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Feb 1994

Help with the new HUD audit rules. (Department of Housing and Urban Development) (Auditing)

by Sacher, Stephen B.

    Abstract- Not all CPAs can audit Dept of Housing and Urban Development (HUD) programs. HUD audits have special complex audit, reporting and disclosure rules that practitioners are required to follow. Some tasks, such as those involving the assessment of rent charges and maintenance costs to see if they are excessive, make it necessary for auditors to acquire relevant knowledge or to seek the assistance of experts. To provide guidance to independent auditors in conducting HUD audits, the HUD's Office of Inspector General recently published Handbook 2000.04 Rev 1, titled 'Consolidated Audit Guide for Audits of Programs.' Guidelines contained in the handbook apply for audits of programs with fiscal years ending Sep 30, 1993 and thereafter. In addition to this manual, practitioners performing HUD audits are also expected to rely on Government Auditing Standards, GAAS and their own professional judgement in developing procedures to achieve audit objectives.

The audit guidance provided in the handbook is not intended to be a complete manual of audit procedures. Auditors are expected to consider Government Auditing Standards and GAAS as well as their professional judgment in designing procedures to meet audit objectives. However, auditors must address all applicable compliance retirements contained in the handbook.

When planning an audit, pursuant to SAS No. 55, Consideration of the Internal Control Structure in a Financial Statement Audit, auditors may assess control risk at maximum and not perform tests of controls. However, HUD requires that auditors test controls to evaluate the effectiveness of the design and operation of the internal control structure policies and procedures that they consider relevant to preventing and detecting noncompliance. Auditors are also required to test and report on the project's compliance with HUD laws and regulations. Furthermore, SAS No. 68, Compliance Auditing Applicable to Governmental Entities and Other Recipients of Governmental Assistance, extends this compliance requirement to any other applicable laws and regulations that may have a material effect on the financial statements.

The new handbook reiterates the Government Auditing Standards requirement that all material instances of noncompliance be reported. SAS No. 68 defines material instances of noncompliance "as failures to follow requirements, or violations of prohibitions, contained in statutes, regulations, contracts, or grants that cause the auditor to conclude the aggregation of misstatements...resulting from those failures or violations is material to the financial statements." Accordingly, auditors may need to estimate the potential dollar effect of instances of noncompliance.

While performing compliance and other auditing procedures, auditors may become aware of illegal acts or indications of acts which could result in criminal prosecution. In these instances, HUD requires that auditors communicate all such acts including related questioned costs immediately and in writing to the Inspector General. Before undergoing such communication auditors are advised to consider SAS No. 54, Illegal Acts by Clients, and may want to consult with their attorney.

The new handbook requires auditors to determine that all project funds and security deposit accounts are Federally insured throughout the entire year. This means that projects are precluded from depositing more than $100,000 in any one bank. Auditors may examine monthly bank statements to determine if projects have complied with this requirement.

If an auditor performs substantial fieldwork outside his or her home state, the auditor should document compliance with that state's licensing requirements in the workpapers. Under the old rules, the auditor was required to submit evidence with the audit report as to compliance with out-of-state licensing rules. Unlike the AICPA independence rule No. 101-3, an auditor who performs a significant portion of a HUD project's bookkeeping and/or maintains the official accounting records is not independent and therefore precluded from performing auditing services.

Effective August 26, 1992, nonprofit organizations owning multiple projects are required to have individual audits performed for each project. These individual audits should serve as the basis for the organizational audit performed pursuant to OMB Circular A-133.

Reporting Requirements

HUD requires that auditors issue the following reports:

a. Opinion on audited financial statements and supplemental information;

b. Report on internal control structure;

c. Opinion on compliance with specific requirements applicable to major HUD programs;

d. Report on compliance with specific requirements applicable to non- major HUD program transactions;

e. Report on compliance with specific requirements applicable to affirmative fair housing;

f. Schedule of findings and questioned costs; and

g. Auditor's comments on audit resolution matters relating to HUD programs.

Under certain circumstances as described below, HUD also requires that projects include a corrective action plan with their annual financial statements. SAS No. 68 also requires auditors to report on compliance with other laws and regulations that may have a material effect on the financial statements. The new handbook provides illustrative examples of standard reports (a-g) it requires. However, it provides little guidance where modified, qualified, disclaimer, or adverse opinions or reports are appropriate. For suggested language in these instances, auditors should consider SAS No. 68 and SOP 92-7, Audits of State and Local Government Entities Receiving Federal Financial Assistance.

The old handbook required supplemental information be presented for Section 8 and HUD mortgage programs. The new rules require only HUD mortgage programs to present this information.

For HUD mortgage programs, HUD requires that the annual financial and supplemental information be certified as accurate by the mortgagor when the project is owned by an individual, by two general partners when the project is owned by a partnership, or by two officers when owned by a corporation. Where applicable, HUD also requires these statements be certified by the management agent.

The new handbook replaces the auditor's report on compliance with common requirements with a report on compliance with the affirmative fair housing marketing (AFHM) requirements. In this report, auditors express positive assurance on the AFHM requirements tested, and negative assurance on the AFHM requirements not tested. Where the program is nonmajor (HUD insured or HUD held mortgages not exceeding $300,000), the AFHM reporting should be included in the compliance report for nonmajor programs.

When an auditor identifies noncompliance, the auditor includes a schedule of findings and questioned costs with the compliance reports. When a project has not taken needed corrective action identified in prior audit reports (including program review reports and state agency reports), the auditor includes a report on audit resolution matters. Auditors should make it clear the responsibilities they are taking with respect to these reports (f and g) referring them to the compliance reports (c-e). When an auditor includes a schedule of findings and questioned costs or comments on audit resolution matters, the project is required to submit a corrective action plan with its annual financial statements. A corrective action plan normally includes comments on findings and recommendations, actions taken or planned, and the status of corrective actions on prior findings. Although auditors take no responsibility with respect to a corrective action plan, they should read the plan to determine whether the information furnished therein is consistent with their understanding. Section 8 Programs

The Section 8 program objective is to provide lower-income families with rental housing. Projects receive partial rents from each tenant and the remaining in housing assistance payments from HUD or public housing agencies. Projects with Section 8 apartments are required to have an affirmative fair housing marketing (AFHM) plan.

The new handbook requires auditors to consider additional compliance testing with respect to AFHM plans. HUD suggests auditors--

a. Obtain a copy of the plan;

b. Inquire as to policies and procedures for processing, approving and rejecting applications;

c. Test that the project's procedures for processing, approving and rejecting applications were placed in operation;

d. Review applications rejected, tenant evictions, and legal invoices for any litigation or potential litigation related to discriminatory practices; and

e. Determine that the project's marketing materials refer to Equal Housing Opportunity.

There are only minor revisions to the suggested audit procedures for testing the project's compliance with management, maintenance, and replacement reserve responsibilities. The suggested inquiry and test procedures include procedures which pertain to the project's 1) routine property inspections, 2) ensuring housing quality standards are met, and 3) use of replacement funds only for repairs approved by HUD. These are procedures which are usually performed regularly by HUD or state agencies. For practicality, auditors could request HUD or state agency reports to determine whether the project has complied with these procedures.

The suggested audit procedures pertaining to Federal financial reports have not changed significantly. When testing financial reports, it is important that auditors not overlook testing the reliability of housing assistance payment (HAP) vouchers. HAP vouchers are especially important since the vouchers are billings to HUD which provide HUD with the basis for funding rents. HUD suggests the following three additional audit procedures relating to Section 8 rents: a. Determine if rents exceed fair market rents. This entails that auditors obtain an understanding of what fair market rents are for the locale of the project.

b. Compare HAP billings to tenant files.

c. Verify mathematical accuracy of HAP vouchers.

The new handbook suggests that auditors determine that security deposits held at year end agree to amounts collected plus interest.

HUD Mortgage Programs

The objectives of HUD mortgage programs are to provide mortgage insurance, mortgage loans, or advances to assist multifamily projects in the construction, rehabilitation, or preservation of rental or cooperative housing. HUD requires two new supplemental schedules. A listing of identity of interest companies and activity is required. This schedule lists services rendered and amounts paid to related parties where the payments during the audit period totaled $1,000 or more. When this information is provided in the notes to the financial statements, some auditors take the position that the project may omit the schedule and refer to the note disclosure. Also required is a schedule of funds in financial institutions, showing the name of each depositor, account title, and balance, including the reserve for replacement and residual receipts accounts that are funded by the project and controlled by the mortgagee. The reserve for replacement account is funded monthly in an amount determined by HUD. Residual receipts are usually any cash remaining at the end of a semi-annual or annual fiscal period after deducting surplus cash, distributions, and other amounts as defined in the project's regulatory agreements with HUD. All disbursements from reserve for replacement and residual receipts accounts must be approved by HUD.

The new handbook places more responsibility on the auditor to determine that the project is adhering to residual receipts requirements. The primary concerns are that deposits are made timely and are calculated correctly and that HUD approved disbursements.

Distributions to owners are also of heightened concern. Distributions to owners are all payments to owners including fees and salaries not approved by HUD as essential to the operation of the project. Distributions can only be made if the project has complied with all provisions of its regulatory agreement, including that the project is in good repair and condition and there are no outstanding maintenance notices. Auditors should determine that any distributions made were in compliance with the project's regulatory agreement. This entails a determination of the project's condition. Auditors may visit the property, read inspection reports, review maintenance and inspection procedures, and test for outstanding maintenance orders.

The new handbook stresses the importance for auditors of testing management functions especially management's responsibility to maintain property. Auditors should inquire whether routine unit and general property inspections were performed and that corrective action was taken where appropriate. Management's inspection guidelines should be compared to Form HUD 9834, which is a checklist HUD utilizes when performing management reviews. The checklist rates a project's maintenance and security, financial management, leasing and occupancy, tenant files and records, drug-free housing policy, general management practices, and overall management operation. Management contracts and vendor invoices should be examined to identify related party transactions. HUD suggests that payments for services, supplies, etc. be sampled to determine that costs are reasonable in the geographic area. This could be a major undertaking. Auditors are generally not considered to be experts in the field of maintenance and repair costs. For large payments, auditors may consider relying on opinions from experts such as engineers, architects and contractors when testing the reasonableness of such payments. Other procedures include comparing payment amounts to amounts paid by unrelated projects, referring to market studies and reviewing the project's bidding and acceptance procedures.

The suggested auditing procedures pertaining to Federal financial reports, affirmative fair housing, replacement reserve, security deposits and tenant application, eligibility, and recertification are similar to those for Section 8 programs.

The suggested auditing procedures pertaining to mortgage status and cash receipts and disbursements have not changed significantly.

The Professional Approach

HUD's new audit rules are numerous, sometimes controversial, and not always comprehensive. Practitioners are advised to carefully consider HUD's suggested audit procedures and to apply their professional judgement when developing an audit approach. The practical approaches provided here, coupled with others tailored to specific audits, is a proven technique in maintaining a successful HUD practice.

Stephen B. Sacher, CPA, D'Arcangelo & Co.

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