Policy on Audits of RUS Borrowers

Federal RegisterJul 17, 1998

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

regulations on audits of RUS borrowers. This final rule incorporates

changes to the audit regulations necessitated by the Single Audit Act

Amendments of 1996 and by Office of Management and Budget (OMB)

Circular A-133, Audits of States, Local Governments, and Non-Profit

Organizations effective for audits of fiscal years beginning after June

30, 1996. This rule also clarifies the peer review requirements in the

interim final rule for certified public accountants (CPA) performing

audits of RUS borrowers, adopts individual management letters for

electric and telecommunications borrowers, and revises the language of

the auditor's report and management letter to conform with technical

guidance provided by the American Institute of Certified Public

Accountants (AICPA).

EFFECTIVE DATE: July 17, 1998.

FOR FURTHER INFORMATION CONTACT: Mr. Richard C. Annan, Chief, Technical

Accounting and Auditing Staff, Program Accounting Services Division,

Rural Utilities Service, Stop 1523, room 2221, South Building, U.S.

Department of Agriculture, 1400 Independence Avenue, SW, Washington, DC

20250-1523, telephone number (202) 720-5227.

SUPPLEMENTARY INFORMATION:

Executive Order 12866

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

purposes of Executive Order 12866 and therefore has not been reviewed

by OMB.

Civil Justice Reform

This final rule has been reviewed under Executive Order 12998,

Civil Justice Reform. RUS has determined that this final rule meets the

applicable standards provided in section 3 of the Executive Order.

Regulatory Flexibility Act Certification

The Administrator of RUS has determined that this rule will not

have significant impact on a substantial number of small entities

defined in the Regulatory Flexibility Act (5 U.S.C. 601 et seq.), and

therefore, the Regulatory Flexibility Act does not apply to this rule.

Information Collection and Recordkeeping Requirements

The reporting and recordkeeping requirements contained in this

final rule will be submitted for approval to the Office of Management

and Budget (OMB) pursuant to the Paperwork Reduction Act of 1995 (44

U.S.C. Chapter 34, as amended) under control number 0572-0095. The

paperwork contained in this rule will not be effective until approved

by OMB.

Send questions or comments regarding this burden or any aspect of

this collection, including suggestions for reducing the burden to Mr.

F. Lamont Heppe, Jr., Director, Program Development and Regulatory

Analysis, Rural Utilities Service, Stop 1522, 1400 Independence Avenue

SW, Washington, DC 20250-1522.

National Environmental Policy Act Certification

The RUS Administrator has determined that this final 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 final rule is listed in the Catalog

of Federal Domestic Assistance Programs under numbers 10.850--Rural

Electrification Loans and Loan Guarantees, 10.851--Rural Telephone

Loans and Loan Guarantees, and 10.852--Rural Telephone Bank Loans. This

catalog is available on a subscription basis from the Superintendent of

Documents, the United States Government Printing Office, Washington, DC

20402.

Executive Order 12372

This final 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.

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.

Unfunded Mandates

This rule contains no Federal Mandates (under the regulatory

provision of Title II of the Unfunded Mandate Reform Act) for State,

local, and tribal governments or the private sector. Thus this rule is

not subject to the requirements of section 202 and 205 of the Unfunded

Mandate Reform Act.

Background

This final rule implements the changes required by the Single Audit

Act Amendments of 1996 (31 U.S.C. 7501 et seq.) and the revised OMB

Circular A-133, Audits of States, Local Governments, and Non-Profit

Organizations (31 U.S.C. 7501 et seq.). The purposes of the Single

Audit Act Amendments of 1996 were to promote sound financial management

with respect to Federal awards administered by non-Federal entities,

establish uniform requirements for audits of Federal awards, promote

the efficient and effective use of audit resources, and reduce the

burden on State and local governments, Indian tribes, and non-profit

organizations. OMB Circular A-128, Audits of States and Local

Governments, was merged with the former OMB Circular A-133, Audits of

Institutions of Higher Education and Other Non-Profit Institutions, to

form the revised OMB Circular A-133. The revised Circular implements

the Single Audit Act Amendments of 1996 and raises the expenditure

threshold. The Circular requires auditors to issue a report on

compliance and on internal control over financial reporting and a

report on compliance with requirements applicable to each major program

and internal control over compliance in accordance with OMB Circular A-

133.

Previously, separate reports were issued on compliance and internal

controls. With the issuance of the revised Circular A-133, the AICPA

developed illustrative report examples that merged the two reports into

one report on compliance and on internal control over financial

reporting.

On January 3, 1996, RUS published 61 FR 104 an interim final rule

with request for comments amending part 1773 to comply with the 1994

revision of Generally Accepted Government Auditing Standards (GAGAS)

and Statement on Auditing Standards (SAS) No. 74, Compliance Auditing

Considerations in Audits of Governmental Entities and Recipients of

Governmental Financial Assistance. The January 3, 1996, interim final

rule also amended RUS' peer review requirements to reflect the merger

of the Private Companies Practice Section of

[[Page 38721]]

the AICPA and the AICPA quality review program and to extend the time

period for peer reviews to 42 months. This final rule amends part 1773

in response to the comments filed on the interim final rule.

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 final rule clarifies that

section to require the CPA's statement to indicate whether the most

recent December 31 RUS Form 7, 12, or 479, agrees with the borrower's

``audited'' records if a borrower has a December 31 year end. For

borrowers with a year end other than December 31, the CPA must state

whether the information provided appears reasonable based upon the

audit procedures performed.

The management letter for electric borrowers was also modified to

conform with changes in Sec. 1717.612, which states that funds are cash

proceeds from loans made or guaranteed by RUS; Sec. 1717.618 to

redefine ``substantially all'' in management, operation, or maintenance

contracts covering the borrower's system as being 90 percent; and

Sec. 1717.609 to delete the provision requiring the CPA to determine

whether RUS approval was obtained for contracts between the borrower

and its manager.

The management letter for telecommunications borrowers was changed

to include additional requirements for compliance with RUS

telecommunications loan and security instrument provisions. The rule

clarifies that section to require the CPA to determine whether the

borrower is in compliance with the provisions pertaining to the funded

reserve requirements and net plant to secured debt ratio requirements

for RUS loans approved after June 10, 1991, and before October 7, 1997,

and the funded reserve requirement for RTB loans approved after June

10, 1991.

Both the management letters for electric and telecommunications

borrowers were modified to remove the negative assurance language

pertaining to items not tested in conformance with GAGAS.

The January 3, 1996, interim final rule also amended Sections

1773.5, Qualifications of CPA, and 1773.6, Audit Agreement, to include

changes necessitated by the 1994 revision of GAGAS. In that amendment,

the abbreviation OIG (Office of Inspector General, United States

Department of Agriculture) was inadvertently replaced by OGC (Office of

General Counsel) in paragraph 1773.5(c)(6)(iii) and paragraph

1773.6(a)(6). This final rule corrects that error.

The renaming of the Borrower Accounting Division (BAD) to the

Program Accounting Services Division (PASD) was not incorporated into

the interim final rule. This final rule serves to incorporate the name

change by deleting all references to BAD and replacing them with PASD.

This final rule also adds a definition of the term ``borrower'' to

mean all entities which receive financial assistance in the form of

loans, loan guarantees, or grants from RUS.

Comments

An interim final rule entitled ``Policy on Audits of RUS

Borrowers,'' published January 3, 1996, at 61 FR 104, invited

interested parties to submit comments on or before March 4, 1996.

Comments were received from three accounting firms, the Assistant

Administrator, Telecommunications Program, the Deputy Assistant

Administrator, Electric Program, and from OIG. The following paragraphs

address the topics that were discussed by the two commenters.

Comment. The revisions to Secs. 1773.33 (e)(1)(iii) and

1773.33(e)(2)(iii) require the CPA to state whether the information

submitted by a borrower 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 ``audited'' records.

Commenters expressed concern that this requirement did not properly

consider borrowers with fiscal year ends other than December 31. One

commenter asked if this requirement necessitated a calendar year audit

or alternate audit procedures to comply.

Response. The intent of this section was to require CPAs to state

whether the information submitted by a borrower to RUS in its most

recent December 31 RUS Form 7, 12, or 479 was in agreement with the

borrower's audited records if the borrower has a December 31 year end.

For borrowers with year ends other than December 31, the section was

intended to require the CPA to state whether the information provided

appeared reasonable based upon the procedures performed during the

audit. The final rule has been amended to clarify this requirement.

Comment. When 7 CFR part 1717 was revised by the electric program,

certain modifications affected part 1773. In Sec. 1717.608, RUS

approval of contracts between the borrower and its manager are no

longer required. Additionally, the electric program determined that the

quantification of ``substantial part'' was too low and raised it to 90

percent. Section 1717.612 defined funds as cash proceeds from loans

made or guaranteed by RUS. These changes should to be incorporated into

part 1773.

Response. This final rule has been amended to incorporate the

changes necessitated by revisions made to part 1717.

Comment. The revisions to Sec. 1773.33 (e)(2) excluded a

requirement for compliance with RUS loan and security instrument

provision for telecommunications borrowers. Under existing regulations,

if the loan maturity period selected by the borrower exceeds the

expected composite economic life of the facilities financed by a period

of more than three years, the loan is conditioned upon the borrower

electing to maintain a net plant to secured debt ratio of at least 1.2,

or a funded reserve in such amount that the balance of the reserve plus

the value of the facilities less depreciation be at least equal to the

remaining principal payments on the loan.

Response. It was not our intent to omit this requirement for

compliance with the RUS loan and security instrument from the

management letter. The final rule has been amended to include this

requirement.

Comment. One commenter noted that the management letter in part

1773 included a sentence that was in conflict with GAGAS. It was his

opinion that the sentence concerning negative assurance should be

eliminated from the management letter.

Response. We agree with the comment and we have deleted this

sentence from the management letter.

Comment. The revision to Sec. 1773.5 (c)(4)(C) set forth in the

January 3, 1996, interim final rule extended the timeframe for

submission of peer reviews to 42 months. Commenters expressed concern

that the 42 months timeframe did not meet the requirements of GAGAS.

Response. The intent of this section was to provide a 6-month

period for CPAs to submit their peer review reports to RUS. Upon

further review of the interim final rule, we have revised the language

in the final rule to require completion of peer reviews within 36

[[Page 38722]]

months of the issuance of the prior review in accordance with GAGAS.

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

1773 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. In part 1773 all references to items indicated in the left

column are revised to read as stated in the right column:

------------------------------------------------------------------------

Remove BAD--Borrower Accounting Add PASD--Program Accounting

Division Services Division

------------------------------------------------------------------------

Director, BAD.......................... Assistant Administrator,

Program Accounting and

Regulatory Analysis.

Telephone Program report on compliance. Telecommunications Program

report on compliance and on

internal controls over

financial reporting.

Report on internal controls............ Report on compliance and on

internal controls over

financial reporting.

Report on compliance and internal Report on compliance and on

controls. internal controls over

financial reporting.

------------------------------------------------------------------------

3. Section 1773.2 is amended by adding the definition for Borrower.

Sec. 1773.2 Definitions.

* * * * *

Borrower means an entity that has an outstanding RUS, RTB, or FFB

loan or loan guarantee, or that has received a grant for electric,

telecommunications, distance learning, or telemedicine purposes under

the act.

* * * * *

4. Section 1773.3 is amended by removing paragraph (d)(2),

redesignating paragraphs (d)(3) and (d)(4) to (d)(2) and (d)(3) and

revising paragraphs (d) introductory text, (d)(1) through (d)(3)

introductory text, (d)(3)(ii) and (e).

Sec. 1773.3 Annual audit.

* * * * *

(d) A borrower that qualifies as a unit of state or local

government or Indian tribe as such terms are defined in the Single

Audit Act of 1984 (31 U.S.C. 7501 et seq.), the Single Audit Act

Amendments of 1996 (31 U.S.C. 7505 et seq.) and OMB Circular A-133,

Audits of States, Local Governments, and Non-Profit Organizations (copy

available from the Executive Office of the President, Publication

Services, 725 17th St., NW., Suite 2200, Washington, DC 20502; 202-395-

7332), must comply with this part as follows:

(1) A borrower that expends $300,000 or more in a year in Federal

awards must have an audit performed and submit an auditor's report

meeting the requirements of the Single Audit Act of 1984 and the Single

Audit Act Amendments of 1996.

(2) A borrower that expends less than $300,000 in Federal awards

during the year must have an audit performed in accordance with the

requirements of this part.

(3) A borrower must notify RUS, in writing, within 30 days of the

as of audit date, of the total Federal awards expended during the year

and must state whether it will have an audit performed in accordance

with the Single Audit Act of 1984 and the Single Audit Act Amendments

of 1996, or this part.

* * * * *

(ii) If an audit is performed in accordance with the Single Audit

Act of 1984 and the Single Audit Act Amendments of 1996, an auditor's

report that meets the requirements of the Single Audit Act of 1984, and

the Single Audit Act Amendments of 1996, will be sufficient to satisfy

that borrower's obligations under this part.

(e) OMB Circular A-133, Audits of States, Local Governments, and

Non-Profit Organizations does not apply to audits of RUS electric and

telecommunications cooperatives and commercial telecommunications

borrowers.

* * * * *

5. Section 1773.5 is amended by revising paragraphs (c)

introductory text and (c)(6) (iii) to read as follows:

Sec. 1773.5 Qualifications of CPA.

* * * * *

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 36 months of the issuance of the previous peer review or at such

additional times as designated by the peer review executive committee.

* * * * *

(6) * * *

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

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

upon request.

* * * * *

6. Section 1773.6 is amended by revising paragraph (a)(6) to read

as follows:

Sec. 1773.6 Audit agreement.

(a) * * *

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

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

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

photocopying of all audit-related documents; and

* * * * *

7. Section 1773.30 is amended by removing paragraph (a)(3), and

redesignating paragraph (a)(4) to (a)(3) and revising paragraphs (a)(2)

and (a)(3) to read as follows:

Sec. 1773.30 General.

(a) * * *

(2) A report on compliance and on internal control over financial

reporting, examples of which are set forth in appendices A, exhibits 2

and 3 (Electric) and B, exhibits 4 and 5 (Telecommunications) of this

part 1773; and

(3) A management letter, an example of which is set forth in

appendix C of this part 1773.

* * * * *

8a. Section 1773.31 is amended by revising the last sentence to

read as follows:

[[Page 38723]]

Sec. 1773.31 Auditor's Report.

* * * This report must be signed by the CPA, cover all statements

presented, and refer to the separate report on compliance and on

internal control over financial reporting issued in conjunction with

the auditor's report.

8b. Section 1773.32 is revised to read as follows:

Sec. 1773.32 Report on compliance and on internal control over

financial reporting.

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

tests performed for compliance with applicable laws, regulations,

contracts, and grants, and on the borrower's internal control structure

and on 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 control risk;

conditions were found, the CPA must issue a report as illustrated in

appendix A, exhibit 2 (Electric), and appendix B, exhibit 4

(Telecommunications) of this part 1773;

(d) If material instances of noncompliance and reportable

conditions are identified, the CPA must issue a report as illustrated

in appendix A, exhibit 3 (Electric), and appendix B, exhibit 5

(Telecommunications) of this part 1773;

(e) Other nonmaterial instances of noncompliance should not be

disclosed in the report on compliance and on internal control over

financial reporting, but should be reported in a separate communication

to the board of directors, preferably in writing. All such

communications must be documented in the workpapers and submitted to

RUS in compliance with Sec. 1773.21.

(f) If the CPA has issued a separate letter detailing immaterial

instances of noncompliance, the report on compliance and on internal

control over financial reporting must be modified to include a

statement such as:

We noted certain immaterial instances of noncompliance that we

have reported to the management of (borrower's name) in a separate

letter dated (month, day, year).

(g) If the CPA has issued a separate letter to management to

communicate other matters involving the design and operation of the

internal control over financial reporting, the report on compliance and

on internal control over financial reporting must be modified to

include a statement such as:

However, we noted other matters involving the internal control

over financial reporting that we have reported to the management of

(borrower's name) in a separate letter dated (month, day, year).

(h) The report must contain the status of known but uncorrected

significant or material findings and recommendations from prior audits

that affect the current audit objective.

9. Section 1773.33 is removed.

10. Section 1773.34 is redesignated to Sec. 1773.33 and amended by

removing paragraph (e)(1)(ii)(E), revising paragraphs (e)(1)(i),

(e)(1)(ii) introductory text, (e)(1)(ii)(C) and (e)(1)(iii) and

(e)(2)(iii) and adding (e)(2)(iv) to read as follows:

Sec. 1773.33 Management letter.

* * * * *

(e) * * *

(1) * * *

(i) The requirement for funds to be deposited in banks or other

depositories designated in the loan documents or approved by RUS. For

purposes of this part, funds shall be defined as cash proceeds from

loans made or guaranteed by RUS in accordance with 7 CFR 1717.612.

(ii) The requirement for a borrower to obtain written approval of

mortgagees to enter into any contract for the management, operation, or

maintenance of the borrower's system if the contract covers all or

substantially all (90 percent) of the electric system. For purposes of

this part, the following contracts shall be deemed as requiring RUS

approval:

* * * * *

contracted to have another borrower or other entity operate and/or

maintain all or substantially all (90 percent) of the physical plant

facilities of the plant.

* * * * *

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

mortgagees annual financial and statistical reports on the borrower's

financial condition and operations. For borrowers with a December 31

year end, 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. For borrowers with a year end other than December 31, the CPA

must state whether the information appears reasonable based upon the

audit procedures performed. 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 financial and statistical reports on the borrower's

financial condition and operations. For borrowers with a December 31

year end, 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. For

borrowers with a year end other than December 31, the CPA must state

whether the information appears reasonable based upon the audit

procedures performed. If the borrower represents that an amended report

has been filed as of December 31, the comments must relate to the

amended report.

(iv) The requirement that a borrower maintain either a net plant to

secured debt ratio or a funded reserve.

(A) For loans approved after June 10, 1991, and before October 7,

1997, if a borrower selected a loan maturity period in excess of the

expected economic life of the facilities financed, the borrower must

maintain a secured debt ratio of at least 1.2 or a funded reserve. If,

during the audit period, the borrower has been issued refunding notes

that match the remaining composite economic life of the facilities thus

eliminating the requirement, the auditor should so state.

(1) If the net plant to secured debt ratio option was selected,

this ratio must be achieved one year following the first advance of

funds.

(2) If the funded reserve option was selected, the reserve must be

of such amount that the balance of the reserve plus the value of the

facilities less depreciation be at least equal to the remaining

principal payments on the loan. Funding of the reserve must begin

within one year of approval of release of funds and must continue

regularly over the composite economic life of the facilities financed.

(B) For loans approved after October 7, 1997, if a borrower

selected a loan maturity period in excess of the expected economic life

of the facilities financed, the borrower must maintain a funded reserve

in such amount that the balance of the reserve plus the value of the

facilities less depreciation be at least equal to the remaining

principal

[[Page 38724]]

payments on the loan. Funding of the reserve must begin within one year

of approval of release of funds and must continue regularly over the

composite economic life of the facilities financed. If, during the

audit period, the borrower has been issued refunding notes that match

the remaining composite economic life of the facilities thus

eliminating the requirement for maintaining the funded reserve

requirement, the auditor should so state.

* * * * *

11. Reserve Sec. 1773.34.

12. Appendix A to Part 1773 is amended by revising exhibits 1, 2,

and 3, removing exhibits 4, 5, and 6, and redesignating exhibit 7 as

exhibit 4 and revising it 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, 1998 and 1997, 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 the standards applicable to financial audits

contained in Government Auditing Standards, issued by the

Comptroller General of the United States. Those standards required

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 audit

provides 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, 1998 and 1997,

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, 1999, on our consideration of Center

County Electric Cooperative's internal control over financial

reporting and our tests of its compliance with certain provisions of

laws, regulations, contracts, and grants.

Certified Public Accountants

March 2, 1999

Exhibit 2--Sample Report on Compliance and on Internal Control

over Financial Reporting, the CPA found No Reportable Instances of

Noncompliance and No Material Weaknesses (No Reportable Conditions

Identified).

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, 1998

and 1997, and have issued our report thereon dated March 2, 1999. We

conducted our audit in accordance with generally accepted auditing

standards and the standards applicable to financial audits contained

in Government Auditing Standards, issued by the Comptroller General

of the United States.

Compliance

As part of obtaining reasonable assurance about whether Center

County Electric Cooperative's financial statements are free of

material misstatement, we performed tests of its compliance with

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

noncompliance with which could have a direct and material effect on

the determination of financial statement amounts. However, providing

an opinion on compliance with those provisions was not an objective

of our audit, and accordingly, we do not express such an opinion.

The results of our tests disclosed no instances of noncompliance

that are required to be reported under Government Auditing

Standards. [If the CPA has issued a separate letter to the

management detailing immaterial instances of noncompliance, modify

this paragraph to include a statement such as the following:

However, we noted certain immaterial instances of noncompliance

which we have reported to the management of Center County Electric

Cooperative in a separate letter dated March 2, 1999.]

Internal Control Over Financial Reporting

In planning and performing our audit, we considered Center

County Electric Cooperative's internal control over financial

reporting in order to determine our auditing procedures for the

purpose of expressing our opinion on the financial statements and

not to provide assurance on the internal control over financial

reporting. Our consideration of the internal control over financial

reporting would not necessarily disclose all matters in the internal

control over financial reporting that might be material weaknesses.

A material weakness is a condition in which the design or operation

of one or more of the internal control components does not reduce to

a relatively low level the risk that misstatements 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 over

financial reporting and its operation that we consider to be

material weaknesses. [If the CPA has issued a separate letter to

management to communicate other matters involving the design and

operation of the internal control over financial reporting, modify

this paragraph to include a statement such as the following:

However, we noted other matters involving the internal control over

financial reporting which we have reported to the management of

Center County Electric Cooperative in a separate letter dated March

2, 1999.]

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, 1999

Exhibit 3--Sample Report on Compliance and on Internal Control

over Financial Reporting, the CPA found Reportable Instances of

noncompliance and Reportable Conditions Identified.