Policy on Audits of RUS Borrowers

DEPARTMENT OF AGRICULTURE

Rural Utilities Service

7 CFR Part 1773

RIN 0572-AA93

Policy on Audits of RUS Borrowers

AGENCY: Rural Utilities Service, USDA.

ACTION: Interim final rule with request for comments.

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SUMMARY: The Rural Utilities Service (RUS) hereby amends its

regulations on audits of RUS borrowers. This rule incorporates changes

to the audit regulations necessitated by the 1994 revision of

Government Auditing Standards (GAGAS), issued by the Comptroller

General of the United States, United States General Accounting Office

(GAO), effective for financial audits of periods ending on or after

January 1, 1995 and by Statement on Auditing Standards (SAS) No. 74,

[[Page 105]]

Compliance Auditing Considerations in Audits of Governmental Entities

and Recipients of Governmental Financial Assistance, issued by the

Auditing Standards Board of the American Institute of Certified Public

Accountants (AICPA), effective for fiscal periods ending after December

31, 1994.

This rule also clarifies the peer review requirements for certified

public accountants (CPA) performing audits of RUS borrowers.

DATES: This rule is effective January 3, 1996. This rule applies to

audits of periods ending on December 31, 1995, and thereafter.

Written comments must be received by RUS or carry a postmark or

equivalent no later than March 4, 1996.

ADDRESSES: Submit written comments to Ms. Roberta D. Purcell, Chief,

Technical Accounting and Auditing Staff, Borrower Accounting Division,

Rural Utilities Service, Ag Box 1523, room 2221-S, U.S. Department of

Agriculture, Washington, DC 20250, telephone number (202) 720-5227. RUS

requires a signed original and three copies of all comments (7 CFR part

1700). All comments will be made available for inspection at room 2234

South Building during regular business hours (7 CFR 1.27(b)).

FOR FURTHER INFORMATION CONTACT: Ms. Roberta D. Purcell, Chief,

Technical Accounting and Auditing Staff, Borrower Accounting Division,

Rural Utilities Service, Ag Box 1523, room 2221-S, U.S. Department Of

Agriculture, Washington, DC 20250, telephone number (202) 720-5227.

SUPPLEMENTARY INFORMATION:

Executive Order 12866

This interim rule has been determined to be not significant for the

purposes of Executive Order 12866 and therefore has not been reviewed

by the Office of Management and Budget (OMB).

Regulatory Flexibility Act Certification

The Administrator, RUS, has determined that the Regulatory

Flexibility Act (5 U.S.C. 601 et seq.) does not apply to this rule.

Information Collection and Record Keeping Requirements

The reporting and recordkeeping requirements contained in the

interim rule were approved by the Office of Management and Budget (OMB)

pursuant to the Paperwork Reduction Act of 1995 (44 U.S.C. Chapter 35,

as amended) under control number 0572-0095.

Send questions or comments regarding this burden or any other

aspect of these collections of information, including suggestions for

reducing the burden, to F. Lamont Hepppe, Jr., Deputy Director, Program

Support Staff, Rural Utilities Service, Ag Box 1522, Washington, DC

20250-1522.

National Performance Review

This regulatory action is being taken as part of the National

Performance Review program to eliminate unnecessary regulations and

improve those that remain in force.

National Environmental Policy Act Certification

The Administrator, RUS, has determined that this rule will not

significantly affect the quality of the human environment as defined by

the National Environmental Policy Act of 1969 (42 U.S.C. 4321 et seq.).

Therefore, this action does not require an environmental impact

statement or assessment.

Catalog of Federal Domestic Assistance

The program described by this interim rule is listed in the Catalog

of Federal Domestic Assistance Programs under number 10.850--Rural

Electrification Loans and Loan Guarantees. This catalog is available on

a subscription basis from the Superintendent of Documents, the United

States Government Printing Office, Washington, DC 20402, (202) 512-

1800.

Executive Order 12372

This rule is excluded from the scope of Executive Order 12372,

Intergovernmental Consultation. A Notice of Final Rule entitled

Department Programs and Activities Excluded from Executive Order 12372

(50 FR 47034) exempts RUS electric loans and loan guarantees from

coverage under this Order.

Executive Order 12778

This rule has been reviewed under Executive Order 12778, Civil

Justice Reform. This rule: (1) Will not preempt any state or local

laws, regulations, or policies, unless they present an irreconcilable

conflict with this rule; (2) Will not have any retroactive effect; and

(3) Will not require administrative proceeding before parties may file

suit challenging the provisions of this rule.

Background

Part 1773 implements the standard RUS security instrument provision

requiring RUS borrowers to prepare and furnish to RUS, at least once

during each 12-month period, a full and complete report of its

financial condition, operations, and cash flows, in form and substance

satisfactory to RUS, audited and certified by an independent CPA,

satisfactory to RUS, and accompanied by a report of such audit, in form

and substance satisfactory to RUS. A report of the audit was defined in

Sec. 1773.1, General, to include the auditor's report, report on

compliance, report on internal controls and management letter.

On January 6, 1994, RUS published a final rule amending part 1773,

at 59 FR 657, that revised and clarified a provision of part 1773 that

requires a certified public accountant (CPA) to state whether an

electric borrower has complied with certain provisions of its loan and

security instruments. The January 6, 1994 final rule also incorporated

the illustrative management letter issued by the AICPA in a Technical

Practice Aid dated November 11, 1992.

This rule amends part 1773 to comply with the 1994 revision of

GAGAS. The 1994 revision of GAGAS adds three additional field work

standards. It also provides guidance on reporting, required

communications, and external quality control review.

The first additional standard requires CPAs to follow up on known,

material findings and recommendations from previous audits. This

standard is accomplished through compliance with Sec. 1773.32(a) and

Sec. 1773.33 of the current regulation.

The second additional standard requires CPAs to design their audits

to detect material noncompliance with contracts or grant agreements.

Section 1773.9, Disclosure of Irregularities and Illegal Acts, requires

CPAs to design the audit to include audit steps and procedures to

provide reasonable assurance of detecting errors, irregularities, and

illegal acts that could have a material effect on the financial

statement amounts and to extend audit procedures if there is an

indication that an irregularity may have occurred. This rule revises

the language of this section to include the supplemental standard to

design the audit to detect material noncompliance with contracts or

grant agreements as required by the 1994 revision of GAGAS.

The third additional standard requires CPAs to provide, in the

working papers, sufficient information to allow an experienced auditor

to locate the evidence supporting the CPA's significant conclusions and

judgments. Section 1773.6, Audit Agreement, requires the CPA and

borrower to enter into an audit agreement. Among the declarations that

must be included in the audit agreement is a statement that the CPA

will document the audit work

[[Page 106]]

performed in accordance with the professional standards of the AICPA

and part 1773. This rule revises this section to incorporate the

additional working paper requirements set forth in the 1994 revision of

GAGAS.

The 1994 revision of GAGAS requires the CPA to communicate the

auditor's responsibilities for consideration of internal controls and

compliance with laws and regulations and to contrast those

responsibilities with the additional procedures that could be performed

and the additional assurances or opinions on the internal control

structure or on compliance with laws and regulations that would result.

This communication must be with the board of directors. This rule

revises Sec. 1773.6 to include this required communication.

Section 1773.6 also requires the audit agreement to include a

statement that ``The borrower and CPA acknowledge that RUS regulations

provide that if the borrower fails to have an audit performed and

documented in compliance with GAGAS and this part, the borrower is in

violation of its security instrument with RUS''. In response to our

September 23, 1993, proposed rule, one CPA firm stated that this

language exceeds the applicable mortgage covenant and the following

language should be substituted ``The borrower and CPA acknowledge that

RUS will consider the borrower to be in violation of its security

instrument with RUS if the borrower fails to have an audit performed

and documented in compliance with GAGAS and 7 CFR part 1773. The

proposed rule published on September 23, 1993, did not include

revisions to Sec. 1773.6; therefore, we have incorporated the

aforementioned revision in this proceeding.

Section 1773.5, Qualifications of CPA, requires a CPA to submit to

a peer review of its accounting and audit practice every three years or

at such additional times as designated by the peer review executive

committee. Due to the increased number of peer reviews being performed,

many reviewers have experienced problems scheduling peer reviews within

the required time period. As a result, the AICPA extended the time

period to 42 months. RUS is, therefore, amending its requirement to

allow CPAs an additional six months to comply.

Similarly, the AICPA Board of Directors and the AICPA Council

approved the combination of the peer review program conducted by the

Private Companies Practice Section of the AICPA and the AICPA quality

review program effective for reviews performed April 3, 1995, and

thereafter. The AICPA Peer Review Board will conduct this program in

cooperation with the state CPA societies. Section 1773.5 has been

revised to reflect the changes necessitated by this merger.

The 1994 revision of GAGAS also provides guidance on external

quality control (peer) reviews. The CPA is required to provide a copy

of its most recent peer review report to those contracting for the

audit. Reciprocal peer reviews are prohibited; for example, an audit

organization is not permitted to review the organization that conducted

its most recent review. This interim rule revises Sec. 1773.5 to

incorporate the aforementioned change.

RUS's peer review requirement as currently set forth in Sec. 1773.5

does not allow individual CPAs that previously audited RUS borrowers as

part of a CPA firm to enter into private practice and audit RUS

borrowers without first obtaining a peer review. RUS is allowing the

Administrator of RUS to waive the peer review requirement for a period

of 18 months if the CPA meets certain proposed criteria set forth in

Sec. 1773.5(c)(7). The criteria established provides RUS with assurance

that the CPA has previously participated in establishing the quality

control standards for a CPA firm, the CPA has had responsibility for

the audit of an RUS borrower, and that a CPA firm is not reorganizing

for the sole purpose of evading the peer review requirement or

extending the time period for the performance of a peer review.

The 1994 revision of GAGAS requires the auditor's report to refer

to separate reports on compliance and on internal controls. Section

1773.31, Auditor's Report, requires the CPA to prepare a written report

covering all statements issued. This rule revises the language of this

section to incorporate the aforementioned change.

The 1988 revision of GAGAS required auditors to express positive-

negative assurance on compliance with laws and regulations in the

report on compliance and to identify the categories of controls

considered significant in the report on the internal control structure.

These requirements were eliminated in the 1994 revision of GAGAS.

Section 1773.32, Report on Compliance, requires the CPA to prepare a

written report on compliance with applicable laws, regulations, and

contracts as required by GAGAS. This rule removes the positive-negative

assurance requirement from the report on compliance. Similarly,

Sec. 1773.33, Report on Internal Controls, requires the CPA to prepare

a written report on the borrower's internal control structure and the

assessment of control risk made as part of the financial statement

audit as required by GAGAS. This rule deletes the requirement to

identify the categories of controls considered significant in the CPA's

report on the internal control structure.

Section 1773.34, Management Letter, specifies the minimum

requirements for the CPA's management letter. Among these is the

requirement for the CPA to state whether the information submitted to

RUS in its most recent December 31 RUS Form 7, Financial and

Statistical Report; Form 12, Operating Report--Financial; or Form 479,

Financial and Statistical Report for Telephone Borrowers, is in

agreement with the borrower's records. This rule would clarify that the

CPA's statement must indicate whether the most recent December 31 RUS

Form 7, 12, or 479 agrees with the borrower's ``audited'' records.

The CPA is also required by Sec. 1773.34 to comment when

depreciation rates for electric borrowers are not in compliance with

RUS requirements. This rule clarifies the requirement that the CPA

comment when the depreciation rates used by the borrower for each

primary plant account are not within the range established for that

particular account by RUS Bulletin 183-1, Depreciation Rates and

Procedures, or by the requirements of the state regulatory body having

jurisdiction over the borrower's depreciation rates.

Also included in Sec. 1773.34 is a requirement for the CPA to

comment on the adequacy of the borrower's controls over materials and

supplies. As part of the comment, RUS requires the presentation of a

``Detailed Schedule of Inventory Differences.'' RUS is eliminating this

schedule as it does not provide information that is beneficial to the

users of the financial statements. The above changes are also reflected

in the revision of Appendix C to Part 1773--Illustrative Independent

Auditor's Management Letter.

In February 1995, the Auditing Standards Board issued SAS No. 74,

Compliance Auditing Considerations in Audits of Governmental Entities

and Recipients of Governmental Financial Assistance, effective for

fiscal periods ending after December 31, 1994. SAS No. 74 supersedes

SAS No. 68, Compliance Auditing Applicable to Governmental Entities and

Other Recipients of Governmental Financial Assistance. In conjunction

with the issuance of SAS No. 74 and the 1994 revision of GAGAS, the

AICPA also revised its illustrative reports in the Audit and Accounting

Guide, Audits of State and Local Governmental Units, thereby

necessitating the changes in the

[[Page 107]]

sample reports contained in Appendix A to Part 1773--Sample Auditor's

Report for an Electric Cooperative and Appendix B to Part 1773--Sample

Auditor's Report for a Class A or B Commercial Telephone Company.

RUS has determined that, for a number of reasons, good cause exists

to make this rule effective immediately on an interim basis. Notice and

comment prior to the effective date is impractical, unnecessary and

contrary to the public interest. RUS loan documents and implementing

regulations generally require that each borrower provide RUS with an

annual audit report, prepared by an independent CPA within 120 days of

the ``as of'' audit date. To meet this deadline for audits of financial

statements prepared as of December 31, 1995, audits must be undertaken

immediately. In conducting the audit and preparing the report, CPAs are

required to comply with the provisions of GAGAS and with the provisions

of this part 1773. As a result of changes in GAGAS, there are currently

inconsistencies between GAGAS and this part 1773; therefore, CPAs must

be immediately advised of the applicable audit requirements and any

inconsistencies between GAGAS and part 1773 must be resolved. If the

inconsistencies are not resolved, borrowers could be placed in

technical default under their loan documents with both the government

and private co-lenders. Any failure to comply with loan documents can

of course affect borrowers access to and cost of capital. Moreover,

borrowers could be forced to incur additional audit expense absent an

immediate reconciliation of RUS audit requirements. Such consequences

are not in the interests of the RUS program, the borrowers or the

people they serve. In addition, many of the changes implemented by this

rule were previously subjected to notice and comment prior to being

issued by GAO. Consequently, further notice and comment is unnecessary.

List of Subjects in 7 CFR Part 1773

Accounting, Electric power, Loan programs--communications, Loan

programs--energy, Reporting and recordkeeping requirements, Rural

areas, Telecommunications.

For the reasons set forth in the preamble, RUS hereby amends 7 CFR

chapter XVII as follows:

PART 1773--POLICY ON AUDITS OF RUS BORROWERS

1. The authority citation for Part 1773 continues to read as

follows:

Authority: 7 U.S.C. 901 et seq.; 7 U.S.C. 1921 et seq.; Pub. L.

103-354, 108 Stat. 3178 (7 U.S.C. 6941 et seq.).

2. Section 1773.1 is amended by revising paragraph (c) to read as

follows:

Sec. 1773.1 General.

* * * * *

(c) This part complies with the 1994 revision of Government

Auditing Standards, issued by the Comptroller General of the United

States, United States General Accounting Office.

* * * * *

3. Section 1773.5 is amended by revising paragraph (c) to read as

follows:

Sec. 1773.5 Qualifications of CPA.

* * * * *

(c) Peer review requirement. The CPA must belong to and participate

in a peer review program, and must have undergone a satisfactory peer

review of the accounting and audit practice conducted by an approved

peer review program under paragraph (c)(4) of this section, unless a

waiver is granted under paragraph (c)(7) of this section. The reviewing

organization must not be affiliated with or have had its most recent

peer review conducted by the organization currently being reviewed

(reciprocal reviews). After the initial peer review has been performed,

the CPA must undergo a peer review of the accounting and audit practice

within 42 months of the previous ``as of'' peer review date or at such

additional times as designated by the peer review executive committee.

(1) A CPA that receives an unqualified peer review report will be

satisfactory to RUS provided that the CPA meets the other criteria set

forth in this section.

(2) If a CPA receives a qualified or adverse peer review report,

the CPA must undergo a second peer review within 18 months of the date

of the qualified or adverse report. A CPA that receives an unqualified

second peer review report will be satisfactory to RUS provided that the

CPA meets the other criteria set forth in this section.

(3) A CPA that receives a second qualified or adverse peer review

report will not be satisfactory to RUS.

(4) Approved peer review programs. The following peer review

programs are approved by RUS:

(i) The peer review programs conducted by the AICPA;

(ii) The peer review program conducted by the regulated audit

program group of the National Conference of CPA Practitioners; and

(iii) An independent peer review program that, in RUS's

determination, requires its members to:

(A) Ensure that the CPA can legally engage in the practice of

certified public accounting;

(B) Adhere to the quality control standards established by the

AICPA;

(C) Submit to peer reviews of the CPA's accounting and audit

practice every 42 months or at such additional times as designated by

its own executive committee; and

(D) Ensure that all professionals in the firm, including CPAs and

nonCPAs, take part in the qualifying continuing professional education

requirements of GAGAS, as set forth in paragraphs (c)(4)(iii)(D)(1) and

(c)(4)(iii)(D)(2). A qualified continuing professional education course

is one which meets the standards of the AICPA.

(1) An auditor responsible for planning, directing, conducting, or

reporting on government audits must complete, every two years, at least

eighty hours of continuing education and training which contributes to

the auditor's professional proficiency. At least twenty hours must be

completed in any one year of the two-year period; and

(2) An individual responsible for planning, directing, and

conducting substantial portions of the field work, or reporting on the

government audit must complete at least 24 of the 80 hours of

continuing education and training in subjects directly related to the

government environment and to government auditing. If the audited

entity operates in a specific or unique environment, auditors must

receive training that is related to that environment.

(5) Notification. The CPA must notify the Director, BAD, in

writing, of participation in a peer review program. RUS will notify the

CPA within 60 days of receipt of this notice if the selected peer

review program is acceptable.

(6) Submission of reports. The CPA must submit to the Director,

BAD, a copy of any peer review report and accompanying letter of

comment, if any, within 60 days of the date such report and letter of

comment are released by the peer review group.

(i) If the peer review report indicates that a follow-up review

will be made, the CPA must submit subsequent reports to the Director,

BAD, within 60 days of the date such reports are released by the peer

review group.

(ii) A peer review report must be submitted to the Director, BAD,

at least once every 42 months, or more frequently, if required by the

peer review program.

(iii) A copy of the peer review report, accompanying letter of

comment, and the partners' inspections must be made available to OGC,

upon request.

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(7) Waiver of the peer review requirement.

(i) A CPA may request that the Administrator, RUS, waive the peer

review requirement. To be eligible for a waiver, the following criteria

must be met:

(A) The firm has been in existence for less than 1 year from the

date of the request and has not been previously organized under a

different name;

(B) One of the partners organizing the firm has previously, within

18 months preceding the request, worked for a firm that has been peer

reviewed and the partner was partner-in-charge of audits of RUS

borrowers in the previous firm;

(C) The firm has enrolled in an approved peer review program; and

(D) The firm agrees to have the peer review conducted within 18

months of the date of the RUS waiver.

(ii) Waiver requests must address each of the criteria in paragraph

(c)(7)(i) of this section and should be submitted to the Director,

Borrower Accounting Division.

* * * * *

4. Section 1773.6 is amended by revising paragraph (a) to read as

follows:

Sec. 1773.6 Audit agreement.

(a) An audit agreement must be entered into between the CPA and the

borrower. The audit agreement must set forth the auditor's

responsibilities in a financial statement audit, including the

responsibilities for testing and reporting on internal controls and

compliance with laws and regulations and the nature of any additional

testing of internal controls and compliance required by laws and

regulations. These responsibilities should be contrasted with the

additional procedures that could be performed that would result in

additional assurances or opinions on the internal control structure and

compliance with laws and regulations. The audit agreement must also

include the following:

(1) The borrower and the CPA acknowledge that the audit is being

performed and the auditor's report, report on compliance, report on

internal controls, and management letter is being issued in order to

enable the borrower to comply with the provisions of RUS's security

instrument;

(2) The borrower and CPA acknowledge that RUS will consider the

borrower to be in violation of its security instrument with RUS if the

borrower fails to have an audit performed and documented in compliance

with GAGAS and this part;

(3) The CPA represents that he/she meets the requirements under

this part to be satisfactory to RUS;

(4) The CPA will perform the audit and will prepare the auditor's

report, report on compliance, report on internal controls, and

management letter in accordance with the requirements of this part;

(5) The CPA will document the audit work performed in accordance

with GAGAS, the professional standards of the AICPA, and the

requirements of this part;

(6) The CPA will make all audit-related documents, including

auditor's reports, workpapers, and management letters available to RUS

or its representatives (OGC and GAO), upon request, and will permit the

photocopying of all audit-related documents; and

(7) The CPA will follow the requirements of reporting

irregularities and illegal acts as outlined in Sec. 1773.9.

* * * * *

5. Section 1773.9 is amended by revising paragraphs (a) and (b) to

read as follows:

Sec. 1773.9 Disclosure of irregularities and illegal acts.

(a) In accordance with GAGAS, the CPA must design audit steps and

procedures to provide reasonable assurance of detecting errors,

irregularities, illegal acts, and noncompliance with the provisions of

contracts or grant agreements that could have a direct and material

effect on financial statement amounts.

(b) If there is an indication that an irregularity may have

occurred or evidence concerning the existence of a possible instance of

noncompliance with the provisions of contracts or grant agreements that

could have a material direct or indirect effect on the financial

statements, the CPA must extend audit steps and procedures to obtain

sufficient, competent evidential matter to determine whether, in fact,

an irregularity or an instance of noncompliance has occurred and the

effect on the borrower's financial statements.

* * * * *

6. Section 1773.31 is revised to read as follows:

Sec. 1773.31 Auditor's report.

The CPA must prepare a written report on comparative balance

sheets, statements of revenue and patronage capital (or income and

retained earnings, depending upon the structure of the borrower) and

statements of cash flows. This report must be signed by the CPA, cover

all statements presented, and refer to the separate reports on internal

controls and on compliance with laws and regulations issued in

conjunction with the auditor's report.

7. Section 1773.32 is amended by revising paragraph (a) to read as

follows:

Sec. 1773.32 Report on compliance.

(a) As required by GAGAS, the CPA must prepare a written report on

the tests performed for compliance with applicable laws, regulations,

contracts, and grants. This report must be signed by the CPA and must

contain the status of known but uncorrected significant or material

findings and recommendations from prior audits that affect the current

audit objective.

* * * * *

8. Section 1773.33 is revised to read as follows:

Sec. 1773.33 Report on internal controls.

As required by GAGAS, the CPA must prepare a written report on the

borrower's internal control structure and the assessment of control

risk made as part of the financial statement audit. This report must be

signed by the CPA and must include, as a minimum:

(a) The scope of the CPA's work to obtain an understanding of the

borrower's internal control structure and in assessing the control

risk;

(b) A description of the reportable conditions noted which include

material weaknesses identified as a result of the CPA's work in

understanding and assessing the control risk; and

(c) The status of known but uncorrected, significant or material

findings and recommendations from prior audits that affect the current

audit objective.

9. Section 1773.34 is amended by removing paragraphs (d)(1),

(d)(2), and (d)(3) and revising paragraphs (e)(1)(iii), (e)(2)(iii),

and (g) to read as follows:

Sec. 1773.34 Management letter.

* * * * *

(e) * * *

(1) * * *

(iii) The requirement for a borrower to prepare and furnish

mortgagees annual financial and statistical reports on the borrower's

financial condition and operations. The CPA must state whether the

information represented by the borrower as having been submitted to RUS

in its most recent December 31 RUS Form 7 or Form 12 is in agreement

with the borrower's audited records, and must comment on any exceptions

noted. If the borrower represents that an amended report has been filed

as of December 31, the comments must relate to the amended report.

(2) * * *

(iii) The requirement for a borrower to prepare and furnish

mortgagees annual

[[Page 109]]

financial and statistical reports on the borrower's financial condition

and operations. The CPA must state whether the information represented

by the borrower as having been submitted to RUS in its most recent

December 31 RUS Form 479 is in agreement with the borrower's audited

records, and must comment on any exceptions noted. If the borrower

represents that an amended report has been filed as of December 31, the

comments must relate to the amended report;

* * * * *

(g) Depreciation rates. For electric borrowers, comment when the

depreciation rates used in computing monthly accruals are not in

compliance with RUS requirements (See RUS Bulletin 183-1, Depreciation

Rates and Procedures), which require the use of depreciation rates that

are within the ranges established by RUS for each primary plant

account, or with the requirements of the State regulatory body having

jurisdiction over the borrower's depreciation rates; and

* * * * *

10. In Appendix A to Part 1773 Exhibits 1 through 6 are revised to

read as follows:

Appendix A to Part 1773--Sample Auditor's Report for an Electric

Cooperative

* * * * *

Exhibit 1--Sample Auditor's Report

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center County Electric Cooperative:

Independent Auditor's Report

We have audited the accompanying balance sheets of Center County

Electric Cooperative as of December 31, 19X9 and 19X8, and the

related statements of revenue and patronage capital, and cash flows

for the years then ended. These financial statements are the

responsibility of Center County Electric Cooperative's management.

Our responsibility is to express an opinion on these financial

statements based on our audit.

We conducted our audits in accordance with generally accepted

auditing standards and Government Auditing Standards issued by the

Comptroller General of the United States. Those standards require

that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material

misstatement. An audit includes examining, on a test basis, evidence

supporting the amounts and disclosures in the financial statements.

An audit also includes assessing the accounting principles used and

significant estimates made by management, as well as evaluating the

overall financial statement presentation. We believe that our audits

provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above

present fairly, in all material respects, the financial position of

Center County Electric Cooperative as of December 31, 19X9 and 19X8,

and the results of its operations and its cash flows for the years

then ended in conformity with generally accepted accounting

principles.

In accordance with Government Auditing Standards, we have also

issued a report dated March 2, 19X0, on our consideration of Center

County Electric Cooperative's internal control structure and a

report dated March 2, 19X0, on its compliance with laws and

regulations.

Certified Public Accountants

March 2, 19X0

Exhibit 2--Sample Report on Compliance When, Based on Assessments

of Materiality and Audit Risk, the CPA Concluded It Was Not

Necessary to Perform Tests of Compliance With Laws and Regulations

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center County Electric Cooperative:

We have audited the financial statements of Center County

Electric Cooperative as of and for the years ended December 31, 19X9

and 19X8, and have issued our report thereon dated March 2, 19X0.

We conducted our audits in accordance with generally accepted

auditing standards and the Government Auditing Standards, issued by

the Comptroller General of the United States. Those standards

require that we plan and perform the audit to obtain reasonable

assurance about whether the financial statements are free of

material misstatement.

Compliance with laws, regulations, contracts, and grants

applicable to Center County Electric Cooperative is the

responsibility of Center County Electric Cooperative's management.

As part of our audit, we assessed the risk that noncompliance with

certain provisions of laws, regulations, contracts, and grants could

cause the financial statements to be materially misstated. We

concluded that the risk of such material misstatement was

sufficiently low that it was not necessary to perform tests of

Center County Electric Cooperative's compliance with such provisions

of laws, regulations, contracts, and grants.

This report is intended for the information of the audit

committee, management, the Rural Utilities Service, and supplemental

lenders. However, this report is a matter of public record and its

distribution is not limited.

Certified Public Accountants

March 2, 19X0

Exhibit 3--Sample Report on Compliance When, Based on Assessments

of Materiality and Audit Risk, the CPA Performed Compliance Testing

and Found No Reportable Instances of Noncompliance

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center County Electric Cooperative:

We have audited the financial statements of Center County

Electric Cooperative as of and for the years ended December 31, 19X9

and 19X8, and have issued our report thereon dated March 2, 19X0.

We conducted our audits in accordance with generally accepted

auditing standards and Government Auditing Standards, issued by the

Comptroller General of the United States. Those standards require

that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material

misstatement.

Compliance with laws, regulations, contracts, and grants

applicable to Center County Electric Cooperative is the

responsibility of Center County Electric Cooperative's management.

As part of obtaining reasonable assurance about whether the

financial statements are free of material misstatement, we performed

tests of Center County Electric Cooperative's compliance with

certain provisions of laws, regulations, contracts, and grants.

However, the objective of our audit of the financial statements was

not to provide an opinion on overall compliance with such

provisions. Accordingly, we do not express such an opinion.

The results of our tests disclosed no instances of noncompliance

that are required to be reported herein under Government Auditing

Standards.

This report is intended for the information of the audit

committee, management, the Rural Utilities Service, and supplemental

lenders. However, this report is a matter of public record and its

distribution is not limited.

Certified Public Accountants

March 2, 19X0

Exhibit 4--Sample Report on Compliance When, Based on Assessments

of Materiality and Audit Risk, the CPA Performed Compliance Testing

and Found Reportable Instances of Noncompliance

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center County Electric Cooperative:

We have audited the financial statements of Center County

Electric Cooperative as of and for the years ended December 31, 19X9

and 19X8, and have issued our report thereon dated March 2, 19X0.

We conducted our audits in accordance with generally accepted

auditing standards and Government Auditing Standards, issued by the

Comptroller General of the United States. Those standards require

that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material

misstatement.

Compliance with laws, regulations, contracts, and grants

applicable to Center County Electric Cooperative is the

responsibility of Center County Electric Cooperative's management.

As part of obtaining reasonable assurance about whether the

financial statements are free of material misstatement, we preformed

tests of Center County Electric Cooperative's compliance with

certain provisions of laws, regulations, contracts, and grants.

However, the objective of our audit of the financial

[[Page 110]]

statements was not to provide an opinion on overall compliance with

such provisions. Accordingly, we do not express such an opinion.

The results of our tests disclosed instances of noncompliance

that are required to be reported herein under Government Auditing

Standards for which the ultimate resolution cannot presently be

determined. Accordingly, no provision for any liability that may

result has been recognized in Center County Electric Cooperative's

19X9 and 19X8 financial statements.

[Include paragraphs describing the instances of noncompliance

noted.]

We considered these instances of noncompliance in forming our

opinion on whether Center County Electric Cooperative's 19X9 and

19X8 financial statements are presented fairly, in all material

respects, in conformity with generally accepted accounting

principles, and this report does not effect our report dated March

2, 19X0, on those financial statements.

This report is intended for the information of the audit

committee, management, the Rural Utilities Service, and supplemental

lenders. However, this report is a matter of public record and its

distribution is not limited.

Certified Public Accountants

March 2, 19X0

Exhibit 5--Sample Report on Internal Controls When Reportable

Conditions Were Found

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center County Electric Cooperative:

We have audited the financial statements of Center County

Electric Cooperative as of and for the years ended December 31, 19X9

and 19X8, and have issued our report thereon dated March 2, 19X0.

We conducted our audits in accordance with generally accepted

auditing standards and Government Auditing Standards, issued by the

Comptroller General of the United States. Those standards require

that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material

misstatement.

The management of Center County Electric Cooperative is

responsible for establishing and maintaining an internal control

structure. In fulfilling this responsibility, estimates and

judgements by management are required to assess the expected

benefits and related costs of internal control structure policies

and procedures. The objectives of an internal control structure are

to provide management with reasonable, but not absolute, assurance

that the assets are safeguarded against loss from unauthorized use

or disposition, and that transactions are executed in accordance

with management's authorization and recorded properly to permit the

preparation of financial statements in accordance with generally

accepted accounting principles. Because of inherent limitations in

any internal control structure, errors or irregularities may

nevertheless occur and not be detected. Also, projection of any

evaluation of the structure to future periods is subject to the risk

that procedures may become inadequate because of changes in

conditions or that the effectiveness of the design and operation of

policies and procedures may deteriorate.

In planning and performing our audit of the financial statements

of Center County Electric Cooperative for the years ended December

31, 19X9 and 19X8, we obtained an understanding of the internal

control structure. With respect to the internal control structure,

we obtained an understanding of the design of relevant policies and

procedures and whether they have been placed in operation, and we

assessed control risk in order to determine our auditing procedures

for the purpose of expressing our opinion on the financial

statements and not to provide an opinion on the internal control

structure. Accordingly, we do not express such an opinion.

We noted certain matters involving the internal control

structure and its operation that we consider to be reportable

conditions under standards established by the American Institute of

Certified Public Accountants. Reportable conditions involve matters

coming to our attention relating to significant deficiencies in the

design or operation of the internal control structure that, in our

judgement, could adversely affect the entity's ability to record,

process, summarize, and report financial data consistent with the

assertions of management in the financial statements.

[Include paragraphs to describe the reportable conditions noted.]

A material weakness is a reportable condition in which the

design or operation of one or more of the specific internal control

structure elements does not reduce to a relatively low level the

risk that errors or irregularities in amounts that would be material

in relation to the financial statements being audited may occur and

not be detected within a timely period by employees in the normal

course of performing their assigned functions.

Our consideration of the internal control structure would not

necessarily disclose all matters in the internal control structure

that might be reportable conditions and, accordingly, would not

necessarily disclose all reportable conditions that are also

considered to be material weaknesses as defined above. However, we

believe none of the reportable conditions described above is a

material weakness.

We also noted other matters involving the internal control

structure and its operation that we have reported to the management

of Center County Electric Cooperative in a separate letter dated

March 2, 19X0.

This report is intended for the information of the audit

committee, management, the Rural Utilities Service, and supplemental

lenders. However, this report is a matter of public record, and its

distribution is not limited.

Certified Public Accountants

March 2, 19X0

Exhibit 6--Sample Report on Internal Controls When No Reportable

Conditions Were Found

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center County Electric Cooperative:

We have audited the financial statements of Center County

Electric Cooperative, as of and for the years ended December 31,

19X9 and 19X8, and have issued our report thereon dated March 2,

19X0.

We conducted our audits in accordance with generally accepted

auditing standards and Government Auditing Standards, issued by the

Comptroller General of the United States. Those standards require

that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material

misstatement.

The management of Center County Electric Cooperative is

responsible for establishing and maintaining an internal control

structure. In fulfilling this responsibility, estimates and

judgements by management are required to assess the expected

benefits and related costs of internal control structure policies

and procedures. The objectives of an internal control structure are

to provide management with reasonable, but not absolute, assurance

that assets are safeguarded against loss from unauthorized use or

disposition, and that transactions are executed in accordance with

management's authorization and recorded properly to permit the

preparation of financial statements in accordance with generally

accepted accounting principles. Because of inherent limitations in

any internal control structure, errors or irregularities may

nevertheless occur and not be detected. Also, projection of any

evaluation of the structure to future periods is subject to the risk

that procedures may become inadequate because of changes in

conditions or that the effectiveness of the design and operation of

policies and procedures may deteriorate.

In planning and performing our audit of the financial statements

of Center County Electric Cooperative for the years ended December

31, 19X9 and 19X8, we obtained an understanding of the internal

control structure. With respect to the internal control structure,

we obtained an understanding of the design of relevant policies and

procedures and whether they have been placed in operation, and we

assessed control risk in order to determine our auditing procedures

for the purpose of expressing our opinion on the financial

statements and not to provide an opinion on the internal control

structure. Accordingly, we do not express such an opinion.

Our consideration of the internal control structure would not

necessarily disclose all matters in the internal control structure

that might be material weaknesses under standards established by the

American Institute of Certified Public Accountants. A material

weakness is a condition in which the design or operation of one or

more of the specific internal control structure elements does not

reduce to a relatively low level the risk that errors or

irregularities in amounts that would be material in relation to the

financial statements being audited may occur

[[Page 111]]

and not be detected within a timely period by employees in the normal

course of performing their assigned functions. We noted no matters

involving the internal control structure and its operations that we

consider to be material weaknesses as defined above.

However, we noted other matters involving the internal control

structure and its operation that we have reported to the management

of Center County Electric Cooperative in a separate letter dated

March 2, 19X0.

This report is intended for the information of the audit

committee, management, the Rural Utilities Service, and supplemental

lenders. However, this report is a matter of public record, and its

distribution is not limited.

Certified Public Accountants

March 2, 19X0

* * * * *

11. In Appendix B to Part 1773, Exhibits 1 through 6 are revised to

read as follows:

Appendix B to Part 1773--Sample Auditor's Report for a Class A or B

Commercial Telephone Company

* * * * *

Exhibit 1--Sample Auditor's Report

Certified Public Accountants, 1600 Main Street, City, State 24105,

The Board of Directors, Center Telephone Company:

Independent Auditor's Report

We have audited the accompanying balance sheets of Center

Telephone Company as of December 31, 19X9 and 19X8, and the related

statements of revenue and patronage capital, and cash flows for the

years then ended. These financial statements are the responsibility

of Center Telephone Company's management. Our responsibility is to

express an opinion on these financial statements based on our audit.

We conducted our audits in accordance with generally accepted

auditing standards and Government Auditing Standards issued by the

Comptroller General of the United States. Those standards require

that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material

misstatement. An audit includes examining, on a test basis, evidence

supporting the amounts and disclosures in the financial statements.

An audit also includes assessing the accounting principles used and

significant estimates made by management, as well as evaluating the

overall financial statement presentation. We believe that our audits

provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above

present fairly, in all material respects, the financial position of

Center Telephone Company as of December 31, 19X9 and 19X8, and the

results of its operations and its cash flows for the years then

ended in conformity with generally accepted accounting principles.

In accordance with Government Auditing Standards, we have also

issued a report dated March 2, 19X0, on our consideration of Center

Telephone Company's internal control structure and a report dated

March 2, 19X0, on its compliance with laws and regulations.

Certified Public Accountants

March 2, 19X0

Exhibit 2--Sample Report on Compliance When, Based on Assessments

of Materiality and Audit Risk, the CPA Concluded It Was Not

Necessary to Perform Tests of Compliance With Laws and Regulations

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center Telephone Company

We have audited the financial statements of Center Telephone

Company as of and for the years ended December 31, 19X9 and 19X8,

and have issued our report thereon dated March 2, 19X0.

We conducted our audits in accordance with generally accepted

auditing standards and the Government Auditing Standards, issued by

the Comptroller General of the United States. Those standards

require that we plan and perform the audit to obtain reasonable

assurance about whether the financial statements are free of

material misstatement.

Compliance with laws, regulations, contracts, and grants

applicable to Center Telephone Company is the responsibility of

Center Telephone Company's management. As part of our audit, we

assessed the risk that noncompliance with certain provisions of

laws, regulations, contracts, and grants could cause the financial

statements to be materially misstated. We concluded that the risk of

such material misstatement was sufficiently low that it was not

necessary to perform tests of Center Telephone Company's compliance

with such provisions of laws, regulations, contracts, and grants.

This report is intended for the information of the audit

committee, management, the Rural Utilities Service, and supplemental

lenders. However, this report is a matter of public record and its

distribution is not limited.

Certified Public Accountants

March 2, 19X0

Exhibit 3--Sample Report on Compliance When, Based on Assessments

of Materiality and Audit Risk, the CPA Performed Compliance Testing

and Found No Reportable Instances of Noncompliance

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center Telephone Company:

We have audited the financial statements of Center Telephone

Company as of and for the years ended December 31, 19X9 and 19X8,

and have issued our report dated March 2, 19X0.

We conducted our audits in accordance with generally accepted

auditing standards and Government Auditing Standards, issued by the

Comptroller General of the United States. Those standards require

that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material

misstatement.

Compliance with laws, regulations, contracts, and grants

applicable to Center Telephone Company is the responsibility of

Center Telephone Company's management. As part of obtaining

reasonable assurance about whether the financial statements are free

of material misstatement, we performed tests of Center Telephone

Company's compliance with certain provisions of laws, regulations,

contracts, and grants. However, the objective of our audit of the

financial statements was not to provide an opinion on overall

compliance with such provisions. Accordingly, we do not express such

an opinion.

The results of our tests disclosed no instances of noncompliance

that are required to be reported herein under Government Auditing

Standards.

This report is intended for the information of the audit

committee, management, the Rural Utilities Service, and supplemental

lenders. However, this report is a matter of public record and its

distribution is not limited.

Certified Public Accountants

March 2, 19X0

Exhibit 4--Sample Report on Compliance When, Based on Assessments

of Materiality and Audit Risk, the CPA Performed Compliance Testing

and Found Reportable Instances of Noncompliance

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center Telephone Company:

We have audited the financial statements of Center Telephone

Company as of and for the years ended December 31, 19X9 and 19X8,

and have issued our report thereon dated March 2, 19X0.

We conducted our audits in accordance with generally accepted

auditing standards and Government Auditing Standards, issued by the

Comptroller General of the United States. Those standards require

that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material

misstatement.

Compliance with laws, regulations, contracts, and grants

applicable to Center Telephone Company is the responsibility of

Center Telephone Company's management. As part of obtaining

reasonable assurance about whether the financial statements are free

of material misstatement, we preformed tests of Center Telephone

Company's compliance with certain provisions of laws, regulations,

contracts, and grants. However, the objective of our audit of the

financial statements was not to provide an opinion on overall

compliance with such provisions. Accordingly, we do not express such

an opinion.

The results of our tests disclosed instances of noncompliance

that are required to be reported herein under Government Auditing

Standards for which the ultimate resolution cannot presently be

determined. Accordingly, no provision for any liability that may

result has been recognized in Center Telephone Company's 19X9 and

19X8 financial statements.

[Include paragraphs describing the instances of noncompliance

noted.]

We considered these instances of noncompliance in forming our

opinion on whether Center Telephone Company's 19X9

[[Page 112]]

and 19X8 financial statements are presented fairly, in all material

respects, in conformity with generally accepted accounting

principles, and this report does not effect our report dated March

2, 19X0, on those financial statements.

This report is intended for the information of the audit

committee, management, the Rural Utilities Service, and supplemental

lenders. However, this report is a matter of public record and its

distribution is not limited.

Certified Public Accountants

March 2, 19X0

Exhibit 5--Sample Report on Internal Controls When Reportable

Conditions Were Found

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center Telephone Company:

We have audited the financial statements of Center Telephone

Company as of and for the years ended December 31, 19X9 and 19X8,

and have issued our report thereon dated March 2, 19X0.

We conducted our audits in accordance with generally accepted

auditing standards and Government Auditing Standards, issued by the

Comptroller General of the United States. Those standards require

that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material

misstatement.

The management of Center Telephone Company is responsible for

establishing and maintaining an internal control structure. In

fulfilling this responsibility, estimates and judgements by

management are required to assess the expected benefits and related

costs of internal control structure policies and procedures. The

objectives of an internal control structure are to provide

management with reasonable, but not absolute, assurance that the

assets are safeguarded against loss from unauthorized use or

disposition, and that transactions are executed in accordance with

management's authorization and recorded properly to permit the

preparation of financial statements in accordance with generally

accepted accounting principles. Because of inherent limitations in

any internal control structure, errors or irregularities may

nevertheless occur and not be detected. Also, projection of any

evaluation of the structure to future periods is subject to the risk

that procedures may become inadequate because of changes in

conditions or that the effectiveness of the design and operation of

policies and procedures may deteriorate.

In planning and performing our audit of the financial statements

of Center Telephone Company for the years ended December 31, 19X9

and 19X8, we obtained an understanding of the internal control

structure. With respect to the internal control structure, we

obtained an understanding of the design of relevant policies and

procedures and whether they have been placed in operation, and we

assessed control risk in order to determine our auditing procedures

for the purpose of expressing our opinion on the financial

statements and not to provide an opinion on the internal control

structure. Accordingly, we do not express such an opinion.

We noted certain matters involving the internal control

structure and its operation that we consider to be reportable

conditions under standards established by the American Institute of

Certified Public Accountants. Reportable conditions involve matters

coming to our attention relating to significant deficiencies in the

design or operation of the internal control structure that, in our

judgement, could adversely affect the entity's ability to record,

process, summarize, and report financial data consistent with the

assertions of management in the financial statements.

[Include paragraphs to describe the reportable conditions noted.]

A material weakness is a reportable condition in which the

design or operation of one or more of the specific internal control

structure elements does not reduce to a relatively low level the

risk that errors or irregularities in amounts that would be material

in relation to the financial statements being audited may occur and

not be detected within a timely period by employees in the normal

course of performing their assigned functions.

Our consideration of the internal control structure would not

necessarily disclose all matters in the internal control structure

that might be reportable conditions and, accordingly, would not

necessarily disclose all reportable conditions that are also

considered to be material weaknesses as defined above. However, we

believe none of the reportable conditions described above is a

material weakness.

We also noted other matters involving the internal control

structure and its operation that we have reported to the management

of Center Telephone Company in a separate letter dated March 2,

19X0.

This report is intended for the information of the audit

committee, management, and Rural Utilities Service, and supplemental

lenders. However, this report is a matter of public record, and its

distribution is not limited.

Certified Public Accountants

March 2, 19X0

Exhibit 6--Sample Report on Internal Controls When No Reportable

Conditions Were Found

Certified Public Accountants, 1600 Main Street, City, State

24105, The Board of Directors, Center Telephone Company:

We have audited the financial statements of Center Telephone

Company, as of and for the years ended December 31, 19X9 and 19X8,

and have issued our report thereon dated March 2, 19X0.

We conducted our audit in accordance with generally accepted

auditing standards and Government Auditing Standards, issued by the

Comptroller General of the United States. Those standards require

that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material

misstatement.

The management of Center Telephone Company is responsible for

establishing and maintaining an internal control structure. In

fulfilling this responsibility, estimates and judgements by

management are required to assess the expected benefits and related

costs of internal control structure policies and procedures. The

objectives of an internal control structure are to provide

management with reasonable, but not absolute, assurance that assets

are safeguarded against loss from unauthorized use or disposition,

and that transactions are executed in accordance with management's

authorization and recorded properly to permit the preparation of

financial statements in accordance with generally accepted

accounting principles. Because of inherent limitations in any

internal control structure, errors or irregularities may

nevertheless occur and not be detected. Also, projection of any

evaluation of the structure to future periods is subject to the risk

that procedures may become inadequate because of changes in

conditions or that the effectiveness of the design and operation of

policies and procedures may deteriorate.

In planning and performing our audit of the financial statements

of Center Telephone Company for the years ended December 31, 19X9

and 19X8, we obtained an understanding of the internal control

structure. With respect to the internal control structure, we

obtained an understanding of the design of relevant policies and

procedures and whether they have been placed in operation, and we

assessed control risk in order to determine our auditing procedures

for the purpose of expressing our opinion on the financial

statements and not to provide an opinion on the internal control

structure. Accordingly, we do not express such an opinion.

Our consideration of the internal control structure would not

necessarily disclose all matters in the internal control structure

that might be material weaknesses under standards established by the

American Institute of Certified Public Accountants. A material

weakness is a condition in which the design or operation of one or

more of the specific internal control structure elements does not

reduce to a relatively low level the risk that errors or

irregularities in amounts that would be material in relation to the

financial statements being audited may occur and not be detected

within a timely period by employees in the normal course of

performing their assigned functions. We noted no matters involving

the internal control structure and its operations that we consider

to be material weaknesses as defined above.

However, we noted other matters involving the internal control

structure and its operation that we have reported to the management

of Center Telephone Company in a separate letter dated March 2,

19X0.

This report is intended for the information of the audit

committee, management, the Rural Utilities Service, and supplemental

lenders. However, this report is a matter of public record, and its

distribution is not limited.

Certified Public Accountants

March 2, 19X0

* * * * *

12. Appendix C to Part 1773 is revised to read as follows:

[[Page 113]]

Appendix C to Part 1773--Illustrative Independent Auditor's

Management Letter

RUS requires that CPAs auditing RUS borrowers provide a

management letter in accordance with Sec. 1773.34. This letter must

be signed by the CPA, bear the same date as the auditor's report,

and be addressed to the borrower's board of directors.

Illustrative Independent Auditor's Management Letter

March 15, 19X6

Board of Directors, [Name of Borrower], [City, State].

We have audited the financial statements of [Name of Borrower]

for the year ended December 31, 19X5, and have issued our report

thereon dated March 15, 19X6. We conducted our audit in accordance

with generally accepted auditing standards, Government Auditing

Standards issued by the Comptroller General of the United States,

and 7 CFR part 1773, Policy on Audits of Rural Utilities Service

(RUS) Borrowers. Those standards require that we plan and perform

the audit to obtain reasonable assurance about whether the financial

statements are free of material misstatement.

In planning and performing our audit of the financial statements

of [Name of Borrower] for the year ended December 31, 19X5, we

considered its internal control structure in order to determine our

auditing procedures for the purpose of expressing an opinion on the

financial statements and not to provide assurance on the internal

control structure.

A description of the responsibility of management for

establishing and maintaining the internal control structure and the

objectives of and inherent limitations in such a structure is set

forth in our independent auditors' report on the internal control

structure dated March 15, 19X6, and should be read in conjunction

with this report.

Our consideration of the internal control structure would not

necessarily disclose all matters in the internal control structure

that might be material weaknesses under standards established by the

American Institute of Certified Public Accountants.

A material weakness is a condition in which the design or

operation of the specific internal control structure elements does

not reduce to a relatively low level the risk that errors or

irregularities in amounts that would be material in relation to the

financial statements being audited may occur and not be detected

within a timely period by employees in the normal course of

performing their assigned functions. However, we noted no matters

involving the internal control structure and its operation that we

consider to be a material weakness as defined above. [If a material

weakness was noted, refer the reader to the independent auditors'

report on internal control structure.]

7 CFR 1773.34 requires comments on specific aspects of the

internal control structure, compliance with specific RUS loan and

security instrument provisions, and other additional matters. We

have grouped our comments accordingly. In addition to obtaining

reasonable assurance about whether the financial statements are free

from material misstatements, at your request, we performed tests of

specific aspects of the internal control structure, of compliance

with specific RUS loan and security instrument provisions, and of

additional matters. The specific aspects of the internal control

structure, compliance with specific RUS loan and security instrument

provisions, and additional matters tested include, among other

things, the accounting procedures and records, materials control,

compliance with specific RUS loan and security instrument provisions

set forth in 7 CFR 1773.34 (e)(1), [for telephone borrowers, 7 CFR

1773.34 (e)(2)], related party transactions, and depreciation rates.

[For electric borrowers:] The additional matters tested also include

a schedule of deferred debits and credits, upon which we express an

opinion. In addition, our audit of the financial statements also

included the procedures specified in 7 CFR 1773.38-.45. Our

objective was not to provide an opinion on these specific aspects of

the internal control structure, compliance with specific RUS loan

and security instrument provisions, or additional matters, and

accordingly, we express no opinion thereon.

No reports (other than our independent auditors' report, our

independent auditors' compliance report, and our independent

auditors' report on the internal control structure, all dated March

15, 19X6) or summary of recommendations related to our audit have

been furnished to management.

Our comments on specific aspects of the internal control

structure, compliance with specific RUS loan and security instrument

provisions, and other additional matters as required by 7 CFR

1773.34 are presented below.

Comments on Certain Specific Aspects of the Internal Control Structure

We noted no matters regarding [Name of Borrower]'s internal

control structure and its operation that we consider to be a

material weakness as previously defined with respect to:

--The accounting procedures and records [list other comments];

--The process for accumulating and recording labor, material, and

overhead costs, and the distribution of these costs to construction,

retirement, and maintenance or other expense accounts [list other

comments]; and

--The materials control [list other comments].

Comments on Compliance With Specific RUS Loan and Security Instrument

Provisions

Management's responsibility for compliance with laws,

regulations, contracts, and grants is set forth in our independent

auditors' report on compliance dated March 15, 19X6, and should be

read in conjunction with this report. At your request, we have

performed the procedures enumerated below with respect to compliance

with certain provisions of laws, regulations, and contracts. The

procedures we performed are summarized as follows:

--Procedure performed with respect to the requirement to maintain

all funds in institutions whose accounts are insured by an Agency of

the Federal government:

1. Obtained information from financial institutions with which

[Name of Borrower] maintains funds that indicated that the

institutions are insured by an Agency of the Federal government.

--Procedures performed with respect to the requirement for a

borrower to obtain written approval of the mortgagee to enter into

any contract for the operation or maintenance of property, or for

the use of mortgaged property by others [see 1773.34 (e)(2)(i) for

additional telephone borrower requirements in accordance with 7 CFR

1773.34 (e)] for the year ended December 31, 19X5 of [Name of

Borrower]:

1. Obtained and read a borrower prepared schedule of new written

contracts entered into during the year for the operation or

maintenance of its property, or for the use of its property by

others as defined in Sec. 1773.34 (e)(1)(ii) [Sec. 1773.34 (e)(2)(i)

for telephone borrowers]

2. Reviewed Board of Director minutes to ascertain whether

board-approved written contracts are included in the borrower-

prepared schedule.

3. Noted the existence of written RUS [and other mortgagee]

approval of each contract listed by the borrower.

--Procedure performed with respect to the requirement to submit RUS

Form 7 or Form 12 [Form 479 for telephone borrowers] to the RUS:

1. Agreed amounts reported in Form 7 or Form 12 [Form 479 for

telephone borrowers] to [Name of Borrower]'s records.

The results of our tests indicate that, with respect to the

items tested, [Name of Borrower] complied, except as noted below, in

all material respects, with the specific RUS loan and security

instrument provisions referred to below. With respect to items not

tested, nothing came to our attention that caused us to believe that

[Name of Borrower] had not complied, in all material respects, with

those provisions. The specific provisions tested, as well as any

exceptions noted, include the requirements that:

--The borrower maintains all funds in institutions whose accounts

are insured by an Agency of the Federal government [list all

exceptions];

--The borrower has obtained written approval of the RUS [and other

mortgagees] to enter into any contract for the operation or

maintenance of property, or for the use of mortgaged property by

others as defined in Sec. 1773.34 (e)(1)(ii) [Sec. 1773.34 (e)(2)(i)

for telephone borrowers] [list all exceptions]; and

--The borrower has submitted its Form 7 or Form 12 [Form 479 for

telephone borrowers] to the RUS and the Form 7 or Form 12 [Form 479

for telephone borrowers], Financial and Statistical Report, as of

December 31, 19X5, represented by the borrower as having been

submitted to RUS is in agreement with the [Name of Borrower]'s

audited records in all material respects [list all exceptions].

Comments on Other Additional Matters

In connection with our audit of the financial statements of

[Name of Borrower],

[[Page 114]]

nothing came to our attention that caused us to believe that [Name

of Borrower] failed to comply with respect to:

--The reconciliation of subsidiary plant records to the controlling

general ledger plant accounts addressed at 7 CFR 1773.34 (c)(1)

[list all exceptions];

--The clearing of the construction accounts and the accrual of

depreciation on completed construction addressed at 7 CFR 1773.34

(c)(2) [list all exceptions];

--The retirement of plant addressed at 7 CFR 1773.34 (c)(3) and (4)

[list all exceptions];

--Sales of plant material, or scrap addressed at 7 CFR 1773.34

(c)(5) [list all exceptions];

--The disclosure of material related party transactions, in

accordance with Statement of Financial Accounting Standards No. 57,

Related Party Transactions, for the year ended December 31, 19X5, in

the financial statements referenced in the first paragraph of this

report addressed at 7 CFR 1773.34 (f) [list all exceptions]; and

--For electric borrowers only: depreciation rates addressed at 7 CFR

1773.34 (g) [list all exceptions].

For Electric Borrowers Only: Detailed Schedule of Deferred Debits and

Deferred Credits

Our audit was made for the purpose of forming an opinion on the

basic financial statements taken as a whole. The detailed schedule

of deferred debits and deferred credits required by 7 CFR 1773.34

(h) and provided below is presented for purposes of additional

analysis and is not a required part of the basic financial

statements. This information has been subjected to the auditing

procedures applied in our audit of the basic financial statements

and, in our opinion, is fairly stated in all material respects in

relation to the basic financial statements taken as a whole.

[The detailed schedule of deferred debits and deferred credits would

be included here. The total amount of deferred debits and deferred

credits as reported in the schedule must agree with the totals

reported on the Balance Sheet under the specific captions of

``Deferred Debits'' and ``Deferred Credits''. Those items that have

been approved, in writing, by RUS should be clearly indicated.]

This report is intended solely for the information and use of

the board of directors, management, and the RUS and supplemental

lenders. However, this report is a matter of public record and its

distribution is not limited.

Certified Public Accountants

Dated: December 19, 1995.

Jill Long Thompson,

Under Secretary, Rural Economic and Community Development.

[FR Doc. 96-93 Filed 1-2-96; 8:45 am]

BILLING CODE 3410-15-P