Fiscal Year 2003 U.S. Government Financial Statements
Sustained Improvement in Federal Financial Management Is Crucial to Addressing Our Nation's Future Fiscal Challenges Gao ID: GAO-04-886T July 8, 2004GAO is required to annually audit the consolidated financial statements of the U.S. government. Proper accounting and reporting practices are essential in the public sector. The U.S. government is the largest, most diverse, most complex, and arguably the most important entity on earth today. Its services--homeland security, national defense, Social Security, mail delivery, and food inspection, to name a few--directly affect the well-being of almost every American. But sound decisions on the future direction of vital federal government programs and policies are made more difficult without timely, accurate, and useful financial and performance information. Until the problems discussed in GAO's audit report on the U.S. government's consolidated financial statements are adequately addressed, they will continue to (1) hamper the federal government's ability to accurately report a significant portion of its assets, liabilities, and costs; (2) affect the federal government's ability to accurately measure the full cost as well as the financial and nonfinancial performance of certain programs while effectively managing related operations; and (3) significantly impair the federal government's ability to adequately safeguard certain significant assets and properly record various transactions.
As in the 6 previous fiscal years, certain material weaknesses in internal control and in selected accounting and reporting practices resulted in conditions that continued to prevent GAO from being able to provide the Congress and American citizens an opinion as to whether the consolidated financial statements of the U.S. government are fairly stated in conformity with U.S. generally accepted accounting principles. Three major impediments to an opinion on the consolidated financial statements continue to be (1) serious financial management problems at DOD, (2) the federal government's inability to fully account for and reconcile transactions between federal government entities, and (3) the federal government's ineffective process for preparing the consolidated financial statements. For fiscal year 2003, 20 of 23 Chief Financial Officers (CFO) Act agencies received unqualified opinions, the same number received by these agencies in fiscal year 2002, up from 6 for fiscal year 1996. However, only 3 of the CFO Act agencies had neither a material weakness in internal control, an issue involving compliance with applicable laws and regulations, nor an instance of lack of substantial compliance with Federal Financial Management Improvement Act requirements. The requirement for timely, accurate, and useful financial and performance management information is greater than ever as our nation faces major longterm fiscal challenges that will require tough choices in setting priorities and linking resources to results. Given the nation's large and growing long-term fiscal imbalance, which is driven largely by known demographic trends and health care costs, coupled with new homeland security and defense commitments, the status quo is unsustainable. Current financial reporting does not clearly and transparently show the wide range of responsibilities, programs, and activities that may either obligate the federal government to future spending or create an expectation for such spending and provides an unrealistic and even misleading picture of the federal government's overall performance and financial condition. In addition, too many significant federal government commitments and obligations, such as Social Security and Medicare, are not adequately addressed in the federal government's financial statements and budget process, and current federal financial reporting standards do not require such disclosure. A top-to-bottom review of government activities to ensure their relevance and fit for the 21st century and their relative priority is long overdue. The federal government needs a three-pronged approach to (1) restructure existing entitlement programs, (2) reexamine the base of discretionary and other spending, and (3) review and revise the federal government's tax policy and enforcement programs. New accounting and reporting approaches, budget control mechanisms, and metrics are needed for considering and measuring the impact of spending and tax policies and decisions over the long term.
GAO-04-886T, Fiscal Year 2003 U.S. Government Financial Statements: Sustained Improvement in Federal Financial Management Is Crucial to Addressing Our Nation's Future Fiscal Challenges
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Sustained Improvement in Federal Financial Management Is Crucial to
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GAO Highlights:
Highlights of GAO-04-886T, testimony before the Subcommittee on
Financial Management, the Budget, and International Security,
Committee on Governmental Affairs, U.S. Senate:
Why GAO Did This Study:
GAO is required to annually audit the consolidated financial statements
of the U.S. government.
Proper accounting and reporting practices are essential in the public
sector. The U.S. government is the largest, most diverse, most complex,
and arguably the most important entity on earth today. Its services”
homeland security, national defense, Social Security, mail delivery,
and food inspection, to name a few”directly affect the well-being of
almost every American. But sound decisions on the future direction of
vital federal government programs and policies are made more difficult
without timely, accurate, and useful financial and performance
information.
Until the problems discussed in GAO‘s audit report on the U.S.
government‘s consolidated financial statements are adequately
addressed, they will continue to (1) hamper the federal government‘s
ability to accurately report a significant portion of its assets,
liabilities, and costs; (2) affect the federal government‘s ability to
accurately measure the full cost as well as the financial and
nonfinancial performance of certain programs while effectively managing
related operations; and (3) significantly impair the federal
government‘s ability to adequately safeguard certain significant assets
and properly record various transactions.
What GAO Found:
As in the 6 previous fiscal years, certain material weaknesses in
internal control and in selected accounting and reporting practices
resulted in conditions that continued to prevent GAO from being able
to provide the Congress and American citizens an opinion as to whether
the consolidated financial statements of the U.S. government are fairly
stated in conformity with U.S. generally accepted accounting
principles. Three major impediments to an opinion on the consolidated
financial statements continue to be (1) serious financial management
problems at DOD, (2) the federal government‘s inability to fully
account for and reconcile transactions between federal government
entities, and (3) the federal government‘s ineffective process for
preparing the consolidated financial statements.
For fiscal year 2003, 20 of 23 Chief Financial Officers (CFO) Act
agencies received unqualified opinions, the same number received by
these agencies in fiscal year 2002, up from 6 for fiscal year 1996.
However, only 3 of the CFO Act agencies had neither a material weakness
in internal control, an issue involving compliance with applicable laws
and regulations, nor an instance of lack of substantial compliance with
Federal Financial Management Improvement Act requirements.
The requirement for timely, accurate, and useful financial and
performance management information is greater than ever as our nation
faces major long-term fiscal challenges that will require tough choices
in setting priorities and linking resources to results. Given the
nation‘s large and growing long-term fiscal imbalance, which is driven
largely by known demographic trends and health care costs, coupled with
new homeland security and defense commitments, the status quo is
unsustainable. Current financial reporting does not clearly and
transparently show the wide range of responsibilities, programs, and
activities that may either obligate the federal government to future
spending or create an expectation for such spending and provides an
unrealistic and even misleading picture of the federal government‘s
overall performance and financial condition. In addition, too many
significant federal government commitments and obligations, such as
Social Security and Medicare, are not adequately addressed in the
federal government‘s financial statements and budget process, and
current federal financial reporting standards do not require such
disclosure.
A top-to-bottom review of government activities to ensure their
relevance and fit for the 21st century and their relative priority is
long overdue. The federal government needs a three-pronged approach to
(1) restructure existing entitlement programs, (2) reexamine the base
of discretionary and other spending, and (3) review and revise the
federal government‘s tax policy and enforcement programs. New
accounting and reporting approaches, budget control mechanisms, and
metrics are needed for considering and measuring the impact of spending
and tax policies and decisions over the long term.
www.gao.gov/cgi-bin/getrpt?GAO-04-886T.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Jeffrey C. Steinhoff or
Gary T. Engel at (202) 512-2600.
[End of section]
Testimony:
Before the Subcommittee on Financial Management, the Budget, and
International Security, Committee on Governmental Affairs, U.S. Senate:
For Release on Delivery Expected at 10:30 a.m. EDT Thursday, July 8,
2004:
Fiscal Year 2003 U.S. Government Financial Statements:
Sustained Improvement in Federal Financial Management Is Crucial to
Addressing Our Nation's Future Fiscal Challenges:
Statement of David M. Walker, Comptroller General of the United States:
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-886T]:
Mr. Chairman and Members of the Subcommittee:
I am pleased to be here today to discuss our report on the U.S.
government's consolidated financial statements for fiscal years 2003
and 2002.[Footnote 1] Both the consolidated financial statements and
our report are included in the fiscal year 2003 Financial Report of the
United States Government, which was issued by the Department of the
Treasury (Treasury) on February 27, 2004, and is available through
GAO's Internet site, at [Hyperlink, http://www.gao.gov], and Treasury's
Internet site, at [Hyperlink, http://www.fms.treas.gov/fr/index.html].
As in the 6 previous fiscal years, certain material weaknesses[Footnote
2] in internal control and in selected accounting and reporting
practices resulted in conditions that continued to prevent us from
being able to provide the Congress and American citizens an opinion as
to whether the consolidated financial statements of the U.S. government
are fairly stated in conformity with U.S. generally accepted accounting
principles (GAAP). Until the problems discussed in our report are
adequately addressed, they will continue to (1) hamper the federal
government's ability to accurately report a significant portion of its
assets, liabilities, and costs; (2) affect the federal government's
ability to accurately measure the full cost as well as the financial
and nonfinancial performance of certain programs while effectively
managing related operations; and (3) significantly impair the federal
government's ability to adequately safeguard certain significant assets
and properly record various transactions.
While the federal government has not yet been able to prepare auditable
financial statements, the requirement to do so at the consolidated
level as well as at the agency level has already yielded important
results. We see continuous movement toward the ultimate goals of annual
accountability and, more importantly, of development of the day-to-day
financial information that the federal government will need to best
address today's budgetary challenges and the looming longer-term fiscal
imbalance driven by demographic trends, rising health care costs, and
new homeland security and defense commitments. Across government,
financial management improvement initiatives are under way that, if
effectively implemented, have the potential to appreciably improve the
quality of the federal government's financial management and reporting.
Federal agencies continue to make progress in their efforts to
modernize their financial management systems and improve financial
management performance as called for in the President's Management
Agenda.[Footnote 3]
The Principals of the Joint Financial Management Improvement Program
(JFMIP)[Footnote 4] agreed with the Office of Management and Budget's
(OMB) initiative to accelerate the agency financial statements
reporting date to November 15 for fiscal year 2004. For fiscal year
2003, OMB required the Chief Financial Officers (CFO) Act
agencies[Footnote 5] to deliver their Performance and Accountability
Reports, including their audited financial statements, to OMB by
January 30, 2004. However, to prepare for meeting the required November
15 accelerated reporting date for fiscal year 2004, OMB encouraged the
CFO Act agencies to accelerate the issuance of their fiscal year 2003
audited financial statements to November 15, 2003, or as close to that
date as possible. OMB reported that 8 CFO Act agencies--the Department
of Education, the Environmental Protection Agency, the Department of
Health and Human Services, the National Science Foundation, the Social
Security Administration, the Department of the Treasury, the Agency for
International Development, and the Department of Veterans Affairs--were
able to issue their fiscal year 2003 financial statements with
unqualified audit opinions by mid-November 2003. Another 10 CFO Act
agencies issued their financial statements by December 31, 2003, and
the remaining 5 CFO Act agencies issued by the end of January 2004. A
24th major agency, the Department of Homeland Security (DHS),[Footnote
6] issued its financial statements on February 13, 2004. DHS faced a
herculean challenge with respect to issuing audited financial
statements, since the department had been in operation only for the
last 7 months of the fiscal year and involved a transfer of operations
from a number of diverse entities, some with known financial management
problems.
While these results represent a significant improvement over previous
years in the timeliness of CFO Act agencies' issuance of audited
financial statements, they also demonstrate the significant challenges
that the federal government will face in meeting the November 15
accelerated reporting date for fiscal year 2004. Auditors at several of
the CFO Act agencies reported that the agencies may not be able to
produce auditable financial statements within the accelerated time
frame for fiscal year 2004 without making fundamental changes to
improve a number of their financial management practices. For example,
certain federal agency auditors reported that major improvements are
needed in (1) management controls to monitor established policies and
procedures for conducting financial analyses and reconciliations
throughout the year, (2) fully integrating financial management
systems, and (3) providing adequate and skilled staff to support
efficient, effective preparation of federal agency consolidated
financial statements. Our experience as the auditor of the financial
statements of the Internal Revenue Service, which successfully
accelerated its reporting to November 15 beginning with its fiscal year
2002 financial statements, showed that significant changes had to be
made to improve routine financial management procedures in order to be
able to accelerate reporting.
For fiscal year 2003, as in fiscal year 2002, 20 of 23 CFO Act agencies
were able to attain unqualified audit opinions on their financial
statements (see table 1 and app. I),[Footnote 7] up from 6 agencies for
fiscal year 1996. This is the same number of unqualified opinions
received by these CFO Act agencies for fiscal year 2002. However, 2
agencies' fiscal year 2003 opinions were different from those they
received for fiscal year 2002. The Agency for International Development
received an unqualified opinion on all of its fiscal year 2003
financial statements for the first time, while the National Aeronautics
and Space Administration (NASA), which for fiscal year 2002 received an
unqualified opinion on its financial statements, received a disclaimer
of opinion for fiscal year 2003. DHS, which as I mentioned before
prepared consolidated financial statements for fiscal year 2003
covering its first 7 months of operations, received a qualified opinion
on two of the six required financial statements.[Footnote 8]
In identifying improved financial performance as one of its five
governmentwide initiatives, the President's Management Agenda
recognized that a clean (unqualified) financial audit opinion is a
basic prescription for any well-managed organization. At the same time,
it recognized that "most federal agencies that obtain clean audits only
do so after making extraordinary, labor-intensive assaults on financial
records" at or after year-end. The President's Management Agenda
further recognized that without sound internal control and accurate and
timely financial information, it is not possible to accomplish the
agenda and secure the best performance and highest measure of
accountability for the American people. The JFMIP Principals have
defined certain measures, in addition to receiving an unqualified
financial statement opinion, for achieving financial management
success. These additional measures include being able to routinely
provide timely, accurate, and useful financial and performance
information and having no material internal control weaknesses or
material noncompliance with laws and regulations and the requirements
of the Federal Financial Management Improvement Act of 1996
(FFMIA).[Footnote 9] As shown in table 1, while the severity and
magnitude of the problems identified vary greatly, reports of
inspectors general and their contract auditors indicated that for
fiscal year 2003 only 3 of the 23 CFO Act agencies had neither a
material weakness in internal control, an issue involving compliance
with applicable laws and regulations, nor an instance of lack of
substantial compliance with the requirements of FFMIA.
Table 1: Fiscal Year 2003 CFO Act Agency Results Reported by Auditors:
Agencies with unqualified opinions: 20[A];
Agencies with unqualified opinions and no material weaknesses or
noncompliances: 3[B].
Source: GAO.
[A] Agriculture, Commerce, Education, Energy, Health and Human
Services, Housing and Urban Development, Interior, Justice, Labor,
State, Transportation, Treasury, Veterans Affairs, Agency for
International Development, Environmental Protection Agency, General
Services Administration, National Science Foundation, Nuclear
Regulatory Commission, Office of Personnel Management, and Social
Security Administration.
[B] Energy, National Science Foundation, and Social Security
Administration.
[End of table]
In this testimony, I will highlight the major issues relating to the
consolidated financial statements for fiscal years 2003 and 2002,
discuss systems problems that continue to hinder federal agency
accountability, and describe progress that has been made toward
addressing major impediments to an opinion on the consolidated
financial statements. I will also discuss why sound financial
management today and in the future is critical to meeting tomorrow's
fiscal needs and the need for "truth and transparency" in connection
with our nation's financial condition and fiscal outlook.
Highlights of Major Issues Related to the U.S. Government's
Consolidated Financial Statements for Fiscal Years 2003 and 2002:
As I mentioned earlier, as has been the case for the previous 6 fiscal
years, the federal government continues to have a significant number of
material weaknesses related to financial systems, fundamental
recordkeeping and financial reporting, and incomplete documentation.
Several of these material weaknesses (referred to hereafter as material
deficiencies) resulted in conditions that continued to prevent us from
forming and expressing an opinion on the U.S. government's consolidated
financial statements for the fiscal years ended September 30, 2003 and
2002.[Footnote 10] There may also be additional issues that could
affect the consolidated financial statements that have not been
identified.
Major challenges include the federal government's inability to:
* properly account for and report property, plant, and equipment and
inventories and related property, primarily at the Department of
Defense (DOD);
* reasonably estimate or adequately support amounts reported for
certain liabilities, such as environmental and disposal liabilities and
related costs at DOD, and ensure complete and proper reporting for
commitments and contingencies;
* support major portions of the total net cost of government
operations, most notably related to DOD, and ensure that all
disbursements are properly recorded;
* fully account for and reconcile intragovernmental activity and
balances;
* demonstrate how net outlay amounts reported in the consolidated
financial statements were related to net outlay amounts reported in the
underlying federal agencies' financial statements; and:
* effectively prepare the federal government's financial statements,
including ensuring that the consolidated financial statements are
consistent with the underlying audited agency financial statements,
balanced, and in conformity with GAAP.
In addition to these material deficiencies, we identified four other
material weaknesses in internal control related to loans receivable and
loan guarantee liabilities, improper payments, information security,
and tax collection activities.
The material weaknesses identified by our work are discussed in more
detail in appendix II, and their primary effects are described in
appendix III.
Recurring Systems Problems Hinder Accountability:
The ability to produce the data needed to efficiently and effectively
manage the day-to-day operations of the federal government and provide
accountability to taxpayers and the Congress has been a long-standing
challenge at most federal agencies. The results of the fiscal year 2003
assessments performed by agency inspectors general or their contract
auditors under FFMIA show that these problems continue to plague the
financial management systems used by most of the CFO Act agencies.
While the problems are much more severe at some agencies than at
others, their nature and severity indicate that overall, management at
most CFO Act agencies lacks the full range of information needed for
accountability, performance reporting, and decision making. These
problems include nonintegrated financial systems, lack of accurate and
timely recording of data, inadequate reconciliation procedures, and
noncompliance with accounting standards and the U.S. Government
Standard General Ledger (SGL).
Agencies' inability to meet the federal financial management systems
requirements continues to be the major barrier to achieving compliance
with FFMIA. Under FFMIA, CFO Act agency auditors are required to
report, as part of the agencies' financial statement audits, whether
agencies' financial management systems substantially comply with (1)
federal financial management systems requirements, (2) applicable
federal accounting standards, and (3) the SGL at the transaction level.
As shown in figure 1, auditors most frequently reported instances of
noncompliance with federal financial management systems requirements.
These instances of noncompliance involved not only core financial
systems, but also administrative and programmatic systems.
Figure 1: Auditors' FFMIA Assessments for Fiscal Years 2000, 2001,
2002, and 2003:
[See PDF for image]
[End of figure]
For fiscal year 2003, auditors for 17 of the 23 CFO Act agencies
reported that the agencies' financial management systems did not comply
substantially with one or more of FFMIA's three requirements. For the
remaining 6 CFO Act agencies, auditors provided negative assurance,
meaning that nothing came to their attention indicating that the
agencies' financial management systems did not substantially meet FFMIA
requirements. The auditors for these 6 agencies did not definitively
state whether the agencies' systems substantially complied with FFMIA
requirements, as is required under the statute. DHS is not subject to
the requirements of the CFO Act and, consequently, is not required to
comply with FFMIA. Accordingly, DHS's auditors did not report on DHS's
compliance with FFMIA. However, the auditors identified and reported
deficiencies that related to the aforementioned three requirements of
FFMIA.
Federal agencies have recognized the seriousness of their financial
systems weaknesses and have efforts under way to implement or upgrade
their financial systems to alleviate long-standing problems, but some
of these efforts face significant challenges. For example, as we
testified in May 2004,[Footnote 11] we have identified several issues
related to NASA's financial management systems modernization effort:
(1) NASA did not involve key stakeholders in the design and
implementation of the agency's new financial management system's core
financial module; (2) NASA did not follow key best practices for
acquiring and implementing this system; and (3) the new system lacks
key external reporting capabilities for property and budgetary data. In
addition, as I will discuss later in this testimony, DOD faces major
challenges in its efforts to develop a business enterprise
architecture. We recognize that it will take time, investment, and
sustained emphasis to improve agencies' underlying financial management
systems.
Addressing Major Impediments to an Opinion on Consolidated Financial
Statements:
As I mentioned earlier, for the past 7 fiscal years, the federal
government has been required to prepare, and have audited, consolidated
financial statements. Successfully meeting this requirement is tightly
linked to the requirements for the CFO Act agencies to also have
audited financial statements. This has stimulated extensive cooperative
efforts and considerable attention by agency chief financial officers,
inspectors general, Treasury and OMB officials, and GAO. With the
benefit of the past 7 years' experience by the federal government in
having the required financial statements subjected to audit, more
intensified attention will be needed on the most serious obstacles to
achieving an opinion on the U.S. government's consolidated financial
statements. Three major impediments to an opinion on the consolidated
financial statements are (1) serious financial management problems at
DOD, (2) the federal government's inability to fully account for and
reconcile transactions between federal government entities, and (3) the
federal government's ineffective process for preparing the consolidated
financial statements.
Financial Management at DOD:
Essential to achieving an opinion on the consolidated financial
statements is resolution of the serious financial management problems
at DOD, which we have designated as high risk[Footnote 12] since 1995.
In accordance with section 1008 of the National Defense Authorization
Act for Fiscal Year 2002,[Footnote 13] DOD reported that for fiscal
year 2003, it was not able to provide adequate evidence supporting
material amounts in its financial statements. DOD stated that it is
unable to comply with applicable financial reporting requirements for
(1) property, plant, and equipment (PP&E); (2) inventory and operating
materials and supplies; (3) environmental liabilities; (4)
intragovernmental eliminations and related accounting adjustments; (5)
disbursement activity; and (6) cost accounting by responsibility
segment. Although DOD represented that the military retirement health
care liability data had improved for fiscal year 2003, the cost of
direct health care provided by DOD-managed military treatment
facilities was a significant amount of DOD's total recorded health
care liability and was based on estimates for which adequate support
was not available.
DOD continues to confront pervasive decades-old financial management
and business problems related to its systems, processes (including
internal controls), and people (human capital). These problems preclude
the department from producing accurate, reliable, and timely
information to make sound decisions and to accurately report on its
billions of dollars of assets. DOD's long-standing business management
systems problems adversely affect the economy, effectiveness, and
efficiency of its operations and have resulted in a lack of adequate
accountability across all major business areas. To date, none of the
military services or major DOD components has passed the test of an
independent financial audit[Footnote 14] because of pervasive
weaknesses in financial management systems, operations, and controls.
Additionally, the department's stovepiped, duplicative, and
nonintegrated systems contribute to its vulnerability to fraud, waste,
and abuse. In this regard, we have recently testified on problems
related to military pay[Footnote 15] and unused airline tickets.
[Footnote 16] Vulnerability to fraud, waste, and abuse continues
despite substantial systems investment. For fiscal year 2004, DOD
requested approximately $19 billion to operate, maintain, and modernize
its reported 2,274 business systems. The duplicative and stovepiped
nature of DOD's systems environment is illustrated by the numerous
systems it has in the same functional areas. For example, DOD reported
that it has 565 systems to support logistics functions. These systems
are not integrated and thus have multiple points of data entry, which
can result in significant data integrity problems.
Further, DOD continues to lack effective management oversight and
control over business systems modernization investments. The actual
funding continues to be distributed among the military services and
defense agencies, thereby enabling the numerous DOD components to
continue to develop stovepiped, parochial solutions to the department's
long-standing financial management and business operation challenges.
Lacking a departmentwide focus and effective management oversight and
control of business systems investment, DOD continues to invest
billions of dollars in systems that fail to provide integrated
corporate solutions to its long-standing business operations problems.
Over the past 14 years, DOD has initiated several broad-based reform
efforts intended to fundamentally reform its business operations and
improve the reliability of information used in the decision-making
process. While these initiatives produced some incremental
improvements, they did not result in the fundamental reform necessary
to resolve the department's long-standing management challenges.
Secretary Rumsfeld has made business transformation a priority. For
example, through its Business Management Modernization Program, DOD is
continuing its efforts to develop and implement a business enterprise
architecture and establish effective management and control over its
business system modernization investments.
However, we recently reported[Footnote 17] that after about 3 years of
effort and over $203 million in obligations, we have not seen
significant change in the content of DOD's architecture or in DOD's
approach to investing billions of dollars annually in existing and new
systems. Few actions have been taken to address the recommendations we
made in our previous reports,[Footnote 18] which were aimed at
improving DOD's plans for developing the next version of the
architecture and implementing the institutional means for selecting and
controlling both planned and ongoing business systems investments. To
date, DOD has not addressed 22 of our 24 recommendations.
Currently, DOD has various initiatives under way to support its efforts
to obtain an unqualified audit opinion on its fiscal year 2007
financial statements. Because there are not yet detailed plans guiding
these activities, however, it is unclear whether and how they support
each other and whether they support this goal. Therefore, the
feasibility of meeting this goal is as yet unknown.
The seriousness of DOD's business management weaknesses underscores the
importance of no longer condoning "status quo" business operations at
DOD. Cultural resistance to change, military service parochialism, and
stovepiped operations have all contributed significantly to the failure
of previous attempts to implement broad-based management reforms at
DOD. The department has acknowledged that it confronts decades-old
problems deeply grounded in the bureaucratic history and operating
practices of a complex, multifaceted organization and that many of
these practices were developed piecemeal and evolved to accommodate
different organizations, each with its own policies and procedures.
To improve the likelihood that the department's current business
transformation efforts will be successful, we have previously
suggested[Footnote 19] that a chief management official[Footnote 20]
position be created. Previous failed attempts to improve DOD's business
operations illustrate the need for sustained involvement of DOD
leadership in helping to assure that DOD's financial and overall
business process transformation efforts remain a priority. While the
Secretary and other key DOD leaders have demonstrated their commitment
to the current business transformation efforts, the long-term nature of
these efforts requires the development of an executive position capable
of providing strong and sustained executive leadership over a number of
years and various administrations.
This position would provide the sustained attention essential for
addressing key stewardship responsibilities such as strategic planning,
performance and financial management, and business systems
modernization in an integrated manner. This position could be filled by
an individual, appointed by the President and confirmed by the Senate,
for a set term of 7 years with the potential for reappointment. Such an
individual should have a proven track record as a business process
change agent in large, complex, and diverse organizations--experience
necessary to spearhead business process transformation across the
department, and potentially administrations, and serve as an integrator
for the needed business transformation efforts.
Further, in a recent report[Footnote 21] we also suggest that to
improve management oversight, accountability, and control of the
department's business systems funding, Congress may wish to consider
providing the funds to operate, maintain, and modernize DOD's business
systems to the functional areas, known as domains, rather than the
military services and the defense agencies. Currently, each military
service and defense agency receives its own funding and is largely
autonomous in deciding how to spend these funds, thereby hindering the
development of broad-based, integrated corporate system solutions to
common DOD-wide problems. We believe it is critical that funds for DOD
business systems be appropriated to the domain owners in order to
provide for accountability and the ability to prevent the continued
parochial approach to systems investment that exists today. The domains
would establish a hierarchy of investment review boards with DOD-wide
representation, including the military services and defense agencies.
These boards would be responsible for reviewing and approving
investments to develop, operate, maintain, and modernize business
systems for the domain portfolio, including ensuring that investments
were consistent with DOD's business enterprise architecture.
DOD still has a long way to go, and top leadership must continue to
stress the importance of achieving lasting improvement that truly
transforms the department's business systems and operations. Only
through major transformation, which will take time and sustained
leadership from top management, will DOD be able to meet the mandate of
the CFO Act and achieve the President's Management Agenda goal of
improved financial performance.
Intragovernmental Transactions:
OMB and Treasury require the CFOs of 35 executive departments and
agencies, including the 23 CFO Act agencies, to reconcile selected
intragovernmental activity and balances with their "trading
partners"[Footnote 22] and to report to Treasury, the agency's
inspector general, and GAO on the extent and results of
intragovernmental activity and balances reconciliation efforts. A
substantial number of the agencies continue to be unable to fully
perform reconciliations of intragovernmental activity and balances with
their trading partners, citing reasons such as (1) trading partners not
providing needed data; (2) limitations and incompatibility of agency
and trading partner information systems; and (3) lack of human
resources. Amounts reported for federal agency trading partners for
certain intragovernmental accounts were significantly out of balance in
the aggregate for both fiscal years 2003 and 2002.
We reported in previous years that the heart of the intragovernmental
transactions issue was that the federal government lacked clearly
articulated business rules for these transactions so that they would be
handled consistently by agencies. In this regard, at the start of
fiscal year 2003, OMB issued business rules to transform and
standardize intragovernmental ordering and billing. To address long-
standing problems with intragovernmental exchange transactions between
federal agencies, Treasury provided federal agencies with quarterly
detailed trading partner information during fiscal year 2003 to help
them better perform their trading partner reconciliations. In addition,
the federal government began a three-phase Intragovernmental
Transactions e-gov project to define a governmentwide data architecture
and provide a single source of detailed trading partner data. On April
20, 2004, however, OMB announced that it was appropriate to pause and
evaluate the results of the project to date. OMB estimated that the
evaluation will take 120 days and will be followed by a phased
deployment. Resolving the intragovernmental transactions problem
remains a difficult challenge and will require a commitment by the CFO
Act agencies and continued strong leadership by OMB.
Preparing the Consolidated Financial Statements:
The federal government did not have adequate systems, controls, and
procedures to ensure that the consolidated financial statements are
consistent with the underlying audited agency financial statements,
balanced, and in conformity with GAAP. In this regard, Treasury is
developing a new system and procedures to prepare the consolidated
financial statements beginning with the statements for fiscal year
2004. Treasury officials have stated that these actions are intended
to, among other things, directly link information from federal
agencies' audited financial statements to amounts reported in the
consolidated financial statements and resolve many of the issues we
identified in the process for preparing the consolidated financial
statements. As part of our fiscal year 2004 audit, we will evaluate the
new system and procedures as they are fully developed and implemented
and determine the extent of linkage accomplished for the fiscal year
2004 financial statements. Resolving issues surrounding preparing the
consolidated financial statements has been a significant challenge and
will require continued strong leadership by Treasury management.
Truth and Transparency in the Fiscal Outlook:
Our nation's large and growing long-term fiscal imbalance, which is
driven largely by known demographic trends and rising health care
costs--coupled with new homeland security and defense commitments--
serves to sharpen the need to fundamentally review and re-examine basic
federal entitlements, as well as other mandatory and discretionary
spending, and tax policies. As we look ahead, our nation faces an
unprecedented demographic challenge with significant implications,
among them budgetary and economic. Between now and 2035, the number of
people who are 65 years old or over will double, driving federal
spending on the elderly to a larger and ultimately unsustainable share
of the federal budget. As a result, tough choices will be required to
address the resulting structural imbalance.
GAO prepares long-term budget simulations that seek to illustrate the
likely fiscal consequences of the coming demographics and rising health
care costs. Our latest long-term budget simulations reinforce the need
for change in the major cost drivers--Social Security and health care
programs. As shown in figure 2, by 2040, absent reform of these
entitlement programs, projected federal revenues may be adequate to pay
little beyond interest on the debt.
Figure 2: Composition of Spending as a Share of GDP Assuming
Discretionary Spending Grows with GDP after 2004 and All Expiring Tax
Provisions Are Extended:
[See PDF for image]
Note: Although expiring tax provisions are extended, revenue as a share
of gross domestic product (GDP) increases through 2014 due to (1) real
bracket creep, (2) more taxpayers becoming subject to the alternative
minimum tax, and (3) increased revenue from tax-deferred retirement
accounts. After 2014, revenue as a share of GDP is held constant.
[End of figure]
Current financial reporting does not clearly and transparently show the
wide range of responsibilities, programs, and activities that may
either obligate the federal government to future spending or create an
expectation for such spending and provides an unrealistic and even
misleading picture of the federal government's overall performance and
financial condition. Few agencies adequately show the results they are
getting with the taxpayer dollars they spend. In addition, too many
significant federal government commitments and obligations, such as
Social Security and Medicare, are not fully and consistently disclosed
in the federal government's consolidated financial statements and
budget, and current federal financial reporting standards do not
require such disclosure.[Footnote 23] Figure 3 shows some selected
fiscal exposures. The spectrum of these exposures ranges from covering
only the explicit liabilities that are shown on the consolidated
financial statements to implicit promises embedded in current policy or
public expectations. These liabilities, commitments, and promises have
created a fiscal imbalance that will put unprecedented strains on the
nation's spending and tax policies. Although economic growth can help,
the projected fiscal gap is now so large that the federal government
will not be able to simply grow its way out of the problem. Tough
choices are inevitable.
Figure 3: Selected Fiscal Exposures: Sources and Examples[A]:
[See PDF for image]
[A] All figures are as of the end of fiscal year 2003, except Social
Security and Medicare estimates, which are as of the end of calendar
year 2003.
[B] This amount includes $774 billion held by military and civilian
pension funds that would offset the explicit liabilities reported by
those funds.
[C] Figures for Social Security and Medicare are net of debt held by
the trust funds ($1,531 billion for Social Security, $256 billion for
Medicare Part A, and $24 billion for Medicare Part B) and represent net
present value estimates over a 75-year period. Over an infinite
horizon, the estimate for Social Security would be $10.4 trillion,
$21.8 trillion for Medicare Part A, $23.2 trillion for Medicare Part B,
and $16.5 trillion for Medicare Part D.
[End of figure]
Particularly troubling are the many big-ticket items that taxpayers
will eventually have to deal with. The federal government has pledged
its support to a long list of programs and activities, including
pension and health care benefits for senior citizens, medical care for
veterans, and contingencies associated with various government-
sponsored entities, whose claims on future spending total trillions of
dollars. Despite their serious implications for future budgets, tax
burdens, and spending flexibilities, these unfunded commitments get
short shrift in the federal government's current financial statements
and in budgetary deliberations.
The federal government's gross debt as of September 2003 was about $7
trillion, or about $24,000 for every man, woman, and child in this
country today. But that number excludes many big-ticket items,
including the gap between promised and funded Social Security and
Medicare benefits, veterans' health care, and a range of other
commitments and contingencies. If these items are factored in, the
total burden in current dollars is at least $42 trillion. To put that
number into perspective, $42 trillion is 18 times the current federal
budget, or 3.5 times our current annual gross domestic product. One of
the biggest contributors to this total bill will be the new Medicare
prescription drug benefit, whose estimated current-dollar cost over the
next 75 years is more than $8 trillion. Stated differently, the current
total burden for every American is more than $140,000--and every day
that burden is growing larger. GAO's long-term budget simulations show
that by 2040, the federal government may have to cut federal spending
by 60 percent or raise taxes to about 2.5 times today's level to pay
for the mounting cost of the federal government's current unfunded
commitments. Either would be devastating.
Proper accounting and reporting practices are essential in the public
sector. After all, the U.S. government is the largest, most diverse,
most complex, and arguably the most important entity on earth today.
Its services--homeland security, national defense, Social Security,
mail delivery, and food inspection, to name a few--directly affect the
well-being of almost every American. But sound decisions on the future
direction of vital federal government programs and policies are made
more difficult without timely, accurate, and useful financial and
performance information.
Fortunately, we are starting to see efforts to address the shortcomings
in federal financial reporting. The President's Management Agenda,
which closely reflects GAO's list of high-risk government programs, is
bringing attention to troubled areas across the federal government and
is taking steps to better assess the results that programs are getting
with the resources they are given. The Federal Accounting Standards
Advisory Board is also making progress on many key financial reporting
issues.
In addition to these efforts, we have published frameworks for
analyzing various Social Security reform proposals[Footnote 24] and for
analyzing health care reform proposals.[Footnote 25] We have also
helped to create a consortium of "good government" organizations to
stimulate the development of a set of key national indicators to assess
the United States' overall position and progress over time and in
comparison to those of other industrialized nations.
Budget experts at the Congressional Budget Office (CBO) and GAO
continue to encourage reforms to the federal budget process to better
reflect the federal government's commitments and signal emerging
problems. Among other things, we have recommended that the federal
government issue an annual report on major fiscal exposures. The
President's fiscal year 2005 budget also proposes that future
President's budgets report on any enacted legislation in the past year
that worsens the unfunded obligations of programs with long-term
actuarial projections, with CBO to make a similar report. Such
reporting could be a good starting point.
Although these are positive initial steps, much more must be done given
the magnitude of the federal government's fiscal challenge. A top-to-
bottom review of government activities to ensure their relevance and
fit for the 21st century and their relative priority is long overdue.
As I have spoken about in the past, the federal government needs a
three-pronged approach to (1) restructure existing entitlement
programs, (2) reexamine the base of discretionary and other spending,
and (3) review and revise the federal government's tax policy,
including major tax preferences, and enforcement programs. New
accounting and reporting approaches, budget control mechanisms, and
metrics are needed for considering and measuring the impact of spending
and tax policies and decisions over the long term.
Closing Comments:
Our report on the U.S. government's consolidated financial statements
for fiscal years 2003 and 2002 highlights the need to continue
addressing the federal government's serious financial management
weaknesses. With the significantly accelerated financial reporting time
frame for fiscal year 2004 and beyond, it is essential that the federal
government move away from the extraordinary efforts many federal
agencies continue to make to prepare financial statements and toward
giving prominence to strengthening the federal government's financial
systems, reporting, and controls. This is the only way the federal
government can meet the end goal of making timely, accurate, and useful
financial and performance information routinely available to the
Congress, other policymakers, and the American public. The requirement
for timely, accurate, and useful financial and performance management
information is greater than ever as our nation faces major long-term
fiscal challenges that will require tough choices in setting priorities
and linking resources to results.
The Congress and the President face the challenge of sorting out the
many claims on the federal budget without the budget enforcement
mechanisms or fiscal benchmarks that guided the federal government
through the previous years of deficit reduction into the brief period
of surplus. While a number of steps will be necessary to address this
challenge, truth and transparency in federal government reporting are
essential elements of any attempt to address the nation's long-term
fiscal challenges. The fiscal risks I mentioned earlier can be managed
only if they are properly accounted for and publicly disclosed. A
crucial first step will be to face facts and identify the significant
commitments facing the federal government. If citizens and federal
government officials come to understand various fiscal exposures and
their potential claims on future budgets, they are more likely to
insist on prudent policy choices today and sensible levels of fiscal
risk in the future. In addition, new budget control mechanisms will be
required, along with effective approaches to successfully engage in a
fundamental review, reassessment, and reprioritization of the base of
federal government programs and policies that I have recommended
previously.
Public officials will have more incentive to make difficult but
necessary choices if the public has the facts and comes to support
serious and sustained action to address the nation's fiscal challenges.
Without meaningful public debate, however, real and lasting change is
unlikely. Clearly, the sooner action is taken, the easier it will be to
turn things around.
I believe that nothing less than a national education campaign and
outreach effort is needed to help the public understand the nature and
magnitude of the long-term financial challenge facing this nation. An
informed electorate is essential for a healthy democracy. Members of
Generations X and Y especially need to become active in this discussion
because they and their children will bear the heaviest burden if
policymakers fail to act in a timely and responsible manner.
We at GAO are committed to doing our part, but others also need to step
up to the plate. By working together, I believe we can make a
meaningful difference for our nation, fellow citizens, and future
generations of Americans.
In closing, Mr. Chairman, I want to reiterate the value of sustained
congressional interest in these issues, as demonstrated by the
Congress's annual hearings on the results of our audit of the
consolidated financial statements and of audits of certain federal
agencies' financial statements. It will also be key that the
appropriations, budget, authorizing, and oversight committees hold
agency top leadership accountable for resolving these problems and that
they support improvement efforts.
Contacts:
For further information regarding this testimony, please contact
Jeffrey C. Steinhoff, Managing Director, or Gary T. Engel, Director,
Financial Management and Assurance, at (202) 512-2600.
[End of section]
Appendix I: Selected Major Federal Agencies: Fiscal Year 2003 Audit
Results, Principal Auditors, and Number of Other Audit Contractors:
23 CFO Act agencies: Agency for International Development;
Audit results: Unqualified;
Principal auditor: Inspector General;
Number of: other audit contractors: 1.
23 CFO Act agencies: Agriculture;
Audit results: Unqualified;
Principal auditor: Inspector General;
Number of: other audit contractors: 3.
23 CFO Act agencies: Commerce;
Audit results: Unqualified;
Principal auditor: KPMG LLP;
Number of: other audit contractors: 0.
23 CFO Act agencies: Defense;
Audit results: Disclaimer;
Principal auditor: Inspector General;
Number of: other audit contractors: 1.
23 CFO Act agencies: Education;
Audit results: Unqualified;
Principal auditor: Ernst & Young LLP;
Number of: other audit contractors: 0.
23 CFO Act agencies: Energy;
Audit results: Unqualified;
Principal auditor: KPMG LLP;
Number of: other audit contractors: 0.
23 CFO Act agencies: Environmental Protection Agency;
Audit results: Unqualified;
Principal auditor: Inspector General;
Number of: other audit contractors: 0.
23 CFO Act agencies: General Services Administration;
Audit results: Unqualified;
Principal auditor: PricewaterhouseCoopers LLP;
Number of: other audit contractors: 0.
23 CFO Act agencies: Health and Human Services;
Audit results: Unqualified;
Principal auditor: Inspector General;
Number of: other audit contractors: 4.
23 CFO Act agencies: Housing and Urban Development;
Audit results: Unqualified;
Principal auditor: Inspector General;
Number of: other audit contractors: 1.
23 CFO Act agencies: Interior;
Audit results: Unqualified;
Principal auditor: KPMG LLP;
Number of: other audit contractors: 0.
23 CFO Act agencies: Justice;
Audit results: Unqualified;
Principal auditor: PricewaterhouseCoopers LLP;
Number of: other audit contractors: 2.
23 CFO Act agencies: Labor;
Audit results: Unqualified;
Principal auditor: R. Navarro & Associates, Inc;
Number of: other audit contractors: 2.
23 CFO Act agencies: National Aeronautics and Space Administration;
Audit results: Disclaimer;
Principal auditor: PricewaterhouseCoopers LLP;
Number of: other audit contractors: 2.
23 CFO Act agencies: National Science Foundation;
Audit results: Unqualified;
Principal auditor: KPMG LLP;
Number of: other audit contractors: 0.
23 CFO Act agencies: Nuclear Regulatory Commission;
Audit results: Unqualified;
Principal auditor: R. Navarro & Associates, Inc;
Number of: other audit contractors: 0.
23 CFO Act agencies: Office of Personnel Management;
Audit results: Unqualified;
Principal auditor: KPMG LLP;
Number of: other audit contractors: 0.
23 CFO Act agencies: Small Business Administration;
Audit results: Disclaimer;
Principal auditor: Cotton & Company LLP;
Number of: other audit contractors: 0.
23 CFO Act agencies: Social Security Administration;
Audit results: Unqualified;
Principal auditor: PricewaterhouseCoopers LLP;
Number of: other audit contractors: 0.
23 CFO Act agencies: State;
Audit results: Unqualified;
Principal auditor: Leonard G. Birnbaum and Company, LLP;
Number of: other audit contractors: 2.
23 CFO Act agencies: Transportation;
Audit results: Unqualified;
Principal auditor: Inspector General;
Number of: other audit contractors: 2.
23 CFO Act agencies: Treasury;
Audit results: Unqualified;
Principal auditor: Inspector General;
Number of: other audit contractors: 6[A].
23 CFO Act agencies: Veterans Affairs;
Audit results: Unqualified;
Principal auditor: Deloitte & Touche LLP;
Number of: other audit contractors: 0.
Other major agency Homeland Security;
Audit results: Disclaimer[B];
Principal auditor: KPMG LLP;
Number of: other audit contractors: 0.
Source: GAO.
[A] In addition, GAO audited the Internal Revenue Service's financial
statements and the Schedules of Federal Debt Managed by the Bureau of
the Public Debt.
[B] DHS began operations as an agency 5 months after the start of the
fiscal year, on March 1, 2003. Transfers of funds, assets, liabilities,
and obligations from 22 existing federal agencies to DHS began on March
1, 2003. DHS's auditors issued a qualified opinion on the consolidated
balance sheet and statement of custodial activity as of September 30,
2003, and disclaimed on the consolidated statement of net cost,
consolidated statement of changes in net position, combined statement
of budgetary resources, and consolidated statement of financing for the
7 months ended September 30, 2003.
[End of table]
[End of section]
Appendix II: Material Deficiencies:
The federal government did not maintain adequate systems or have
sufficient, reliable evidence to support information reported in the
consolidated financial statements of the U.S. government, as described
below. These material deficiencies contributed to our disclaimer of
opinion on the consolidated financial statements and also constitute
material weaknesses in internal control.
Property, Plant, and Equipment and Inventories and Related Property:
The federal government could not satisfactorily determine that all PP&E
and inventories and related property were included in the consolidated
financial statements, verify that certain reported assets actually
exist, or substantiate the amounts at which they were valued. Most of
the PP&E and inventories and related property are the responsibility of
DOD. As in past years, DOD did not maintain adequate systems or have
sufficient records to provide reliable information on these assets.
Other agencies, most notably the National Aeronautics and Space
Administration, reported continued weaknesses in internal control
procedures and processes related to PP&E.
Liabilities and Commitments and Contingencies:
The federal government could not reasonably estimate or adequately
support amounts reported for certain liabilities. For example, DOD was
not able to estimate with assurance key components of its environmental
and disposal liabilities. In addition, DOD could not support a
significant amount of its estimated military postretirement health
benefits liabilities included in federal employee and veteran benefits
payable. These unsupported amounts related to the cost of direct health
care provided by DOD-managed military treatment facilities. Further,
the federal government could not determine whether commitments and
contingencies, including those related to treaties and other
international agreements entered into to further the U.S. government's
interests, were complete and properly reported.
Cost of Government Operations and Disbursement Activity:
The previously discussed material deficiencies in reporting assets and
liabilities, material deficiencies in financial statement preparation,
as discussed below, and the lack of adequate disbursement
reconciliations at certain federal agencies affect reported net costs.
As a result, the federal government was unable to support significant
portions of the total net cost of operations, most notably related to
DOD.
With respect to disbursements, DOD and certain other federal agencies
did not adequately reconcile disbursement activity. For fiscal years
2003 and 2002 there were unsupported adjustments to federal agencies'
records and unreconciled disbursement activity, including unreconciled
differences between federal agencies' and Treasury's records of
disbursements, totaling billions of dollars, which could also affect
the balance sheet.
Accounting for and Reconciliation of Intragovernmental Activity and
Balances:
OMB and Treasury require the CFOs of 35 executive departments and
agencies, including the 23 CFO Act agencies, to reconcile selected
intragovernmental activity and balances with their "trading
partners"[Footnote 26] and to report to Treasury, the agency's
inspector general, and GAO on the extent and results of
intragovernmental activity and balances reconciliation efforts. A
substantial number of the agencies did not fully perform the required
reconciliations for fiscal years 2003 and 2002, citing reasons such as
(1) trading partners not providing needed data, (2) limitations and
incompatibility of agency and trading partner information systems, and
(3) lack of human resources. For both of these years, amounts reported
for federal agency trading partners for certain intragovernmental
accounts were significantly out of balance. Treasury's ability to
eliminate certain intragovernmental activity and balances is impaired
by these federal agencies' problems in handling their intragovernmental
transactions.
Net Outlays:
OMB Bulletin 01-09, Form and Content of Agency Financial
Statements,[Footnote 27] states that outlays in federal agencies'
Statements of Budgetary Resources (SBR) should agree with the
respective agency's net outlays reported in the budget of the U.S.
government. In addition, Statement of Federal Financial Accounting
Standards (SFFAS) No. 7, Accounting for Revenue and Other Financing
Sources and Concepts for Reconciling Budgetary and Financial
Accounting, requires explanation of any material differences between
the information required to be disclosed (including net outlays) and
the amounts described as "actual" in the budget of the U.S. government.
We found material differences between the total net outlays reported in
selected federal agencies' audited SBRs and the records used to prepare
the Statement of Changes in Cash Balance from Unified Budget and Other
Activities (Statement of Changes in Cash Balance),[Footnote 28]
totaling about $140 billion and $186 billion for fiscal years 2003 and
2002, respectively.[Footnote 29] Two agencies (Treasury and the
Department of Health and Human Services (HHS)) accounted for about 83
percent and 75 percent of the differences identified in fiscal years
2003 and 2002, respectively. We found that the major cause of the
differences for the two agencies was the treatment of offsetting
receipts.[Footnote 30] Some offsetting receipts for these two agencies
had not been included in the agencies' SBRs, which would have reduced
the agencies' net outlays and made the amounts more consistent with the
records used to prepare the Statement of Changes in Cash
Balance.[Footnote 31] For example, we found that HHS reported net
outlays for fiscal year 2003 as $596 billion on its audited SBR, while
the records that Treasury uses to prepare the Statement of Changes in
Cash Balance showed $505 billion for fiscal year 2003 for this agency.
Until these differences between the total net outlays reported in the
federal agencies' SBRs and the records used to prepare the Statement of
Changes in Cash Balance are reconciled, the effect that these
differences may have on the U.S. government's consolidated financial
statements will be unknown. OMB has stated that it plans to work with
the agencies to address this issue.
Preparation of Consolidated Financial Statements:
The federal government did not have adequate systems, controls, and
procedures to ensure that the consolidated financial statements are
consistent with the underlying audited agency financial statements,
balanced, and in conformity with generally accepted accounting
principles (GAAP). During our fiscal year 2003 audit, we found the
following:[Footnote 32]
* The process for compiling the consolidated financial statements does
not directly link information from federal agencies' audited financial
statements to amounts reported in the consolidated financial
statements, and therefore does not ensure that the information in the
consolidated financial statements is consistent with the underlying
information in federal agencies' audited financial statements and other
financial data.
* Internal control weaknesses exist in Treasury's process for preparing
the consolidated financial statements, such as a lack of (1)
segregation of duties and (2) appropriate documentation of certain
policies and procedures for preparing the consolidated financial
statements.
* The net position reported in the consolidated financial statements is
derived by subtracting liabilities from assets, rather than through
balanced accounting entries. To make the fiscal years 2003 and 2002
consolidated financial statements balance, Treasury recorded a net
$24.5 billion and a net $17.1 billion decrease, respectively, to net
operating cost on the Statements of Operations and Changes in Net
Position, which it labeled "Unreconciled Transactions Affecting the
Change in Net Position."[Footnote 33] An additional net $11.3 billion
and $12.5 billion of unreconciled transactions were recorded in the
Statements of Net Cost for fiscal years 2003 and 2002, respectively.
Treasury does not identify and quantify all components of these
unreconciled activities, nor does Treasury perform reconciliation
procedures, which would aid in understanding and controlling the net
position balance as well as eliminating the unreconciled transactions
associated with compiling the consolidated financial statements.
* Significant differences in other intragovernmental accounts,
primarily related to appropriations, still remain unresolved.
Intragovernmental activity and balances are "dropped" or "offset" in
the preparation of the consolidated financial statements rather than
eliminated through balanced accounting entries. This contributes to the
federal government's inability to determine the impact of these
differences on amounts reported in the consolidated financial
statements.
* The federal government did not have an adequate process to identify
and report items needed to reconcile the operating results, which for
fiscal year 2003 showed a net operating cost of $665 billion, to the
budget results, which for the same period showed a unified budget
deficit of $374.8 billion.
* The consolidated financial statements include certain financial
information for the executive, legislative, and judicial branches, to
the extent that federal agencies within those branches have provided
Treasury such information. However, there are undetermined amounts of
assets, liabilities, costs, and revenues that are not included, and the
federal government did not provide evidence or disclose in the
consolidated financial statements that such excluded financial
information was immaterial.
* Treasury lacks an adequate process to ensure that the financial
statements, related notes, Stewardship Information, and Supplemental
Information are presented in conformity with GAAP. We found that
certain financial information required by GAAP was not disclosed in the
consolidated financial statements. Treasury did not provide us with
documentation of its rationale for excluding this information. As a
result of this and certain material deficiencies noted above, we were
unable to determine if the missing information was material to the
consolidated financial statements.
Other Material Weaknesses:
In addition to the material deficiencies noted above, we found four
other material weaknesses in internal control as of September 30, 2003:
(1) several federal agencies continue to have deficiencies in the
processes and procedures used to estimate the costs of their lending
programs and value their related loans receivable; (2) most federal
agencies have not reported the magnitude of improper payments in their
programs and activities; (3) federal agencies have not yet fully
institutionalized comprehensive security management programs; and (4)
material internal control weaknesses and systems deficiencies continue
to affect the federal government's ability to effectively manage its
tax collection activities.
Loans Receivable and Loan Guarantee Liabilities:
In general, federal agencies continue to make progress in reducing the
number of material weaknesses and reportable conditions[Footnote 34]
related to their lending activities. However, significant deficiencies
in the processes and procedures used to estimate the costs of certain
lending programs and value the related loans receivable still remain.
These deficiencies continue to adversely affect the government's
ability to support annual budget requests for these programs, make
future budgetary decisions, manage program costs, and measure the
performance of lending activities. The most notable deficiencies
existed at the Small Business Administration (SBA), which, while
improved from last year, continues to have a material weakness related
to this area. For example, SBA did not adequately document its
estimation methodologies, lacked the management controls necessary to
ensure that appropriate estimates were prepared and reported based on
complete and accurate data, and could not fully support the
reasonableness of the costs of its lending programs and valuations of
its loan portfolio. We are currently assessing SBA's actions to resolve
certain of these deficiencies related to accounting for previous loan
sales and cost estimates for disaster loans.
Improper Payments:
Across the federal government, improper payments occur in a variety of
programs and activities, including those related to health care,
contract management, federal financial assistance, and tax
refunds.[Footnote 35] While complete information on the magnitude of
improper payments is not yet available, based on available data, OMB
has estimated that improper payments exceed $35 billion annually. Many
improper payments occur in federal programs that are administered by
entities other than the federal government, such as states. Improper
payments often result from a lack of or an inadequate system of
internal controls. Although the President's Management Agenda includes
an initiative to reduce improper payments, most federal agencies have
not reported the magnitude of improper payments in their programs and
activities.
The Improper Payments Information Act of 2002[Footnote 36] provides for
federal agencies to estimate and report on their improper payments. It
requires federal agencies to (1) annually review programs and
activities that they administer to identify those that may be
susceptible to significant improper payments, (2) estimate improper
payments in susceptible programs and activities, and (3) provide
reports to the Congress that discuss the causes of improper payments
identified and the status of actions to reduce them. In accordance with
the legislation, OMB issued guidance for federal agencies' use in
implementing the act. Among other things, the guidance requires federal
agencies to report on their improper payment-related activities in the
Management Discussion and Analysis section of their annual Performance
and Accountability Reports (PAR). While the act does not require such
reporting by all federal agencies until fiscal year 2004, OMB required
44 programs and 14 CFO Act agencies to report improper payment
information in their fiscal year 2003 PARs. Our preliminary review of
the PARs found that 12 of the 14 agencies reported improper payment
amounts for 27 of the 44 programs identified in the guidance. We also
found that, for the programs where improper payments were identified,
the reports often contained information on the causes of the payments
but little information that addressed the other reporting requirements
cited in the legislation.
Information Security:
Although progress has been made, serious and widespread information
security weaknesses continue to place federal assets at risk of
inadvertent or deliberate misuse, financial information at risk of
unauthorized modification or destruction, sensitive information at risk
of inappropriate disclosure, and critical operations at risk of
disruption. GAO has reported information security as a high-risk area
across government since February 1997. Such information security
weaknesses could result in compromising the reliability and
availability of data that are recorded in or transmitted by federal
financial management systems. A primary reason for these weaknesses is
that federal agencies have not yet fully institutionalized
comprehensive security management programs, which are critical to
identifying information security weaknesses, resolving information
security problems, and managing information security risks on an
ongoing basis. The Congress has shown continuing interest in addressing
these risks, as evidenced by recent hearings on information security
and enactment of the Federal Information Security Management Act of
2002[Footnote 37] and the Cyber Security Research and Development
Act.[Footnote 38] In addition, the administration has taken important
actions to improve information security, such as integrating
information security into the Executive Branch Management
Scorecard.[Footnote 39]
Tax Collection Activities:
Material internal control weaknesses and systems deficiencies continue
to affect the federal government's ability to effectively manage its
tax collection activities.[Footnote 40] Due to errors and delays in
recording activity in taxpayer accounts, taxpayers were not always
credited for payments made on their taxes owed, which could result in
undue taxpayer burden. In addition, the federal government did not
always follow up on potential unreported or underreported taxes and did
not always pursue collection efforts against taxpayers owing taxes to
the federal government.
[End of section]
Appendix III: Primary Effects of the Material Weaknesses Described in
This Report:
Areas Involving Material Weaknesses: Property, plant, and equipment and
inventories and related property;
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated
Financial Statements and the Management of Government Operations:
Without accurate asset information, the federal government does not
fully know the assets it owns and their location and condition and
cannot effectively (1) safeguard assets from physical deterioration,
theft, or loss, (2) account for acquisitions and disposals of such
assets, (3) ensure the assets are available for use when needed, (4)
prevent unnecessary storage and maintenance costs or purchase of assets
already on hand, and (5) determine the full costs of programs that use
these assets.
Areas Involving Material Weaknesses: Liabilities and commitments and
contingencies;
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated
Financial Statements and the Management of Government Operations:
Problems in accounting for liabilities affect the determination of the
full cost of the federal government's current operations and the extent
of its liabilities. Also, improperly stated environmental and disposal
liabilities and weak internal control supporting the process for their
estimation affect the federal government's ability to determine
priorities for cleanup and disposal activities and to allow for
appropriate consideration of future budgetary resources needed to carry
out these activities. In addition, when disclosures of commitments and
contingencies are incomplete or incorrect, reliable information is not
available about the extent of the federal government's obligations.
Areas Involving Material Weaknesses: Cost of government operations and
disbursement activity;
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated
Financial Statements and the Management of Government Operations:
Inaccurate cost information affects the federal government's ability
to control and reduce costs, assess performance, evaluate programs, and
set fees to recover costs where required. Improperly recorded
disbursements could result in misstatements in the financial statements
and in certain data provided by federal agencies for inclusion in the
President's budget concerning obligations and outlays.
Areas Involving Material Weaknesses: Accounting for and reconciliation
of intragovernmental activity and balances;
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated
Financial Statements and the Management of Government Operations:
Problems in accounting for and reconciling intragovernmental activity
and balances impair the government's ability to account for billions of
dollars of transactions between governmental entities.
Areas Involving Material Weaknesses: Net outlays;
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated
Financial Statements and the Management of Government Operations: Until
the differences between the total net outlays reported in federal
agencies' Statements of Budgetary Resources and the records used by the
Department of the Treasury to prepare the Statement of Changes in Cash
Balance from Unified Budget and Other Activities are reconciled, the
effect that these differences may have on the U.S. government's
consolidated financial statements will be unknown.
Areas Involving Material Weaknesses: Preparation of consolidated
financial statements;
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated
Financial Statements and the Management of Government Operations:
Because the federal government did not have adequate systems, controls,
and procedures to prepare its consolidated financial statements, the
federal government's ability to ensure that the consolidated financial
statements are consistent with the underlying audited agency financial
statements, balanced, and in conformity with U.S. generally accepted
accounting principles was impaired.
Areas Involving Material Weaknesses: Improper payments;
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated
Financial Statements and the Management of Government Operations:
Without a systematic measurement of the extent of improper payments,
federal agency management cannot determine (1) if improper payment
problems exist that require corrective action, (2) mitigation
strategies and the appropriate amount of investments to reduce them,
and (3) the success of efforts implemented to reduce improper
payments.
Areas Involving Material Weaknesses: Loans receivable and loan
guarantee liabilities;
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated
Financial Statements and the Management of Government Operations:
Weaknesses in the processes and procedures for estimating credit
program costs affect the government's ability to support annual budget
requests for these programs, make future budgetary decisions, manage
program costs, and measure the performance of lending activities.
Areas Involving Material Weaknesses: Information security weaknesses;
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated
Financial Statements and the Management of Government Operations:
Information security weaknesses over computerized operations are
placing enormous amounts of federal assets at risk of inadvertent or
deliberate misuse, financial information at risk of unauthorized
modification or destruction, sensitive information at risk of
inappropriate disclosure, and critical operations at risk of
disruption.
Areas Involving Material Weaknesses: Tax collection activities;
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated
Financial Statements and the Management of Government Operations:
Weaknesses in controls over tax collection activities continue to
affect the federal government's ability to efficiently and effectively
account for and collect revenue. Additionally, weaknesses in financial
reporting affect the federal government's ability to make informed
decisions about collection efforts. As a result, the federal government
is vulnerable to loss of tax revenue and exposed to potentially
billions of dollars in losses due to inappropriate refund
disbursements.
Source: GAO.
[End of table]
(198304):
FOOTNOTES
[1] In addition, GAO is providing separate statements today on problems
related to financial and business management systems and processes at
the Department of Defense and the Department of Homeland Security. See
U.S. General Accounting Office, Department of Defense: Financial and
Business Management Transformation Hindered by Long-standing Problems,
GAO-04-941T (Washington, D.C.: July 8, 2004), and Department of
Homeland Security: Financial Management Challenges, GAO-04-945T
(Washington, D.C.: July 8, 2004).
[2] A material weakness is a condition that precludes the entity's
internal control from providing reasonable assurance that
misstatements, losses, or noncompliance material in relation to the
financial statements or to stewardship information would be prevented
or detected on a timely basis.
[3] The President's Management Agenda is the Bush administration's
strategy for improving the management and performance of the federal
government. Its purpose is to identify and address the most significant
problems facing the federal government. It contains five governmentwide
and nine agency-specific goals to improve federal management and
deliver results to the American people.
[4] JFMIP is a joint and cooperative undertaking of the Department of
the Treasury, GAO, the Office of Management and Budget (OMB), and the
Office of Personnel Management working in cooperation with each other
and other federal agencies to improve financial management practices in
the federal government. Leadership and program guidance are provided by
the four Principals of the JFMIP--the Comptroller General of the United
States, the Secretary of the Treasury, and the Directors of OMB and the
Office of Personnel Management.
[5] 31 U.S.C. § 901(b). One of the 24 CFO Act agencies, the Federal
Emergency Management Agency, was transferred to the new Department of
Homeland Security effective March 1, 2003. With this transfer, the
Federal Emergency Management Agency will no longer be required to
prepare and have audited stand-alone financial statements under the CFO
Act, leaving 23 CFO Act agencies.
[6] DHS is not a CFO Act agency and is therefore not subject to CFO Act
requirements. However, along with most other executive branch agencies
not covered by the CFO Act, DHS is required to prepare and have audited
financial statements under the Accountability of Tax Dollars Act of
2002, Pub. L. No. 107-289, 116 Stat. 2049 (Nov. 7, 2002). For fiscal
year 2003, the act provided that OMB could grant executive branch
agencies' requests for waivers from having audited financial statements
for fiscal year 2003. However, DHS and certain other agencies chose to
prepare and have their fiscal year 2003 financial statements audited.
[7] At least 4 CFO Act agencies restated certain of their audited
fiscal year 2002 financial statements to correct misstatements in such
financial statements. All 4 of the agencies had received unqualified
opinions on their fiscal year 2002 financial statements. These
restatements were not material to the consolidated financial
statements.
[8] DHS began operations as an agency 5 months after the start of the
fiscal year, on March 1, 2003. Transfers of funds, assets, liabilities,
and obligations from 22 existing federal agencies to DHS began on March
1, 2003. DHS's auditors issued a qualified opinion on the consolidated
balance sheet and statement of custodial activity as of September 30,
2003, and disclaimed on the consolidated statement of net cost,
consolidated statement of changes in net position, combined statement
of budgetary resources, and consolidated statement of financing for the
7 months ended September 30, 2003. In accordance with Federal
Accounting Standards Advisory Board Technical Bulletin 2003-1, Certain
Questions and Answers Related to the Homeland Security Act of 2002, the
fiscal year 2003 activities that occurred prior to the transfer of
operations to DHS were to be reflected in the transferring agencies'
financial statements.
[9] FFMIA, Pub. L. No. 104-208, div. A, § 101(f), title VIII, 110 Stat.
3009, 3009-389 (Sept. 30, 1996).
[10] We previously reported that material deficiencies prevented us
from expressing an opinion on the fiscal years 1997, 1998, 1999, 2000,
2001, and 2002 consolidated financial statements of the U.S.
government.
[11] U.S. General Accounting Office, National Aeronautics and Space
Administration: Significant Actions Needed to Address Long-standing
Financial Management Problems, GAO-04-754T (Washington, D.C.: May 19,
2004).
[12] GAO identifies areas at high risk due to either their greater
vulnerabilities to waste, fraud, abuse, and mismanagement or major
challenges associated with their economy, efficiency, or effectiveness.
[13] Pub. L. No. 107-107, § 1008, 115 Stat. 1012, 1204 (Dec. 28, 2001).
[14] Although not major DOD components, the Military Retirement Fund
received an unqualified opinion on its fiscal year 2003 financial
statements, and the DOD Medicare-Eligible Retiree Health Care Fund
received a qualified opinion on its fiscal year 2003 financial
statements.
[15] U.S. General Accounting Office, Military Pay: Army National Guard
Personnel Mobilized to Active Duty Experienced Significant Pay
Problems, GAO-04-413T (Washington, D.C.: Jan. 28, 2004).
[16] U.S. General Accounting Office, DOD Travel Cards: Control
Weaknesses Led to Millions in Fraud, Waste, and Improper Payments, GAO-
04-825T (Washington, D.C.: June 9, 2004).
[17] U.S. General Accounting Office, DOD Business Systems
Modernization: Limited Progress in Development of Business Enterprise
Architecture and Oversight of Information Technology Investments, GAO-
04-731R (Washington, D.C.: May 17, 2004).
[18] U.S. General Accounting Office, DOD Business Systems
Modernizations: Improvements to Enterprise Architecture Development
and Implementation Efforts Needed, GAO-03-458 (Washington, D.C.: Feb.
28, 2003), and DOD Business Systems Modernizations: Important Progress
Made to Develop Business Enterprise Architecture, but Much Work
Remains, GAO-03-1018 (Washington, D.C.: Sept. 19, 2003).
[19] U.S. General Accounting Office, Department of Defense: Further
Actions Needed to Establish and Implement a Framework for Successful
Financial and Business Management Transformation, GAO-04-551T
(Washington, D.C.: Mar. 23, 2004), and Department of Defense: Further
Actions Needed to Establish and Implement a Framework for Successful
Business Transformation, GAO-04-626T (Washington, D.C.: Mar. 31, 2004).
[20] On September 9, 2002, GAO convened a roundtable of executive
branch leaders and management experts to discuss the Chief Operating
Officer concept. For more information, see U.S. General Accounting
Office, Highlights of a GAO Roundtable: The Chief Operating Officer
Concept: A Potential Strategy to Address Federal Governance Challenges,
GAO-03-192SP (Washington, D.C.: Oct. 4, 2002).
[21] U.S. General Accounting Office, DOD Business Systems
Modernization: Billions Continue to Be Invested with Inadequate
Management Oversight and Accountability, GAO-04-615 (Washington, D.C.:
May 27, 2004).
[22] Trading partners are U.S. government agencies, departments, or
other components included in the consolidated financial statements that
do business with each other.
[23] The Federal Accounting Standards Advisory Board has a project
under way to consider recognition, measurement, and display of social
insurance obligations.
[24] U.S. General Accounting Office, Social Security Reform: Analysis
of Reform Models Developed by the President's Commission to Strengthen
Social Security, GAO-03-310 (Washington, D.C.: Jan. 15, 2003).
[25] GAO's health care framework can be found at www.gao.gov/cghome/
hccrisis/health.pdf. See also Comptroller General's Forum on Health
Care: Unsustainable Trends Necessitate Comprehensive and Fundamental
Reforms to Control Spending and Improve Value, GAO-04-793SP
(Washington, D.C.: May 1, 2004).
[26] Trading partners are U.S. government agencies, departments, or
other components included in the consolidated financial statements that
do business with each other.
[27] Office of Management and Budget Bulletin No. 01-09, Form and
Content of Agency Financial Statements (Washington, D.C.: Sept. 25,
2001). This bulletin is OMB's official guidance for the form and
content of federal agencies' financial statements.
[28] OMB and U.S. generally accepted accounting principles (GAAP)
require agencies to report net outlays in the SBR. The Statement of
Changes in Cash Balance also reports unified budget outlays-actual.
Both are intended to represent the same amount and be consistent with
the information presented in the budget of the U.S. government.
[29] In some agencies' fiscal year 2003 financial statements, the
comparable fiscal year 2002 amounts were restated.
[30] Offsetting receipts are collections that are credited to general
fund, special fund, or trust fund receipt accounts and that offset
gross outlays at the agency or governmentwide level.
[31] These two agencies did not adequately explain their fiscal year
2002 differences between the net outlays reported on the SBR and the
budget of the U.S. government in their notes to the fiscal year 2003
financial statements.
[32] The same issues we identified in fiscal year 2003 existed in
fiscal year 2002, and some have existed for a number of years. In
October 2003, we reported in greater detail on the issues we
identified, in U.S. General Accounting Office, Financial Audit: Process
for Preparing the Consolidated Financial Statements of the U.S.
Government Needs Improvement, GAO-04-45 (Washington, D.C.: Oct. 30,
2003). This report included 44 recommendations to address weaknesses we
identified. It also included recommendations related to 16 disclosure
areas that are required by GAAP. We recommended that the 16 disclosures
that are not included in the consolidated financial statements either
be included or that the rationale for their exclusion be documented.
[33] Although Treasury was unable to determine how much of the
unreconciled transactions, if any, relate to operations, it reported
unreconciled transactions as a component of net operating cost in the
consolidated financial statements.
[34] Reportable conditions are matters coming to our attention that, in
our judgment, should be communicated because they represent significant
deficiencies in the design or operation of internal control that could
adversely affect the federal government's ability to meet the internal
control objectives relating to financial reporting and compliance with
laws and regulations.
[35] Improper payments include inadvertent errors, such as duplicate
payments and miscalculations, payments for unsupported or inadequately
supported claims, payments for services not rendered, payments to
ineligible beneficiaries, and payments resulting from fraud and abuse
by program participants and/or federal employees.
[36] Pub. L. No. 107-300, 116 Stat. 2350 (Nov. 26, 2002). The act's
reporting requirement on actions taken by agencies to reduce improper
payments applies only to an agency program or activity with estimated
improper payments exceeding $10 million.
[37] E-Government Act of 2002, Pub. L. No. 107-347, title III, 116
Stat. 2899, 2946 (Dec. 17, 2002).
[38] Pub. L. No. 107-305, 116 Stat. 2367 (Nov. 27, 2002).
[39] The Executive Branch Management Scorecard highlights agencies'
progress in achieving management and performance improvements embodied
in the President's Management Agenda.
[40] U.S. General Accounting Office, Financial Audit: IRS's Fiscal
Years 2003 and 2002 Financial Statements, GAO-04-126 (Washington, D.C.:
Nov. 13, 2003).
