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, (2) assisting the 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. 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 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. 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. 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. 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. 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. 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. 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.