This is the accessible text file for GAO report number GAO-06-768R 
entitled 'Financial Audit: Guidance for Auditing Federal Employees and 
Veteran Benefit Payable Actuarial Estimates' which was released on July 
5, 2006. 

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June 29, 2006: 

Inspectors General: 

Subject: Financial Audit: Guidance for Auditing Federal Employee and 
Veteran Benefit Payable Actuarial Estimates: 

In our role as principal auditor of the consolidated financial 
statements of the U.S. government (CFS), we plan to use the work of the 
inspectors general and contracted independent public accountants who 
audit the agency-level financial statements. The development of the 
joint PCIE/GAO Financial Audit Manual (FAM) has provided a common 
framework and methodology for federal financial statement auditing. 
Adherence to the FAM will enable us to readily review the work of other 
auditors as a basis for using that work under auditing standards. We 
want to all be on the same page so that we are in the position to use 
your work. 

Certain CFS line items that will be subject to our concurrent review 
because of their significance, such as the federal employee and veteran 
benefits payable line item, involve federal agencies' significant 
actuarial estimations. Statement on Auditing Standards (SAS) No. 57, 
Auditing Accounting Estimates applies to such estimations. In addition, 
Statement of Federal Financial Accounting Standard (SFFAS) No. 5 
requires that federal agencies disclose specific information in their 
financial statements for pensions, other retirement benefits, and other 
postemployment benefits. Additional related audit guidance was provided 
in November 2004 when the American Institute of Certified Public 
Accountants (AICPA) issued its Statement of Position (SOP) 04-1, 
Auditing the Statement of Social Insurance,[Footnote 1] effective for 
periods beginning after September 30, 2005. This audit guidance 
discusses the auditor's responsibility under SAS No. 57 and includes 
specific illustrative control and audit procedures that are applicable 
to auditing actuarial estimates to achieve SAS No. 57 objectives. 
Actuarial estimates for both social security and the federal employee 
and veteran benefit payable line item are developed by methods which 
calculate for the projection period covered by an actuarial valuation, 
the excess of (a) the present value of projected benefits of the group 
included in an actuarial valuation over (b) the actuarial value of 
program-related assets. Although the SOP 04-1 was specifically 
developed for use in auditing federal agencies' statements of social 
insurance, we consider the internal control and audit procedures 
discussed in SOP 04-1 to be appropriate for auditing the significant 
actuarial estimates in the federal employee and veteran benefit payable 
line item as well. Beginning in fiscal year 2006, we plan to use SOP 04-
1 as criteria in determining the extent to which we can use audit work 
performed by agency auditors in this area. To the extent that the 
concepts and objectives of SOP 04-1 are found to be appropriate to 
other audit areas in the future, we will consider its use in such 
areas. 

The purpose of this letter and the enclosure is to alert you to (1) our 
plan to use SOP 04-1 audit guidance in our review of agency auditors' 
work on federal employee and veteran benefits payable estimates that 
are significant to the CFS and (2) observations made during our review 
of selected agency auditors' work regarding such actuarial estimations 
as outlined in enclosure I and what additional work would need to be 
done to be consistent with SOP 04-1 audit guidance. We look forward to 
continuing to work with the federal audit community as we collectively 
strive to ensure the highest quality audits of federal financial 
statements. 

We are sending copies of this letter to the Controller of the Office of 
Management and Budget, the Fiscal Assistant Secretary of the Department 
of the Treasury (Treasury), and the Chief Financial Officers of the 35 
federal executive agencies required by OMB to verify and submit a 
closing package to Treasury.[Footnote 2] If you have any questions 
regarding the information in this letter, please contact me at (202) 
512-2600, or Gary Engel, Director, Financial Management and Assurance 
at (202) 512-3406 or engelg@gao.gov. Major contributors to this letter 
are Linda P. Garrison, Assistant Director, and Vera M. Seekins, Auditor-
in-charge. 

Sincerely yours, 

Signed by: 

Jeffrey C. Steinhoff: 
Managing Director: 
Financial Management and Assurance: 

Enclosure: 

ADDRESSEES: 

The Honorable Donald A. Gambatesa: 
Inspector General: 
Agency for International Development: 

The Honorable Phyllis Fong: 
Inspector General: 
Department of Agriculture: 

The Honorable Johnnie E. Frazier: 
Inspector General: 
Department of Commerce: 

Mr. Thomas Gimble: 
Acting Inspector General: 
Department of Defense: 

The Honorable John P. Higgins, Jr. 
Inspector General: 
Department of Education: 

The Honorable Gregory H. Friedman: 
Inspector General: 
Department of Energy: 

Mr. Bill Roderick: 
Acting Inspector General: 
Environmental Protection Agency: 

Mr. Carl A. Clinefelter: 
Inspector General: 
Farm Credit Administration: 

Mr. Kent R. Nilsson: 
Acting Inspector General: 
Federal Communications Commission: 

Ms. Patricia Black: 
Acting Inspector General: 
Federal Deposit Insurance Corporation: 

The Honorable Brian D. Miller: 
Inspector General: 
General Services Administration: 

The Honorable Daniel Levinson: 
Inspector General: 
Department of Health and Human Services: 

The Honorable Richard L. Skinner: 
Inspector General: 
Department of Homeland Security: 

The Honorable Kenneth M. Donohue: 
Inspector General: 
Department of Housing and Urban Development: 

The Honorable Earl E. Devaney: 
Inspector General: 
Department of the Interior: 

The Honorable Glenn Fine: 
Inspector General: 
Department of Justice: 

The Honorable Gordon S. Heddell: 
Inspector General: 
Department of Labor: 

The Honorable Robert W. Cobb: 
Inspector General: 
National Aeronautics and Space Administration: 

Mr. William DeSarno: 
Inspector General: 
National Credit Union Administration: 

Ms. Christine C. Boesz: 
Inspector General: 
National Science Foundation: 

The Honorable Hubert T. Bell: 
Inspector General: 
Nuclear Regulatory Commission: 

The Honorable Patrick E. McFarland: 
Inspector General: 
Office of Personnel Management: 

Mr. Robert Emmons: 
Inspector General: 
Pension Benefit Guaranty Corporation: 

The Honorable Martin J. Dickman: 
Inspector General: 
Railroad Retirement Board: 

Mr. Walter Stachnik: 
Inspector General: 
Securities and Exchange Commission: 

The Honorable Eric M. Thorson: 
Inspector General: 
Small Business Administration: 

Ms. A. Sprightley Ryan: 
Acting Inspector General: 
Smithsonian Institution: 

The Honorable Patrick P. O'Carroll: 
Inspector General: 
Social Security Administration: 

The Honorable Howard J. Krongard: 
Inspector General: 
Department of State: 

The Honorable Richard Moore: 
Inspector General: 
Tennessee Valley Authority: 

Mr. Todd J. Zinser: 
Acting Inspector General: 
Department of Transportation: 

The Honorable Harold Damelin: 
Inspector General: 
Department of the Treasury: 

The Honorable Dave Williams: 
Inspector General: 
U.S. Postal Service: 

The Honorable George Opfer: 
Inspector General: 
Department of Veterans Affairs: 

Enclosure Enclosure 1: 

Certain Agency Audit Procedures Over Actuarial Estimations Would Need 
To Be Expanded In Future Audits To Be Consistent With SOP 04-1 
Guidance: 

We reviewed the nature and extent of fiscal year 2004 audit work 
performed on the $4 trillion consolidated financial statements of the 
U.S. government's (CFS) federal employee and veteran benefits payable 
(FEVBP) line item by independent public accountants contracted by 
agency inspectors general. For this effort, we compared the fiscal year 
2004 audit documentation related to actuarial estimations for six 
selected postemployment benefit program liabilities to Statement of 
Position (SOP) 04-1 audit guidance. In general, we concluded that 
future years' audit work would need to be expanded to be consistent 
with SOP 04-1 audit guidance. 

Specifically, for each of the six selected benefit program liabilities, 
we noted that audit documentation for the following areas were not 
consistent with SOP 04-1 §19 guidance: 

* specific audit procedures performed with the assistance of an 
independent actuary, 

* the relationship between the procedures performed with the assistance 
of an independent actuary and the auditor's assessments of audit risk 
and materiality, and: 

* any other significant matters related to the objectives and scope of 
the independent actuary's work, including any limitations on the 
independent actuary's procedures. 

Without a clear understanding of the independent actuary's procedures 
and the level of assurance provided by the independent actuary's work, 
the auditor may inappropriately use and rely on the independent 
actuary's report. For example, for one of the selected benefit 
programs, agency audit officials informed us that they were unaware of 
any written program detailing the work planned by the independent 
actuary. The auditor advised us that they had relied on their 
independent actuary's professional judgment to design and perform 
appropriate procedures. In addition, although the agency actuary for 
the same agency used the concept of materiality in developing the 
estimate, the auditor was not aware of what the agency actuary's 
materiality level was and had not discussed the audit materiality with 
the agency actuary. 

In addition, SOP 04-1 illustrative procedures refine Statement on 
Auditing Standards (SAS) No. 57 audit guidance. As stated in SAS No. 
57, the auditor should obtain an understanding of how management 
developed the estimate and use one or a combination of the following 
approaches to evaluate the reasonableness of that estimate: 

* review and test the process used by management to develop the 
estimates, 

* develop an independent expectation of the estimate to corroborate the 
reasonableness of management's estimate, and: 

* review subsequent events or transactions occurring prior to the 
completion of fieldwork. 

SOP 04-1 provides more specific guidance and illustrative procedures to 
fulfill these SAS No. 57 requirements. 

In accordance with SOP 04-1 §9, if controls over the estimation process 
are effective, the most practicable and efficient approach to 
fulfilling the auditor's responsibility under SAS No. 57 may be to 
review and test the estimation process used by management. SOP 04-1 §6 
describes management's process as ordinarily consisting of the 
following activities: 

1. identifying the relevant factors that affect the estimates; 

2. developing assumptions that represent management's best estimate of 
circumstances and events with respect to the relevant factors; 

3. accumulating relevant, sufficient, and reliable data on which to 
base the estimates; 

4. determining the estimated amounts based on assumptions and other 
relevant factors; and: 

5. determining that the estimates are presented in conformity with GAAP 
and that disclosure is adequate. 

SOP 04-1§9 specifies that if the auditor finds that controls over the 
estimation process are ineffective, the auditor should develop an 
independent expectation of the estimate, or portions of the estimate, 
to corroborate management's estimate, or obtain competent evidence from 
outside the audited agency's process that would be sufficient to 
support the financial statement assertions. 

The five activities in management's estimation process relate to the 
elements in figure 1 of SOP 04-1 that depicts the process of developing 
social insurance estimates. We consider these same five elements to be 
appropriate for auditing other actuarial liability estimates. As such, 
during our review of fiscal year 2004 audit documentation, we looked 
for evidence that auditors understood the agencies' process for 
developing and evaluating actuarial estimates, internal control 
procedures, and test procedures over these five actuarial estimate 
elements using the illustrative controls and audit procedures. For the 
six selected benefit programs, audit documentation made available for 
our review did not include evidence that the auditors performed certain 
procedures illustrated in the appendix to SOP 04-1 or equivalent 
procedures. The following table shows the illustrative procedures by 
liability element that we did not see documented in our review of 
fiscal year 2004 audit documentation for the six selected programs. 

Table 1: Number of Selected Programs Without Documented Procedures 
Included in the SOP 04-1's Illustrative Procedures: 

Liability element; Factors; 
SOP 04-1 Illustrative procedure not documented: Understand management's 
process for monitoring the environment to determine the effect that 
changes in the environment, such as legislation or health, might have 
on the variables selected for use in the actuarial estimate; 
Affected number of selected programs: 5. 

Liability element; Factors; 
SOP 04-1 Illustrative procedure not documented: Understand management's 
procedures to prevent and detect the inadvertent omission of factors 
that should be considered in developing the actuarial estimate; 
Affected number of selected programs: 3. 

Liability element; Assumptions; 
SOP 04-1 Illustrative procedure not documented: Understand the source 
of assumptions and how management considers and determines the effect 
that variation in the underlying assumptions will have on the 
estimates; 
Affected number of selected programs: 3. 

Liability element; Assumptions; 
SOP 04-1 Illustrative procedure not documented: Understand how the 
agency generates, evaluates, and reviews assumptions; 
Affected number of selected programs: 3. 

Liability element; Assumptions; 
SOP 04-1 Illustrative procedure not documented: Understand how the 
agency compares assumptions made in the current period with those of 
prior periods and explains or reconciles any differences; 
Affected number of selected programs: 4. 

Liability element; Assumptions; 
SOP 04-1 Illustrative procedure not documented: Consider the aggregate 
effect of individually insignificant assumptions; 
Affected number of selected programs: 4. 

Liability element; Model; 
SOP 04-1 Illustrative procedure not documented: Understand how 
management and other knowledgeable personnel design or select the model 
and how they document that model and the programs used to determine the 
actuarial estimate; 
Affected number of selected programs: 3. 

Liability element; Model; 
SOP 04-1 Illustrative procedure not documented: Understand procedures 
for assigning responsibility to individuals in a manner that ensures 
that no single individual has the authority to read, add, change, or 
delete information without an independent review of that activity; 
Affected number of selected programs: 3. 

Liability element; Model; 
SOP 04-1 Illustrative procedure not documented: Understand procedures 
for designating responsibility for significant information resources 
within the agency and establishing and maintaining security over such 
resources; 
Affected number of selected programs: 3. 

Liability element; Model; 
SOP 04-1 Illustrative procedure not documented: Review documentation 
that describes the instructions, rules, or procedures used by the model 
to calculate estimates; 
Affected number of selected programs: 4. 

Liability element; Model; 
SOP 04-1 Illustrative procedure not documented: Reperform calculations 
used in the model to translate the assumptions, data, and factors into 
the estimate; 
Affected number of selected programs: 5. 

Liability element; Model; 
SOP 04-1 Illustrative procedure not documented: Review management's 
documentation of its sensitivity analysis and consider whether the 
results were consistent with the auditor's expectations; 
Affected number of selected programs: 4. 

Liability element; Estimate; 
SOP 04-1 Illustrative procedure not documented: Inquire to determine 
who has final authority for reviewing and approving estimates; 
Affected number of selected programs: 4. 

Liability element; Estimate; 
SOP 04-1 Illustrative procedure not documented: Understand controls 
related to review of estimates and the related supporting documentation;
Affected number of selected programs: 6. 

Liability element; Estimate; 
SOP 04-1 Illustrative procedure not documented: Understand controls 
related to the supervision of individuals who develop estimates; 
Affected number of selected programs: 6. 

Liability element; Estimate; 
SOP 04-1 Illustrative procedure not documented: Compare the estimated 
future expenditures predicted by the actuarial model to actual 
expenditures for the previous fiscal year; 
Affected number of selected programs: 5. 

Liability element; Estimate; 
SOP 04-1 Illustrative procedure not documented: Evaluate the 
reasonableness of the time period covered by the actuarial liability 
estimate;
Affected number of selected programs: 4. 

Liability element; Estimate; 
SOP 04-1 Illustrative procedure not documented: Determine whether the 
information in the actuarial liability estimate, including related 
disclosures, is supported by sufficient competent evidential matter; 
Affected number of selected programs: 3. 

Source: GAO. 

[End of table] 

(198454): 

FOOTNOTES 

[1] This document is available from the AICPA at https:// 
www.cpa2biz.com (last visited May 22, 2006). Once at this site, search 
on SOP 04-1. 

[2] The closing package is a methodology developed by Treasury to 
directly link information from federal agencies' audited financial 
statements to amounts reported in the CFS. A complete closing package 
consists of the special purpose audit opinion, the management 
representation letter for the closing package, audit trail report 
(reclassification journal voucher report), closing package financial 
statement report, trading partner summary report, notes reports, and 
other data reports. 

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