Financial Audit
Restatements to the Department of State's Fiscal Year 2003 Financial Statements Gao ID: GAO-05-814R September 20, 2005The Secretary of the Treasury, in coordination with the Director of the Office of Management and Budget (OMB), is required to annually prepare and submit audited financial statements of the U.S. government to the President and Congress. We are required to audit these consolidated financial statements (CFS) and report on the results of our work. An issue meriting concern and close scrutiny that emerged during our fiscal year 2004 CFS audit was the growing number of Chief Financial Officers (CFO) Act agencies that restated certain of their financial statements for fiscal year 2003 to correct errors. Errors in financial statements can result from mathematical mistakes, mistakes in the application of accounting principles, or oversight or misuse of facts that existed at the time the financial statements were prepared. Frequent restatements to correct errors can undermine public trust and confidence in both the entity and all responsible parties. Further, when restatements do occur, it is important that financial statements clearly communicate and readers of the restated financial statements understand that the financial statements originally issued by management in the previous year and the opinion thereon should no longer be relied on and instead the restated financial statements and related auditor's opinion should be used. Nine of the 11 agencies that had restatements for fiscal year 2003 received unqualified opinions on their originally issued fiscal year 2003 financial statements. The auditors for 6 of these 9 agencies issued unqualified opinions on the restated financial statements, replacing the previous unqualified opinions on the respective agencies' original fiscal year 2003 financial statements. The auditors for 2 of these 9 withdrew their unqualified opinions on the fiscal year 2003 financial statements and issued other than unqualified opinions on the respective agencies' restated fiscal year 2003 financial statements because they could not determine whether there were any additional misstatements and the effect of any such misstatements on the restated fiscal year 2003 financial statements. For the remaining agency, the principal auditor of the agency's fiscal year 2004 financial statements was not the principal auditor of the agency's fiscal year 2003 financial statements, and an audit opinion on the agency's restated fiscal year 2003 financial statements was not issued. Because of the varying nature and circumstances surrounding the restatements, we are issuing a number of separate reports on the matter. This report communicates our observations regarding State's fiscal year 2003 restatements. We reviewed four key areas with respect to the restatements of State's fiscal year 2003 financial statements: (1) the nature and cause of the errors that necessitated the restatements, including planned corrective actions by the agency and its auditors; (2) the timing of communicating the material misstatement to users of the financial statements; (3) the extent of transparency exhibited in disclosing the nature and impact of the material misstatement in the financial statements and the reissued auditor's report; and (4) audit issues that contributed to the failure to detect the errors that necessitated the restatements during the audit of the agency's fiscal year 2003 financial statements.
Failure to properly record journal voucher entries for two large transactions that together accounted for most of a $927 million error and inadequate management review of these journal vouchers to detect the improper entries led to the material error that necessitated State's restatements of certain of its fiscal year 2003 financial statements. We determined that State's auditor did not detect the errors because the fiscal year 2003 audit tests performed by the auditor were not designed to detect journal voucher entry errors for the affected accounts. In addition, the title of State's note disclosure of the restatements could be misinterpreted. We are making a recommendation to State's Acting CFO to address the issues we identified with respect to the journal voucher errors that necessitated the fiscal year 2003 restatements. We are also making a recommendation to State's Inspector General to work with the contracted independent public accountant (IPA) to ensure that audit tests to detect any similar journal voucher errors in the future are implemented. In commenting on a draft of this report, State's Acting CFO stated that his office agrees with our recommendation for management to evaluate whether State's new journal voucher review procedures are effective and that State is currently reviewing the effectiveness of these procedures. State's Inspector General concurred with our recommendation and stated that his office will work with the IPA to implement audit steps in conformance with the Financial Audit Manual (FAM) to test journal vouchers in the Bureau of International Organizations unfunded and funded liabilities accounts. We also received technical comments from State's Acting CFO and Inspector General, which we have incorporated as appropriate.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-05-814R, Financial Audit: Restatements to the Department of State's Fiscal Year 2003 Financial Statements
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Fiscal Year 2003 Financial Statements' which was released on September
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September 20, 2005:
Mr. Sid L. Kaplan:
Acting Assistant Secretary and Chief Financial Officer:
Department of State:
The Honorable Howard J. Krongard:
Inspector General:
Department of State:
Subject: Financial Audit: Restatements to the Department of State's
Fiscal Year 2003 Financial Statements:
As you know, the Secretary of the Treasury, in coordination with the
Director of the Office of Management and Budget (OMB), is required to
annually prepare and submit audited financial statements of the U.S.
government to the President and Congress. We are required to audit
these consolidated financial statements (CFS) and report on the results
of our work.[Footnote 1] An issue meriting concern and close scrutiny
that emerged during our fiscal year 2004 CFS audit was the growing
number of Chief Financial Officers (CFO) Act agencies that
restated[Footnote 2] certain of their financial statements for fiscal
year 2003 to correct errors.[Footnote 3] Errors in financial statements
can result from mathematical mistakes, mistakes in the application of
accounting principles, or oversight or misuse of facts that existed at
the time the financial statements were prepared. Frequent restatements
to correct errors can undermine public trust and confidence in both the
entity and all responsible parties. Further, when restatements do
occur, it is important that financial statements clearly communicate
and readers of the restated financial statements understand that the
financial statements originally issued by management in the previous
year and the opinion thereon should no longer be relied on and instead
the restated financial statements and related auditor's opinion should
be used.
Eleven of the 23 CFO Act agencies[Footnote 4] restated certain of their
financial statements for fiscal year 2003. Five CFO Act agencies had
restatements in fiscal year 2003 covering their fiscal year 2002
financial statements. Three CFO Act agencies had restatements covering
both years. We noted that the extent of the restatements to CFO Act
agencies' fiscal year 2003 financial statements varied from agency to
agency, ranging from correcting two line items on an agency's balance
sheet to correcting numerous line items on several of another agency's
financial statements. In some cases, the net operating results of the
agency were affected by the restatement. The amounts of the agencies'
restatements ranged from several million dollars to more than $91
billion.
Nine of the 11 agencies that had restatements for fiscal year 2003
received unqualified opinions on their originally issued fiscal year
2003 financial statements. The auditors for 6 of these 9 agencies
issued unqualified opinions on the restated financial statements,
replacing the previous unqualified opinions on the respective agencies'
original fiscal year 2003 financial statements. The auditors for 2 of
these 9 withdrew their unqualified opinions on the fiscal year 2003
financial statements and issued other than unqualified opinions on the
respective agencies' restated fiscal year 2003 financial statements
because they could not determine whether there were any additional
misstatements and the effect of any such misstatements on the restated
fiscal year 2003 financial statements. For the remaining agency, the
principal auditor of the agency's fiscal year 2004 financial statements
was not the principal auditor of the agency's fiscal year 2003
financial statements, and an audit opinion on the agency's restated
fiscal year 2003 financial statements was not issued.
Our review focused on the 9 agencies with restatements for fiscal year
2003 that received unqualified opinions on their originally issued
fiscal year 2003 financial statements.[Footnote 5] These were the
Department of Agriculture, Department of State (State), Department of
Justice, Department of Transportation, Department of Health and Human
Services, General Services Administration, National Science Foundation,
Nuclear Regulatory Commission, and Office of Personnel Management.
Because of the varying nature and circumstances surrounding the
restatements, we are issuing a number of separate reports on the
matter. This report communicates our observations regarding State's
fiscal year 2003 restatements. Going forward, we hope that the lessons
learned from the fiscal year 2003 restatements, together with our
recommendations, (1) help State avoid the need for restatements to its
future financial statements and (2) help ensure that State's auditor
applies appropriate auditing procedures for journal voucher entries in
the Bureau of International Organizations unfunded and funded
liabilities accounts, which is where the original fiscal year 2003
financial statements were subsequently found to have been misstated.
We reviewed four key areas with respect to the restatements of State's
fiscal year 2003 financial statements: (1) the nature and cause of the
errors that necessitated the restatements, including planned corrective
actions by the agency and its auditors; (2) the timing of communicating
the material misstatement to users of the financial statements; (3) the
extent of transparency[Footnote 6] exhibited in disclosing the nature
and impact of the material misstatement in the financial statements and
the reissued auditor's report; and (4) audit issues that contributed to
the failure to detect the errors that necessitated the restatements
during the audit of the agency's fiscal year 2003 financial statements.
Results in Brief:
Failure to properly record journal voucher entries for two large
transactions that together accounted for most of a $927 million error
and inadequate management review of these journal vouchers to detect
the improper entries led to the material error that necessitated
State's restatements of certain of its fiscal year 2003 financial
statements. We determined that State's auditor did not detect the
errors because the fiscal year 2003 audit tests performed by the
auditor were not designed to detect journal voucher entry errors for
the affected accounts. In addition, the title of State's note
disclosure of the restatements could be misinterpreted.
We are making a recommendation to State's Acting CFO to address the
issues we identified with respect to the journal voucher errors that
necessitated the fiscal year 2003 restatements. We are also making a
recommendation to State's Inspector General to work with the contracted
independent public accountant (IPA) to ensure that audit tests to
detect any similar journal voucher errors in the future are
implemented.
In commenting on a draft of this report, State's Acting CFO stated that
his office agrees with our recommendation for management to evaluate
whether State's new journal voucher review procedures are effective and
that State is currently reviewing the effectiveness of these
procedures. State's Inspector General concurred with our recommendation
and stated that his office will work with the IPA to implement audit
steps in conformance with the Financial Audit Manual (FAM)[Footnote 7]
to test journal vouchers in the Bureau of International Organizations
unfunded and funded liabilities accounts. We also received technical
comments from State's Acting CFO and Inspector General, which we have
incorporated as appropriate.
Background:
In conducting the fiscal year 2004 audit of the CFS, we reviewed the 23
CFO Act agencies' performance and accountability reports for possible
restatements and identified 11 agencies that had restated certain of
their audited fiscal year 2003 financial statements.
The primary intended users of federal agencies' financial reports are
citizens, Congress, federal executives, and federal program
managers.[Footnote 8] Each of these groups may use federal agencies'
financial statements to satisfy their specific needs. Citizens are
interested in many aspects of the federal government, particularly
federal programs that affect their financial well-being. Congress is
interested in monitoring and assessing the efficiency and effectiveness
of federal programs. Federal executives, such as central agency
officials at OMB and the Department of the Treasury (Treasury), are
interested in federal financial statements to assist the President of
the United States. OMB assists the President in overseeing the
preparation of the federal budget by formulating the President's
spending plans, evaluating the effectiveness of agency programs,
assessing competing funding demands among agencies, and setting funding
priorities. Treasury assists the President in managing the finances of
the federal government and prepares the CFS, which is based on audited
financial statements prepared by federal agencies. GAO audits the CFS
and reports on the results of its audit. Finally, federal program
managers use agency financial statements as tools for managing their
operations within the limits of the spending authority granted by
Congress.
The primary accounting and auditing standards that apply to restatement
disclosures by federal entities are the Federal Accounting Standards
Advisory Board's Statement of Federal Financial Accounting Standards
(SFFAS) No. 21, Reporting Corrections of Errors and Changes in
Accounting Principles, and the American Institute of Certified Public
Accountants (AICPA) Codification of Auditing Standards, AU section 561,
Subsequent Discovery of Facts Existing at the Date of the Auditor's
Report.[Footnote 9]
Objective, Scope, and Methodology:
The objective of our review of restatements of State's fiscal year 2003
financial statements was to determine the nature and cause of the
errors, the transparency and timing of communicating the material
misstatements, any audit issues relating to such misstatements, and any
actions being taken to help preclude similar errors from occurring in
the future.
We reviewed the nature and causes of the restatements, and we also
examined corrective actions taken by State to help preclude similar
errors from occurring in the future. We interviewed the preparers and
auditors of State's fiscal year 2003 financial statements, including
staff from the agency's Office of Inspector General (OIG), and we
obtained and reviewed relevant audit documentation.
In our review, we considered certain accounting and auditing standards,
including SFFAS No. 21; the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 16, Prior Period
Adjustments; and the AICPA Codification of Auditing Standards, AU
section 420, Consistency of Application of Generally Accepted
Accounting Principles, AU section 508, Reports on Audited Financial
Statements, and AU section 561.
We performed our review of the restatements of State's fiscal year 2003
financial statements from December 2004 to July 2005 in accordance with
U.S. generally accepted government auditing standards.
We requested comments on a draft of this report from State's Acting CFO
and Inspector General or their designees. Written comments from State's
Acting CFO and Inspector General are reprinted in enclosures I and II,
respectively, and are also discussed in the Agency Comments section.
Issues Related to Restatement of Certain of State's Fiscal Year 2003
Financial Statements:
With respect to the restatement of certain of State's fiscal year 2003
financial statements, we identified the following three areas that need
improvement: (1) review of journal voucher transactions for the Bureau
of International Organizations accounts, (2) design of journal voucher
audit steps for the Bureau of International Organizations accounts, and
(3) the title of the note disclosure of the restatements. These issues
are discussed in detail below.
Bureau of International Organizations Journal Voucher Transactions Were
Not Sufficiently Reviewed:
Certain of State's financial statements for fiscal year 2003 were
restated to reflect activity related to approximately $927 million in
liabilities incurred by the department's Bureau of International
Organizations. Specifically, in connection with recording two large
transactions in fiscal year 2003 that involved the reclassification of
certain liabilities as funded liabilities from unfunded liabilities, a
State official informed us that State failed to record the companion
proprietary[Footnote 10] journal entries that are necessary once a
liability has been funded. As a result, Unexpended Appropriations--Used
was overstated by approximately $927 million, and Expended
Appropriations was understated by approximately $927 million. The
overall effect of the errors was that the amounts for Unexpended
Appropriations and Cumulative Results of Operations on the originally
issued fiscal year 2003 Balance Sheet and fiscal year 2003 Statement of
Changes in Net Position were materially overstated and understated,
respectively, by $927 million.
State officials discovered the fiscal year 2003 errors in late October
2004, during State's year-end analysis of the fiscal year 2004
financial statements. Through analytical procedures and research, State
observed inconsistencies between the unfunded and funded liabilities
accounts. Following the discovery, State informed its IPA of the
errors, which was appropriate. State completed its analysis of the
errors on November 10, 2004. According to State, two incorrectly
entered journal vouchers primarily caused the errors.
Although State had a process for reviewing journal vouchers, it was not
followed in the case of these two journal vouchers. The process called
for a supervisor to approve journal vouchers before they were entered
into the general ledger. According to a State official, however, the
erroneous journal vouchers were not reviewed by a supervisor before
they were entered into the accounting system. According to another
State official, prior to the discovery of these errors, State took
steps to improve its journal voucher postings by strengthening its
journal voucher review process. Specifically, accounting personnel who
create journal vouchers are now required to have a coworker review and
sign the journal voucher before forwarding it for supervisory approval.
The Director or Deputy Director of Financial Reporting and Analysis is
then required to enforce compliance with the approval process by
reviewing the approved journal vouchers--including determining that
they have been signed by a supervisor--before the journal vouchers are
entered into the accounting system.
Journal Voucher Audit Steps Did Not Detect Errors in the Bureau of
International Organizations Accounts:
The above-noted accounting breakdown was not discovered during the
audit of the department's fiscal year 2003 financial statements because
the fiscal year 2003 audit tests performed by State's IPA were not
designed to detect journal voucher errors in the Bureau of
International Organizations unfunded and funded liabilities accounts.
The FAM states that during the audit planning process, the auditor
should identify conditions that significantly increase inherent, fraud,
and control risk. Among other things, the auditor should perform
procedures to identify account balances and transactions that might
signal inherent risk. According to FAM 260.40, to detect evidence of
possible material misstatement due to fraud, the auditor should examine
journal entries and other adjustments, including reclassifications,
consolidating entries, and other routine and nonroutine journal entries
and adjustments. This section of the FAM also states that the auditor
should obtain an understanding of the financial reporting process and
the controls over journal entries and other adjustments; identify and
select journal entries and other adjustments for testing; determine the
nature, timing, and extent of the testing; and inquire of individuals
involved in the financial reporting process about inappropriate or
unusual activity related to the processing of journal entries and
adjustments. If the IPA had identified the journal vouchers involving
the Bureau of International Organizations accounts as presenting
increased inherent, fraud, or control risk and had then followed the
above-noted FAM procedures, the errors that necessitated the
restatements might have been detected.
According to State's OIG, future audit tests will be designed to detect
any material journal voucher errors in the Bureau of International
Organizations unfunded and funded liabilities accounts.
The Title of State's Note Disclosure of the Restatements Could Be
Misinterpreted:
The notes to State's comparative fiscal years 2004 and 2003 financial
statements included a note disclosure titled "Prior Period Adjustment."
This title could be misinterpreted, since the note disclosure discussed
the adjustment to correct the $927 million material misstatement and
the adjustment represented a restatement rather than a prior period
adjustment as defined by SFFAS No. 21.
Conclusions:
The restatements were caused by an error that State identified. State
corrected the error and issued restated financial statements. Going
forward, the key will be for State to ensure that the planned
corrective actions to address the cause of the error are fully and
effectively implemented. In addition, it will be important that State's
OIG work with State's IPA to ensure that audit tests to detect any
similar errors in the future are fully and effectively implemented.
Recommendations for Executive Action:
We recommend that State's Acting CFO determine whether the new journal
voucher review procedures established to ensure adequate review of
Bureau of International Organizations journal voucher transactions are
being fully and effectively implemented.
We recommend that State's Inspector General work with State's IPA to
ensure that audit tests in conformance with the FAM to test journal
vouchers in the Bureau of International Organizations unfunded and
funded liabilities accounts are fully and effectively implemented.
Agency Comments:
In commenting on a draft of this report, State's Acting CFO stated that
his office agrees with our recommendation for management to evaluate
whether State's new journal voucher review procedures are effective and
that State is currently reviewing the effectiveness of these
procedures. State's Inspector General concurred with our recommendation
and stated that his office will work with the IPA to implement audit
steps in conformance with the FAM to test journal vouchers in the
Bureau of International Organizations' unfunded and funded liabilities
accounts. We also received technical comments from State's Acting CFO
and Inspector General, which we have incorporated as appropriate.
Within 60 days of the date of this report, we would appreciate
receiving a written statement on actions taken to address these
recommendations.
We are sending copies of this report to the Chairmen and Ranking
Minority Members of the Senate Committee on Homeland Security and
Governmental Affairs; the Subcommittee on Federal Financial Management,
Government Information, and International Security, Senate Committee on
Homeland Security and Governmental Affairs; the House Committee on
Government Reform; and the Subcommittee on Government Management,
Finance and Accountability, House Committee on Government Reform. In
addition, we are sending copies to the Fiscal Assistant Secretary of
the Treasury and the Controller of OMB. This report is also available
at no charge on GAO's Web site at www.gao.gov.
We appreciate the courtesy and cooperation extended to us by your staff
throughout our work. We look forward to continuing to work with your
offices to help improve financial management in the federal government.
If you have any questions about the contents of this report, please
contact me at (202) 512-3406 or engelg@gao.gov.
Signed by:
Gary T. Engel:
Director:
Financial Management and Assurance:
[End of section]
Enclosure I: Comments from the Acting Assistant Secretary and Chief
Financial Officer, Department of State:
United States Department of State:
Assistant Secretary and Chief Financial Officer:
Washington, D.C. 20520:
SEP 13 2005:
Gary T. Engel, Director:
Financial Management and Assurance:
Government Accountability Office:
441 G Street, NW:
Room 5476:
Washington, DC 20548:
Dear Mr. Engel:
We appreciate the opportunity to comment on the Government
Accountability Office's (GAO) draft report entitled Financial Audit:
Restatements to the Department of State's Fiscal Year 2003 Financial
Statements, dated August 2005.
We agree with your recommendations for management to evaluate whether
our new journal voucher (JV) review procedures are effective. In that
regard, we have strengthened controls over this process and are
currently reviewing the effectiveness of these procedures.
If you have questions or require additional information, please contact
Sheila Conley, Managing Director, Financial Policy Reporting and
Analysis, at (202) 663-1447.
Sincerely,
Signed by:
Sid Kaplan, Acting:
[End of section]
Enclosure II: Comments from the Inspector General, Department of State:
United States Department of State and the Broadcasting Board of
Governors:
Inspector General:
August 31, 2005:
Gary T. Engel, Director:
Financial Management and Assurance:
Government Accountability Office:
441 G Street, NW:
Room 5476:
Washington, DC 20548:
Dear Mr. Engel:
The Office of Inspector General (OIG) appreciates the opportunity to
comment on the Government Accountability Office's (GAO) draft report
entitled Restatements to tire Department of State's Fiscal Year 2003
Financial Statements, dated August 2005.
Based on GAO's agreement to incorporate the technical changes OIG
communicated to it on August 31, OIG concurs with GAO's recommendation.
OIG will work with the independent public accountant to implement audit
steps in conformance with the Financial Audit Manual to test journal
vouchers in the Bureau of International Organizations' unfunded and
funded liabilities accounts.
If you have any questions or need any additional information, please
contact Mark W. Duda, Assistant Inspector General for Audits, at (2172)
663-0372 or Gayle Voshell, Director of the Financial Management
Division, at (703) 2842698.
Sincerely,
Signed by:
Howard J. Krongard:
Inspector General:
cc: RM - Mr. Sid L. Kaplan, Acting;
RM/DCFO - Mr. Chris H. Flaggs;
RM/GAO - Ms. Julianne Shinnick;
Leonard G. Birnbaum and Company, LL.P - Mr. Leslie A. Leiper:
[End of section]
(198364):
FOOTNOTES
[1] The Government Management Reform Act of 1994 has required such
reporting, covering the executive branch of government, beginning with
financial statements prepared for fiscal year 1997. 31 U.S.C. § 331
(e). The federal government has elected to include certain financial
information on the legislative and judicial branches in the CFS as
well.
[2] A financial statement restatement occurs when an entity either
voluntarily or prompted by its auditors or regulators revises public
financial information that has previously been reported.
[3] According to Federal Accounting Standards Advisory Board, Statement
of Federal Financial Accounting Standards (SFFAS) No. 21, Reporting
Corrections of Errors and Changes in Accounting Principles, prior
period financial statements presented should be restated only to
correct errors that caused such statements to be materially misstated.
[4] The Federal Emergency Management Agency (FEMA) was transferred to
the Department of Homeland Security (DHS) effective March 1, 2003. With
this transfer, FEMA was no longer required to prepare and have audited
stand-alone financial statements under the CFO Act, leaving 23 CFO Act
agencies for the remainder of fiscal year 2003 and for fiscal year
2004. The DHS Financial Accountability Act, Pub. L. No. 108-330, 118
Stat. 1275 (October 16, 2004), added DHS to the list of CFO Act
agencies, increasing the number of CFO Act agencies again to 24
beginning in fiscal year 2005.
[5] The 2 agencies that had restatements for fiscal year 2003 but did
not receive unqualified opinions on their originally issued fiscal year
2003 financial statements were the Department of Defense and the Small
Business Administration.
[6] Transparency is the full, accurate, and timely disclosure of
information.
[7] GAO/President's Council on Integrity and Efficiency, Financial
Audit Manual, GAO-01-765G (Washington, D.C.: July 2001), updated by GAO-
04-1015G and GAO-04-942G (July 2004).
[8] Federal Accounting Standards Advisory Board, Statement of Federal Financial Accounting Concepts No. 1, Objectives of Federal Financial Reporting.
[9] Generally accepted government auditing standards incorporate AICPA
reporting and auditing standards unless the Comptroller General of the
United States excludes them by formal announcement.
[10] Proprietary accounts provide the information for the financial
statements based on Federal Accounting Standards Advisory Board
standards and are intended to provide an economic, rather than a
budgetary, measure of operations and resources.
