As provided by the Panama Canal Treaty of 1977, the Panama Canal Commission will terminate on December 31, 1999, when the Republic of Panama will assume full responsibility for the management, operation, and maintenance of the Panama Canal. The Treaty provides that the Canal be turned over in operating condition and free of liens and debts, except as the two parties may otherwise agree. As discussed in note 9 to the financial statements, as of September 30, 1995, the Commission forecasts that the present $90.7 million in unfunded liabilities should be covered by tolls over the remaining life of the Treaty. We did not examine the Commission’s forecast and express no opinion on it. The ability to cover these future costs, including administrative costs, is dependent upon (1) obtaining the budgeted levels of Canal operations and (2) future economic events. The Commission operates as a rate-regulated utility. In fiscal year 1995 approximately 74 percent of its operating revenues were obtained from tolls and the remaining 26 percent, from nontoll revenues, such as navigation services and electric power sales. Early retirement, compensation benefits for work injuries, and post-retirement medical care costs are being funded from Canal revenues on an accelerated basis in order to be fully funded by 1999. During the period of our audit, the President of the United States served as the rate regulator for tolls, which are established at a level to recover the costs of operating and maintaining the Canal. The following is taken from management’s analysis of the Commission’s financial statements. The analysis generally explains the changes in major financial statement line items from fiscal years 1994 to 1995. Our opinions on these financial statements do not extend to the analysis presented below, and, accordingly, we express no opinion on this analysis. While we do not express an opinion on the analysis, we found no material inconsistencies with the financial statements taken as a whole. The Commission’s operations ended fiscal year 1995 at breakeven, compared to the net operating revenue of $1.7 million for fiscal year 1994. The net operating revenue for 1994 was applied to the $0.6 million outstanding balance of unrecovered costs from fiscal year 1992 operations and the $1.1 million balance left was paid to the Republic of Panama on March 9, 1995. From fiscal years 1991 through 1995, toll and nontoll revenues increased an average of approximately 3.8 percent annually. Fiscal year 1995 total operating revenues increased to $586 million, up 6.9 percent from fiscal year 1994 due mainly to an increase in Canal traffic, principally larger vessels. Nontoll revenues, which consist primarily of navigation services and electric power sales, increased to $164 million during fiscal year 1995, up 12.6 percent from fiscal year 1994. The deduction from tolls revenue for working capital was increased from $5 million in fiscal year 1994 to $10 million in fiscal year 1995 in order to substantially complete the financing of the Commission’s storehouse and fuel inventories. The deduction from tolls revenue for contributions for capital expenditures increased from $11.5 million in fiscal year 1994 to $30.3 million in fiscal year 1995. The increase was attributable to the funding required for the increase in the Commission’s capital program in 1995 for the acquisition of the crane TITAN and to provide funding for anticipated additional capital expenditures for replacements and additions to the tug fleet, acceleration of the Gaillard Cut widening project and the purchase of additional towing locomotives. From fiscal years 1991 through 1995, total operating expenses increased an average of approximately 4.0 percent annually. Fiscal year 1995 total operating expenses increased to $586 million, up 7.3 percent over fiscal year 1994. The following were some of the highlights: Tonnage payments to the Republic of Panama increased $9.8 million or 13.9 percent in fiscal year 1995. The additional net tonnage transiting the Canal produced $7.6 million of the increase and a rate change from 36 cents to 37 cents per ton accounted for $2.2 million of the change. Navigation service and control costs increased $13.6 million or 14.8 percent due mainly to the cost of additional resources required to service the record traffic levels experienced in fiscal year 1995. The increase in locks operation costs of $10.4 million or 18.2 percent reflected the cost of additional crews required for the increased level of traffic, additional locks maintenance and repair projects, and increased costs for locks overhaul projects. Depreciation expense increased $5.7 million or 22.1 percent in fiscal year 1995 principally as the result of (1) an adjustment to the service life for certain assets, (2) the change in the capitalization limit from $1,500 to $5,000 for minor items acquired in fiscal year 1995, and (3) the depreciation for new additions to plant during the fiscal year. Partially offsetting these increases was a credit adjustment resulting from the amortization of capital contributions of assets acquired prior to fiscal year 1992. Interest expense on the interest-bearing investment of the United States decreased $3.2 million or 42.2 percent in fiscal year 1995 because of the larger average cash balances maintained by the Commission in its U.S. Treasury revolving fund account and lower interest rates. Other operating expenses increased $5.8 million or 18.8 percent primarily because of an increase in the provision for marine accident claims during the year related to accidents that occurred during fiscal year 1995. By the end of fiscal year 1995, total assets of the Commission increased by 3.3 percent to $851 million, and total liabilities and reserves decreased by 1.6 percent to $263 million. Capital increased by 5.6 percent to $588 million. The most significant changes in individual account balances by the end of fiscal year 1995 were the following: Property, plant, and equipment (excluding depreciation and valuation allowances) increased by a net $38 million to $1,141 million. This increase was due primarily to net capital expenditures of $38.7 million and the acquisition of several plant items from other U.S. government agencies. Major capital additions to plant from capital expenditures included $9.4 million for the Canal widening/straightening program; $8.0 million for the replacement and improvement of facilities and buildings; $6.6 million for the replacement and addition of floating equipment; $5.2 million for the replacement and addition of miscellaneous equipment; $4.0 million for improvements to electric power, communication, and water systems; $2.6 million for the replacement of motor vehicles; and $1.6 million for the replacement of launches and launch engines. Current assets increased by a net $54 million to $262 million due principally to an increase in cash. Cash increased by $46.8 million as a result of the net cash provided by operating activities exceeding the net cash used in investing activities. Deferred charges decreased by a net $26 million to $87 million. This was due principally to the amortization of deferred charges for early retirement, compensation benefits for work injuries, and post-retirement medical care costs. Liabilities and reserves decreased by a net $4.2 million to $263 million. The major reason for the net decrease included a decrease of $26.9 million for certain employee benefits, offset in part by increases in the liabilities for severance pay, accounts payable, employees’ leave, marine accident claims, and in the reserve for lock overhauls. Capital increased by a net $31 million to $588 million, principally because of a $21.4 million net increase in capital contributions for capital expenditures and a $10.0 million increase in contributions for working capital. The Panama Canal Act of 1979 requires us to include in our annual audit report to the Congress a statement listing (1) all direct and indirect costs incurred by the United States in implementing the 1977 Treaty, net of any savings, and (2) the cost of any property transferred to the Republic of Panama. The act also provides that direct appropriated costs of U.S. government agencies should not exceed $666 million, adjusted for inflation over the life of the Treaty. As of September 30, 1995, the inflation-adjusted target was $1,367 million. U.S. Government agencies that provided services to the former Panama Canal Company and Canal Zone Government provided the direct and indirect cost information including the cost of property transferred to the Republic of Panama as required under the 1977 Treaty. This information is presented in unaudited supplementary schedules to the Commission’s financial statements, and, accordingly, we express no opinion on these schedules. From fiscal years 1980 to 1995, the net reported costs to the U.S. Government under the Treaty amounted to $791 million, which is less than the act’s inflation-adjusted target. As required by the Panama Canal Act of 1979, we are sending copies of this report to the President of the United States and the Secretary of the Treasury. We are also sending copies to the Director of the Office of Management and Budget; the Secretaries of State, Defense, and the Army; the Chairman of the Board of Directors of the Panama Canal Commission; and the Administrator of the Panama Canal Commission. Comptroller General of the United States United States General Accounting Office Washington, D.C. 20548 Comptroller General of the United States To the Board of Directors Panama Canal Commission Our audits of the Panama Canal Commission found the fiscal years 1995 and 1994 financial statements to be reliable in all material respects; although certain internal controls to help assure compliance with a statutory spending limitation should be improved, management fairly stated that internal controls in place on September 30, 1995, were effective in safeguarding assets from material loss, assuring material compliance with laws governing the use of budget authority and with other relevant laws and regulations, and assuring that there were no material misstatements in the financial statements; and reportable noncompliance with laws and regulations we tested for the fiscal year ended September 30, 1995. We discussed a draft of this report with the Commission’s Chief Financial Officer who agreed with our findings and conclusions. Described below are significant matters considered in performing our audit and forming our conclusions. The Commission’s management identified and reported an instance of reportable noncompliance with laws and regulations and certain related controls. The amount of the violation was not material to the financial statements. In January 1996, the Commission reported to us a violation of the Antideficiency Act for the fiscal year 1995 Panama Canal Revolving Fund. The Commission exceeded its $50,030,000 congressional spending limitation for administrative expenses, as set forth in the fiscal year 1995 appropriation (Public Law 103-331) by $160,225. Management determined that the violation resulted from a weakness in the Commission’s system of internal controls related to the review of the classification of obligations for consultant services. Management has taken steps to improve the specific control weaknesses related to this incident. As required in 31 U.S.C. Section 1351, the Commission has reported all relevant facts of this Antideficiency Act violation and a statement of actions taken to the President, the Office of Management and Budget (OMB), the Speaker of the House of Representatives, and the President of the Senate. As discussed in note 9 to the financial statements, the Panama Canal Treaty requires that the Commission transfer the Canal to the Republic of Panama on December 31, 1999, free of liens and debts, except as the two parties may otherwise agree. To comply with this provision, the Commission is required to identify and fully fund its liabilities by that date. Note 9 indicates that, as of September 30, 1995, the Commission had total liabilities and reserves of $262.7 million and total resources of $172.0 million. The Commission forecasted that the net unfunded $90.7 million in liabilities should be collected from future toll revenues over the remaining life of the Treaty. We did not examine the Commission’s forecast and, accordingly, express no opinion on the forecast. The following sections provide our opinions on the Commission’s financial statements and assertion on internal controls, and our report on the Commission’s compliance with laws and regulations we tested. This section also discusses the information presented in the unaudited supplemental schedules and the scope of our audit. The financial statements including the accompanying notes present fairly, in all material respects, in conformity with generally accepted accounting principles, the Commission’s assets, liabilities, and capital; operating revenue and expenses; changes in capital; and cash flows. We evaluated management’s assertion about the effectiveness of its internal controls designed to safeguard assets against loss from unauthorized acquisition, use, or disposition; assure the execution of transactions in accordance with laws governing the use of budget authority and with other laws and regulations that have a direct and material effect on the financial statements or that are listed in OMB audit guidance and could have a material effect on the financial statements; and properly record, process, and summarize transactions to permit the preparation of reliable financial statements and to maintain accountability for assets. Management of the Commission fairly stated that those controls in effect on September 30, 1995, provided reasonable assurance that losses, noncompliance, or misstatements material to the financial statements would be prevented or detected on a timely basis. Management of the Commission also fairly stated the need to improve certain internal controls for review of the classification of obligations for consultant services, as described above. These weaknesses in internal controls, although not considered to be material to the financial statements, represent deficiencies in the design or operations of internal controls which could adversely affect the entity’s ability to meet the internal control objectives to assure the execution of transactions in accordance with laws and regulations or meet OMB criteria for reporting matters under the Federal Managers’ Financial Integrity Act (FMFIA) of 1982. Management made this assertion based upon criteria established under FMFIA and OMB Circular A-123, Internal Control Systems. Except as noted above, our tests for compliance with selected provisions of certain laws and regulations disclosed no other instances of noncompliance that would be reportable under generally accepted government auditing standards. However, the objective of our audit was not to provide an opinion on overall compliance with laws and regulations. Accordingly, we do not express such an opinion. The Treaty related cost schedules are presented as required by the Panama Canal Act of 1979, and the schedule of property, plant, and equipment is presented for purposes of additional analysis. This information has not been subjected to the auditing procedures applied in the audit of the financial statements, and, accordingly, we express no opinion on these schedules. While we do not express an opinion on the detailed schedule of property, plant, and equipment, we found no material inconsistencies with the financial statements taken as a whole. preparing the annual financial statements in conformity with generally establishing, maintaining, and assessing the internal control structure to provide reasonable assurance that the broad control objectives of FMFIA are met; and complying with applicable laws and regulations. We are responsible for obtaining reasonable assurance about whether (1) the financial statements are reliable (free of material misstatement and presented fairly, in all material respects, in conformity with generally accepted accounting principles) and (2) management’s assertion about the effectiveness of internal controls is fairly stated, in all material respects, based upon criteria established under FMFIA and OMB Circular A-123, Internal Control Systems. We are also responsible for testing compliance with selected provisions of certain laws and regulations and for performing limited procedures with respect to unaudited supplementary information appearing in this report. In order to fulfill these responsibilities, we examined, on a test basis, evidence supporting the amounts and disclosures in the financial statements; assessed the accounting principles used and significant estimates made by evaluated the overall presentation of the financial statements; obtained an understanding of the internal control structure related to safeguarding of assets, compliance with laws and regulations, and financial reporting; tested relevant internal controls over safeguarding, compliance, and financial reporting and evaluated management’s assertion about the effectiveness of internal controls; tested compliance with selected provisions of the following laws and regulations: Panama Canal Act of 1979, Antideficiency Act, Prompt Payment Act, Civil Service Reform Act of 1978, as amended, Fair Labor Standards Act, and Accounting and Auditing Act of 1950; considered compliance with the process required by FMFIA for evaluating and reporting on internal control and accounting systems; prepared Treaty related costs schedules using unaudited information obtained from other federal agencies; and compared the unaudited detailed schedule of property, plant, and equipment for consistency with the information presented in the financial statements. We did not evaluate all internal controls relevant to operating objectives as broadly defined by FMFIA, such as those controls relevant to preparing statistical reports and ensuring efficient operations. We limited our internal control testing to those controls necessary to achieve the objectives outlined in our opinion on management’s assertion about the effectiveness of internal controls. Because of inherent limitations in any internal control structure, losses, noncompliance, or misstatements may nevertheless occur and not be detected. We also caution that projecting our evaluation to future periods is subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with controls may deteriorate. We did our work in accordance with generally accepted government auditing standards. The first copy of each GAO report and testimony is free. Additional copies are $2 each. 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Summary: Pursuant to a legislative requirement, GAO audited the Panama Canal Commission's financial statements for the fiscal years ended September 30, 1995 and 1994, focusing on: (1) the statements' reliability; (2) internal controls; and (3) compliance with selected applicable laws and regulations. GAO found that: (1) the financial statements presented fairly, in all material respects, the Commission's financial position as of September 30, 1995 and 1994, and the results of its operations, changes in capital, and cash flows for the years then ended, in conformity with generally accepted accounting principles; (2) although improvements are needed, the Commission's internal controls in effect as of September 30, 1995, reasonably ensured that losses, noncompliance, or material misstatements would be prevented or detected; (3) the Commission disclosed a nonmaterial violation of the Antideficiency Act and has implemented internal controls that should prevent any future violations; (4) there were no other reportable instances of noncompliance with applicable laws and regulations; (5) the Commission has improved its general controls over its computerized information systems to correct previously identified weaknesses; and (6) the Commission expects to have its liabilities fully funded by the time the Canal is transferred to Panama.