We conducted our audit work at the Bureau’s Denver, Colorado office and at its Mid-Pacific region. We reviewed and analyzed relevant legislation, written policies and directives, accounting standards, and other documents pertaining to managerial cost accounting. We also interviewed knowledgeable personnel at each audit site to obtain information relevant to the objectives of this assignment. The scope of our review included the Bureau’s managerial cost accounting practices and the Bureau’s treatment of different types of costs related to its administration and operation of its projects and the delivery of its programs. We conducted our review from November 2001 to July 2002 in accordance with generally accepted government auditing standards. Appendix I describes our objectives, scope, and methodology in detail. We provided the Department of the Interior and the Bureau of Reclamation with copies of a draft of this report for review and received written comments on the report. The Bureau constructs and operates multiple-purpose water resource projects in 17 western states. These projects provide water for irrigation, M&I use, power generation, recreation, and fish and wildlife protection, and also provide for flood control, water conservation, and land resource management. The Bureau’s facilities include 348 reservoirs with a storage capacity of 245 million acre-feet of water, 58 hydroelectric power plants, and more than 300 recreation sites. These facilities: generate more than 40 billion kilowatt hours of energy each year, making the Bureau the nation’s second largest producer of hydroelectric power; deliver water to one out of every five western farmers for about 10 million acres of irrigated land that produces 60 percent of the nation’s vegetables and 25 percent of its fruit and nuts; deliver 10 trillion gallons of municipal, rural, and industrial water to over 31 million people in the West; provide water to support habitat for wildlife refuges, migratory waterfowl, fish, and threatened and endangered species; deliver water to Native American tribes through irrigation projects and provide water-based recreation activities for about 90 million visitors a provide flood control benefits and drought contingency planning and assistance to western states and tribes. Construction, operation, and maintenance of these projects and Bureau programs are financed primarily with federal funds. The Bureau assigns a percentage of capital and operation and maintenance (O&M) costs to each project purpose based on the project’s expected uses and benefits. Costs associated with irrigation, M&I use, and power generation are generally required to be recovered through water delivery contracts and rates charged for water and power. In contrast, costs associated with flood control, fish and wildlife enhancement, and recreation are generally not recoverable under current law. To facilitate cost recovery and manage the projects and programs, the Bureau collects budget and cost information through its program and budget and financial accounting systems. The need for cost information is not unique to the Bureau. Cost information is needed throughout government for management, resource allocation, and oversight purposes. The cost of government is a concern to the public as well as to the federal government itself. One of the ways to capture cost information is by applying managerial cost accounting techniques. By using managerial cost accounting information, agency executives and managers, the Congress, citizens, news media, and interest groups can better assess the costs of governmental activities. The need for useful managerial cost information has been recognized for some time. The Congress and others have taken a number of actions to require cost accounting information and to encourage its use in administering federal projects and programs. Some of the specific requirements for managerial cost accounting are as follows. The Chief Financial Officers Act of 1990 includes among the functions of chief financial officers “the development and reporting of cost information” and “the systematic measurement of performance.” Statement of Federal Financial Accounting Concepts (SFFAC) No. 1, Objectives of Federal Financial Reporting, issued in 1993, states that the objectives of federal financial reporting are to provide useful information to assist internal and external users in assessing the budget integrity, operating performance, stewardship, and systems and control of the federal government. It also states that federal financial reporting should provide information that helps users to determine the (1) costs of specific programs and activities and the composition of, and changes in, those costs, (2) efforts and accomplishments associated with federal programs and their changes over time and in relation to costs, and (3) efficiency and effectiveness of the government’s management of its assets and liabilities. Statement of Federal Financial Accounting Standards (SFFAS) No. 4, Managerial Cost Accounting Standards states that the objective of the standard is to (1) provide program managers with relevant and reliable information relating costs to outputs and activities, (2) provide relevant and reliable cost information to assist the Congress and executives in making decisions about allocating federal resources, authorizing and modifying programs, and evaluating program performance, and (3) ensure consistency between costs reported in general purpose financial reports and costs reported to program managers. The stated purposes in the standard for managerial cost accounting are: budgeting and cost control, cost reimbursement (and setting fees and prices), making economic choice decisions. The Federal Financial Management Improvement Act of 1996 (FFMIA) requires agencies to implement and maintain financial management systems that comply with federal accounting standards, including SFFAS No. 4. The Joint Financial Management Improvement Program (JFMIP) issued a statement on January 31, 2002, stating that “A key element of financial planning and evaluation is clear measurement of the full costs of agencies’ activities during each fiscal year.” The Bureau has taken steps in recent years to improve its cost accounting practices. It better defined the treatment of costs by issuing in 1999 the Standard Processes of Costing (SPOC) report that clarified and standardized direct and indirect cost treatment. In addition, it changed the basis it uses to distribute some indirect costs to better reflect actual usage. Also, at the direction of the Department of the Interior, the Bureau will be implementing Activity Based Costing (ABC), a cost accounting method that measures the cost of work efforts leading to a specific result. On January 16, 2002, Interior’s Deputy Secretary sent a memo to all Bureau and office heads directing them to implement an ABC cost model by fiscal year 2004 (October 1, 2003). The Bureau’s ABC initiative is discussed in more detail later in this report. The Bureau does not distribute all the costs it incurs to its specific projects and activities. Thus, full cost information is not available for managerial decision making as envisioned in federal accounting standards and the President’s management improvement initiatives. The Bureau’s distribution of costs is driven largely by the need to recover certain costs. Its cost accounting system focuses primarily on recovering costs in accordance with specific project provisions. It does not identify the full costs of the Bureau’s activities such as irrigation, M&I water supply, power generation, recreation, fish and wildlife protection, flood control, water conservation, and land resource management. Therefore, complete information on the cost of the Bureau’s activities is not readily available to support managerial decisions pertaining to each of the purposes of managerial cost information described in SFFAS No. 4, Managerial Cost Accounting Standards. The standard notes that when full cost information is made available, analysts and decision makers will have a comprehensive data source to develop the cost concepts that they need in their analyses. However, it recognizes that full cost is not necessary for all analyses and decisions. Two large categories of costs—Policy and Administration costs and Bureauwide program costs—are not distributed to project purposes. Policy and Administration costs are not distributed to project purposes because the Bureau’s focus is on cost recovery and legislation specifically designates these costs to be nonreimbursable as provided by 43 U.S.C. sec. 377. Bureauwide program costs are generally not distributed to project purposes for one of two reasons: either because legislation specifically designates these costs to be unrecoverable or the Bureau has otherwise decided not to seek reimbursement for them. These two undistributed cost categories totaled nearly $200 million or 21 percent of the Bureau’s total budget authority for fiscal year 2002. See appendix III for additional information pertaining to budgeted amounts for Policy and Administration and Bureauwide program costs for fiscal years 1997 through 2002. As discussed in the next section, we believe that certain of these undistributed costs may be recoverable. Because such a large portion (21 percent) of the Bureau’s budget is not distributed, complete information regarding the total cost of each of the Bureau’s activities is not readily available. Bureau managers and external parties, such as congressional appropriators, do not have information on the total costs of the Bureau’s main activities at their disposal for decision making purposes. For example, it is not possible to analyze what the Bureau spends on irrigation, M&I water supply, power generation, recreation, fish and wildlife protection, flood control, water conservation, and land resource management either currently or over time. The Bureau’s managerial cost accounting system contrasts sharply with that of another Department of the Interior organization—the Bureau of Land Management (BLM). BLM has already implemented an ABC model, which contributed to Interior’s previously mentioned decision to implement ABC departmentwide. BLM’s model fully distributes costs and can readily identify, among other things, (1) the full costs of each of its activities, and (2) what it costs to pursue each of its strategic goals. BLM’s system provides detailed information that facilitates external reporting and can be used for internal purposes such as developing budgets and analyzing the unit costs of activities and outputs. “ . . . provide the linkage of strategic planning, budgeting, costing and performance reporting. It will increase the value we provide to our customers through more efficient operations and enhance accountability to the Congress and the public (by tying costs to performance measures).