AUDIT REPORT ON INTERFUND LOANS

Report No. 98-I-670
Title: Audit Report on Interfund Loans and Federal Grant Balances, Government of the Virgin Islands
Date: September 9, 1998
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U.S. Department of the Interior Office of Inspector General
AUDIT REPORT
INTERFUND LOANS AND FEDERAL GRANT BALANCES, GOVERNMENT OF THE VIRGIN ISLANDS
REPORT NO. 98-I-670
SEPTEMBER 1998
MEMORANDUM
TO: The Secretary
FROM: Richard N. Reback Acting Inspector General
SUBJECT SUMMARY: Final Audit Report for Your Information – "Interfund Loans and Federal Grant Balances, Government of the Virgin Islands" (No. 98-I-670)
Attached for your information is a copy of the subject final audit report. The objective of the review was to determine (1) all amounts borrowed by the General Fund from special fund accounts during fiscal years 1995, 1996, and 1997 and (2) the outstanding balances of such interfund loans and the unobligated balances of Federal grant accounts. This report also updated preliminary information presented in our December 1997 advisory report "Status of Interfund Loans and Other Obligations, Government of the Virgin Islands" (No. 98-I-187).
We found that the Government, as of September 30, 1998, had outstanding operations- related obligations (excluding bonded debt) totaling $588 million, which included $120 million for unauthorized and unrecorded interfund loans that may include Federal funds; the Virgin Islands Office of Management and Budget maintained a tracking system for Federal grants received by the Government, even though this system relied on information provided by individual operating agencies of the Government and was not current or reliable; the Department of Public Works did not fully use Federal grants of about $38.1 million it had received during the period of 1984 to 1997; and the Government, although it had made some improvements in its operations, continued to have problems in the areas of overall financial management, expenditure control, revenue collection, and program operations.
The report contained 20 recommendations, which, although they would not solve the Government's immediate financial crisis, could provide a basis for the Government to initiate long-term improvements in its daily operations and in its overall financial condition. Based on the response to the recommendations, we considered 6 recommendations resolved and implemented and 3 recommendations unresolved. Also based on the response, we requested additional information for the remaining 11 recommendations.
If you have any questions concerning this matter, please contact me at (202) 208-5745 or Mr. Robert J. Williams, Assistant Inspector General for Audits, at (202) 208-4252.
Attachment
Honorable Roy L. Schneider V-IN-VIS-005-97 Governor of the Virgin Islands No. 21 Kongens Gade Charlotte Amalie, Virgin Islands 00802
Subject: Audit Report on Interfund Loans and Federal Grant Balances, Government of the Virgin Islands (No. 98-I-670)
Dear Governor Schneider:
This report presents the results of our review of interfund loans and Federal grant balances of the Government of the Virgin Islands. The objective of our audit, as amended, was to determine (1) all amounts borrowed by the General Fund from special fund accounts during fiscal years 1995, 1996, and 1997 and (2) the outstanding balances of such interfund loans and the unobligated balances of Federal grant accounts. This report also updates preliminary information presented in our advisory report "Status of Interfund Loans and Other Obligations, Government of the Virgin Islands" (No. 98-I-187), which was issued on December 22, 1997.
Based on our review, we concluded that (1) the Government, as of September 30, 1997, had outstanding operations-related obligations of about $588 million; (2) complete, current, and reliable information on the balances of Federal grants awarded to the Government was not readily available; and (3) the Government had not taken adequate steps to correct long-standing financial management problems that had an adverse impact on its financial condition. Specially, we found that:
– The Government, as of September 30, 1997, had outstanding operations-related obligations (excluding bonded debt) totaling $588 million as follows: $120 million for unauthorized and unrecorded interfund loans; $21 million for authorized and recorded interfund loans; $150 million for disaster-related loans received from the Federal Emergency Management Agency after Hurricanes Hugo and Marilyn; $141 million for retroactive salary increases and fringe benefits for fiscal years 1991 through 1997; $76 million for income tax refunds for tax years 1994 through 1996; at least $67 million for goods and services provided by approximately 4,000 vendors; and $13 million for the Government Employees Retirement System for the Early Retirement Incentive, Training and Promotion Act of 1994 and regular retirement contributions for September 1997. In January 1998, the Legislature approved and the Governor signed into law Act No. 6197, which authorized the Government to obtain a short-term (10-month) loan of $106 million to pay $64 million in outstanding income tax refunds and $42 million in outstanding vendor invoices. Regarding the Government's overall financial condition, the effect of Act No. 6197 was to convert accounts payable of $106 million into loans payable of $106 million that would accrue interest at the rate of 6.9 percent annually. The Government said that it intended to liquidate the $106 million loan from the proceeds of bonds that were issued in May 1998.
– Although the Virgin Islands Office of Management and Budget maintained a tracking system for Federal grants received by the Government, this system relied on information provided by individual operating agencies of the Government and was not current or reliable. Financial information on Federal grants contained in the Financial Management System operated by the Department of Finance also was not current or reliable. Our review of Federal grant accounting practices at the four Government agencies that receive the largest amount of Federal grant funds on a recurring annual basis disclosed that the Department of Health and the Department of Human Services generally maintained effective control over their grant funds and did not have any material amounts of unobligated grant funds; the Department of Education did not liquidate outstanding encumbrances or submit grant Financial Status Reports for its fiscal year 1997 consolidated block grant ($17 million) within the time frames required by the Code of Federal Regulations; and the Department of Public Works did not fully use grants of about $38.1 million it had received during the period of 1984 to 1997 for the establishment and operation of the public bus transportation system ($6.6 million), the purchase of buses for elderly and handicapped persons ($0.8 million), various environmental protection projects ($17 million), and various highway improvement and construction projects ($13.7 million).
– Although the Government has made some improvements in its operations, long- standing problems still existed in the areas of overall financial management, expenditure control, revenue collection, and program operations. We believe that these long-standing problems have a negative impact on the Government's overall financial condition and that significant improvements in these areas could have been achieved if the Government had implemented audit recommendations made by the Office of Inspector General and the Virgin Islands Bureau of Audit and Control. To correct t
hese conditions, we have made 20 recommendations that, although they will not solve the Government's immediate financial crisis, could provide a basis for the Government to initiate long-term improvements in its daily operations and in its overall financial condition.
On June 4, 1998, we discussed a preliminary draft of this report with the Commissioner and other officials of the Department of Finance, who generally concurred with the recommendations but disagreed with our conclusion that, as a result of the unrecorded interfund loans of $120 million, Federal funds may have been used to cover an overdraft in the Special and Other Funds bank account. On June 22, 1998, the Commissioner of Finance also provided us with a written response (Appendix 5) to the preliminary draft report, which disagreed with our conclusions that (1) unrecorded interfund loans of $120 million were not authorized by the Legislature and (2) Federal funds may have been used to cover an overdraft in the Special and Other Funds bank account. In its response, Finance also stated that it had begun actions to implement several of the audit recommendations.
On June 30, 1998, we transmitted the draft of this report to the Governor of the Virgin Islands requesting a response by August 7, 1998. On August 20, 1998, we received the response from the Governor that was dated August 7, 1998. Based on the response received, we consider 6 of the report's 20 recommendations resolved and implemented, 3 recommendations unresolved, and request additional information for 11 recommendations (see Appendix 6).
The Inspector General Act, Public Law 95-452, Section 5(a)(3), as amended, requires semiannual reporting to the U.S. Congress on all audit reports issued, the monetary impact of audit findings (Appendix 1), actions taken to implement audit recommendations, and identification of each significant recommendation on which corrective action has not been taken.
In view of the above, please provide a response, as required by Public Law 97-357, to this report by October 9, 1998. The response should be addressed to Caribbean Office, Federal Building – Room 207, Charlotte Amalie, Virgin Islands 00802. The response should provide the information requested in Appendix 6.
Sincerely,
Richard N. Reback Acting Inspector General
CONTENTS
Page
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . 1
BACKGROUND. . . . . . . . . . . . . . . . . . . . . 1 OBJECTIVE AND SCOPE . . . . . . . . . . . . . . . . 3 PRIOR AUDIT COVERAGE. . . . . . . . . . . . . . . . . 4
FINDINGS AND RECOMMENDATIONS . . . . . . . . . . . . . . 6
A. INTERFUND LOANS AND OTHER OBLIGATIONS . . . . . 6 B. FEDERAL GRANT BALANCES. . . . . . . . . . . . . .19 C. LONG-STANDING PROBLEMS. . . . . . . . . . . . . .27
APPENDICES
1. CLASSIFICATION OF MONETARY AMOUNTS . . . . . . . .31 2. SUMMARY OF OUTSTANDING OBLIGATIONS AS OF SEPTEMBER 30, 1997, AND JANUARY 31, 1998. . . .32 3. GOVERNOR OF THE VIRGIN ISLANDS RESPONSE TO THE DRAFT ADVISORY REPORT. . . . . . . . . . . . .33 4. OFFICE OF INSPECTOR GENERAL REPLY TO GOVERNOR'S RESPONSE TO THE DRAFT ADVISORY REPORT. . . . . . .36 5. GOVERNOR OF THE VIRGIN ISLANDS RESPONSE TO THE DRAFT REPORT . . . . . . . . . . . . . . . . . . .43 6. STATUS OF AUDIT REPORT RECOMMENDATIONS . . . . . .54
INTRODUCTION
BACKGROUND
The Government has three main checking accounts: the General Fund bank account (at the Chase Manhattan Bank), which is used for the general revenues and operating expenses of the Government; the Special and Other Funds bank account (at the Banco Popular de Puerto Rico), which is used for revenues and expenses related to special programs such as Federal grant programs and a variety of specially funded local programs; and the Payroll Fund bank account (at the Chase Manhattan Bank), which is a "zero balance" clearing account. Each pay period, sufficient monies from the General Fund and the special funds are deposited into the Payroll Fund bank account and used to pay employee salaries and other related payroll expenses, such as withholding and Federal Insurance Contributions Act (FICA) taxes, retirement contributions, and health insurance premiums.
In accordance with generally accepted government accounting principles, the General Fund and each of the Government's special funds should have complete sets of general ledger accounts, which consist of balance sheet accounts (assets, liabilities, and equities) and operating accounts (revenues and expenditures). These general ledger accounts are maintained in the computerized Financial Management System maintained by the Department of Finance and are used as the basis for preparing annual financial statements of the Government. Generally accepted government accounting principles require the issuance of a comprehensive annual financial report, and the Single Audit Act of 1984 requires that audited financial statements be issued as part of an overall audit of all Federal financial assistance within 12 months of the end of each fiscal year. However, the most recent audited financial statements and single audit report issued by the Government were for the fiscal year ended September 30, 1994.
Interfund Loans
Since at least March 1995, the Government of the Virgin Islands has experienced financial difficulties that have resulted in cash flow problems and the need for interfund loans to meet regular operating expenses. In March 1995, the Legislature, anticipating that the Government of the Virgin Islands would not be able to meet payroll costs in March and August 1995 (which had three Government paydays), passed Act No. 6068, which the Governor signed into law. The Act authorized the Governor, through the Commissioner of Finance, "to borrow, on a temporary, short-term basis, an amount not to exceed $15 million for the exclusive purpose of meeting the recurring payroll cost of the Government of the Virgin Islands when the Governor determines that the revenues collected are insufficient to cover any payroll which comes due during such insufficiency." The Act further stated, "No short-term loan may be made which cannot be retired with revenues collected for the fiscal year in which it was obtained." The Act had an expiration date of September 30, 1995. However, in November 1996, the Legislature passed Act No. 6128, which the Governor signed into law and which (among other provisions) retroactively extended the period to repay any funds borrowed under the authority of Act No. 6068 to September 30, 1997.
Based on the authority provided by Act No. 6068, the Government, during the period of March to September 1995, borrowed a total of $20 million from special fund accounts to meet its payroll obligations. Of the $20 million borrowed, only $8.5 million had been repaid ($5 million in June 1995 and $3.5 million in July 1997) as of September 30, 1997. Thus, $11.5 million remained outstanding.
Despite the borrowing authority provided by Act No. 6068, the Government has not been able to meet its operating expenses with current operating revenues. This situation was exacerbated by a general economic downturn and by the impact of Hurricanes Marilyn in September 1995 and Bertha in July 1996. The fiscal year 1998 Executive Budget consisted of estimated General Fund revenues totaling $361.9 million and General Fund expenditures totaling $459.5 million, or a revenue shortfall of $97.6 million. Also, the payment of any portion of the outstanding obligations discussed in this report would increase that shortfall accordingly.
Federal Grants
The Federal Grants Management Unit within the Virgin Islands Office of Management and Budget is responsible for (1) monitoring recipient compliance with financial and performance objectives of Federal grant awards and (2) developing programs and policies to ensure the effective application of Federal funds. To comply with these responsibilities, the Federal Grants Management Unit maintains a grant tracking system that is based on information that the Unit requests from Government agencies on a quarterly basis regarding gr
ant award, drawdown, and balance amounts. Federal Grants Management Unit officials told us that they requested this information directly from the grantee agencies because they did not consider information contained in the Government's Financial Management System to be accurate, current, complete, and reliable. The grant tracking system is used by the Office of Management and Budget for budget and grant management purposes.
As of March 1997 (the most recent data available from the Federal Grants Management Unit as of January 31, 1998), the grant tracking system contained information on approximately 400 Federal grants, totaling $427 million (exclusive of long-term Federal grants for health facilities construction and Federal Emergency Management Agency (FEMA) disaster loans), that were awarded during fiscal years 1993 through 1997. In addition, drawdowns reported against the grants totaled $272 million, leaving reported balances totaling $155 million available for drawdown. However, as discussed in Finding B, these grant balances were not necessarily available for expenditure by the Government because the amounts were inaccurate or the funds were committed for specific projects or programs.
OBJECTIVE AND SCOPE
The original objective of our audit was to determine the status of interfund loans and other outstanding obligations of the Government as of September 30, 1997, and the unobligated balances of Federal grant accounts as of March 31, 1997. However, because of inappropriate interfund loan transfers found during our fieldwork, our objective was amended to determine (1) all the amounts borrowed by the General Fund from special fund accounts during fiscal years 1995, 1996, and 1997 and (2) the outstanding balances of such interfund loans and the unobligated balances of Federal grant accounts. With respect to the interfund loans portion of the audit, the scope of the audit was extended to January 31, 1998, to consider the $106 million loan negotiated by the Government to pay income tax refunds and vendor invoices. With respect to the Federal grants portion of the audit, the scope of the audit was qualified to the extent that we did not audit the costs claimed against Federal grants to determine whether these costs were reasonable, allowable, or allocable in accordance with grant terms and conditions because the objective of that portion of the audit was limited to determining the unobligated balances of grants. We generally relied on information compiled by the Virgin Islands Office of Management and Budget but expanded the scope of our review to include limited testing of Federal grant transactions at the Departments of Health, Human Services, Education, and Public Works (the four Government agencies that receive the largest amount of Federal grants on a recurring annual basis). The audit was conducted from September 1997 through January 1998 at the Department of Finance, the Office of Management and Budget, the Bureau of Internal Revenue, the Government Employees Retirement System, and the four largest grantee agencies.
Our review was made, as applicable, in accordance with the "Government Auditing Standards," issued by the Comptroller General of the United States. Accordingly, we included such tests of records and other auditing procedures that were considered necessary under the circumstances.
We included an evaluation of internal controls to the extent we considered necessary to accomplish the audit objective. The internal control weaknesses identified were related to the recording of interfund loans and the establishment of a grants management system to monitor the financial and compliance aspects of Federal grants. The control weaknesses are discussed in the Findings and Recommendations section of this report. The recommendations, if implemented, should improve the internal controls in these areas.
PRIOR AUDIT COVERAGE
Since November 1985, the Office of Inspector General has issued five reports on financial management within the Government of the Virgin Islands as follows:
– The December 1997 advisory report "Status of Interfund Loans and Other Obligations, Government of the Virgin Islands" (No. 98-I-187) was issued to provide Government of the Virgin Islands officials with preliminary information on the status of interfund loans and other outstanding obligations to allow them to make informed decisions on the Government's finances. Although the advisory report did not contain any recommendations, the Governor was provided with the opportunity to respond to the advisory report before it was issued in final form. However, the Governor did not provide a response until after the final report was issued. The Governor's response to the advisory report (Appendix 3) and the Office of Inspector General's reply to the Governor (Appendix 4) are discussed in Finding A of this report.
– The September 1994 special report "Status of Improvements in Financial Management and Program Operations, Government of the Virgin Islands" (No. 94-I-1284) (1) presented a summary of long-standing problems in financial management, expenditure control, revenue collection, and program operations; (2) recognized the corrective actions taken by the Government of the Virgin Islands and the then-Office of Territorial and International Affairs (now the Office of Insular Affairs) of the U.S. Department of the Interior to address those problems; and (3) provided the Government with a series of suggested goals and corrective actions to address the remaining problem areas. The suggested improvement goals are discussed in Finding C of this report.
– The April 1994 special report "Bonded Debt of the Government of the Virgin Islands and its Autonomous Agencies" (No. 94-I-513) stated that, as of March 31, 1993, the Government and its autonomous agencies had outstanding bonds totaling $445.6 million. The report also stated that from 1994 through maturity, the remaining debt service requirement on those bonds, including $423.3 million of interest, would total $868.9 million, or about $8,600 in bonded debt for every resident of the Virgin Islands. The report further stated that, as of August 1993, the Government and its autonomous agencies had issued an additional $13.9 million in bonds and had been authorized or were planning to issue $232.3 million more in bonds. The report concluded that, in general, pledged revenues should be sufficient to meet the debt service requirements of the then-outstanding bonds but that the issuance of the additional $232.3 million in bonds could adversely affect the ability of the Government's Internal Revenue Matching Fund, the Water and Power Authority's water system, and the Port Authority's aviation division to meet further debt service requirements. The report did not contain any recommendations. However, since the report was issued, the Government has been authorized by the U.S. Congress to restructure its bonded debt, allowing the issuance of additional bonds. As of September 30, 1997, the Virgin Islands Water and Power Authority was seeking an increase in its bond ceiling from $130 million to $220 million. Additionally, in May 1998, the Government's Public Finance Authority issued $541 million in bonds, the proceeds of which are to be used to refinance $257 million in existing Public Finance Authority bonds, pay off a $106 million bank loan that the Government secured in January 1998 to pay a portion of outstanding income tax refunds and vendor invoices, and fund various capital improvement projects.
– The August 1993 audit report "Implementation of the Financial Management System, Government of the Virgin Islands" (No. 93-I-1382) concluded that although the System was designed to provide an on-line environment for the Government's accounting system, improved cash management capabilities, greater control over Federal grant funds, and overall compliance with generally accepted accounting principles, the System (which was implemented by the Government in fiscal year 1989) did not produce accurate and timely financial stateme
nts and reports and did not meet generally accepted accounting principles and various Federal financial reporting requirements. This occurred because of undetected data entry errors, data transmission problems, the lack of a nontechnical user manual, insufficient user training, and the inability of the System to handle the number of users and volume of transactions. Our current review showed that the System did not provide accurate, current, reliable, and complete data with respect to Federal grants.
– The November 1985 special report "Government of the Virgin Islands 1985 Operating Deficit" (No. V-TG-VIS-30-85) stated that the fiscal year 1985 deficit was in excess of $50 million and that proposed deficit reduction initiatives of $46.9 million were undertaken too late in the fiscal year to have any impact on the deficit, the Government was meeting cash-flow requirements by deferring payments of payroll-related employee/employer contributions and by borrowing from other special purpose funds within the Division of Treasury (about $4.2 million outstanding as of May 1985), the actual financial condition of the Government was unknown, and the existing financial crisis was exacerbated by financial information that was not current or accurate. The report recommended that the Governor prepare a detailed deficit reduction plan identifying specific areas of expenditure reduction and sources of revenues to resolve the deficit, request assistance from the then-Assistant Secretary for the Office of Territorial and International Affairs to establish a Federal/local task force to address financial management system problems, and require that local managers who administer Federal grant programs review the status of all current grants to ensure that those funds were used for their intended purposes.
Our current review has shown that the same types of problems continued to exist in that (1) the General Fund could end fiscal year 1998 with an operating deficit of as much as $97 million unless additional revenue sources are found or expenditures are held to levels below those appropriated by the Legislature; (2) the level of interfund borrowing to meet cash-flow requirements has increased more than thirty-threefold (from $4.2 million to $141 million) since the issuance of the November 1985 report; and (3) the financial condition of the Government is still unknown because, as of January 31, 1998, audited financial statements had not been issued for fiscal years 1995 and 1996, although they should have been issued within 12 months of the end of each fiscal year.
FINDINGS AND RECOMMENDATIONS
A. INTERFUND LOANS AND OTHER OBLIGATIONS
We found that although the Legislature, in March 1995, authorized the Governor to borrow funds not to exceed $15 million to meet payroll costs, the Government borrowed and recorded $20 million based on that authorization and borrowed an additional $120 million during the period of April 1995 to July 1997 which was not authorized by the Legislature or recorded in the Government's financial records. As of September 30, 1997, the Government had outstanding operations-related obligations (excluding bonded debt) totaling $588 million. Title 33, Sections 3101 and 3108, of the Virgin Islands Code contains prohibitions against deficit spending. However, the outstanding obligations existed because the Government did not have sufficient General Fund revenues to meet all operating expenses and made it a priority to meet its biweekly payroll. In addition, the Department of Finance did not implement sound financial management practices to ensure that interfund loans and other obligations were recorded in the official financial records, and it did not inform the Legislature of the unrecorded interfund loans until our audit was initiated. As a result, as of September 30, 1997, the Government had a total operations-related debt of about $588 million, or $226 million more than the projected General Fund operating revenues of $362 million for fiscal year 1998. In addition, because the Department of Finance borrowed $120 million from the Special and Other Funds bank account to cover biweekly payroll costs but did not record those loans in the financial records of the Government, the balances of individual special fund accounts maintained in the Department of Finance's Financial Management System were not accurate. Moreover, there was little assurance that Federal funds were not used to pay for General Fund payroll-related expenditures because Federal and local funds were commingled in the Special and Other Funds bank account.
Interfund Loans
As of September 30, 1997, the Government had outstanding interfund loans totaling about $141 million, which consisted of unauthorized and unrecorded loans of $120 million and additional interfund loans of $21 million that were legally authorized and recorded in the financial records.
Unauthorized Interfund Loans. We found that because the Government was unable to meet its biweekly payroll and payroll-related expenses, the Department of Finance established the practice of borrowing but not recording in its financial records amounts from the Special and Other Funds bank account to cover the payroll-related expenses for FICA taxes and health insurance premiums. Department of Finance officials told us that although the practice of making interfund loans to meet payroll-related expenses had been occurring for a number of years, during the past 3 fiscal years the Department was unable to reimburse the Special and Other Funds bank account before the end of each fiscal year because of a decline in General Fund revenues. As of September 30, 1997, the Payroll Fund owed the Special and Other Funds bank account a total of $120 million. There was no legislative authorization to borrow this money, and these "unauthorized loans" had not been recorded against individual special fund accounts. Accordingly, the balances maintained by the Department of Finance's Financial Management System for the General Fund and special fund accounts were not accurate. Specifically, the financial records for the General Fund should include a Due to Other Funds liability account for the $120 million in loans, and the financial records for each special fund should include a Due From Other Funds asset account for its appropriate share of the $120 million in loans.
According to the Department of Finance's Accounting Manual, the Payroll Fund was established so that "payroll costs chargeable to various funds may be segregated and consolidated." Furthermore, Department of Finance officials told us that the Payroll Fund operated as a zero balance fund, or "wash account." Therefore, according to Department of Finance officials, amounts should have been transferred to the Payroll Fund bank account from the General Fund bank account on a biweekly basis to cover the payroll and payroll- related expenses. However, because of an insufficient balance in the General Fund bank account, the Government used the Special and Other Funds bank account to pay for the payroll-related expenses. In order for the Payroll Fund to operate as a zero balance fund, the Department of Finance prepared checks from the Payroll Fund bank account to reimburse the Special and Other Funds bank account for amounts borrowed. These checks were held by the Department of Finance's cashier awaiting authorization from Division of Treasury officials to deposit the checks into the Special and Other Funds bank account when there were sufficient General Fund revenues to cover the checks. Accordingly, as of September 30, 1997, the Department of Finance's cashier held, at the Department's offices on St. Thomas, 87 checks, totaling $120 million, that were written against the Payroll Fund bank account for expenses related to pay periods from April 24, 1995, through July 31, 1997. The checks were made payable to either the FICA Taxes Withheld Fund ($91 million) or the Health Insurance Fund ($29 million). (Both funds are part of the Special and Other Funds bank account.) Based on our review of the financial
information contained in the Department of Finance's Financial Management System for the FICA Taxes Withheld Fund and the Health Insurance Fund for fiscal years 1995 through 1997, we found that the two funds had a combined deficit of about $130 million for fiscal years 1995 through 1997. (The $10 million difference could be accounted for by other interfund transactions and transactions in transit that should be reconciled during the year-end process when the financial statements for these fiscal years are prepared.)
According to Title 3, Chapter 11, of the Virgin Islands Code, the Department of Finance is responsible for providing "general supervision over, and custody of, the special and public trust funds." Furthermore, according to the Department of Finance's Accounting Manual, the "Special Fund" group consists of about 400 funds "created to account for certain types of revenues specifically earmarked for certain activities of the Government, and also for grants and/or contributions to finance certain special programs sponsored by the Insular Government or jointly with the Federal Government." In addition to most Federally funded programs, many locally funded programs are accounted for through the Special and Other Funds bank account, including the Internal Revenue Matching Fund (pledged for debt service on most Government bonds), the Health Revolving Fund (used to finance hospital operations), the Tourism Advertising Revolving Fund (used to promote the tourism industry), the Transportation Trust Fund (used to finance highway construction and repairs), and the Paternity and Child Support Revolving Fund (used to receive and distribute child support payments). Therefore, the Special and Other Funds bank account contained both local and Federal funds. According to the Accounting Manual, "The use of the revenues and receipts credited to these [special] funds are restricted to the purposes determined by the provisions of the legislation or directives creating them, and expenditures and obligations against these funds shall be made only in accordance with such provisions."
We reviewed the activity in the Special and Other Funds bank account and found that the Department of Finance maintained three accounts, one savings account and two checking accounts, at Banco Popular de Puerto Rico's St. Thomas branch. One of the checking accounts was referred to as the "old" account, and the other was referred to as the "new" account. According to the Department of Finance's Acting Director of Treasury, the savings account contained only local funds not immediately earmarked for expenditure, such as proceeds from the Internal Revenue Matching Fund. As of September 30, 1997, the savings account had a balance of $23 million. With respect to the checking accounts, we found that electronic transfers of Federal funds were credited to either the "old" or the "new" checking account but that checks could be written only against the "new" account. Therefore, electronic transfers of Federal funds received into the "old" account were transferred to the "new" account by means of debit and credit memoranda. In addition, daily local collections were deposited into the "new" account.
For purposes of our review, we concentrated our audit efforts on the "new" checking account and found that the account was overdrawn on 143 days during fiscal years 1996 and 1997, including by $12 million on December 4, 1995. We also found that the bank started to charge the Government for overdrafts in November 1996 and that, through September 30, 1997, such charges totaled about $12,150.
We also analyzed the electronic transfers of Federal grant funds received by the "new" checking account during fiscal years 1996 and 1997 and found 182 unidentified electronic transfers of Federal funds, totaling $25 million, for which a Statement of Remittance had not been prepared. Accordingly, these 182 transactions were not recorded in the Financial Management System and credited to the appropriate special fund accounts.
During legislative hearings on April 7, 1998, the Commissioner of Finance stated that he "categorically denie[d]" that Federal and local funds "were commingled" with respect to the $120 million in unauthorized interfund loans. However, we found 76 instances in which the Special and Other Funds bank account was overdrawn on days when Federal funds (157 electronic transfers, totaling $18.8 million) were received and should have been available in the account. For example, on October 10, 1996, the Department of Education requested and received an electronic transfer of Federal funds to pay for educational supplies totaling $479,000. The Department of Finance processed a check on October 11, 1996, to pay for the educational supplies, but the check was not released to the vendor until October 15, 1996. We found that the Special and Other Funds checking account was overdrawn during the 4 business days between October 10 and 15, 1996, although the October 10, 1996, electronic fund transfer of $479,000 should have been available in the bank account at least until October 15, 1996, the date that the check was released by the Department of Finance. Therefore, we concluded that the electronic transfer of Federal funds earmarked for educational supplies for the Department of Education was used to fund the overdrawn status of the checking account during the period of October 10 to 15, 1996.
We believe that this example and the 75 other instances in which the Special and Other Funds bank account was overdrawn on days when Federal funds were received support our conclusion that Federal funds were used to cover the overdrawn condition of the Special and Other Funds bank account, which would not have occurred if the $120 million in unauthorized and unrecorded interfund loans had not been made. As a result, the unauthorized loans restricted the amount of funds available for the payment of expenses of Federal programs funded through special fund accounts.
In our opinion, the unrecorded loans of $120 million from the Special and Other Funds bank account were not authorized by the Legislature and were therefore improper. In addition, the unauthorized loans may be in violation of Title 33, Section 3101, of the Virgin Islands Code, which states:
No officer or employee of the Virgin Islands shall make or authorize an expenditure from, or create or authorize an obligation under, any appropriation or fund in excess of the amount available therein; nor shall any such officer or employee involve the government in any contract or obligation for the payment of money for any purpose, in advance of appropriations made for such purpose, unless such contract or obligation is authorized by law. [Emphasis added.]
Further, the Government's failure to record these loans in its financial records as liabilities of the General Fund and receivables of the special funds was contrary to generally accepted accounting principles. Specifically, Section 1100.101 of the Codification of the Government Accounting and Financial Reporting Standards states:
A government accounting system must make it possible both: (a) to present fairly and with full disclosure the financial position and results of financial operations of the funds and account groups of the governmental unit in conformity with generally accepted accounting principles and (b) to determine and demonstrate compliance with finance-related legal and contractual provisions.
In addition to the requirements imposed by laws, regulations, contractual obligations, and generally accepted accounting principles, the Government, in our opinion, has a trust responsibility to the residents of the Virgin Islands to accurately record and report on all of its financial activities. This responsibility includes recording in the financial records of the respective funds all known outstanding obligations, including the obligations discussed in this report.
Authorized Interfund L
oans. We also found that, as of September 30, 1997, certain special funds were owed about $21 million for authorized interfund loans, which consisted of $11.5 million that was still outstanding on the loans of $20 million made in accordance with Act No. 6068 (see Background section of this report) and an additional $9.6 million borrowed by the Government in 1996. Regarding the $9.6 million in loans, the Government, in March 1996, borrowed $3.1 million from the AMPAC (American Property and Casualty Insurance Company) Settlement bank account, which was established with funds from the settlement of a case against an insurance company that defaulted on policyholder claims after Hurricane Hugo in 1989. The $3.1 million was used as an allotment to the University of the Virgin Islands for operating expenses. Additionally, in August 1996, the Government borrowed $6.5 million from the St. John Capital Improvement Fund for General Fund expenses. These two loans were outstanding as of September 30, 1997. All of these loans were recorded in the financial records of the related funds.
Other Outstanding Obligations
In addition to the interfund loans totaling $141 million, we found that, as of September 30, 1997, the Government had other outstanding obligations totaling $447 million as follows:
– FEMA was owed about $150 million for Community Disaster Loans provided to the Government. Specifically, in May 1996, FEMA denied the Government's request to convert the $44.3 million outstanding balance (including interest) of the 1989 Hurricane Hugo loan to a grant. In addition, the Government had not requested that FEMA convert the $96.5 million outstanding balance (including interest) of the 1995 Hurricane Marilyn loan to a grant. The Government also owed FEMA $9.5 million (including interest) on a State-Share Loan that was provided to allow the Government to meet the state matching requirement for FEMA disaster assistance funds.
– Governmental employees were owed $141 million for the estimated cost of salary increases and related fringe benefits based on union negotiations (concluded and pending) for fiscal years 1992 through 1997.
– Taxpayers were owed $76 million for income tax refunds for tax years1994 through 1996, which consisted of $23 million for tax years 1994 and prior years, $26 million for tax year 1995, and $27 million for tax year 1996.
– Vendors were owed at least $67 million, which consisted of $61 million for miscellaneous disbursement vouchers and purchase orders (for about 4,000 vendors) processed but not paid by the Department of Finance during March to September 1997, $4 million for about 1,000 vendor payments for which checks had been prepared but insufficient funds precluded the checks from being issued to the vendors, and $2 million for about 1,000 vouchers that had been rejected by the accounts payable system because of data entry errors or insufficient data (these vouchers were pending completion of processing). Of the $61 million for miscellaneous disbursement vouchers and purchase orders that were processed but not paid, $12 million represented amounts owed by the General Fund to 16 of the Government's special funds.
– The Government Employees Retirement System was owed $13 million, which consisted of $7 million for unfunded portions of the Early Retirement Incentive, Training and Promotion Act of 1994 and $6 million for Government contributions and loan payments to the Retirement System for the two pay periods in September 1997.
A summary of outstanding obligations as of September 30, 1997, and the estimated obligations as of January 31, 1998, is presented in Appendix 2. Although total obligations decreased by $6 million during the intervening 4 months, the $106 million bank loan that was approved in January 1998 only postponed the payment of $106 million in obligations to future periods, with an additional obligation to pay interest on the $106 million loan.
Response to Advisory Report
On November 21, 1997, we requested that the Government respond, by December 3, 1997, to the draft advisory report on the status of interfund loans and other obligations (see Prior Audit Coverage section of this report). The draft advisory report further stated that the Government's comments had to be submitted by that date to ensure that they would be included in the final version of the report. However, we did not receive the response from the Governor, dated December 1, 1997, and postmarked December 29, 1997, until January 6, 1998. Therefore, the Governor's comments were not included in the final version of the advisory report.
Governor's Response. In response to the draft advisory report, the Governor's response (see Appendix 3) expressed "strong objection" to the conclusions of the report and stated that the Administration did not make $120 million in unauthorized interfund loans during the period of April 1995 to September 30, 1997. The response stated that "our records for that same period show that over $41 million was already borrowed before April 1, 1995" and "the fact is that this total represents amounts borrowed that remain unpaid, and the amounts legally authorized to be transferred from other funds to support operating expenses of the General Fund." The response also stated that "at the start of Fiscal Year 1995, October 1, 1994, the General Fund owed $34.5 million to the Payroll Fund for further disbursement to the FICA and the Health Insurance Funds."
In addition, the response stated, "During Fiscal Years 1995 through 1997, legislation was enacted authorizing borrowings and transfers of $49.9 million to support the operating expenses of the General Fund, which includes payroll." The five legislative acts referred to in the response as authorizing a total of $49.9 million in interfund borrowing and transfers were Act Nos. 6075, 6078, 6084, 6086, and 6119. Finally, the response "seriously" questioned the "figure of $574 million [as stated in the draft advisory report] as the 'general operating obligations' of the Government." The response stated, "Only the current portion of the long-term debt is considered for accounting purposes, as general operating obligations."
Office of Inspector General Reply. We replied to the Governor's response to the draft advisory report in a letter dated February 5, 1998 (see Appendix 4). In the letter, we stated that "our review of the 87 checks showed that, although they were dated from September 9, 1995, through September 12, 1997, the checks were for repayment of FICA and health insurance expenses related to the pay periods April 11-24, 1995, through July 18-31, 1997." Our reply also stated, "If, as stated in [the Governor's] response, 'over $41 million was already borrowed before April, 1995,' then that $41 million was in addition to, not a part of, the $120 million discussed in our report." Our reply further noted that the Governor's statement that "at the start of Fiscal Year 1995, October 1, 1994, the General Fund owed $34.5 million to the Payroll Fund for further disbursement to the FICA and the Health Insurance Funds" raises concerns about the accuracy of the General Purpose Financial Statements included in the single audit report for the fiscal year ended September 30, 1994, because the financial statements and the accompanying notes did not include reference to an amount of $34.5 million that the General Fund owed to the Payroll Fund as of September 30, 1994 (which would have been carried forward to beginning balances on October 1, 1995).
In regard to the five legislative acts, with appropriations totaling $49.9 million, referred to in the Governor's response to the advisory report, our reply described in detail the reasons for our conclusion that those legislative acts did not authorize loans of the type included in the $120 million in unauthorized interfund loans reported in the advisory report (and in this report). We indicated that the only exception we were inclined to make was th
at Act No. 6078 authorized the transfer of $6 million from "any funds available in the Treasury of the Government of the Virgin Islands to offset the decrease in revenue" that occurred as a result of an authorized rollback in 1994 real property taxes to the 1992 rate of assessment. However, we stated that we would offset this $6 million against the reported $120 million in unauthorized interfund loans only when the transfer was recorded in the official financial records of the Government.
Finally, we did not identify the $570 million (as reported in the final advisory report but adjusted to $588 million in this report) as "general operating obligations" but as a "total operating debt," with the intention of differentiating it from bonded debt, which is generally incurred for the purpose of funding capital improvement projects. All of the items included in the $570 million amount were incurred either as a result of the Government's general operations or to finance general operating expenses. However, to more clearly identify the nature of the obligations that were the subject of our review, we have referred to these debts as "operations-related obligations" in this report.
Response to Preliminary Draft Report
In the June 22, 1998, response (Appendix 5) to the preliminary draft of this report from the Commissioner of Finance, the response stated that Title 23, Section 1125, of the Virgin Islands Code authorized the Governor "to utilize all available resources of the Territory while under a State of an Emergency." However, because that authorization is contained in a section of the Virgin Islands Code (titled the "Virgin Islands Territorial Emergency Management Act") that pertains specifically to the proclamation of a state of emergency to "activate the disaster preparation, response and recovery aspects of the territorial and interjurisdictional emergency and major disaster plans," we do not believe it was applicable to the use of "all available resources" to meet regular payroll-related expenses. In addition, the unrecorded interfund loans of $120 million were made during the period of April 1995 (5 months before Hurricane Marilyn) through July 1997 (22 months after Hurricane Marilyn). Therefore, the entire amount would not have been related to the state of emergency that existed after the hurricane. Further, the Government received FEMA Community Disaster Loans totaling $50 million after Hurricane Hugo (September 1989) and $127 million after Hurricane Marilyn (September 1995) to compensate the Government for the decline in revenues that occurred during the 3 years immediately following each hurricane. One of the primary uses of the disaster loan funds was to meet payroll expenses during the hurricane recovery period. Therefore, any additional borrowing by the Government to meet General Fund payroll expenses during the 3-year period after Hurricane Marilyn would not, in our opinion, have come under the "state of emergency" provisions of Title 23, Section 1125, of the Virgin Islands Code.
The response also "vehemently" objected to our conclusion that Federal funds were used to cover the overdrawn condition of the Special and Other Funds bank account, stating that we "neglected to review the group of bank accounts that provide funding for Special and Other Funds obligations." However, our report (page 8) states that we found that there were only three bank accounts related to Special and Other Funds activities: (1) a savings account that, according to the Acting Director of Treasury, contained only local funds (including Internal Revenue Matching Fund monies) that were not immediately earmarked for expenditures; (2) an "old" checking account that was inactive except for occasional electronic transfers of Federal funds that were subsequently transferred to a "new" checking account; and (3) the "new" checking account, which was the active account used for regular receipts and disbursements pertaining to Special and Other Funds. Regardless of the existence of the savings account and the "old" checking account, we believe that the examples cited in the report in which the "new" checking account was overdrawn on days when electronic fund transfers of Federal funds were received clearly indicate that those Federal funds were not immediately available for expenditure because of the overdrawn condition of the "new" checking account.
Finally, the response stated that "the Department has always maintained that cash from the local portion of the Special and Other Funds group of bank accounts has been supplementing the Federal portion." Specifically, the response stated that the Department's review of Federal accounts related to the Department of Public Works shows that during the period of October 1, 1995, through July 31, 1997, disbursements of Federal funds exceeded Federal receipts. While we agree that some Federal programs of the Department of Public Works operate on a reimbursable basis and therefore require the initial use of local funds, such reimbursable funding is the exception. Based on our limited review of the grant accounting practices of the Departments of Health, Human Services, Education, and Public Works (see Finding B), we found that these agencies generally operated on an "advance" funding basis and that, in particular, the Departments of Health and Human Services requested drawdowns of Federal funds in advance of the payment of expenditures related to their Federal programs.
Despite the cited disagreements with our audit conclusions, the response to the preliminary draft report stated that the Department of Finance (1) was in the process of recording all interfund borrowings and transfers from the Special and Other Funds account to the General Fund account, (2) was in the process of establishing a separate bank account for all Federally funded programs, (3) had issued policy memoranda to departments and agencies to request that they provide the Department with sufficient information to identify the source of Federal electronic fund transfers, (4) had contacted U.S. Treasury officials to determine whether any interest liability exists with regard to Federal funds drawn down in advance of need (see Finding B), and (5) will assess current and future financial accounting and reporting needs of the Government (see Finding C).
Recommendations
We recommend that the Governor of the Virgin Islands:
1. Require the Department of Finance to record in the Financial Management System the $120 million borrowed by the General Fund from the Special and Other Funds bank account to pay FICA taxes and health insurance premiums for pay periods during April 1995 to July 1997. Specifically, the Department should process journal entry transactions to establish a Due to Other Funds liability account in the General Fund in the amount of $120 million and a Due From Other Funds receivables account in each of the special funds from which monies were borrowed for each fund's appropriate share of the $120 million interfund loan. In addition, the Department of Finance should provide a report to the Legislature explaining the uses made of the amounts borrowed without legislative authorization and the status of repayment so that informed decisions on the Government's finances can be made as they pertain to the fund accounts affected by this unauthorized interfund debt.