Please answer the following requirement based on the scenario:

Assume you are a staff auditor employed by Hart, Reed, and Yates LLP (hereafter HR&Y), a large, regional public accounting firm. Because local governments typically have a June 30 fiscal year end, HR&Y accepts government audits during the traditionally slower audit season of summer. As a result, HR&Y audits several large municipalities in the state. The municipal audit fees represent approximately 35% of the firm's auditing revenues. You have recently been assigned to work on the compliance portion of the single audit of Sagebrush City, a mid-sized municipality in Texas. You have never worked on the audit of a state or local government and are unfamiliar with the requirements of the Single Audit Act or with federal regulations regarding tests of compliance.

An engagement under the Single Audit Act involves testing and reporting on compliance with federal laws for entities that receive federal financial assistance, along with an audit of the basic (general purpose) financial statements. Recipients of federal funds include states, counties, non-profits, and municipalities. The federal government requires single audits to ensure that federal monies are properly spent by grant recipients. For example, a government that administers a Federal Food Stamps grant must have policies and procedures in place to make certain that only persons who are eligible for food stamps actually receive the benefit. To determine whether a person is eligible, an auditor might test the application file of someone currently receiving food stamps to ensure that established criteria are being met.

During a planning meeting for the Sagebrush City audit, the audit manager on the engagement, Sarah Miller, informed you that few auditors at HR&Y had knowledge of governmental auditing before they were put on municipal engagements. According to Sarah, most collegiate accounting programs she knew of only briefly discussed audit requirements for federal programs, despite the fact that government audits account for a substantial proportion of the audit revenue generated by many accounting firms. She told you that while public accountants performed about 6,000 audits of publicly-held corporations each year, they perform over 35,000 single audits under the OMB Uniform Grant Guidance and the Compliance Supplement. Sarah also gave you the following background information to help you obtain an understanding of a municipal audit.

The Single Audit Act (SAA), passed in 1984, provides guidance to auditors of state and local governments on how to audit entities that receive federal funding. The SAA is described in the OMB Uniform Grant Guidance, which details when an audit of federal programs is required as well as the auditor's responsibilities. The OMB Uniform Grant Guidance is available online at www.grants.gov/learn-grants/grant-policies/omb-uniform-guidance-2014.html.

Prior to the SAA, federal agencies responsible for disbursements of federal funds generally required audits for each contract, grant, or program. Governmental entities with multiple grants, contracts, and programs were subjected to numerous different audits conducted by a variety of auditors, each with a specific, limited scope. To establish uniform requirements for audits of federal financial assistance, as well as to improve the financial management and accountability of state and local governments (SLGs), the SAA was enacted.

Requirement

Sarah Miller informs you that the National School Lunch Program, or NSLP, (CFDA No. 10.555) has been identified as being major for the Sagebrush City audit.

The Sagebrush City School District operates the National School Lunch Program for Sagebrush City. Thirty-seven elementary, middle and high schools offer the program to eligible students. At the beginning of every school year, each family with children enrolled in the school system is contacted by the district administration to determine eligibility in the NSLP. The Sagebrush City School Board maintains application records of each family as support for the program. A staff of nine people administers the lunch program, and the director is a licensed nutritionist. Over 5,000 students receive free or reduced lunches under the program each year.

Separate accounting records are maintained for the school lunch program. All lunchroom sales, sales of meal tickets, and reimbursements from the state for meals provided to needy children are deposited into the school lunch program fund. Meal service expenditures such as food purchases and workers' wages are paid out of the fund.

Part A

Describe the purpose of the NSLP grant for inclusion in the Sagebrush City audit working papers. You may need to go to the CFDA or actual U.S. Code sections to learn more about the program. Address why Congress enacted the program, what citizens or groups benefit from the program, and what social objectives the grant promotes.

Part B

Describe each of the compliance features that applies to the NSLP grant for the working papers and indicate whether the feature would apply to the city serving as a subrecipient to the state (that is, the state may have to match funding but the city would not). For each feature, describe how it relates to the grant specifically for a city. Do not provide generalized descriptions that could apply to any program. If a feature does not apply to Sagebrush City, explain why it would not apply.

Part C

HR&Y conducted compliance testing of Sagebrush City's lunch program by sampling applications for participant eligibility (i.e., to ensure that those receiving free lunches meet federal guidelines). The auditors also tested to determine that the school food accounting records were properly maintained, that federal monies were properly deposited and recorded into the food service account, and that transfers out (e.g., monies spent food purchases) were proper.

During its testing, HR&Y discovered that the number of students who qualified for a free or reduced lunch was materially overstated; in addition, records of the number of lunches served were also overstated to reconcile with the number of students that qualify. When the audit manager inquired about the findings, she learned that director of the lunch program was concerned that students in the district simply did not get enough to eat at home despite the free lunches provided by the school. A plan was devised to overstate the number of students who qualify for a free or reduced lunch so that the excess funding (subsequently used for food purchases) created by the overstatement would be distributed to students for take-home dinners and food on the weekends. Further investigation into the school lunch program supported the director's assertion, and excess food was in fact being distributed to impoverished students. As the director explained to the audit manager, "We had to do something. It's not the fault of these kids that they come from the 'wrong side of the tracks.' Good nutrition is essential to learning. If a kid is hungry, how can he concentrate in school and make good grades? It's a shame when this happens so we have simply helped out these kids. You will see that none of us personally benefitted from this - it is all for the kids."

How would you handle this scenario? Is this a case of fraud, waste, or abuse? Why or why not? Would your answer differ if the overstatement was not material? Would your answer differ if the lunch program director personally benefitted from the overstatement?