Los Alamos National Lab Observations from Audit Procedures June 30, 2005
Table of Contents Page Your Needs and Expectations 3 Background 4 Risk Assessment 5 Audit Strategy 7 Details of Work Performed 9 Other Matters 26 Service Team 27 This document is intended for us by the University of California Regents Committee on Audit and the management of the University of California and has been completed in the context of our audit of the University of California taken as a whole. The matters raised in this report are only those which have come to our attention that we believe need to be brought to you. They are not a complete listing of every potential matter arising from our procedures and we cannot be responsible for reporting all risks in your business nor internal control weaknesses. This report should not be quoted in whole or in part without our prior written consent. No responsibility for any third party is accepted as the report has not been prepared for, and is not intended for, any other purpose. 2
Your Needs and Expectations Based on our discussions with the University of California Regents Committee on Audit (the Audit Committee) and with input from the management of the University of California (UC), we have set forth these needs and expectations and our actions to address them. We understand that your needs and expectations are as follows: Need/Expectation Provide the Audit Committee and UC management an assessment of the Lab s financial accounting and reporting. Prior to issuance to UC management and the Audit Committee, results of the assessments are to be provided to the Lab s financial management. Develop management comments with departmental responses for submission to the Audit Committee. Keep management apprised of audit results and issues on a timely basis. Provide communication of our expectations to Lab personnel and UC management. On this engagement we completed analytics, internal controls review and substantive audit testing and ensured that a consistent level of quality and rigor was applied. Recommendations for internal control improvements will be communicated to the Lab s financial management for comment and a final report will be prepared and delivered to the Audit Committee. Ongoing. PwC Actions We will prepare a detailed listing of items required to be provided PBC list. We will monitor the listing and notify management of any issues that arise. As discussed at the March Audit Committee meeting, since certain of the Lab s financial data is restricted, and since our procedures were limited to the June 30, 2005 period, we did not perform a complete audit of the Lab on a stand-alone basis. Had we conducted such an audit, additional matters may have arisen to report to you. 3
Background This year, we conducted expanded audit procedures at all three UC operated national laboratories. We noted that management has undertaken considerable effort to bring reconciliations current and have been successful in making marked improvements in the control environment in comparison to prior years. As the Enterprise Project ( EP ) Oracle Business System progresses, a critical needs assessment should be performed to evaluate all employees capabilities, backgrounds and the overall organizational structure within Finance to ensure optimal efficiency and effectiveness. The overall needs assessment performed will ensure the maximum benefit of the software implementation is received. While this report raises control and documentation issues, these should be viewed as recommendations for continuous improvement in the control environment. 4
Risk Assessment Our audit approach of the University of California is risk-based. In connection with the performance of that audit, we performed certain expanded procedures, as detailed herein, to provide the Audit Committee and UC management with additional information on the Lab processes and identify areas for improvement. Assessment and identification of risk is performed continuously throughout the process. We focused on the risks that have a potential impact on financial reporting and the controls that mitigate those risks. The table below outlines our risk assessments and our responses to them. Risk Assessment A preliminary assessment of the significant balance sheet accounts to identify significant variances and unusual items within the accounts as of June 30, 2005. PwC Actions By performing various tests, as well as interviews with LANL s management, we assessed and documented our understanding of LANL s control environment during the year end phase of this year s testing and utilized that assessment as a preliminary basis for our procedures. 5
Risk Assessment (continued) Risk Assessment Obtain an understanding of the overall control environment including understanding of the key accounting cycles. Review all known audit and assessment reports issued by internal and external parties during 2005. We will also review the audit matrix which provides a summary and status of all significant audit findings covering almost three years and includes in excess of 300 findings. The key accounting cycles addressed as part of this control risk assessment were: PwC Actions We met with LANL management to obtain an overall understanding of the Lab s control environment. We documented the process and control procedures as they relate to each of the accounting cycles noted in the grid to the left. In addition, we performed tests of monitoring controls for each of the accounting cycles. Treasury - cash Fixed assets Purchasing and payables Payroll Receivables and revenue Our assessment was complemented by substantive testing of the above areas. Financial statement assertions (Completeness, Accuracy, Validity, Existence) of the significant financial statement accounts are addressed. We performed substantive detail testing of significant balance sheet and expense accounts. The details and the results of the work performed are documented herein. Fraud review procedures and internal audit reports review. We obtained and reviewed all internal audit, GAO, IG and other reports issued in fiscal 2005. In addition, we performed SAS No. 99 inquiries of 7 members of LANL management and internal audit of their awareness of any known instances of fraud. 6
Audit Strategy Audit Strategy Cash and cash equivalents Accounts receivable Prepaid expenses Inventory Buildings, equipment and accumulated depreciation Audit Procedure Assess and test monitoring controls over the cash cycle Review and test bank account reconciliations Perform analytical reviews Assess and test monitoring controls over the receivables cycle Perform analytical reviews Review accounts receivable reconciliations Perform subsequent receipts testing Evaluate the allowance for doubtful accounts Review prepaid account reconciliations Perform analytical reviews Perform testing to support account balances Review inventory reconciliations Perform analytical reviews Compile a grid documenting our understanding of inventory methods used, frequency and responsibility for physical inventories, book to physical adjustments and inventory pricing methods utilized Review account reconciliations Perform disposal and addition testing Perform analytical reviews Review repair and maintenance accounts 7
Audit Strategy (continued) Audit Strategy Accounts payable, accrued liabilities and funds held for others Audit Procedure Assess and test monitoring controls over the purchasing and payables cycle Review account reconciliations Perform search for unrecorded liabilities Perform substantive testing Perform analytical reviews Pension and post-retirement medical Review account reconciliations Perform analytical reviews Deferred revenue Commitments and contingencies Payroll Assess and test monitoring controls over the revenue cycle Review account reconciliations Perform analytical reviews Perform substantive testing Discuss any commitments/contingencies with management Consider results of other audit tests for additional commitments/contingencies Assess and test monitoring controls over the payroll cycle Performed substantive testing 8
Cash Assessed and tested monitoring controls over the cash cycle Obtained an updated internal control memo over the cash cycle Assessed and tested monitoring controls over the cash cycle We tested the 5 bank account reconciliations to ensure they were prepared and reviewed in a timely manner Reviewed and tested bank account reconciliations Obtained information regarding the Lab s main bank accounts 1) Wells Fargo Master, Accounts Payable, Payroll, Travel and Affiliates Tested bank reconciliations A) Agreed the adjusted bank balance to the book balance B) Reviewed material reconciling items (outstanding checks were tested through PwC sampling and testing procedures) Performed analytical reviews Obtained an understanding and documented the composition and description of significant accounts Obtained explanations and assessed reasonableness of significant and material variances 9
Accounts Receivable Assessed and tested monitoring controls over the receivables cycle Obtained an updated internal control memo over the receivables cycle Assessed and tested monitoring controls over the receivables cycle We obtained a sample of 3 monthly account reconciliations for 2 general ledger accounts and performed a review to ensure the reconciliations are prepared and reviewed in a timely manner before the next month s closing. Performed analytical reviews Obtained an understanding and documented the composition and description of significant accounts Obtained explanations and assessed reasonableness of significant and material variances Performed subsequent receipts testing Of the $48 million in the outstanding Other Federal Agency accounts and the DOE Inter Office accounts receivables at June 30, 2005, we reviewed subsequent cash receipts support for $26 million or 55% of the balance as of September 15, 2005. 10
Accounts Receivable (continued) Evaluated the allowance for doubtful accounts Composition of accounts receivable Obtained an understanding of the process management performs in order to write off an accounts receivable balance 11
Prepaid Expenses Reviewed account reconciliations Detail tested the prepaid balance The largest prepaid accounts are: Travel advances Los Alamos Fire, Security and Maintenance Pension Plan Asset: UC employees pension plan Performed analytical reviews Obtained an understanding and documented the composition and description of the accounts Obtained explanations and assessed reasonableness of significant and material variances 12
Inventory Reviewed inventory reconciliations Reviewed the physical inventory/account reconciliations/summary of the details for Current Use Stores, Nuclear, Other Special and Weapons Inventory to the general ledger Performed analytical reviews Obtained an understanding and documented the composition and description of the accounts Obtained explanations and assessed reasonableness of significant and material variances Approximately 98% of LANL s inventory is comprised of Nuclear Materials. PwC does not have the requisite security clearance to conduct a physical inventory of this balance and accordingly compiled the following grid to document our understanding of inventory methods used, frequency and responsibility for physical inventories, book to physical adjustments and inventory pricing methods utilized. 13
Inventory (continued) *June & July, 2005 TA-55, TA-18 & CMR; CAT IV's were scheduled in June & Dec. 2005. MC&A is required to conduct a certain number and type of inventories, as dictated by DOE Order 747.1-1B ** There are adjustments made, but the driver in making the adjustments is not the physical inventory. When a physical inventory is conducted measurements are performed during the inventory and adjustments are identified. Normal adjustments are speeded up by the fact that measurements are performed as part of an inventory. The physical inventory is not intended to be a driver in changing book values. 14
Building and Equipment Assessed and tested monitoring controls over the fixed asset cycle Obtained an updated internal control memo over the fixed asset cycle Assessed and tested monitoring controls over the fixed asset cycle Reviewed account reconciliations Reviewed the reconciliations for all significant accounts Performed testing of additions Reviewed disposal activity Performed analytical reviews Obtained an understanding and documented the composition and description of significant accounts Obtained explanations and assessed reasonableness of significant and material variances 15
Building and Equipment (continued) Observation Underlying support for various plant projects is not consistently forwarded by the Project Leaders to CFO-1 in a timely manner. A delay in sending such documentation could cause financial results to be inaccurately reported. Recommendation Review the process by which supporting documentation for fixed asset projects is provided to CFO-1 to ascertain the timeliness and completeness of the transfer of such information. Management Response The process by which supporting documentation for fixed assets is provided to CFO-1 is currently being reviewed by CFO-3. The review and corresponding process changes will be implemented by March 31, 2006. It is noted that since the review began in June 2005, the timeliness and completeness of the transfer of fixed asset projects to CFO-1 in July and August 2005 has improved. 16
Accounts Payable Assessed and tested monitoring controls over the purchases and payables cycle Obtained an updated internal control memo over purchases and payables cycle Assessed and tested monitoring controls over the purchases and payables cycle Reviewed the reconciliations for all significant accounts Performed search for unrecorded liabilities Performed analytical reviews Obtained an understanding and documented the composition and description of significant accounts Obtained explanations and assessed reasonableness of significant and material variances 17
Accounts Payable (continued) Observation LANL released the Oracle Accounts Payable Module in October 2004 and has recently implemented procedures so that all general ledger account reconciliations are assigned and centrally reported through General Accounting. We noted the accounts payable aging report detail does not currently reconcile to the accounts payable general ledger. Through our review and discussion with management, it was noted the AP aging report detail includes all invoices, including those invoices which have yet to be approved, and therefore, are unable to ensure accounts payable balances represent all amounts owed by the entity arising from the purchase of goods and services. Recommendation Management should ensure the sub-ledger system for accounts payable has the functionality to track open invoices in an effective manner to allow a proper management of accounts payable transactions and that reconciliations performed receive adequate review. Management Response LANL CFO Management agrees with the recommendation and is currently working with Oracle consultants to get the Accounts Payable Trial balance, the Accounts Payable Aging Schedule and the General Ledger to agree to each other for much of the past fiscal year. This issue is a high priority and one that the Enterprise Project SWAT Team is working on. The issue has been minimized to an immaterial dollar amount but LANL CFO Management understands the importance of the reports balancing to the General ledger. Estimate Completion Date: 12/31/2005. 18
Accrued Liabilities Performed analytical reviews Obtained an understanding and documented the composition and description of significant accounts Obtained explanations and assessed reasonableness of significant and material variances Reviewed account reconciliations Reviewed the reconciliations for all significant accounts Performed substantive testing of accrued liabilities Payroll and severance Vacation 19
Accrued Liabilities (continued) Accrual Account Maintenance Observation We noted several accrued liability balances that remained unchanged from June 2004 to June 2005. Per discussion with management, these balances have remained the same since at least 2002 and some have not changed or otherwise been used since 2000. We understand that management has assigned responsibility for the review and reconciliation of every general ledger account to a specific accountant. It is also our understanding that every general ledger account is to be reviewed and reconciled and that oversight of this function has been equally designated among the accounting managers with the expectation that management review, on a scope basis, the accountants work. Based on our review and discussions with management the process of reconciling the general ledger accounts have been implemented but the review thereof by management has not been fully implemented. Recommendations Based on work performed and discussions with management, the following accounts (amounting to approximately $43,000) should be investigated and, if necessary, balances related thereto adjusted to the appropriate amount and, again if necessary, close all accounts no longer required. 32100, 32210, 32260, 32280, 32290, 32320, 32400, 325A0, 325D0, 325E0, 32940, 32790 20
Accrued Liabilities (continued) Accrual Account Maintenance Recommendations (continued) Management should ensure all staff members are adequately trained to perform the reconciliations for their assigned accounts and the review process be implemented as soon as possible. Management implemented a system to track the reconciliations which included among other things a required sign off by the assigned parties certifying the completion of the reconciliations. We encourage management to incorporate the sign off by the designated reviewer within the tracking system. As the process evolves, management should strive for 100% compliance month over month. Management Response: LANL CFO Management agrees with this recommendation and has taken steps to remove a majority of the accounts from the Balance Sheet and to return the excess funds to the U.S. Treasury during FY05. A few accounts maintained on record through FY05 in order to allow further investigation CFO-1 intends to continue with the General Ledger reconciliations process on a quarterly basis. The General Ledger Team Leader will be asked to sign off on the reconciliations process as completed each quarter. 21
Pension and Post-retirement Reviewed account reconciliations Reviewed the reconciliations for all significant balances Reviewed the FAS 87 and 106 disclosures from the UC Retirement Interim Financial Statements Performed analytical reviews Obtained an understanding and documented the composition and description of the accounts Obtained explanations and assessed reasonableness of significant and material variances 22
Deferred Revenue Assessed and tested monitoring controls over the revenue cycle Obtained an updated internal control memo over the revenue cycle Assessed and tested monitoring controls over the revenue cycle Reviewed account reconciliations Reviewed the reconciliations for all significant accounts Performed analytical reviews Obtained an understanding and documented the composition and description of significant accounts Obtained explanations and assessed reasonableness of significant and material variances 23
Deferred Revenue (continued) Observation It is our understanding that LANL provides services to Other Federal Contractors. Per the agreement between the two parties, the Lab is required to obtain funds for 3 months in advance prior to beginning the work. The Lab utilizes the Work for Other Accounting System. The system does not have the ability to process system generated sub-ledgers. As no subledger is available, the reconciliation consist of reviewing the activity in the account. Recommendation The system should be modified to have the ability to generate sub-ledgers. The sub-ledgers should be used to performed the reconciliation. Management Response LANL CFO Management agrees with the recommendation and will work with the Information Management Division to make modifications to the Reimbursable Work System in order to allow it to better serve as a sub-ledger for this advance type activity. Estimated Completion Date: 3/31/2006. 24
Payroll Assessed and tested monitoring controls over the payroll cycle Obtained an updated internal control memo over the payroll cycle Assessed and tested monitoring controls over the payroll cycle Performed substantive testing of payroll cost Selected a sample of 30 employees and agreed information from their Personnel Action Form to payroll checks and payroll check registers (for selected periods) to verify the validity and accuracy of payroll cost. 25
Other Matters We are aware of an allowable cost audit being performed by LANL Internal Audit. We understand that the audit is substantially complete and the results thereof have been prepared in a draft report. We are not, however, familiar with any of the findings or content of the draft report. We are aware that LANL management engaged an outside public accounting firm to assess/validate management s resolution of the findings contained in the audit matrix referred to on page 6 of this presentation. 26
LANL Service Team Michael Schini UC Engagement Partner Rick Wentzel Engagement Partner Steve Gradl Senior Manager Amalia Collins Senior Associate Michael Rosales Associate Rena Martinez Associate 27