flows to the appropriate year of disbursement.

FCRA and SFFAS No. 2 require that cash flows contain certain components, such as loan disbursements; repayments of principal; payments of interest; and other payments, including fees, penalties, and other recoveries. Spreadsheets that capture these cash flows are not part of the CSM and responsibility for creating these spreadsheets lies with CSM users rather than with OMB. However, OMB designed the CSM to read spreadsheets that contain these components.

CSM Results May Differ From Theoretically Precise Net Present Value Calculations

OMB’s assertions state that limitations exist in the CSM resulting from (1) the complexity of the FCRA requirement to calculate the net present value with respect to the time of disbursement, (2) efforts to simplify the CSM while at the same time making it flexible enough to fit all federal credit programs, (3) inherent limitations of discounting methods and financial models such as rounding definitions, and (4) the use of discounting formulas that differ slightly from standard methods. Because of these limitations, the subsidy percentage calculated by the CSM may differ from a “theoretically precise” result. For example, under some government loan programs, an agency receives principal and interest payments from borrowers on a daily basis throughout the year. Therefore, a theoretically precise subsidy calculation would require the daily discounting of these cash flows to time of disbursement. OMB believes that the added precision of such daily discounting would be burdensome and yield little value. Consequently, OMB provides timing options that approximate the daily discounting of cash flows.

Although neither OMB nor Ernst & Young have identified any instances where differences between the CSM subsidy cost calculation and the theoretically precise calculation were significant, the materiality of these differences cannot be precisely determined in general because the relevant factors, such as the applicable discount rate and the size and timing of future cash flows, will vary from case to case. Except for one of the limitations, however, our assessment is that CSM users and their auditors can take steps to minimize or eliminate the impact of the limitations.

Of the several limitations OMB included in its assertions, three impact the subsidy cost calculations. These are described in detail in OMB’s assertions and Ernst & Young’s report. The first limitation results from the CSM’s use of nonstandard discounting equations to calculate the net present value of cash flows for partial periods, such as semiannual and quarterly. The CSM adjusts its discounting equations for partial periods, when timing options other than “simple annual” are used, by dividing the discount rate by a factor, which is determined by the timing of cash flows and the periodicity of discounting. However, such partial period adjustments should be made exponentially to conform with standard discounting conventions. For example, the standard adjustment to the discounting equation for the semiannual discounting of cash flows occurring at the end of each 6-month period is the square root of (1 + rate) while the CSM uses (1 + rate/2). This results in CSM present values that are slightly lower than those calculated using standard geometric formulas. Because these equations are embedded in the CSM’s source code, users and their auditors are unable to mitigate this limitation. To resolve this problem, OMB should revise the computer source code so that the net present value calculations reflect standard discounting equations.

The second limitation arises for programs that disburse loans over several years. FCRA requires that cash flows be discounted to the time of disbursement. OMB interprets the FCRA “time of disbursement” for calculation purposes as the “fiscal year of disbursement.” Consequently, in cases where programs disburse over several years, precisely calculating subsidies requires that agencies prepare cash flows clearly associated with each disbursement so that these cash flows can be discounted to the year of disbursement. Because disbursement year cash flows cannot always be provided due to limited agency accounting systems and credit program data, the CSM permits less detailed, aggregated cohort level data to be used as an approximation. If cohort level data are used, the CSM uses one of two methods to disaggregate the cash flows into portions that are attributable to the amounts that are disbursed in each year. However, the use of cohort level data can introduce distortions that result from (1) the disaggregation of the cohort level data and (2) the CSM’s averaging of discount rates for programs where discount rates differ for each disbursement year. Agencies can eliminate the impact of this limitation by using disbursement year data, when available, rather than cohort level data.

The third limitation involves rounding. Because of rounding, and particularly in programs that have disbursements over several years, the calculated subsidy will be less precise if an inappropriate scale is used in the cash flow data. If the data are presented in millions and the actual values are in thousands, a significant amount of data may be lost when the CSM rounds to three decimal places. This effect is most pronounced when a large portion of program cash flow items are very small, since rounding of smaller dollar values increases the risk that the rounded values will be materially different than the actual values. For example, if a series of underlying values in millions of dollars is 0.0054, 0.0054, 0.0054, the CSM will round each to 0.005—losing 0.0004, or roughly 8 percent in each case, which may be significant. If these values were expressed in thousands of dollars (5.400 instead of 0.0054), none of the underlying values would be lost due to rounding.

Reliable Subsidy Calculations Also Require Quality Cash Flow Data, Proper Use of the CSM, and Management Oversight

When assessing the reliability of the CSM’s subsidy rate calculations, we found it useful to remember the important but limited role that the CSM has in the credit reform process. Reliable subsidy calculations also require quality cash flow data, clear guidance from OMB and proper use of the CSM by credit agencies, and close management oversight by both the credit agency and OMB.

Because the CSM is essentially a calculator that processes estimated cash flows provided by the credit agency, its subsidy calculation is only as reliable as the agency-generated cash flow data. In the audits of credit agencies’ financial statements for fiscal year 1995, significant weaknesses were identified with the quality of cash flow estimates and supporting data. For example, the Department of Agriculture, which has the federal government’s largest balance of loans receivable, received a qualified audit opinion on its Rural Development component financial statements, in part, because of inadequately supported cash flows. Fiscal year 1996 financial statement audit results available as of July 1997 indicate that generally credit agencies are still having difficulty preparing quality, well-supported cash flows that comply with FCRA and SFFAS No. 2 requirements. Staff from GAO, OMB, and credit agencies are currently working together to develop approaches to improve cash flow estimates.

Although the basic function of the CSM—to discount cash flows to the year of disbursement—is conceptually straightforward, use of the CSM can be complex because of the various options available and types of data to be entered. Consequently, proper use of the CSM requires sufficient, clear guidance from OMB on what the CSM options are and how best to use them to reflect the characteristics of credit agency loan programs. Also, credit agency officials must recognize that use of the CSM requires not only adequate knowledge of credit agency loan programs but familiarity with the concepts contained in FCRA and SFFAS No. 2. Moreover, given the complexity inherent in developing cash flow spreadsheets and using them with the CSM in subsidy calculations, agency management must exercise proper oversight to ensure that cash flow data is of high quality, the CSM is used properly, and controls surrounding the preparation of cash flows and the calculation of subsidies are adequate and operating as intended. Finally, given the role assigned to it by FCRA, OMB must oversee agencies’ credit reform implementation even though responsibility for preparing cash flows is with the credit agencies.

We recently had the opportunity to illustrate the need for adequate oversight by credit agencies and OMB. In our July 16, 1997, testimony before the House Committee on Small Business, we reported on the estimates of credit subsidy for the Small Business Administration’s (SBA) guaranteed business loan and certified development company programs—more commonly called the “7(a)” and “504” programs, respectively. We reported on an error in SBA’s cash flow spreadsheet that we had uncovered in the calculation of the fiscal year 1997 subsidy costs for the 7(a) program. A critical cell in SBA’s cash flow spreadsheet was based on the number of dollars guaranteed instead of the number of dollars disbursed, that is, the total face amount of the loans. (SBA projected that it would guarantee on average about 76 percent of the fiscal year 1997 loan cohort.) As a result of this error, SBA’s estimated credit subsidy rate was higher by about 32 percent (1 divided by 0.76, the average guaranteed portion of loans disbursed by private lenders).

This error went unnoticed by both SBA and OMB staff responsible for reviewing the 7(a) credit subsidy rate estimate. If those staff had compared the component data generated by the CSM for the erroneous fiscal year 1997 estimate with the components of the fiscal year 1996 estimate, they would have seen an unexplainable increase in the fee revenue component (there was no increase in the fee rates charged). According to SFFAS No. 2, subsidy estimate component data should be used to monitor and make decisions about the federal government’s credit programs.

In 1995, the Governmentwide Credit Reform Subgroup was formed to resolve issues faced by (1) agencies in implementing credit reform and preparing quality cash flow data and (2) auditors reviewing credit subsidy estimates. An issue paper prepared by the Subgroup, Preparing and Auditing Direct Loan and Loan Guarantee Subsidies Under the Federal Credit Reform Act, is expected to be issued during fiscal year 1998.

Controls and Documentation Should Be Improved

Ernst & Young’s report includes the following control weaknesses surrounding the development, maintenance, and use of the CSM. First, the CSM was not designed, and is not maintained, in accordance with the validation, verification, and testing (VV&T) approach to software development. VV&T is a process of review, analysis, and testing employed throughout a structured system development lifecycle to ensure the production and maintenance of quality, reliable software. Second, the CSM program was developed and tested by a single programmer and was not independently tested to ensure that its functionality met the initial design request. Ernst & Young noted that the loss or absence of the original programmer may substantially hinder significant modification of the current program. Third, documentation provided to CSM users contains several errors and omissions, and exists in several pieces. Fourth, OMB’s storage of the program source code is insufficient to protect against loss, destruction, and corruption. Fifth, agencies visited by Ernst & Young were using the CSM without logical access controls to prevent unauthorized access. Finally, because it is difficult to verify which data the CSM used to calculate the subsidy, the CSM printed output should be enhanced.

Three recommendations were made to improve controls over the CSM, and OMB credit reform staff generally agreed with them. Specifically, OMB staff agreed that (1) future revisions to the CSM will be accompanied by more detailed and complete documentation of the validation, verification, and testing of software, (2) documentation will be improved and expanded to correct for errors and omissions, and (3) the CSM printed output should be enhanced to provide an audit trail showing which data the CSM used to calculate the subsidy.

However, OMB staff expressed concerns about some of the findings and one recommendation relating to controls over the CSM. Although OMB acknowledged in its assertions that it did not have a structured and documented VV&T process for developing and testing the CSM, OMB staff told us that the CSM had been developed through extensive discussions among OMB and agency staffs and had been tested over several years by CSM users at credit agencies as well as by OMB credit reform staff. OMB staff also emphasized that computer access controls are an agency’s responsibility and noted that current versions of desktop operating systems have password protection and other controls. Moreover, OMB said that the source code is stored on-site and off-site, in digital tape, fixed disk, and CD-ROM formats and that these storage media are adequate to prevent loss, destruction, or corruption. Finally, OMB’s position is that the loss of the original CSM programmer would not seriously affect future modifications of the program since (1) there is no immediate or urgent need for modifications to the CSM, so replacement staff would have ample time to familiarize themselves with the CSM, (2) other OMB staff or contract personnel could easily make such modifications by using the existing source code, knowledge of the programming language, and familiarity with credit reform concepts, and (3) the CSM is more likely to be replaced than modified.

We believe that the improvements to the control environment surrounding the CSM agreed to by OMB, especially the use of VV&T or a similar process, will resolve the major control issues raised by Ernst & Young. Although we recognize that user agencies have ultimate responsibility for computer access controls, agencies clearly need guidance on properly controlling access to the CSM—Ernst & Young’s visits to seven user agencies found that none of them had logical access controls over the personal computers containing the CSM. We believe that OMB guidance on proper controls over access to the official agency copy of the CSM can be easily and quickly communicated to agency staff. In addition, since the completion of Ernst & Young’s work, we have confirmed that OMB has adequate storage of the CSM source code to prevent loss, destruction, or corruption.

Revised CSM to Be Released After June 1998

OMB staff told us that they are considering improvements to the CSM, including a refinement of methods, more detailed output, improved documentation, and other improvements identified in the management assertions and, where appropriate, recommendations from the Ernst & Young report. Also, before releasing this improved version, OMB staff are considering whether to have an audit of the CSM calculations. OMB staff told us that the release of the new version of the CSM will be no earlier than June 1998.

OMB staff also told us that they would recommend an interim release of the CSM, prior to the major release described above, if there were a change in law or other requirements or if a significant defect in the calculations was identified. However, in the OMB staff’s judgment, the relatively minor improvements that they believe could be accomplished in an interim update must be weighed against what they believe will be a substantial effort, mainly by agencies, to reinstall the model on hundreds of computers and train staff in the changes from the previous release. As of July 1997, OMB staff told us that they have found no evidence that an interim update is required. Further, OMB staff noted that OMB’s management assertions, which Ernst & Young concluded are “fairly stated in all material respects,” state that the effect of limitations in the current release of the CSM, based on cases reviewed to date, “have not revealed any instance in which such differences were significant.”

Procedures Auditors Should Perform to Ensure Proper Use of the Credit Subsidy Model

OMB’s assertions and Ernst & Young’s report pointed out that proper use of the CSM is the responsibility of the user agencies. This responsibility includes using proper cash flow data, correctly installing the appropriate CSM version, and making correct choices from available CSM options to accurately reflect specific credit program characteristics. In contracting with Ernst & Young, we did not ask the firm to determine whether agencies are properly using the CSM. Therefore, to ensure that CSM subsidy calculations are correct, auditors will need to, among other things, obtain assurance that agencies are using the CSM properly. With assistance from the Federal Audit Executive Council, credit agencies’ inspectors general, representatives of the Governmentwide Credit Reform Subgroup, and OMB’s credit reform staff, we identified supplemental audit procedures to be performed in audits of federal credit agencies and subsidy calculations. These procedures are listed in appendix II.

Conclusions

Taken together, OMB’s assertions on the CSM’s capabilities, Ernst & Young’s report, and the audit procedures included in this report should provide federal credit agencies and their auditors with a better understanding of how the CSM functions and additional guidance on proper use of the CSM. Although generally agreeing with Ernst & Young’s recommended steps for improving the CSM, OMB staff believe that an immediate release of a revised, improved CSM would not be worth the costs involved. OMB staff further note that they have found no evidence that the limitations in the current release of the CSM have had a material impact on subsidy calculations. Thus, they propose waiting until they have decided upon various policy matters and other changes to the CSM before they issue a revised version of the CSM. While this may be reasonable, we believe that the lack of adequate access controls at user agencies should be corrected immediately.

Recommendations

Based on our review of OMB’s assertions and Ernst & Young’s report, we recommend that the Director of OMB ensure that guidance is provided to user agencies to establish logical access controls surrounding use of the CSM. In addition, we recommend that the Director of OMB ensure that the following steps are taken in developing the next revision to the CSM: revise the discounting equations in the CSM to follow standard finance strengthen controls over the CSM by implementing a VV&T or similar process, improve the CSM documentation to correct for the mistakes and omissions noted in OMB’s assertions and Ernst & Young’s report, and enhance the CSM printout with additional data so that users and auditors are able to specifically identify which data were used by the CSM in the subsidy calculations.

Within 60 days of the date of this letter, we would appreciate receiving a written statement on actions taken to address our recommendations.

We are sending copies of this report to the Senate and House Appropriations and Budget Committees, the Senate Committee on Governmental Affairs, and the House Committee on Government Reform and Oversight. We are also sending copies to the chief financial officers and budget officials at federal credit agencies; the inspectors general with audit responsibilities for these agencies; and other interested parties. Copies will also be made available to others upon request.

If you have any questions about this report, please call McCoy Williams, Assistant Director, at (202) 512-6906. Major contributors to this report are listed in appendix III.

Ernst & Young’s Report Including OMB’s Assertions

Audit Procedures to Verify Proper Use of the Credit Subsidy Model

Proper use of OMB’s Credit Subsidy Model (CSM) requires that user agencies correctly install the appropriate CSM version, make correct choices from available CSM options and commands to accurately reflect specific credit program characteristics, control access to the CSM, and understand the CSM’s capabilities and limitations.

With assistance from the Federal Audit Executive Council, credit agencies’ inspectors general, representatives of the Governmentwide Credit Reform Subgroup, and OMB’s credit reform staff, we identified the following audit procedures that should be performed to ensure proper use of the CSM. Comprehensive guidance on auditing credit reform subsidy estimates is included in Preparing and Auditing Direct Loan and Loan Guarantee Subsidies Under the Federal Credit Reform Act, a draft issue paper prepared by the Governmentwide Credit Reform Subgroup, which is expected to be issued during fiscal year 1998. The audit procedures discussed in the following sections should be used in conjunction with those presented in the issue paper. Additionally, these procedures are intended to provide audit guidance that may or may not be applicable in all situations. The auditors should use professional judgment in determining which are applicable to the agency they are auditing.

Ensure Use of an Appropriate and Unmodified Version of the CSM

Since 1990, OMB has periodically revised the CSM to add enhancements, make methodology changes, and otherwise improve its operation. Different versions of the CSM may produce slightly different subsidy rates. As of July 1997, the current version of the CSM was Version r.9, dated August 1, 1994. We expect that OMB will, on occasion, release new versions of the CSM. In addition, although it may be unlikely, the agency’s computer file of the CSM may become modified intentionally or accidentally. Therefore, the auditor should obtain the appropriate version of the CSM for the fiscal year under audit by contacting the agency’s OMB budget examiner. This version should be compared with the version used by the agency in its subsidy calculations. To verify that the agency’s version of the CSM is unmodified, the auditor should use the “file compare” feature of desktop operating software to compare the agency’s version with the OMB official, approved version. If the two versions are the same, the auditor can conclude that the agency’s version is unmodified. If they differ, the auditor should bring this to the attention of agency management and the OMB budget examiner and obtain an explanation for the differences. Finally, as the ultimate check, the auditor can calculate the subsidy rate using the agency’s cash flows, the agency’s version of the CSM, and OMB’s version of the CSM and compare the results.

Verify That Approved Cash Flow Data Is the Same Data Used by the CSM to Calculate the Subsidy Rate

The user agency should provide the auditor with the approved cash flow data that support its credit program subsidy rate for each of the credit programs selected for internal control and substantive testing. (Cash flow data will be available from electronic spreadsheet files in a format prescribed by the CSM User’s Guide.) The auditor should verify that these data were, in fact, the same data used by the CSM to calculate the applicable subsidy rate. The spreadsheet file name, the range name, and the date and time the spreadsheet was last changed are included in the printed CSM output. The auditor can check this information against the named spreadsheet file provided by the agency to verify the cash flow data used in the CSM’s subsidy calculation. However, if the spreadsheet file provided by the agency was changed after the subsidy calculation, the date and time stamp on the spreadsheet file will not match what is on the CSM output. In this case, the CSM output will not provide sufficient information to verify the cash flow data used by the CSM. Therefore, the auditor will need to use other methods. One method is to recalculate the subsidy rate using the cash flow data provided by the agency and the auditor’s copy of the appropriate version of the CSM obtained from the applicable agency’s OMB budget examiner. If the recalculated subsidy rate is the same as the subsidy rate under audit, the auditor should be able to conclude that the cash flow data provided by the user agency was the same data used by the CSM. If the recalculated subsidy rate is different, the auditor should bring this to the attention of agency management and the OMB budget examiner and obtain an explanation for the difference.

Follow Up on Error Messages

Prior to calculating a subsidy rate, the CSM performs several edits on agency-generated cash flows to help ensure that cash flow data do not contain obvious errors. If the CSM edit process identifies a serious error, the CSM will issue an error message and terminate its operation without calculating a subsidy. However, if the CSM edit process determines an error to be less serious, it will issue a “warning” but will not terminate the program. Warnings will be listed with the subsidy rate calculation on CSM output sent to a printer. The auditor should review CSM output to identify whether any warning messages are listed and follow up with agency management to determine why the situation causing the warning message was not resolved and whether not eliminating the error could have any impact on the subsidy rate calculation.

In addition, the CSM provides options for the user to suppress certain warning messages. For example, when cumulative scheduled principal payments do not equal disbursements, a warning message is normally issued. If the agency has suppressed this warning, auditors should determine whether this suppression is appropriate. This concern applies to other warning messages as well. Specifically, the auditor should check the agency’s cash flow spreadsheet to determine whether the “suppress warnings” command was used. If so, the auditor should request that the agency explain why warning messages were suppressed and, if certain warning messages are suppressed, whether conditions exist that would cause those messages to be generated, and whether the warning indicates a material problem in the cash flows.

Ensure That Options Chosen Properly Reflect Specific Characteristics of Each Credit Program

Proper use of the CSM requires that the agencies select the appropriate options from those available (see Chapter III of the CSM User’s Guide, Version r.9) and use the appropriate Treasury rate to discount cash flows to net present value. Particular care should be used in reviewing the choice of timing options for the principal and interest payments in direct loan programs. When a row of cash flows for scheduled principal or interest payments is prepared using standard financial formulas (which assume disbursements at the beginning of the period and payments at the end of the period), the “simple annual” option should be used. In contrast, when estimates of interest and principal payments are based on the assumption that these payments occur continuously throughout the year, the timing option row of cash flows should be “continuous.” When the wrong timing option is used for scheduled principal or interest payments, the financing subsidy may be materially distorted. The auditor may also want to review the choice of timing options for payments and receipts other than principal and interest, although the effects of these distortions are generally smaller.

Care should also be exercised when reviewing cash flows for loan guarantee programs that guarantee less than 100 percent of the face value. As indicated in the User’s Guide, the amount in the cash flow row for “disbursement of loans by private lenders” is the total amount disbursed by the lenders, regardless of how much is guaranteed by the credit agency. The amount of disbursed loans guaranteed by the government is included in the row of the cash flow representing the estimate of claims made against the government. For example, if an agency has a program that guarantees 75 percent of loans disbursed, and the lenders disburse $100,000 in loans that immediately default, the agency should put $100,000 in the disbursement by private lenders cash flow row and $75,000 in the cash flow row for defaults.

Ensure Proper Scale Has Been Used in Cash Flow Spreadsheets

OMB’s assertions state, “The model rounds cash flows to three decimal places when read from spreadsheet files. Because of the rounding, and particularly in programs that have disbursements over several years, the calculated subsidy can change slightly with the scale of the program. This effect is most pronounced when many of the cash flow items are very small after rounding (.005 or .011, for instance). Small values are especially sensitive to the hazards of rounding.” Therefore, agency controls should be in place to ensure that rounding to three decimal places has no significant effect on the spreadsheet values and, in turn, the calculated subsidy. For example, if a series of underlying values, in millions of dollars, are 0.0054, 0.0054, 0.0054, the CSM will round each to 0.005—losing 0.0004 in each case, which could be significant. In this situation, the agency should express values in thousands of dollars so that the underlying values are 5.400, 5.400, 5.400—losing nothing in the rounding—in order to obtain a more precise subsidy rate calculation. The auditor should confirm that management controls are adequate to ensure that the cash flows contain the proper scale and that rounding has no significant effect on the subsidy calculation. If these controls are not adequate, the auditors should review the cash flow spreadsheet to ensure that the scale used is appropriate. The auditor should also bring the situation to the attention of agency management.

Determine Whether Cash Flows Are Prepared at Appropriate Level of Detail

The CSM permits spreadsheet cash flow data to be prepared on a disbursement year basis or a cohort basis. (A disbursement year consists of all loans from a given cohort that are disbursed in a given fiscal year.) For the special case in which all disbursements occur during a single fiscal year, the disbursement year includes the entire cohort and these bases do not differ. However, for loan programs with cohorts that disburse over more than one year, the disbursement year includes just part of the cohort. For such programs, the cash flows for each disbursement year of a given cohort are necessary to precisely calculate subsidies at the time of disbursement. Because agencies cannot always provide such detail, the CSM permits less detailed cohort level data—combinations of 2 or more disbursement years—to be used as an approximation. But the use of cohort level data can introduce distortions. For example, a loan program can be expected to have a zero financing (interest rate) subsidy if the borrower rate is the same as the discount rate. However, if a program disburses loans over 2 or more years, cohort rather than disbursement year cash flows are used, and the discount rates are not held constant in all disbursement years, the CSM will calculate a non-zero subsidy.

Therefore, whenever a loan program has substantial disbursements in 2 or more years and the agency has prepared cash flows using cohort level rather than disbursement year data, the auditor should determine why disbursement year cash flows were not used. Specifically, if there are reasons why disbursement year cash flows cannot be prepared, these reasons should be documented. On the other hand, if disbursement year cash flows are available, the auditor should determine whether the use of cohort level cash flows has had a material effect on the subsidy calculation. A determination that an effect is material should take into account the size of the difference in absolute terms and relative to the subsidy, the effect on the level of loans supported by the subsidy, and other factors the auditor may consider important. If the auditor determines that the effect is material, the auditor should recommend that the agency prepare cash flows on a disbursement year basis to eliminate the problem. If the agency is unable to do this, the auditor should exercise professional judgment to determine whether there is a potential for material misstatement and whether this situation would affect the ability to conclude on the fairness of the amounts in related accounts.

Compare Cash Flow Spreadsheet and Related Subsidy Rate With Prior Years

Credit reform and the CSM require credit agencies to develop spreadsheets of projected cash flows, which must be presented in a prescribed format and require the spreadsheet preparer to choose among various commands and options that properly characterize each credit program. Once an auditor has determined that a spreadsheet contains the proper format, commands, options, etc. for the credit program, then the auditor can have some assurance about future years’ cash flows with the same formats, commands, options, etc. If changes in formats or commands on the cash flow spreadsheets have been made, auditors should discuss with agency officials why such changes were made, including what the changes are intended to accomplish. An auditor may wish to use analytical procedures each year to confirm that any changes to the credit program are properly reflected in the spreadsheet and that changes to the spreadsheet and associated subsidy rate, including components, are reasonable. For example, if an agency’s fee structure has not changed, the auditor should expect the subsidy rate component attributable to fees to remain the same.

Evaluate Agency Security Controls Over CSM Access

OMB’s assertions state that agencies are responsible for ensuring that the CSM has not been corrupted or otherwise inappropriately changed. Such assurance requires that agencies have procedures in place to limit access to the CSM to authorized personnel only. For example, the auditor might expect to find procedures to ensure confirm password protection on the desktop workstation where the CSM resides. The auditor should review these procedures and determine if they are in place to verify that they adequately protect the CSM from unauthorized use and corruption.

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