AUDITING THE

NATION'S FINANCES

Fiscal Year 1999 Results

Continue to Highlight

Major Issues Needing

Resolution

Statement of David M. Walker

Comptroller General of the United States

United States General Accounting Office

GAO Testimony

Before the Subcommittee on Government Management,

Information and Technology, Committee on Government

Reform, House of Representatives

For Release on Delivery

Expected at

10 a.m.

Friday

March 31, 2000

GAO/T-AIMD-00-137
1

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss our report on the U.S. government’s

financial statements for fiscal year 1999. Today’s hearing comes at an especially

appropriate juncture. First, we are nearing the 10th anniversary of the Chief

Financial Officers Act’s passage, which has provided the underpinning for

financial management reform necessary to help improve the economy, efficiency,

and effectiveness of government. Also, since the critical transition period to

agency-level audited financial statements began in 1996, agencies have gained

valuable experience in preparing financial statements, which is beginning to pay

off. Then too, the lessons agencies have learned from successfully meeting the

Year 2000 computing challenge are fresh in the minds of those who must now

focus greater attention to achieve financial and other management improvements.

In passing the CFO Act and other financial management legislation, such as the

Government Management Reform Act and the Federal Financial Management

Improvement Act (FFMIA), the Congress sought to overcome the historical lack

of reliable, useful, and timely information to assure financial accountability for the

federal government. Without such information on the full costs of programs, the

government cannot adequately ensure accountability, measure and control costs,

manage for results, nor make timely and fully informed decisions about allocating

limited resources.

A critical financial management reform component established by the Congress

entails requirements for annual audited financial statements for 24 major federal

departments and agencies beginning with fiscal year 1996. We have seen a steady

increase in the number of agencies that have obtained unqualified opinions on

their financial statements and in agencies’ timeliness in issuing them. Thus far, 13

of 24 major agencies have received unqualified opinions on their fiscal year 1999

financial statements—for fiscal year 1996, only 6 agencies achieved that goal.

However, further progress remains to be accomplished at the 4 agencies which

received qualified opinions and the 5 agencies which received disclaimers thus far

for fiscal year 1999. Also, for fiscal year 1999, 5 agencies were late in issuing their

financial statements, compared with 11 agencies that were late in issuing financial

statements for fiscal year 1997.

Further, several agencies, most notably the Social Security Administration (SSA),

have made good progress toward achieving financial management reform goals.

For the past 2 years, SSA issued its audited financial statements, for which it

received an unqualified audit opinion, in November, only 6 weeks after the close

of the fiscal year and over 3 months before the March 1 statutory deadline. Others

have resolved certain previously reported financial statement deficiencies. For

example, the Department of Energy resolved its previously reported deficiency

related to its environmental and disposal liability associated with nuclear

weapons.
2

In addition, in October 1999, the American Institute of Certified Public

Accountants recognized federal accounting standards as a generally accepted

basis of accounting, which represents a major milestone for the federal

government. This is an important step in the process of improving the reliability

and credibility of federal financial information in the eyes of the public.

At the same time, several major departments are not yet able to produce

auditable financial statements on a consistent basis. The most significant in this

regard is the Department of Defense (DOD), which represents a large percentage

of the government’s assets, liabilities, and net costs. None of the military services

or the department as a whole has yet been able to produce auditable financial

statements. We designated DOD financial management to be a high-risk area in

1995 and it remains so today, although we have seen increased attention to begin

to address many of the issues. DOD recognizes the seriousness of its problems

and has a number of improvement initiatives under way. We have designated as

high risk financial management at IRS, the Forest Service, and the Federal

Aviation Administration. As I will highlight today, challenges also continue in

producing reliable statements for the entire U.S. government.

For the last 2 years, we reported that because of the serious deficiencies in the

government’s systems, recordkeeping, documentation, financial reporting, and

controls, amounts reported in the U.S. government’s financial statements and

related notes may not provide a reliable source of information for decisionmaking by the government or the public.1

Our report on the U.S. government’s

financial statements for fiscal year 1999 has reached the same conclusion. These

deficiencies also affect the reliability of information contained in the

accompanying Management’s Discussion and Analysis and any other financial

management information—including information used to manage the government

day-to-day and certain budget information reported by agencies—which is taken

from the same data source as the financial statements.

The executive branch recognizes that, because of the extent and severity of the

financial management deficiencies, addressing them will require concerted

improvement efforts across government. Annual financial audits represent an

important means to assure continued progress in connection with improving

federal financial management. Further, the President has designated financial

management improvement as a priority management objective and efforts are

underway across government to address pervasive, generally long-standing

financial management problems.

However, while clean audit opinions are essential to providing an annual public

scorecard, they do not guarantee that agencies have the financial systems needed

to dependably produce reliable financial information. Modern systems and good

controls are essential to reach the end goal of reliable, useful, and timely financial

1

Financial Audit: 1997 Consolidated Financial Statements of the United States Government

(GAO/AIMD-98-127, March 31, 1998) and Financial Audit: 1998 Consolidated Financial Statements

of the United States Government (GAO/AIMD-99-130, March 31, 1999).
3

information to support ongoing management and accountability. Some agencies

have only been able to obtain unqualified audit opinions through heroic efforts,

which include using consultants, statistical sampling, and other ad hoc

procedures to derive numbers as of a single point in time—the end of the fiscal

year. These efforts are often completed months after the end of the fiscal year.

The fundamental problem is that their financial systems cannot routinely provide

this information.

Agency financial systems overall are in poor condition and cannot provide reliable

financial information for managing day-to-day government operations and holding

managers accountable. Thus far, for fiscal year 1999, agency financial auditors

have reported that 19 of 22 major agencies’ financial systems did not comply with

FFMIA, which requires agency financial management systems to comply

substantially with federal accounting standards and financial systems and other

requirements. Systems for the remaining two major agencies that have not yet

issued audited fiscal year 1999 financial statements did not comply with the act’s

requirements for fiscal years 1998 and 1997.

Over the longer-term, improving financial systems will involve harnessing

technology and applying the information technology management framework

outlined in the Clinger-Cohen Act. A crucial aspect of this will be to strengthen

internal control, particularly computer controls. Continuing serious and

widespread computer security weaknesses, which we have also designated as a

high-risk area, 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.

Another integral part of financial management reform is revamping human capital

practices to build greater capacity and implementing change management to

achieve the discipline needed to follow sound financial management and

reporting practices. While some attention to delineating core competencies and

training has occurred, a great deal more needs to be done to improve financial

management human capital practices. We have outlined some of these steps in

our executive guide for creating value through world-class financial management.2

The leadership and partnerships established to successfully address the Year 2000

computing problem provide lessons learned that can also be used to address

financial management reform across government. These lessons include

providing high-level congressional and executive branch leadership,

understanding the importance of addressing the issues, providing standard

guidance, employing a constructive engagement approach, facilitating progress

and monitoring performance, and implementing fundamental improvements. It

will be especially important to prepare for a new administration next year and to

2

Executive Guide: Creating Value Through World-class Financial Management (GAO/AIMD-99-45,

August 1999 (Exposure Draft)).
4

put in place the mechanisms to sustain current improvement efforts. This would

include a governmentwide plan, together with milestones, for addressing major

weaknesses, as well as agency-level plans.

The audit community—the Inspectors General and GAO—must play a

constructive role in recommending workable solutions to problems. Working

cooperatively with the Inspectors General, we are continuing to evaluate progress

and make specific suggestions for fixing weaknesses in recordkeeping, financial

reporting, and internal controls. We are also continuing to work with the Office of

Management and Budget (OMB), the Treasury, and agencies across government to

recommend the actions necessary for achieving legislative reform goals. With

concerted effort, the federal government can continue to make progress toward

achieving accountability and generating reliable financial and management

information on a regular basis. Ultimately, providing such data in meaningful,

user-friendly reports is key to assuring adequate accountability to taxpayers,

managing for results, and helping decisionmakers make timely well-informed

judgments.

The remainder of my testimony will focus on these matters and the findings of our

report on the financial statements of the U.S. government for fiscal year 1999. But

first, I would first like to discuss important financial information relating to the

Social Security and Medicare programs, which are two important programs having

major budget implications.

The U.S. government’s fiscal year 1999 Financial Report and, therefore, our report

on our audit of these financial statements, include certain information concerning

the Social Security and Medicare (Part A) trust funds, such as projected

contributions and expenditures, dates when expenditures are expected to exceed

contributions, and dates when such funds are expected to be exhausted. Such

information is as of January 1, 1999, for Social Security and as of September 30,

1999, for Medicare (Part A), the most recent information publicly reported by the

government.

Yesterday, the government issued updated information as of January 1, 2000, for

both programs. The government’s issuance of dated information in this Financial

Report at about the same time that it issues more current information may cause

confusion to the Congress and the public. This can serve to reduce confidence in

and the credibility of the government’s annual financial report. This is especially

true when there are significant differences between the trustees’ new projections

and those included in the annual report. As a result, steps should be taken, in

future years, to ensure that the government’s Financial Report contains up-to-date

information as of no earlier than the end of the most recent fiscal year in these

important federal programs. Because current information on the solvency of the

Social Security and Medicare programs is critical to assessing the financial

condition of the nation, aiding in budget deliberations, and fostering public

debate, we will include the updated information on these two important federal
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programs in a report that will also contain the Fiscal Year 1999 Financial Report

of the United States Government.

Because of its importance, I would like to summarize the new Social Security and

Medicare information and the differences from the information contained in the

stewardship information accompanying the financial statements. This

information is presented in the following figure.

Trust Fund Trustees’

Report

Financial Report

Social Security

--OASI

--DI

2015

2016

2007

2014

Not Reported

Not Reported

First Year Outgo Exceeds

Tax Income Excluding

Interest

Medicare – Part A 2010 Not Reported

Social Security

--OASI

--DI

2037

2039

2023

2034

2036

2020

Year Trust Fund Is

Exhausted

Medicare – Part A 2023 2015

Social Security

--OASI

--DI

Not Reported

Not Reported

Not Reported

$2,935 billion

2,413 billion

522 billion

Present Value of Additional

Resources Needed

Medicare – Part A Not Reported $2,935 billion

Social Security

--OASI

--DI

1.89%

1.53%

0.37%

Not Reported

Not Reported

Not Reported

Actuarial Deficit as a Percentage

of Taxable Payroll Over the 75

Year Projection Period

Medicare – Part A 1.21 % Not Reported

Social Security

--OASI

--DI

6.18 %

5.40 %

0.78 %

Not Reported

Not Reported

Not Reported

Actuarial Deficit as a Percentage

of Taxable Payroll in Year 75

Medicare – Part A 3.28% Not Reported

Key:

OASI – Federal Old-Age Survivors Trust Fund

DI – Federal Disability Insurance Trust Fund
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I will now discuss the findings of the audit of the U.S. government’s fiscal year

1999 Financial Report.

Results of GAO’s Audit of U.S. Government’s

Financial Statements for Fiscal Year 1999

Our report on the U.S. government’s financial statements for fiscal year 1999

states that certain significant financial systems weaknesses, problems with

fundamental recordkeeping and financial reporting, incomplete documentation,

and weak internal control, including computer controls, continue to prevent the

government from accurately reporting a significant portion of its assets, liabilities,

and costs.

Major challenges included the federal government's inability to

• properly account for and report (1) material amounts of property, equipment,

materials, and supplies and (2) certain stewardship assets, primarily at the

Department of Defense;

• properly estimate the cost of certain major federal credit programs and the

related loans receivable and loan guarantee liabilities, primarily at the

Department of Agriculture;

• estimate and reliably report material amounts of environmental and disposal

liabilities and related costs, primarily at the Department of Defense;

• determine the proper amount of various reported liabilities, including

postretirement health benefits for military employees and accounts payable

and other liabilities for certain agencies;

• accurately report major portions of the net cost of government operations;

• ensure that all disbursements are properly recorded; and

• properly prepare the federal government’s financial statements, including

balancing the statements, accounting for substantial amounts of transactions

between governmental entities, properly and consistently compiling the

information in the financial statements, and reconciling the results of

operations to budget results.

In addition, we found that (1) the government is unable to determine the full

extent of improper payments—estimated to total billions of dollars annually—and

therefore cannot develop effective strategies to reduce them, (2) serious, longstanding computer security weaknesses expose the government's financial and

other sensitive information to inappropriate disclosure, destruction, modification,

and fraud, and critical operations to disruption, and (3) material control
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weaknesses affect the government's tax collection activities. Further, the

financial management systems of almost all agencies were again found not to be

in substantial compliance with the requirements of the Federal Financial

Management Improvement Act of 1996.

Major issues identified by our work are discussed below.

Property, Plant, and Equipment and Inventories and Related Property

The federal government--one of the world's largest holders of physical assets—

does not have adequate systems and controls to ensure the accuracy of

information about the amount of assets held to support its domestic and global

operations. A majority of the $472 billion of these reported assets is not

adequately supported by financial and/or logistical records. Assets that are not

adequately supported include: (1) buildings, structures, facilities, and equipment,

(2) various government-owned assets that are in the hands of private sector

contractors, and (3) operating materials and supplies comprised largely of

ammunition, defense repairable items, and other military supplies. Also, the

government cannot ensure that all assets are reported. For example, no

Department of Defense (DOD) contractor-held personal property was reported.

Further, national defense asset unit information reported as Stewardship

Information was incomplete because (1) it did not include major national defense

support equipment, such as uninstalled engines and communications equipment,

and (2) amounts were reported in units, rather than in dollars as required by

current generally accepted accounting principles. DOD, the largest holder of these

assets, has acknowledged the challenges it faces to implement effective systems

and accurately record data to properly account for and report its physical assets

and has a number of initiatives underway that are intended to address this

problem. These initiatives are expected to span several years.

Because the government lacks complete and reliable information to support its

asset holdings, it could not satisfactorily determine that all assets were included

in the financial statements, verify that reported assets actually exist, or

substantiate the amounts at which they were valued. For example, periodic

physical counts have shown that inventory records contain significant error rates.

Further, weak controls significantly impair the government’s ability to detect and

investigate fraud or theft of assets.

Accurate asset information is necessary for the government to (1) know the assets

it owns and their location and condition, (2) safeguard its assets from physical

deterioration, theft, or loss, (3) account for acquisitions and disposals of such

assets, (4) prevent unnecessary storage and maintenance costs or purchase of

assets already on hand, and (5) determine the full costs of government programs

that use these assets.
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Loans Receivable and Loan Guarantee Liabilities

As of the end of fiscal year 1999, the government reported $184 billion of loans

receivable and $35 billion of liabilities for estimated losses related to estimated

future defaults of guaranteed loans. Certain federal credit agencies, responsible

for significant portions of the government’s lending programs, were unable to

properly estimate the cost of these programs in accordance with generally

accepted accounting principles and budgeting requirements. As an example, the

Department of Agriculture, which represents a significant portion of loans

receivable, could not estimate the net loan amounts expected to be collected

because it does not maintain some of the key historical data needed to predict

borrower behavior, such as the amount and timing of future defaults and

prepayments. Agriculture’s lack of historical data is largely the result of system

inadequacies. Certain affected agencies are in the process of implementing action

plans intended to develop reliable loan and loan guarantee information. Reliable

information about the cost of credit programs is important in supporting annual

budget requests for these programs, making future budgetary decisions, managing

program costs, and measuring the performance of credit activities. Federal credit

programs include direct loans and loan guarantees for farms, rural utilities, low

and moderate income housing, small businesses, veterans’ mortgages, and student

loans.

Environmental and Disposal Liabilities

Significant portions of the liability for remediation of environmental

contamination and disposal of hazardous waste, reported at $313 billion, lacked

adequate support and may not be complete. For example, the estimated cost to

remove unexploded ordnance and residual contaminants from training ranges,

amounting to over 40 percent of DOD’s recorded liability, is not adequately

supported. Also, the cost of significant estimated liabilities associated with

certain major weapons systems and training ranges, initially recorded in fiscal

year 1999, was reported as a current year cost, rather than as a prior period

adjustment as required by generally accepted accounting principles.

Properly stating environmental and disposal liabilities and improving internal

control supporting the process for their estimation could assist in determining

priorities for cleanup and disposal activities and allow for appropriate

consideration of future budgetary resources needed to carry out these activities.

DOD, which has significant exposure for environmental and disposal liabilities,

improved its initial estimate in fiscal year 1999 by including additional categories

of liabilities, such as nuclear weapons systems. Also, DOD has a project in

progress that is intended to better identify and document all additional

environmental and disposal liabilities.
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Liabilities

Adequate systems and cost data were not available to accurately estimate the

reported $196 billion military postretirement health benefits liability included in

federal employee and veteran benefits payable. Information used to develop such

estimates did not include the full cost of providing health care benefits. In

addition, some of the underlying patient workload data were not reliable. DOD is

evaluating methods to develop a reliable estimate of this liability. Also, some

agencies do not maintain adequate records or have systems to ensure that

accurate and complete data were used to estimate a reported $86 billion of

accounts payable and a reported $169 billion in other liabilities. For example, a

liability was not reported for certain amounts owed to contractors that, under the

terms of the contracts, were held by the government pending the acceptance of

goods or services. Further, the government was unable to provide adequate

information to determine whether commitments and contingencies were

complete and properly reported. These problems significantly affect the

determination of the full cost of the government’s current operations, the value of

its assets, and the extent of its liabilities.

Cost of Government Operations

The government was unable to support significant portions of the $1.76 trillion

reported as the total net cost of government operations. The previously discussed

material deficiencies in reporting assets and liabilities and the lack of effective

cash disbursement reconciliations and deficiencies in financial statement

preparation, as discussed below, affect reported net costs. Further, we were

unable to determine whether the amounts reported in the individual net cost

categories on the Statement of Net Cost and in the subfunction detail in

Supplemental Information were properly classified. Accurate cost information is

important to the federal government’s ability to control and reduce costs, assess

performance, evaluate programs, and set fees to recover costs where required.

Cash Disbursement Activity

Several major agencies are not effectively reconciling cash disbursements. These

reconciliations are intended to be a key control to detect and correct errors and

other misstatements in financial records in a timely manner--similar in concept to

individuals reconciling personal checkbooks with a bank's records each month.

Although improvements in some agency reconciliation processes have been

noted, there continued to be billions of dollars of unreconciled differences

between agencies' and Treasury records of cash disbursements as of the end of

fiscal year 1999. As a result, the government is unable to ensure that all

disbursements are properly recorded. Improperly recorded disbursements could

result in misstatements in the financial statements and in certain data provided by

agencies for inclusion in the President's budget concerning fiscal year 1999

obligations and outlays.
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Preparation of Financial Statements

The government does not have sufficient systems, controls, or procedures to

properly prepare financial statements for the U.S. government. Such deficiencies,

described below, impair the government’s ability to (1) properly balance the

government’s financial statements and account for billions of dollars of

transactions between governmental entities, (2) properly and consistently compile

the information in the financial statements, and (3) effectively reconcile the

results of operations reported in the financial statements with budget results.

Also, certain financial information required by generally accepted accounting

principles was omitted from the financial statements.

Unreconciled Transactions. To make the financial statements balance, Treasury

recorded a net $24 billion item on the Statement of Operations and Changes in Net

Position, which it labeled unreconciled transactions. Treasury attributes this net

out-of-balance amount to the government’s inability to properly identify and

eliminate transactions between federal government entities, to agency

adjustments that affected net position, and to errors. An additional net $12 billion

of unreconciled transactions was improperly recorded in net cost. These

unreconciled transactions result in material misstatements of assets, liabilities,

revenues, and/or costs.

Agencies’ accounts can be out of balance with each other, for example, when one

or the other of the affected agencies does not properly record a transaction with

another agency or the agencies record the transactions in different accounting

periods. These out-of-balance conditions can be detected and corrected by

instituting procedures for reconciling transactions between agencies on a regular

basis and in a timely manner.

In fiscal year 1999, the government required agencies to reconcile certain

intragovernmental accounts. Some of these accounts, such as those related to

employee benefits, could not be reconciled. Also, in fiscal year 1999, the

government required agencies to report the detail of certain intragovernmental

accounts by “trading partner” agency. Using this information, we estimated that

the amounts reported for agency trading partners for these specific

intragovernmental accounts were out-of-balance by more than $350 billion. With

trading partner information, the government can begin to analyze the nature of

these intragovernmental account differences and develop effective solutions.

Solutions will also be required for significant differences reported in other

intragovernmental accounts, primarily related to appropriations. The government

stated that it plans to require agencies to reconcile additional intragovernmental

accounts in fiscal year 2000 and has formed task forces to recommend solutions

to this long-standing problem.

Unreconciled transactions also may arise because the government does not have

effective controls over reconciling net position. The net position reported in the

financial statements is derived by subtracting liabilities from assets, rather than
11

through balanced accounting entries. Also, certain adjustments and eliminations

do not balance. Such control weaknesses, combined with unbalanced

transactions and the significant volume of transactions and number of reporting

entities, result in misstatements in the financial statements, hinder the ability of

the government to identify misstatements that may exist, and may contribute to

the amount of reported unreconciled transactions.

Financial Statement Compilation. The federal government cannot ensure that the

information in the financial statements of the U.S. government is properly and

consistently compiled. To prepare the federal government’s financial statements,

about 70 agencies submit data to Treasury on approximately 2,000 separate

reporting components, each having many account balances. In fiscal year 1999,

the Department of Treasury, which prepares the accompanying financial

statements, implemented a new process for reconciling these financial statements

with the related agency financial statements. While the process identified the

nature of certain inconsistencies, the government was unable to reconcile all

amounts included in these financial statements with agency financial statements.

Further, material adjustments and reclassifications were required to (1) make the

financial statements more consistent with agency financial statements, (2) correct

identified inconsistencies in reporting similar transactions, (3) conform footnote

information to related financial statement line items, and (4) record other audit

adjustments. We identified over $350 billion of adjustments and reclassifications

which the government subsequently recorded, such as a $66 billion overstatement

of interest cost and a $70 billion overstatement of Medicare costs.

These problems are compounded by the substantial volume of information

submitted and limitations in the federal government’s general ledger (SGL)

account structure. For example, some SGL accounts must be split between

different financial statement line items. As a result, additional misclassifications

and misstatements in the government’s financial statements could exist. Also, the

extensive manual intervention required to compile the federal government’s

financial statements requires significant resources which lessens the

government’s ability to perform effective financial analysis of the information.

For example, because of SGL limitations, the government separately collects

additional information needed to compile the financial statements. However,

such additional information, historically, is initially inconsistent with the related

SGL account balances by hundreds of billions of dollars. After substantial effort,

such inconsistencies were reduced to an immaterial amount.

Reconciling the Results of Operations With Budget Results. The federal

government does not yet have a process to obtain information to effectively

reconcile the reported $77 billion excess of revenue over net cost and a reported

unified budget surplus of $124 billion. Consequently, it could not identify all of

the items needed to reconcile these amounts. Certain differences are expected to

occur because the financial statements of the U.S. government are to be prepared

on the accrual basis in accordance with generally accepted accounting principles,

which is a different basis than the budget. Under accrual accounting, transactions
12

are reported when the events giving rise to the transactions occur, rather than

when cash is received or paid. By contrast, federal budgetary reporting is

generally on the cash basis in accordance with accepted budget concepts and

policies.

Beginning in fiscal year 1998, 24 major agencies were required to reconcile their

reported net costs to budget information, which could provide a basis for

preparing the reconciliation. However, significant amounts reported in certain

agency reconciliations, including unliquidated obligations and certain other

budget information, lacked adequate supporting information and may be

unreliable. For example, significant amounts of DOD transactions were not

applied or were incorrectly applied to specific budget appropriations, which could

misstate certain reported budget information. Once the federal government

produces reliable financial statements, an effective reconciliation could help

provide additional assurance of the reliability of budget results.

Ineffective Internal Control

In addition to the material weaknesses related to the deficiencies discussed

above, we found that (1) the government’s inability to determine the full extent of

improper payments impairs the effective reduction of such improper payments

and (2) material control weaknesses affect the government's tax collection

activities. We also found that widespread and serious computer control

weaknesses, which are further discussed later in this testimony, affect virtually all

federal agencies and significantly contribute to many of the material deficiencies.

Improper Payments. The government is unable to determine the full extent of

improper or erroneous payments, which include payments made for unauthorized

purposes, for excessive amounts, such as overpayments to program recipients or

contractors and vendors, and/or not in accordance with applicable laws and

regulations. Across government, improper payments occur in a variety of

programs and activities, including those related to contract management, federal

financial assistance, and tax refunds. Reported estimates of improper payments

total billions of dollars annually.

The Department of Health and Human Services (HHS) has been reporting a

national estimate of improper Medicare Fee-for-Service payments since fiscal year

1996. In fiscal year 1999, HHS reported estimated improper Medicare Fee-forService payments of $13.5 billion, or about 8 percent of such benefits—down from

$23.2 billion or 14 percent for fiscal year 1996. HHS’ reporting and analysis of

improper Medicare payments has helped lead to the implementation of several

initiatives to identify and reduce such payments. Annual estimates of improper

payments in future audited financial statements will provide information on the

progress of these initiatives.

However, most agencies have not estimated the magnitude of improper payments

in their programs, nor have they considered this issue in their annual performance
13

plans. For example, the Earned Income Tax Credit (EITC) program—a

refundable tax credit available to low income, working taxpayers—has

historically been vulnerable to high rates of invalid claims. During fiscal year

1999, IRS examined about 573,000 suspicious tax returns claiming $1.25 billion in

EITCs and found that $1.08 billion (86 percent) were invalid. Although the full

extent of refunds resulting from invalid EITCs is unknown, the IRS has not

disclosed any improper payment estimates in its financial statement reports. In

another example, HHS has not reported an estimate of improper payments in its

$109 billion state-administered Medicaid program, but is currently studying

methodologies for developing an estimate and has formed partnerships with

various state auditors to share information on improper payments.

Improper payments can result from incomplete or inaccurate data used to make

payment decisions, insufficient monitoring and oversight, or other deficiencies in

agency information systems and weaknesses in internal control. The risk of

improper payments is increased in programs involving (1) complex criteria for

computing payments, (2) a significant volume of transactions, or (3) an emphasis

on expediting payments. The reasons for improper payments range from

inadvertent errors to fraud and abuse.

Without a systematic measurement of the extent of the problem, agency

management cannot determine (1) if the problem is significant enough to require

corrective action, (2) how much to invest in internal control, or (3) the success of

efforts implemented to reduce improper payments. Developing mechanisms to

identify, estimate, and report the nature and extent of improper payments in

annual financial statements is only a first step for agencies. Without this

fundamental knowledge, agencies cannot be fully informed about the magnitude

or trends of improper payments, nor can they pinpoint or target mitigation

strategies.3

In October 1999, we recommended that OMB develop and implement a

methodology for annually estimating and reporting improper payments and for

addressing improper payments in agencies’ annual performance and strategic

plans and performance reports. OMB agrees with this recommendation. In this

regard, the President has made estimating and preventing improper payments a

priority management objective and OMB plans to require agencies to develop and

implement procedures to estimate and report the nature and extent of material

improper payments in annual financial statements and have such information

audited.

Tax Collection Activities. The federal government continues to have material

weaknesses in controls related to its tax collection activities, which affect its

ability to efficiently and effectively account for and collect the government's

revenue. This situation results in the need for extensive, costly, and time3

Financial Management: Increased Attention Needed to Prevent Billions in Improper Payments

(GAO/AIMD-00-10, October 29, 1999).
14

consuming ad hoc programming and analysis, as well as material audit

adjustments, to prepare basic financial information—an approach that cannot be

used to prepare such information on a timely, routine basis to assist in ongoing

decision-making. Additionally, the severity of the system deficiencies that give

rise to the need to resort to such procedures for financial reporting purposes, as

well as deficient physical safeguards, result in burden to taxpayers and lost

revenue.

Serious financial management system deficiencies continue to affect the federal

government's ability to effectively manage its taxes receivable and other unpaid

assessments.4The lack of appropriate subsidiary systems to track the status of

taxpayer accounts affects the government's ability to make informed decisions

about collection efforts. This weakness has resulted in the government pursuing

collection efforts against individual taxpayers who had already paid their taxes in

full. In addition, the government does not always pursue collection efforts against

taxpayers owing taxes to the federal government. This could result in billions of

dollars not being collected and adversely affect future compliance.

The federal government also continues to be vulnerable to loss of tax revenue due

to weaknesses in preventive and detective controls over disbursements for tax

refunds. Although the government does have detective controls in place, they are

not applied to millions of tax returns estimated to have billions of dollars in

underreported tax liabilities. These conditions expose the government to

potentially billions of dollars in losses due to inappropriate refund disbursements.

Also, the government does not perform sufficient up-front verification procedures

to ensure the validity of amounts claimed by taxpayers as overpayments prior to

making disbursements for refunds. Additionally, delays in recording tax amounts

owed result in lost opportunities to retain or offset overpayments made by a

taxpayer for one period to collect on outstanding amounts owed for another

period, resulting in lost revenue. Finally, serious deficiencies in physical controls

over cash, checks, and sensitive data received from taxpayers increase both the

government's and the taxpayers' exposure to losses and increases the risk of

taxpayers becoming victims of crimes committed through identity fraud.

IRS senior management has expressed a commitment to address many of these

operational and financial management issues and has made a number of

improvements to address some of these weaknesses. Successful implementation

of long-term efforts to resolve these serious problems will require the continued

commitment of IRS management as well as substantial resources and expertise.

4

Other unpaid assessments consist of amounts for which (1) neither the taxpayer nor a court has

affirmed are owed or (2) the government does not expect further collections due to factors such as

the taxpayer's death, bankruptcy, or insolvency.
15

Need to Continue Reform Efforts

In addition to financial statements for the U.S. government, 24 major individual

departments and agencies across government have been required to prepare

annual audited financial statements, beginning with fiscal year 1996. As of March

20, 2000, 22 of the 24 agencies had received audit opinions or disclaimers on their

fiscal year 1999 financial statements. These included 13 unqualified opinions,5

4

qualified opinions, and 5 disclaimers. In fiscal year 1998, 12 agencies received

unqualified audit opinions, 11 in fiscal year 1997, and 6 in fiscal year 1996.

While the results continue to be mixed, effort is now being exerted by individual

agencies to address financial management problems. Several agencies that have

received unqualified opinions on their financial statements are continuing to work

on resolving significant weaknesses in financial systems and internal controls.

We have designated as high risk, certain agencies with the most serious

problems.6These include financial management at the Department of Defense,

IRS, the Forest Service, and the Federal Aviation Administration. All, however,

have concerted efforts underway to address their deficiencies, and we will

continue to work with them and the cognizant Inspectors General to advance

recommendations and evaluate progress.

Clean Opinion Must Be Accompanied by

Modern Systems and Better Controls

Audited financial statements are essential to providing an annual public scorecard

on accountability. However, an unqualified audit opinion, while certainly

important, is not an end in itself. Efforts to obtain reliable year-end data that are

not backed up by fundamental improvements in underlying financial management

systems and operations to support ongoing program management and

accountability will not achieve the intended results of the Chief Financial Officers

Act over the long term.

The majority of federal agencies' financial management systems do not meet

systems requirements and cannot provide reliable financial information for

managing day-to-day government operations and holding managers accountable.

For many agencies, the preparation of financial statements requires considerable

reliance on ad hoc programming and analysis of data produced by inadequate

financial systems that are not integrated, reconciled, and often require significant

5

These agencies are the Social Security Administration, the National Science Foundation, the General

Services Administration, the Department of Energy, the National Aeronautics and Space

Administration, the Nuclear Regulatory Commission, the Department of Labor, the Small Business

Administration, the Federal Emergency Management Agency, the Department of Commerce, the

Department of Health and Human Services, the Department of Transportation, and the Department of

Veterans Affairs.

6

High-Risk Series: An Update (GAO/HR-99-1, January 1999).
16

adjustments. As a result, reliable financial information on a day-to-day basis is not

available for effective financial management.

For example, the IRS relies on extensive, costly, and time-consuming ad hoc

programming and analysis, as well as material audit adjustments, to prepare basic

financial information. For fiscal year 1999, IRS was able to reliably report on the

results of its custodial activities, including nearly $1.9 trillion of tax revenue,

$185 billion of tax refunds, and $21 billion of net federal taxes receivable.7

However, as in 1998, this was accomplished only after extensive use of ad hoc

programming by IRS to extract data from its systems, followed by numerous

adjustments to these data totaling tens of billions of dollars to produce final

financial statements. IRS’ controls and systems remain plagued by weaknesses

that affect its ability, among other things, to report reliable financial information

throughout the year.

Improving Systems

The central challenge in generating timely, reliable data throughout the year is

overhauling financial and related management information systems. To help

stimulate attention to this challenge, the Congress passed the Federal Financial

Management Improvement Act (FFMIA) of 1996, which requires auditors

performing financial audits to report whether agencies’ financial management

systems comply substantially with federal accounting standards, financial systems

requirements, and the government's standard general ledger at the transaction

level.

Thus far, for fiscal year 1999, agency financial auditors have reported that 19 of 22

major agencies' financial systems did not comply with the act's requirements.

Systems of the remaining two major agencies that have not yet issued audited

fiscal year 1999 financial statements did not comply with the act’s requirements

for fiscal years 1998 and 1997. Noncompliance with FFMIA, which we further

discuss in our report Financial Management: Federal Financial Management

Improvement Act Results for Fiscal Year 1998 (GAO/AIMD-00-3, October 1, 1999),

is indicative of the overall continuing poor condition of agency financial systems.

Also, as we reported, agency remediation plans, required by FFMIA, may not

adequately address the system deficiencies. Significant time and investments are

needed for agencies to address and correct these long-standing financial

management systems problems.

Most federal agencies’ financial management systems do not meet systems

requirements and cannot provide reliable financial information for managing dayto-day government operations and holding managers accountable. Therefore, it

will take time and effort to raise federal financial systems to the level of quality

and reliability envisioned in FFMIA.

7

Financial Audit: IRS’ Fiscal Year 1999 Financial Statements (GAO/AIMD-00-76, February 29,

2000).
17

Over the longer term, agencies must address their serious systems problems by

applying the framework outlined in the Clinger-Cohen Act and implementing

guidance. This includes adopting sound information technology investment and

control processes, designing well-developed architectures to guide information

flows and technical standards, and establishing disciplined approaches for

developing and acquiring computer software. Strong partnerships between Chief

Financial Officers and Chief Information Officers are essential to achieve these

goals.

Computer Security Weaknesses

Continuing serious and widespread computer security weaknesses 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. Significant computer security weaknesses in systems that handle the

government's unclassified information have been reported in each of the major

federal agencies. The most serious reported problem is inadequately restricted

access to sensitive data. Other types of weaknesses pertain to not adequately

segregating duties to help ensure that people do not conduct unauthorized actions

without detection, preventing unauthorized software from being implemented,

and mitigating and recovering from unplanned interruptions in computer service.

In today's highly computerized and interconnected environment, such weaknesses

are vulnerable to exploitation by outside intruders as well as authorized users

with malicious intent. Recent media reports highlight the potential damage that

can result from computer security breaches.

The government cannot estimate the full magnitude of actual damage and loss

resulting from federal computer security weaknesses because it is likely that

many such incidents are either not detected or not reported. GAO and agency

reviews illustrate the potential for negative impacts. For instance, weaknesses in

DOD information security continue to provide hackers and hundreds of thousands

of authorized users the opportunity to modify, steal, and destroy DOD data

including financial, procurement, logistics and other sensitive information. Also,

identified weaknesses at HCFA, SSA, IRS, and VA place tax, medical and other

sensitive records at risk of unauthorized disclosure, modification, and

destruction. Unauthorized disclosure of sensitive information has led to instances

of identity theft, in which individuals use such information to commit financial

crimes, such as fraudulently establishing credit and running up debts. Likewise,

serious and pervasive computer security problems at EPA increase the risk that

mission-related systems and financial operations are vulnerable to tampering,

disruption, and misuse. Further, pervasive weaknesses at the Department of

Treasury, which collects virtually all of the government’s revenues and makes

most of its disbursements, expose such collections and disbursements to

significant risk of loss or fraud.
18

GAO and the IGs have issued numerous reports that identify information security

weaknesses in the federal government and made recommendations to address

them.8Also, GAO has reported information security as a high-risk area across

government since February 1997.9

Information security problems continue to persist, in large part, because agency

managers have not fully established comprehensive security management

programs. An effective program would include a central security function and

effective procedures for assessing risks, establishing appropriate policies and

related controls, raising employee awareness of prevailing risks and mitigating

controls, and monitoring and evaluating the effectiveness of established controls.

Such programs, if properly implemented, would provide the government with a

solid foundation for resolving computer security problems and managing

computer security risks on an ongoing basis.

The Congress continues to express concern about the significant risks to federal

government systems and information that result from computer security

weaknesses. Congressional hearings have focused on specific agency deficiencies

and have clarified the problem across government. Further, S. 1993, the

Government Information Security Act of 1999, recently introduced in Congress,

seeks to strengthen information security practices throughout the federal

government.

The administration has recognized the importance of computer security and has

taken some steps to prompt improvement from a governmentwide perspective. In

January 2000, the President released the National Plan for Information Systems

Protection,

10 which calls for new initiatives to strengthen the nation’s defenses

against threats to public and private sector information systems that are critical to

the country’s economic and social welfare. In addition, the President designated

computer security as a priority management objective.

Financial Management Human Capital Challenges

An integral part of financial and information management is building, maintaining,

and marshaling the human capital needed to achieve results. Leading

organizations understand that using a strategic approach to human capital is

essential to reaching and maintaining maximum performance.

8

See, for example, Critical Infrastructure Protection: Comprehensive Strategy Can Draw on Year

2000 Experiences (GAO/AIMD-00-1, October 1, 1999) and Information Security: Serious

Weaknesses Place Critical Federal Operations at Risk (GAO/AIMD-98-92, September 23, 1998). 9

High-Risk Series: An Update (GAO/HR-99-1, January 1999), High-Risk Series: An Overview

(GAO/HR-97-1, February 1997), and High-Risk Series: Information Management and Technology

(GAO/HR-97-9, February 1997).

10Defending America’s Cyberspace: National Plan for Information Systems Protection: Version 1.0:

An Invitation to a Dialogue. Released January 7, 2000. The White House.
19

Organizational success is possible only when the right employees are on board

and provided the training, tools, structure, incentives, and accountability to work

effectively. Specifically, in relation to financial management, the Chief Financial

Officers (CFO) Act recognized the importance of leadership in creating CFO

positions throughout government and in establishing a goal for improving the

qualifications of financial management personnel throughout government.

To effectively evaluate and improve the value derived from government programs

and spending, the Congress and other decisionmakers must have accurate and

reliable financial information on program cost and performance. Further, they

must be able to rely on federal finance organizations to provide analysis and

insight about the financial implications of program decisions and the impact of

those decisions on agency performance goals and objectives. Today, the overall

widespread lack of attention to strategic human capital management may be

creating a fundamental weakness in federal management.11

While some attention to delineating core competencies and training has occurred,

a great deal more needs to be done to improve financial management human

capital. The Office of Management and Budget has designated the development of

human capital as a priority financial management objective. In fiscal year 1999,

we issued a draft Executive Guide: Creating Value Through World Class Financial

Management, which describes best practices in financial management.12 In this

report, we point out that world class financial management organizations provide

added value to management’s operating decisions and emphasize the importance

of strategic human capital management in financial management organizations.

To help agencies better implement performance-based management, we have

identified common principles that underlie the human capital strategies and

practices of private sector organizations regularly cited as leaders in the area of

human capital management.13 Further, we have issued a human capital selfassessment checklist for agency leaders to use in taking practical steps to

improve their human capital practices.14

Strengthening Financial Management

Key to Assuring Accountability

Without a firm foundation of reliable and timely financial and management

information, the many reforms underway across government to move to a

performance-based focus will never be successfully fulfilled. That is why it is so

essential that efforts continue to build the necessary fundamental foundation

through lasting financial management reform. Only by generating reliable and

useful information, can the government assure adequate accountability to

11Human Capital: Managing Human Capital in the 21st

Century (GAO/T-GGD-00-77, March 9, 2000). 12(GAO/AIMD-99-45, August 1999).

13Human Capital: Key Principles From Nine Private Sector Organizations (GAO/GGD-00-28, January 31,

2000).

14Human Capital: A Self-Assessment Checklist for Agency Leaders (GAO/GGD-99-179, September 1999).
20

taxpayers, manage for results, and help decisionmakers make timely wellinformed judgments.

Reliable financial information is critical in assessing the long-term fiscal

consequences of decisions that must be made today. The nation’s demographics

are changing; for government, the most direct long-term fiscal consequence of

these changes is in connection with retirement and health care entitlement

programs. Our analyses continue to show that the combination of longer life

expectancy, the aging baby boom generation, and a relatively smaller working

population will lead to renewed fiscal pressures as entitlement programs for the

elderly increasingly encumber a greater share of available budgetary resources.

In deliberations affecting the nation’s future resources, decisionmakers need

reliable financial information, including the perspectives that can be provided by

accrual and present value data.15

Providing reliable financial data in meaningful, user-friendly reports is also

critical. Accountability is enhanced when Congress can examine the relationship

between agency financial information and program results. A pilot program under

the Government Management Reform Act resulted in 10 agencies issuing

accountability reports for 1996. These reports consolidate reporting requirements

under several statutes, including the CFO Act, GPRA, the Federal Managers’

Financial Integrity Act, the Prompt Payment Act, and the Debt Collection

Improvement Act. The accountability reports include both program and financial

information, such as the audited financial statements and performance measures

reflecting performance in meeting key agency goals. They provide the

opportunity for agencies to report a balanced set of measures that link an

agency’s strategic objectives to its financial performance, customer satisfaction,

the results of its business processes and its effort to improve. Twenty-two

agencies are expected to prepare accountability reports for fiscal year 1999. The

initial experience with accountability reports has been promising and we support

congressional adoption of this concept, or at a minimum, reauthorization of these

pilots, which are to expire on June 30, 2000.

Reliable financial information also is essential for analyzing the government’s

financial condition and helping inform budget deliberations by providing

additional information beyond that provided in the budget. The budget of the

federal government is primarily formulated on a cash basis which also is generally

the basis for calculating the annual budget surplus or deficit. The financial

statements are prepared generally on the accrual basis of accounting. The most

significant difference between the two bases is the timing of recognition and

measurement of revenues and costs. Accrual information can be used along with

budgetary information to provide a valuable perspective on the costs of agency

programs and the government’s assets and long-term commitments.

15Managing in The New Millennium: Shaping a More Efficient and Effective Government for the 21st

Century (GAO/T-OCG-00-9, March 29, 2000).
21

-----

In closing, Mr. Chairman, I want to again commend your Subcommittee for its

diligent oversight of actions to improve financial management of government.

Your hearings continue to underscore the critical importance of the issue and the

need to make greater progress. I look forward to working with you and other

Members of the Congress, along with the executive branch, in bringing about the

type of quality financial management envisioned by legislative goals and expected

by the American people.

I would be pleased to answer questions.

Contact

For future contacts regarding this testimony, please contact Robert Dacey,

Director, Consolidated Audit and Computer Security Issues, at (202) 512-3317.

(919505)
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