OMB Circular A-123

13th Annual Rutgers Governmental Accounting & Auditing Update ConferenceDecember 18, 2006

Lessons LearnedTerry CarnahanManaging DirectorKPMG Federal Internal Audit Services

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Agenda

Background

Challenges

Lessons Learned

Just Check the Box ?

Opportunities

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Background

Office of Management and Budget (OMB) Circular A-123, “Management’s Responsibility for Internal Control”, revised December, 2004

A-123 provides guidance to Federal agencies regarding compliance with the Federal Managers’ Financial Integrity Act of 1982 (FMFIA)

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Background, con’t

“. . . A-123 defines management’s responsibility for internal control in Federal agencies . . . A-123 and the statute it implements, the FMFIA, are at the center of the existing Federal requirements to improve internal control.”

—Linda SpringerOffice of Management and BudgetDecember 21, 2004*

* “Memorandum to the Chief Financial Officers, Chief Operation Officers, Chief Information Officers, and Program Managers: Revisions to OMB Circular A-123, Management’s Responsibility for Internal Control,” December 21, 2004

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Internal Control Attestations in the Government

What is Internal Controls over Financial Reporting (ICFR)?

Internal Control is defined as a process, effected by an entity’s

board of directors, management/other personnel, designed to

provide reasonable assurance regarding the achievement of

objectives in the following:Accurate maintenance of records in reasonable detail

Recording of transactions as necessary in preparing financial statements

Assurance that receipts/expenditures have appropriate authorizations

Prevention or detection of unauthorized acquisition

Prevention or detection of unauthorized use of the issuer’s assets

Compliance with applicable laws and regulations

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Enhancing Internal Control over Financial Reporting/Government Attestations

SEC definition: Internal Control over Financial Reporting (ICOFR)

A process designed to provide reasonable assurance regarding the

reliability of financial reporting and the preparation of financial

statements for external purposes.

COSO Is the Recognized Internal Control Framework for Financial Reporting

COSO control components (accepted by U.S. government and its agencies) incorporated into new A-123

GAO adopted into government standards

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Integrated Internal Control Framework

ICOFR

ReportingOversight

Technology

Evaluation

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Challenges

Today, agency managers face three challenges:Compliance with A-123Minimize the cost of compliance by integrating related internal controlsReduce the overall cost of controls and transform operations to improve mission effectiveness

These challenges also present opportunities:Minimize the cost of compliance by integrating related internal controlsReduce the overall cost of controls and transform operations to improve mission effectiveness

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Lessons Learned

1 Bob Violino, “Sarbox: Year 2”, September 15, 2005, CFO IT Fall 2005 Issue, CFO.com. 2 Richard M. Steinberg, “Resources, Ownership, and Discipline; Key 404 Lessons”, Oct. 18, 2005, Compliance Week3 Larry E. Rittenberg and Patricia K. Miller, “Sarbanes-Oxley Section 404 Work: Looking at the Benefits”, Jan. 2005, IIA Research Foundation

Expensive and chaotic1

Realization that requirements are permanent2

Surprising degree to which information technology contributes to financial processes1

Better understanding and analysis of monitoring controls2

Need to embed ICOFR within programs, operations2

Re-implementation of basic controls2

“Over-identified” key controls3

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Just Check the Box ? A-123 Compliance

Federal agencies are usually more willing to embrace new initiatives that address program improvementBut, new regulatory compliance initiatives are generally seen as “necessary evils” that distract an agency from its missionCompliance with new regulations often degenerates into “check the box” exercisesThe additional costs associated with A-123 compliance have not helpedAgencies miss-out by just “checking the A-123 box”

A-123 is an opportunity to transform and improve

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Opportunities

A-123 results in greater focus on strengthening internal controls

High initial A-123 compliance costs

Improved Business PracticesBetter Understanding of CostsLinking Controls to Performance

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Opportunities

TotalCost of a

ControlIncreasinglyfelt by

Agencies doing A-123

Largely hidden;historically

unknown to Agencies

Improved Business PracticesBetter Understanding of CostsLinking Controls to Performance

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Opportunities

Control Portfolio mapping

Manual vs. Automated controls

Detective vs. Preventive controls

Improved Business PracticesBetter Understanding of Costs, con’tLinking Controls to Performance

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Opportunities

Understanding manual controlsCosts of controls relate to actual performanceManual controls-

Labor-intensive (costly); perhaps hundreds of employees involvedIntroduce risk of human errorOften detective, not preventative = no protection against waste

What percentage of an Agency’s Performance costs are related tomanual controls ?

Improved Business PracticesBetter Understanding of Costs, con’tLinking Controls to Performance

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Opportunities

Controls are important tools for identifying:New opportunities for managing riskNew ways to improve business performance

Controls allow agencies to rethink how they operateA-123 compliance leads to fresh insights into performance and potential cost savingsLinkage between controls and program improvement

A-123 compliance encourages agencies to develop a “portfolio” view of their existing controls

Assessment of quality and quantity of controls from different perspectives: operating units, applications, locations, risks, and objectives

Improved Business PracticesBetter Understanding of CostsLinking Controls to Performance

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Opportunities

Automated

Manual

Detective Preventive

Existing Control

Current Control Portfolio (at most Agencies)Mostly manual controls that only detect anomalies after-the-fact

Anomalies’ effects (wasted money, time, effort) already felt Result in higher-than-necessary control costs Missed opportunity for control cost-savings

Current Control Portfolio

Improved Business PracticesBetter Understanding of CostsLinking Controls to Performance, con’t

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Opportunities

Automated

Manual

Detective Preventive

Existing Control

Desired Control PortfolioMostly automated controls that prevent anomalies from occurring or taken effect

Anomalies’ effects (wasted money, time, effort) are never felt Reduce control costs by introducing cost-savingsHelp agencies better manage their risks of doing business

Desired Control Portfolio

Previous ControlFuture (new) Control

Improved Business PracticesBetter Understanding of CostsLinking Controls to Performance, con’t

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Opportunities

Automated

Manual

Detective Preventive

Existing Control

Warning: Simply automating controls is no cure-allBusiness processes must be well understoodControls must exist at the proper places in a process

Goal: generate relevant information to enable appropriate action

The total costs of controls must be understood

Desired Control Portfolio

Previous ControlFuture (new) Control

Improved Business PracticesBetter Understanding of CostsLinking Controls to Performance, con’t

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Don’t Just Check the Box

Enhance controls by embedding them in operations (e.g., business units)Maintain rigorous testing processMove beyond compliance to improve business performancesImprove their controls processes by going from manual controls to automated controls (e.g., detective to preventive)Use the controls portfolio as a new “lens” to improve processes

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The information contained herein for the MEV Independent Validation and Verification Project is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© (2006) KPMG LLC, a Swiss cooperative. All rights reserved. Printed in USA.

Terry Carnahan

Managing Director

Federal Internal Audit ServicesKPMG LLP(202) 533-3342tcarnahan@kpmg.comwww.kpmg.com