CONTACT: Stanford University News Service (650) 723-2558
STANFORD -- Moving to "reestablish Stanford's reputation for integrity and sound management," the university announced Monday, July 22, a major program to reform its financial controls in federally sponsored research.
"Stanford staff, an independent accounting firm and a special outside advisory panel all labored for a number of months to develop this reform program," Stanford President Donald Kennedy said in announcing the package. "We are confident that the fundamental changes we will be implementing will move us to a new position of stronger, more effective accountability for public funds."
Peter Van Etten, who on July 8 became Stanford's new chief financial officer, will lead implementation of the reforms.
"My highest priority is to make these fundamental changes in the financial controls system and the way the university conducts its accounting," Van Etten said. "We are determined to reestablish Stanford's reputation for integrity and sound management."
The reform package spans seven categories:
In its written introduction to the reform package, Stanford acknowledged that government audits, hearings and investigations had "produced widely publicized evidence of error and inappropriate costs in Stanford's submissions for reimbursement of the indirect costs of federally sponsored research." Indirect costs are those - such as buildings, utilities and administration - that are necessary for research but cannot be directly attributed to an individual project.
On the heels of congressional hearings in March, the government in April imposed on Stanford a provisional rate for the current fiscal year of 55.5 percent, after previously having cut the university's original submission of 78 percent to 74 and then 70 percent. Each percentage point equals about $1.25 million in the Stanford budget.
The stated indirect-cost rates are somewhat misleading because they are applied only after many direct costs are excluded. During the past decade, for each dollar of direct costs, the government actually has paid Stanford about 50 cents. Put another way, indirect costs have been about one-third of total research costs at Stanford.
The most urgent aspect of the Arthur Andersen recommendations on overhauling the accounting system, the university said, involves segregating unallowable and inappropriate indirect costs at the time they are incurred. To that end, the outside accounting firm recommended establishing special accounts to capture unallowable costs and creating procedures for more effective screening.
The 35 detailed Arthur Andersen recommendations also include:
In its July 9 statement to the Board of Trustees, the special advisory panel to Stanford agreed with the Arthur Andersen recommendations and made three observations:
The panel's members are Joseph E. Connor, chairman, Price Waterhouse World Firm; Timothy S. Healy, president, New York Public Library; Adm. Bobby R. Inman, former director of the National Security Agency and former deputy director of the Central Intelligence Agency; Paul O'Neill, chairman and chief executive officer of Alcoa; and Maxine Singer, president of the Carnegie Institution of Washington.
"We are confident that, once this reform program has been implemented, Stanford will be able to avoid the errors and inappropriate submissions that have been the subject of so much attention," said Van Etten, Stanford's chief financial officer.
7/22/91 CONTACT: Terry Shepard, News Service, (415) 725-7732
Special Advisory Panel to Stanford University
Standards of Accountability -- Federal Research Costs
To the Board of Trustees
In response to the invitation of the president of Stanford University, Donald Kennedy, we have undertaken to advise Stanford as to recommendations being made to improve the University's accounting for indirect costs related to government-sponsored research efforts carried out by the University.
These recommendations have been made by the accounting firm of Arthur Andersen & Co. as part of Stanford's response to allegations and criticisms by a Congressional Subcommittee, U.S. government auditors, and others of the University's practices in seeking recovery of a number of such indirect costs in submissions made under U.S. government procurement regulations.
In our advisory role we have met with a number of University employees responsible for identifying and reporting such indirect costs, with the Arthur Andersen & Co. staff reviewing the present accounting activities in the indirect cost area, and with selected University trustees and officers. We have studied the problem areas, reviewed the work plan of Arthur Andersen & Co., considered their initial recommendations, and offered suggested changes to further improve these initial recommendations.
We are now prepared to offer our opinion on the adequacy of the final recommendations in meeting the University's intent to comply fully with government procurement regulations. After these comments, we make additional remarks concerning more general issues that surround the federal support of university research.
As a first observation, this advisory panel recognizes that the allegations made against the University of impropriety and inadequacy as to its accounting for indirect costs are very serious. The University appropriately has made corrective efforts a high priority. In our view, that is the right priority. We believe senior management of the University has reacted to this experience by giving clear and unequivocal direction to the University staff regarding management's expectation by way of ethical business practice concerning accounting for and reporting of costs supporting academic research. We view the University's action as a prerequisite in bringing about the cultural change needed to sustain a business process responsive to its obligation to conform to applicable procurement rules and regulations. This needed cultural attitude makes meaningful the necessary framework for implementing the recommendations aimed at improving existing procedures.
As a second observation, it is the advisory panel's opinion that the recommendations offered by Arthur Andersen & Co., as amended by the suggestions made by us, are appropriate. If put in place effectively, these recommendations give reasonable assurance of improving the control environment and providing appropriate internal accounting controls sufficient to account for and report indirect costs relating to U.S. government-sponsored research projects in an accurate and responsible manner.
This is not to say that the expanded accounting control and reporting system for indirect costs can be expected to prevent all error or all misstatements. In the real world this is simply not possible. Any accounting system involves judgment in identifying costs and is subject to inadvertent human error in processing transactions and aggregating amounts. In reviewing the recommendations as a total package, however, the advisory panel believes a substantial good-faith effort has been made to design a system that should be capable of a significantly improved level of regulatory compliance reporting. We believe the new system should be responsive to correcting the deficiencies alleged as to Stanford's present practices.
We have a third observation, one about which we feel very strongly. While advising the University as to the acceptability of the Arthur Andersen & Co. recommendations for the purposes intended, we are concerned that the extent of additional accounting that the University may now undertake may result in an excessive attention to accounting detail. We state this even though the recommendations are well intentioned and the University's previous procedures have been appropriately criticized.
When public funding of scientific research first began in earnest after World War II, there were some principles established to foster an appropriate partnership between private or state institutions and the federal government. The recognition of the need for non-governmental scientists to participate in the nation's research efforts came, in part, from a study by Vannevar Bush, "Science -- The Endless Frontier." In this study he stated:
"The publicly and privately supported colleges, universities, and research institutes are centers of basic research. They are the wellsprings of knowledge and understanding. As long as they are vigorous and healthy and their scientists are free to pursue the truth wherever it may lead, there will be a flow of new scientific knowledge to those who can apply it to practical problems in government, in industry, or elsewhere."
The policies developed from Bush's principles have established an extraordinarily productive partnership in research. American science and technology has flourished and has served in innumerable ways to enhance the lives of Americans and the U.S. economy. At the same time the universities have responded to the national needs embodied in the federal policy and enhanced their own efforts. They have grown in size and stature until they have become the standard for universities worldwide. Therefore, the advisory panel is happy to acknowledge that in spite of the problems found in Stanford's (and other universities') accounting for indirect cost reimbursement, the government remains committed to federally sponsored research in public and private institutions. The focus of government has been appropriately directed to examine and improve the internal control and reporting systems at Stanford and elsewhere. We support that objective.
But we caution that both the government and the University should not lose sight of another need. That need is, simply stated, to strike an appropriate balance between needed research, appropriate reimbursement of costs, and proper administrative accountability for the research effort.
Our concern is that the University, in responding to justified criticism, may have developed an accounting system that is excessive and far too expensive for the value sought. In a word: "overkill." The accounting tail may well now wag the research dog.
Accordingly, we are concerned lest the Arthur Andersen & Co. recommendations and our agreement with them in the context of Stanford's present circumstances be viewed as a model system for others, which, if widely adopted, would resolve the real problem. It is not. We are therefore compelled to ask whether the current system for cost reimbursement and accounting for university research could be revised and improved.
In fashioning a remedy for what is admittedly a serious administrative problem, we challenge both parties to keep clearly in mind the real objective of the government/university relationship: the conduct of vital research in a manner which is in the overall best interest of the nation.
The government must remain sensitive to the dependence on federal support that grew as the universities' contributions to the nation's needs expanded. If these institutions are to sustain their research efforts and their uniquely successful coupling of teaching and research, then new policies on cost recoveries must be sensitive to their needs.
Similarly we urge the nation's universities to consider new approaches toward achieving the appropriate balance between cost recovery and accountability and to engage the government in constructive discussions to that end.
Clearly the accounting emphasis should be on the procurement of the human resources element -- i.e., the intelligence and creativity inherent in research capability, the "brains" of the few who contribute so much to the advancement of progress.
Far simpler procurement, accounting and reporting procedures seem to us appropriate to protect the infrastructure that supports that on-line human effort. These are the indirect costs. They cannot be as precisely accounted for as is the case with direct costs.
Reasonable accountants can and do differ on the definition and measurement of indirect costs benefiting research activity. There is no single correct answer, only a reasonable one. The precision that seems to be sought by the federal auditors may not realistically be attainable.
In short, the advisory panel encourages the Congress and cognizant federal agencies in consultation with the universities to amend and reform and, certainly, to simplify the procurement process, accounting, and reporting requirement, particularly as to indirect costs. New approaches can ensure not only the needs of public accountability but also give an encouraging signal to scientific creativity and be a forceful affirmation of the importance of the public and private universities to the nation's well-being.
The advisory panel is prepared to continue to be available to Stanford University officials or anyone else involved in reforming this very important public service provided by our nation's scientists. Most importantly, the advisory panel hopes to ensure that the outcome of this episode is a system whereby proper accountability for taxpayer resources is assured while needed scientific research is both encouraged and promoted.
Joseph E. Connor
Chairman, Price Waterhouse World Firm
Dr. Timothy S. Healy
President, New York Public Library
Admiral Bobby R. Inman
Former Director, National Security Agency
and former Deputy Director of Central Intelligence
Chairman and Chief Executive Officer, Alcoa
Dr. Maxine Singer
President, The Carnegie Institution of Washington
7/22/91 CONTACT: Terry Shepard, News Service, (415) 725-7732
I. EXECUTIVE SUMMARY
At the request of Stanford University, Arthur Andersen & Co. performed an in-depth review of the University's accounting systems and control procedures for complying with U.S. government contracting requirements. This report presents the recommendations resulting from that review.
The purpose of the review was to develop and present, for Stanford's consideration, recommendations for improvements which, if properly implemented, will reduce Stanford's risk of noncompliance with applicable government regulations. In this regard, particular emphasis was given to reviewing Stanford's systems and control procedures related to the accumulation, classification, allocation, and billing of costs under federal government contracts and grants. Our purpose was not to assess the legality of any particular practice at Stanford, but rather to recommend improvements to the University accounting systems and control procedures. By making these recommendations to improve existing practices, we are not necessarily stating that any current practice is inconsistent with the law.
The review encompassed interviews with Stanford personnel, observation of control techniques as they were performed, examination of documentary evidence, and selective transaction testing. All documents requested were made available to us, and Stanford employees were cooperative in answering questions and providing information.
Stanford must comply with a variety of statutory and regulatory requirements which affect the award, pricing, and performance of federal contracts and grants. Some of these statutes and regulations apply to all federal contracts or grants, while others are unique to individual agencies or even to specific programs within those agencies. The purpose of this report is to set forth, for Stanford's consideration, recommendations for improvements which, if properly implemented, will reduce Stanford's risk of noncompliance with applicable government regulations. Of course, no system of controls can totally eliminate all possibility of noncompliance.
Our recommendations arise from the following broad observations:
In offering these recommendations, we recognize that Stanford and other universities are now operating in a changing regulatory environment. For example, as of the date of this report, the Office of Management and Budget ("OMB") is considering revisions to OMB Circular A-21, Principles for Determining Costs Applicable to Grants, Contracts and Other Agreements with Educational Institutions. At the present time, it is impossible to tell how these changes will affect Stanford's accounting and control obligations. Stanford's accounting systems and control procedures must be responsive to these and other changes which will be forthcoming. These control procedures are designed to assist Stanford in understanding and complying with this diverse set of rules.
Our recommendations are categorized as follows:
A summary of our recommendations is presented below. A more detailed description of each recommendation is set forth in Section II of this Report.
A. CONTROL ENVIRONMENT
The control environment is established at the top of the organization and directly influences all other aspects of internal control. It represents the composite effect of various factors, such as the attitudes and actions of Stanford's Board of Trustees and Administration concerning controls. It is reflected in management philosophy and operating style, organizational structure, and the assignment of authority and responsibility.
Additionally, Stanford's control environment is influenced by the often competing interests of the academic and administrative functions of the University. These competing interests and related lack of centralized control increase the potential for noncompliance with applicable procurement regulations.
To strengthen the control environment, we recommend that Stanford do the following:
1. Update and modify its Mission Statement specifically to acknowledge its responsibilities as a steward of public funds and for compliance with applicable laws and regulations.
2. Establish and adhere to a comprehensive written code of ethics and conduct which sets forth the standards that govern the conduct of all employees in their relationship to the University and which acknowledges and addresses, among other matters, Stanford's responsibilities under applicable laws and regulations and to the public.
3. Establish the position of Compliance Support Officer, reporting to the Dean of Research and having direct access to the President and the Chairman of the Audit Committee of the Board of Trustees.
4. Establish mandatory training requirements for all academic and administrative department personnel with responsibility for government contracting matters.
5. Establish and adhere to a formal program of government contract compliance auditing by the Internal Audit Department.
6. Consider implementing a policy of job rotation at the manager level and above within the Controller's Office to increase the knowledge and experience base of these personnel.
B. ESTABLISHMENT AND IMPLEMENTATION OF WRITTEN POLICIES AND CONTROL PROCEDURES
The establishment and implementation of written policies and control procedures is essential to ensuring that internal control objectives are effectively communicated, properly implemented and consistently followed.
To strengthen its written policies and control procedures, we recommend that Stanford do the following:
1. Develop a single, comprehensive Proposal Preparation Manual to be used by faculty members and their administrative assistants in the preparation of sponsored project proposals.
2. Develop a single, comprehensive Cost Accounting Practices Manual describing its cost accounting practices regarding the accumulation, classification, and allocation of costs under federal government contracts and grants.
3. Establish a formal policy and related procedures for the preparation and submission of contract and grant billings and cost reports.
4. Develop a comprehensive Accounting System and Sponsored Agreement Administration Manual to serve as a practical guide for principal investigators and administrative department personnel involved in federal contract and grant-related activities.
5. Establish and adhere to written procedures for the preparation of Laboratory Time Cards.
C. ACCOUNTING SYSTEM
Stanford's accounting system is structured primarily to satisfy the management and external reporting requirements of the University. Those requirements differ in some respects from the specialized requirements of government research contracts and grants. This condition creates the risk that costs accumulated for federal procurement purposes may be unallowable or be assigned to the wrong cost pool.
Moreover, the current system is built upon a batch accounting system installed in the 1960s, thereby making it difficult to obtain needed management information on a real time basis. Therefore, in addition to the compliance-related recommendations set forth below, we recommend that Stanford modernize its accounting system so that users can capture better information more effectively and efficiently.
To improve compliance controls within the accounting system, we recommend that Stanford do the following:
1. Perform a review of existing indirect cost accounts to determine whether their current classification within accounting system "functions" is consistent with the types of costs being charged to each account.
2. Eliminate the use of department special codes.
3. Establish general ledger accounts to record unallowable costs at the time they are incurred.
4. Establish written procedures for the opening of indirect cost accounts for academic and administrative departments.
5. Revise its current accounting policy and related procedures to require supervisory review and approval of cost transfers that have a high potential of being inappropriate.
D. COST ALLOWABILITY AND ALLOCABILITY
Federal government contracts and grants require compliance with specified laws and regulations, many of which impose specialized cost accounting and reporting requirements. For example, Stanford is required to comply with the provisions of OMB Circular A-21, Principles for Determining Costs Applicable to Grants, Contracts and Other Agreements with Educational Institutions. This Circular requires that costs be properly classified, that they be charged to the appropriate project or indirect cost pool, that unallowables be excluded from reimbursable costs, and that costs be allocated to projects on an equitable basis.
To strengthen the system of internal control in this area, we recommend that Stanford do the following:
1. Establish a policy and related procedures to require approval and documentation of significant cost accounting policy decisions.
2. Implement effort reporting procedures in selected departments which engage in activities, the costs of which are unallowable under federal contracts and grants.
3. Establish a formal, written policy and related procedures that require comprehensive front-end transaction screening for unallowable costs.
4. Identify specific high-risk accounts for additional "scrubbing" for unallowable costs prior to filing its indirect cost submission.
5. Establish a formal, written procedure to improve documentation of, and to better account for, all reclassifications made among indirect cost pools as part of the year-end indirect cost submission process.
6. Develop formal documentation standards for the preparation of indirect cost submission workpapers.
7. Develop procedures to be used by the Government Cost and Rate Studies Department Manager and Assistant Controller for Cost Accounting Policy and Cost Recovery to review Stanford's annual indirect cost submission.
8. Establish a policy and related procedures regarding the timely review and updating of special cost studies such as those for the Operations and Maintenance and Libraries indirect cost pools.
9. Establish a policy and related procedures to require testing of space inventory surveys.
10. Reinstate service center accounting procedures to require regular reviews of billing rates and any related variances from actual costs incurred by the Government Cost and Rate Studies Department.
11. Establish a formal, written policy and related procedures to identify and account for "applicable credits" as defined in OMB Circular A-21.
E. CONTRACT AND GRANT ADMINISTRATION
Government contract compliance requires internal control over contract administration functions. Such controls help ensure that the University is compliant with all of the requirements of its sponsored agreements.
To strengthen controls over contract and grant administration, we recommend that Stanford do the following:
1. Modify its Sponsored Projects Manual to include a formal file document checklist to be used by the Sponsored Projects Office.
2. Implement a policy to require that the Monthly Expenditure Statement internal certifications executed by principal investigators specifically address the appropriateness of all costs charged directly to sponsored agreements and to provide that all other requirements of the contract or grant have been met.
3. Establish a formal policy regarding the granting of indirect cost waivers.
4. Assign responsibility to the Sponsored Projects Office for monitoring and ensuring that principal investigators have filed all required technical reports on a timely basis.
5. Implement computer system changes to permit the transfer of data from the main Universitywide accounting system to the Equipment Inventory System.
6. Develop and implement a program to conduct physical inventories of property on a biannual basis in accordance with the requirements of OMB Circulars A-21, Section J.9, and A-110, Attachment N.
7. Centralize controls over government property administration by increasing the responsibility and authority of the University Property Administrator.
8. Establish review procedures over the preparation of Post Award Administrative Data Sheets used for sponsored project billings and cost reporting purposes.
7/22/91 CONTACT: Terry Shepard, News Service, (415) 725-7732
A PROGRAM TO REFORM FINANCIAL CONTROLS
IN FEDERALLY SPONSORED RESEARCH
Introduction: A Commitment to Act
Recent government audits and reviews by the Office of Naval Research (ONR), the Defense Contract Audit Agency (DCAA), the General Accounting Office (GAO), and the Subcommittee on Oversight and Investigations of the House Committee on Energy and Commerce, chaired by Rep. John D. Dingell, have produced widely publicized evidence of error and inappropriate costs in Stanford's submissions for reimbursement of the indirect costs of federally sponsored research.
As a result of these outside investigations and the University's internal reviews, Stanford recognizes that there have been errors in indirect cost submissions and is committed to implement fundamental changes in the financial controls system and the way the University conducts its accounting. As President Donald Kennedy said in his March 23 statement: "Our obligation is not to do all the law permits, but to do what is right." This document describes the steps the University is taking to reestablish Stanford's reputation for integrity and sound management.
For decades, the nation's universities and the federal government have been in a successful partnership to carry out most of the basic research done in the United States, to train the next generation of our nation's scientists and engineers, and to discover and utilize fundamental knowledge that can benefit society. Universities conduct critical basic research in a variety of areas, including engineering, basic sciences like physics and chemistry, and medicine; medically related fields account for about half of the sponsored research at Stanford. In this partnership, the federal government provides grants and contracts that cover most of the reasonable costs of doing research, both the direct costs that can be attributed to individual projects and the indirect costs that must be borne by the institution as a whole to make these research efforts possible. Universities, including Stanford, have subsidized through cost-sharing the direct and indirect costs in the past and will continue to do so in the future. The partnership between universities and the federal government must be built on mutual trust. Stanford is determined to reestablish this trust.
1. Arthur Andersen & Co. Review of Internal Controls
In January, Stanford hired Arthur Andersen & Co. to make an independent evaluation of the University's systems and procedures related to government contracts and grants and to recommend appropriate improvements. The University's Board of Trustees has accepted the Arthur Andersen report. This report contains 35 detailed recommendations, which resulted from an in- depth review of Stanford's accounting systems and control procedures related to the accumulation, classification, allocation and billing of costs under federal government contracts and grants. Key recommendations of the Arthur Andersen report are:
President Kennedy has ordered the rapid implementation of all of Arthur Andersen's recommendations. The most urgent aspect of these recommendations relates to identifying and segregating unallowable and inappropriate costs at the time the costs are incurred. These recommendations and an associated training program will be implemented by September 1, 1991.
Arthur Andersen has also been asked to issue reports every six months to the Board of Trustees and to the special Advisory Panel (see below) documenting the University's progress in meeting these recommendations. These reports will be made public, as have the Arthur Andersen report and recommendations.
2. Special Advisory Panel
Last January, President Kennedy appointed a special outside Advisory Panel on Standards of Accountability for Federal Research Costs to advise the University on contract and grant issues. The Panel members are:
The Panel reviewed the Arthur Andersen internal controls report and met both with Arthur Andersen staff conducting the study and with selected Stanford staff, officers, and Trustees. In a July 9 statement to the Stanford Board of Trustees, the Panel made three observations. The Panel believes that:
(The full statement of the Advisory Panel contains extended general comments on the indirect cost issue. The statement can be obtained form the Stanford University Office of Public Affairs, Building 170, Stanford, CA 94305. Telephone: 415/723-2862.)
3. Arthur Andersen Review of Potentially Controversial Costs -- Scrubbing of Inappropriate Costs
Stanford is committed to withdrawing all unallowable and inappropriate costs.
Arthur Andersen has been asked to review the University's indirect cost submissions for the open years of the 1980s. They will identify any indirect costs submitted for reimbursement that might be inappropriate and which have not already been removed. All items such as those identified by ONR, DCAA, GAO, and the Subcommittee on Oversight and Investigations will be included in the review. A special internal University advisory group -- including faculty members -- will be appointed and asked to review Arthur Andersen's list of issues and to make recommendations as to how the University should handle these potentially controversial costs.
Arthur Andersen is also assisting the University in the preparation of its indirect cost submissions for 1989 and 1990.
4. New Financial Management Team
5. Management Review
President Kennedy has requested that Arthur Andersen undertake an independent, outside review, beginning with the Board of Trustees and the President's Office, to identify any management weaknesses or failures of communication in regard to financial issues related to federally sponsored research. A member of the Stanford Graduate School of Business faculty will participate in this review. The review should be completed by the end of the summer.
6. Prompt Resolution of Outstanding Audit Issues
President Kennedy and the Board of Trustees have reaffirmed that Stanford will continue to cooperate fully with all audits and investigations and do everything possible to expedite government review of Stanford's past submissions. Accordingly, the University has:
7. Reporting and Reviewing Allegations of Misconduct
The reform program outlined above combines extensive involvement by outside groups -- including Arthur Andersen, Coopers & Lybrand, and the special Advisory Panel -- together with new financial management to oversee the restructuring of Stanford's accounting and financial controls related to federally sponsored research. In addition, an extensive system of checks and balances regarding research accounting has been developed using internal and external resources. We are confident that, once this reform program has been implemented, Stanford will be able to avoid the errors and inappropriate submissions that have been the subject of so much attention.
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