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. 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 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 2, 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.
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. 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 since 1995. In accordance with section  1008 of the National Defense Authorization Act for Fiscal Year 2002, 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.
Overhauling DOD’s financial management operations represents a  challenge that goes far beyond financial accounting to the very fiber of  DOD’s range of business operations, management information systems,  and culture. As I have reported in past years, DOD’s financial management  problems are pervasive, complex, long-standing, and deeply rooted in  virtually all business operations throughout the department. To date, none  of the military services or major DOD components has passed the test of  an independent financial audit because of pervasive weaknesses in  financial management systems, operations, and controls. DOD has been up  front about the seriousness of these problems and the need to transform  the way it does business. To address these problems, DOD has taken  several positive steps in many key areas. For example, the Secretary of  Defense has included improving DOD’s financial management as one of his  top 10 priorities, and the department has taken a number of actions under  its Business Management Modernization Program, including development  in April 2003 of an initial business enterprise architecture to guide  operational and technological changes. DOD is currently working to  refine and implement that architecture and expects to issue new versions  of it during 2004. DOD reports that it is also developing detailed financial  improvement plans intended to provide disciplined leadership, identify  corrective actions, implement solutions, and result in a favorable audit  opinion on the fiscal year 2007 DOD-wide financial statements. But 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” 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. Resolving the intragovernmental transactions  problem, though, still 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. Resolving issues  surrounding preparing the consolidated financial statements 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 3, by 2040, absent reform of these  entitlement programs, projected federal revenues may be adequate to pay  little beyond interest on the debt.
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. Figure 4 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.
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 items such as the gap between  promised and funded Social Security and Medicare commitments and  veterans health care benefit commitments provided through the  Department of Veterans Affairs. If these items are factored in, the burden  for every American rises to well over $100,000. In addition, the new  Medicare prescription drug benefit will add thousands more to that tab.
The new drug benefit is one of the largest unfunded commitments ever  undertaken by the federal government. The Trustees of the Social Security  and Medicare trust funds will include an official estimate of the discounted  present value cost of this new benefit over the next 75 years in their  annual report, which is scheduled for issuance later this month.  Preliminary estimates of its long-term cost range up to $7 trillion in  discounted present value terms over a 75-year period. To put that number  into perspective, it is as much as the total amount of the federal  government’s gross debt outstanding as of September 30, 2003. Even  before the prescription drug benefit was enacted, our long-term budget  simulations showed that by 2040, the federal government may have to cut  federal spending in half or double taxes to pay for the mounting cost of the  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 a framework for analyzing  various Social Security reform proposals and will soon publish a  framework for analyzing health care reform proposals. 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 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 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 sound democracy. Members of Generation 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 this  subcommittee’s hearings and those the former Subcommittee on  Government Efficiency, Financial Management, and Intergovernmental  Relations held over the past several years to oversee financial  management reform. 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, and Gary T. Engel, Director, Financial  Management and Assurance, at (202) 512-2600.

Appendix I: Selected Major Federal Departments and Agencies: Fiscal Year 2003 Audit Results, Principal Auditors, and Number of Other Audit Contractors

R. Navarro & Associates, Inc.
R. Navarro & Associates, Inc.

Appendix II: Primary Effects of the Material Weaknesses Described in This Report

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.
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.
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.
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.
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.
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.
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.
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.
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.
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.

Appendix III: 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” 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,  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, 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), totaling about $140  billion and $186 billion for fiscal years 2003 and 2002, respectively. 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. 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. 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:    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.” 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 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. 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. SBA’s material weakness plus deficiencies at other federal  credit agencies relating to the processes and procedures for estimating  credit program costs 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.

		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. 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 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  and the Cyber Security Research and Development Act. In addition, the  administration has taken important actions to improve information  security, such as integrating information security into the Executive  Branch Management Scorecard.

		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. 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.
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Summary:
Why GAO Did This Study

GAO is required to 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 for 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 the 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 fully and consistently disclosed in the federal government's financial statements and budget, 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.