For Release on Delivery

Expected at

10 a.m.

Wednesday,

May 24, 2000

GAO/T-AIMD-00-180

FINANCIAL

MANAGEMENT

Education’s Financial

Management Problems

Persist

Statement of Gloria L. Jarmon

Director, Health, Education, and Human Services

Accounting and Financial Management Issues

Accounting and Information Management Division

and

Statement of Gary T. Engel

Associate Director, Governmentwide Accounting and

Financial Management Issues

Accounting and Information Management Division

Testimony

Before the Task Force on Education

Committee on the Budget

House of Representatives

United States General Accounting Office

GAO
Page 1 GAO/T-AIMD-00-180

Mr. Chairman and Members of the Task Force:

We are pleased to be here today to discuss (1) the Department of

Education’s fiscal year 1999 financial audit results1 in the context of

related work we have performed, (2) the relationship between the audit

findings and the potential for waste, fraud, and abuse, and (3) the results

of our review of the Department’s grantback account. Much of the

testimony today reflects our March 1, 2000, testimony on these issues.2

The Department’s financial activity is important to the federal government

because Education is the primary agency responsible for overseeing the

more than $75 billion annual federal investment in support of educational

programs for U.S. citizens and eligible noncitizens. The Department is also

responsible for collecting about $175 billion owed by students. In fiscal

year 1999, more than 8.1 million students received over $53 billion in

federal student financial aid through programs administered by Education.

The Department’s stewardship over these assets has been under question

as the agency has experienced persistent financial management

weaknesses. Beginning with its first agencywide financial audit effort in

fiscal year 1995,3 Education’s auditors have each year reported largely the

same serious internal control weaknesses, which have affected the

Department’s ability to provide reliable financial information to decision

makers both inside and outside the agency.

Federal decision makers need reliable and timely financial management

information to ensure adequate accountability, manage for results, and

make timely and well-informed decisions. However, historically, such

financial management information has not been available across the

government. Agency IG reports, independent public accountants’ reports,

and our own work have identified persistent limitations in the availability

of quality financial data for decision making. Audits have shown that

federal financial management is in serious disrepair, which results in

incorrect financial information being provided to the Congress and the

1Department of Education, Fiscal Year 1999 Consolidated Financial Statements, Ernst & Young LLP,

February 2000.

2Financial Management: Education Faces Challenges in Achieving Financial Management Reform

(GAO/T-AIMD-00-106, March 1, 2000).

3For fiscal year 1995, a year before the Government Management Reform Act (GMRA) requirements

became effective, the Department’s Inspector General (IG) hired a contractor to perform its first

agencywide financial audit.

Background
Page 2 GAO/T-AIMD-00-180

administration. Without reliable financial information, government leaders

do not have the full facts necessary to make investments of scarce

resources or direct programs. Creating a government that runs more

efficiently and effectively has been a public concern for decades.

Over the past 10 years, dramatic changes have occurred in federal

financial management in response to the most comprehensive

management reform legislation of the past 40 years. The combination of

reforms ushered in by (1) the Chief Financial Officers (CFO) Act of 1990,

(2) the Government Management Reform Act of 1994, (3) the Federal

Financial Management Improvement Act (FFMIA) of 1996, (4) the

Government Performance and Results Act (GPRA) of 1993, and (5) the

Clinger-Cohen Act of 1996 will, if successfully implemented, provide the

necessary foundation to run an effective, results-oriented government.

Efforts to continue to build the foundation for generating accurate

financial information through lasting financial management reform are

essential. Only by generating reliable and useful information can the

government ensure adequate accountability to taxpayers, manage for

results, and help decision makers make timely, well-informed judgments.

Education’s fiscal year 1999 audit was conducted by Ernst & Young LLP,

independent auditors contracted for by the Education Inspector General.

We reviewed the independent auditors’ reports and workpapers. We

shared a draft of this statement with Education officials, who provided

technical comments. We have incorporated their comments where

appropriate. Our work was conducted in accordance with generally

accepted government auditing standards.

The Office of Management and Budget’s (OMB) implementation guidance

for audited financial statements requires the 24 CFO Act agencies to

receive three reports from their auditors annually: (1) an opinion or report

on the agencies’ financial statements, (2) a report on the agencies’ internal

controls, and (3) a report on the agencies’ compliance with laws and

regulations. We recently reported4 that 13 of the 24 CFO Act agencies

received “clean” or unqualified opinions on their fiscal year 1999 financial

4Letter to the Congress highlighting our conclusions on the Fiscal Year 1999 Financial Report of the

United States Government (GAO/AIMD-00-131, March 31, 2000).

Fiscal Year 1999 Audit

Results
Page 3 GAO/T-AIMD-00-180

statements. 5 The Department of Education did not receive such an

opinion because of its financial management weaknesses.

As reported in December,6 and again in March, 7the Department issued its

fiscal year 1998 financial statements over 8 months late and was one of six

CFO Act agencies that received disclaimers—meaning that the auditors

were unable to express an opinion—on their financial statements for that

fiscal year.8 Pervasive weaknesses in the design and operation of

Education’s financial management systems, accounting procedures,

documentation, recordkeeping, and internal controls, including computer

security controls, prevented Education from reliably reporting on the

results of its operations for fiscal year 1998.

While Education’s financial staff and its contractors worked very hard to

prepare Education’s fiscal year 1999 financial statements before the

March 1, 2000, deadline, and the auditors’ opinion on the financial

statements improved over that of fiscal year 1998, serious internal control

and financial management systems weaknesses continued to plague the

agency. For fiscal year 1999, Education made significant efforts to work

around these weaknesses and produce financial statements. These efforts

enabled its auditors to issue qualified opinions9 on four of its five required

financial statements and a disclaimer on the fifth statement. Its auditors’

qualified opinion states that except for the effect of the matters to which

the qualification relates, the financial statements present fairly, in all

material respects, financial position, net costs, changes in net position, and

budgetary resources in conformity with generally accepted accounting

5As of May 15, 2000, the Department of State had not issued its audit report. Since our last report, the

Department of Interior’s (DOI) Office of Inspector General issued an unqualified opinion on DOI’s

fiscal year 1999 financial statements.

6Financial Management: Financial Management Weaknesses at the Department of Education (GAO/

T-AIMD-00-50, December 6, 1999).

7Financial Management: Education Faces Challenges in Achieving Financial Management Reform

(GAO/T-AIMD-00-106, March 1, 2000).

8In addition to the 6 agencies that received disclaimers in fiscal year 1998, 4 agencies received

qualified opinions, 2 agencies received mixed opinions, and 12 agencies received unqualified or “clean”

opinions.

9Such an opinion is expressed when (1) there is a lack of sufficient competent evidential matter or

there are restrictions on the scope of the audit that have led the auditor to conclude that he or she

cannot express an unqualified opinion and he or she has concluded not to disclaim an opinion or

(2) the auditor believes, on the basis of his or her audit, that the financial statements contain a

departure from generally accepted accounting principles, the effect of which is material, and he or she

has concluded not to express an adverse opinion.

Report on the Financial

Statements
Page 4 GAO/T-AIMD-00-180

principles. The auditors stated the following reasons or matters for their

qualification:

• The Department had significant systems weaknesses during fiscal year

1999 affecting its financial management systems. The new accounting

system, implemented in fiscal year 1998, had several limitations, including

an inability to perform a year-end closing process or produce automated

consolidated financial statements. Through its efforts and those of its

contractors, Education was able to partially compensate for, but did not

correct, certain aspects of the material weaknesses in its financial

reporting process. In addition, during fiscal year 1999, Education

experienced significant turnover of financial management staff, which also

contributed to the overall weakness in financial reporting.

• Education was unable to provide adequate support for about $800 million

reported in the September 30, 1999, net position balance in its financial

statements, and the auditors were unable to perform other audit

procedures to satisfy themselves that this amount was correct.

• Education processed many transactions from prior fiscal years as fiscal

year 1999 transactions and manually adjusted its records in an effort to

reflect the transactions in the proper period; however, the auditors could

not determine if these adjustments for certain costs and obligations were

correct.

• The auditors were unable to determine whether beginning balances for

accounts payable and related accruals were accurate.

In addition, as in the prior year, the auditors did not issue an opinion

(referred to as a disclaimer of an opinion) on the Department’s Statement

of Financing. The Statement of Financing provides a reconciliation or

“translation” from the budget to the financial statements. The statement is

intended to help those who work with the budget to understand the

financial statements and the cost information they provide. The auditors

stated that the reason for this disclaimer was that the Department did not

perform adequate reconciliations and present support for amounts on the

Statement of Financing in a timely manner.

To the extent that Education was able to improve the opinion it received

on its financial statements for fiscal year 1999, it was generally the result

of (1) time-consuming manual procedures, (2) various automated tools to

“work around” the system’s inability to close the books and generate

financial statements, and (3) significant reliance on external consultants to

assist in the preparation of additional reconciliations and the financial

statements. This approach does not produce the timely and reliable
Page 5 GAO/T-AIMD-00-180

financial and performance information Education needs for decision

making on an ongoing basis, which is the desired result of the CFO Act.

The Department also receives annually from its auditors a report on

internal controls. This report is significant for highlighting the agency’s

internal control weaknesses that increase its risk of mismanagement that

can sometimes result in waste, fraud, and abuse. In this report for fiscal

year 1999, the Department’s auditors reported four material10 internal

control weaknesses—three continuing from fiscal year 1998 and one

additional one for fiscal year 1999—and that long-standing internal control

weaknesses persist.

The specific material internal control weaknesses cited by the

independent auditors for fiscal year 1999 were (1) weaknesses in the

financial reporting process, (2) inadequate reconciliations of financial

accounting records, and (3) inadequate controls over information systems.

The independent auditors also identified a new material internal control

weakness related to accounting for certain loan transactions. Summaries

of the material internal control weaknesses follow:

• As in prior years, Education did not have adequate internal controls over

its financial reporting process. Its general ledger system was not able to

perform an automated year-end closing process and directly produce

consolidated financial statements as would normally be expected from

such systems. Because of these weaknesses, Education had to resort to a

costly, labor-intensive, and time-consuming process involving manual and

automated procedures to prepare financial statements for fiscal year 1999.

In addition, Education had to rely heavily on contractor services to help

perform reconciliations among the various data sources used. In one

instance, Education reported a balance of approximately $7.5 billion for its

cumulative results of operations. However, the majority of this amount,

which pertains to the Federal Family Education Loan Program (FFELP),

should have been reported as a payable to Treasury rather than as

cumulative results of operations. As a result of the independent auditors’

10A material internal control weakness is a reportable condition that precludes the entity’s internal

controls from providing reasonable assurance that material misstatements in the financial statements

or material noncompliance with applicable laws or regulations will be prevented or detected on a

timely basis. In addition to these material internal control weaknesses, the independent auditors also

reported four reportable conditions. Reportable conditions are matters coming to the auditors’

attention that, in their judgment, should be communicated because they represent significant

deficiencies in the design or operation of internal controls that could adversely affect the

organization’s ability to meet the objectives of reliable financial reporting and compliance with

applicable laws and regulations.

Report on Internal

Controls
Page 6 GAO/T-AIMD-00-180

work, an adjustment was made to reclassify the $7.5 billion to the proper

account. When such errors occur and are not detected by the

Department’s controls, there are increased risks that the Department

could retain funds inappropriately that should be returned to Treasury.

• Education again did not properly or promptly reconcile its financial

accounting records during fiscal year 1999 and could not provide sufficient

documentation to support some of its financial transactions. Weaknesses

in the Department’s internal controls over the reconciliation process

prevented timely detection and correction of errors in its underlying

accounting records. In some instances, Education adjusted its general

ledger to reflect the balance per the subsidiary records, without

sufficiently researching the cause for differences. Also, as indicated in

prior audits, Education has not been able to identify and resolve

differences between its accounting records and cash transactions reported

by the Treasury. For example, for fiscal year 1999, Education adjusted its

Fund Balance with Treasury, due to a difference between its general

ledger and the Treasury, by a net amount of about $244 million.

Reconciling agencies’ accounting records with relevant Treasury records

is required by Treasury policy and is analogous to individuals reconciling

their checkbooks to monthly bank statements.

• During fiscal year 1999, Education did not properly account for its funds

disbursed under FFELP. Specifically, it did not return about $2.7 billion in

net collections specific to its liquidating account to Treasury as required

by the Credit Reform Act of 1990. The liquidating account is used to record

transactions for loans originated prior to fiscal year 1992. Any unobligated

balances in this account at fiscal year end are unavailable for obligations

in subsequent fiscal years and must be transferred to the general fund.

Further, Education did not sufficiently analyze the balances reflected on

the financial statements to ensure that the FFELP balances agreed with

relevant balances in the Department’s budgetary accounts. The auditors

stated that this situation resulted in an unexplained difference of about

$700 million between the FFELP Fund Balance with Treasury account and

related budgetary accounts as of September 30, 1999. By not properly

accounting for and analyzing its FFELP transactions as required by the

Federal Credit Reform Act of 1990, Education cannot be assured that its

financial or budgetary reports are accurate.

• Education had information systems control deficiencies in

(1) implementing user management controls, such as procedures for

requesting, authorizing, and revalidating access to computing resources,

(2) monitoring and reviewing access to sensitive computer resources,

(3) documenting the approach and methodology for the design and
Page 7 GAO/T-AIMD-00-180

maintenance of its information technology architecture, and

(4) developing and testing a comprehensive disaster recovery plan to

ensure the continuity of critical system operations in the event of disaster.

The Department places significant reliance on its financial management

systems to perform basic functions, such as making payments to grantees

and maintaining budget controls. Consequently, continued weaknesses in

information systems controls increase the risk of unauthorized access or

disruption in services and make Education’s sensitive grant and loan data

vulnerable to inadvertent or deliberate misuse, fraudulent use, improper

disclosure, or destruction, which could occur without being detected.

Our work in this area has shown that other agencies have improved their

financial audit report results but are also facing material internal control

weaknesses. A number of other agencies have focused their efforts

primarily on trying to develop short-term stop-gap measures designed to

produce year-end balances rather than on the fundamental solutions that

are needed to address the management challenges they face. As a result,

these agencies continue to experience pervasive material weaknesses in

the design and operation of their financial management and related

operational systems, accounting procedures, documentation,

recordkeeping, and internal controls, including computer security

controls. Consequently, these agencies rely on costly, time-consuming ad

hoc procedures to determine year-end balances. This approach does not

produce the timely and reliable financial and performance information

needed for decision making on an ongoing basis. This approach is also

inherently incapable of addressing the underlying financial management

and operational issues that adversely affect these agencies’ ability to fulfill

their missions.

The third report that the auditors issue annually is a report on agency

compliance with laws and regulations. Specifically, the Department’s

auditors reported that it was not in full compliance with three laws as

noted below.

• For fiscal year 1999, the independent auditors found that Education was

again not in compliance with FFMIA because it lacked adequate,

integrated financial management systems, reports, and oversight to

prepare timely and accurate financial statements. The Department was 1

of 21 CFO Act agencies whose financial systems did not comply with the

requirements of FFMIA in fiscal year 1998. Because many agencies have

significant financial management systems weaknesses, these results did

Report on Compliance

with Laws and Regulations
Page 8 GAO/T-AIMD-00-180

not change significantly in fiscal year 1999—20 of 2311 agencies’ systems

did not comply with FFMIA. However, it is imperative that these problems

be resolved so that agencies can produce needed financial information on

a day-to-day basis in a timely and accurate manner. FFMIA requires that

agency financial management systems substantially comply with

(1) federal financial management systems requirements,12 (2) federal

accounting standards, and (3) the U.S. Government Standard General

Ledger13 at the transaction level. We are working with OMB and the

agencies to evaluate their progress in resolving these significant

weaknesses.

• The Department had neither fully implemented a capital planning and

investment process nor performed an assessment of the information

resource management knowledge and skills of agency personnel, including

a plan to correct identified deficiencies, as required by the Clinger-Cohen

Act of 1996. A key goal of the Clinger-Cohen Act is that agencies should

have processes and information in place to help ensure that information

technology (IT) projects are being implemented at acceptable costs and

within reasonable and expected time frames and that they are contributing

to tangible, observable improvements in mission performance. By not fully

implementing the plans called for under the act, Education was not

maximizing the value and assessing and managing the risks of its IT

investments.

• The Department did not transfer its excess funds related to FFELP,

specifically the $2.7 billion of net collections previously mentioned, to

Treasury as required by the Federal Credit Reform Act of 1990.

Education continues to be plagued by serious internal control and system

deficiencies that hinder its ability to achieve lasting financial management

improvements. The internal control weaknesses discussed above and in

more detail in the auditors’ report need to be addressed to reduce the

potential for waste, fraud, and abuse in the Department. Some of the

vulnerabilities identified in the audit report include weaknesses in the

financial reporting process, inadequate reconciliations of financial

11As of May 15, 2000, the Department of State had not issued its audit report.

12The financial management systems requirements have been developed by the Joint Financial

Management Improvement Program, which is a joint and cooperative undertaking of the Department

of the Treasury, OMB, GAO, and the Office of Personnel Management.

13The Standard General Ledger provides a standard chart of accounts and standardized transactions

that agencies are to use in all their financial systems.

Potential for Fraud,

Waste, and Abuse
Page 9 GAO/T-AIMD-00-180

accounting records, information systems weaknesses, and property

management weaknesses. Specific examples of vulnerabilities related to

these weaknesses follow:

• The material internal control weakness related to financial reporting

highlights the fact that managers do not receive accurate and timely

financial information, such as information on disbursements made and

amounts collected, that could be used to identify unusual activity and

other anomalies.

• Some of the known duplicate payments mentioned by the auditors in their

report on internal controls could have been identified earlier if proper

reconciliations had been performed. The auditors stated that the

Department has procedures in place that should detect duplicate

payments and correct them within a reasonable time frame. We have not

reviewed these procedures.

• The auditors stated that because the Department has not developed formal

policies and procedures to reconcile grant expenditures between its

payments system and its general ledger system, there is increased risk that

material errors or irregularities could occur and not be detected on a

timely basis. This is significant because the volume of grant transactions is

over $30 billion per year.

• The information systems weaknesses highlight some of the computer

security vulnerabilities, such as the lack of an effective process to monitor

security violations on all critical systems of the Department. Information

systems control weaknesses increase the risk of unauthorized access or

disruption in services and make Education’s sensitive grant and loan data

vulnerable to inadvertent or deliberate misuse, fraudulent use, improper

disclosure, or destruction, which could occur without being detected. A

report issued by the Department’s Inspector General in February 14

emphasizes the need for the Department to focus on addressing its

computer security vulnerabilities. In addition, earlier this year, the White

House recognized the importance of strengthening the nation’s defenses

against threats to public and private sector information systems that are

critical to the country’s economic and social welfare when it issued its

National Plan for Information Systems Protection.

15 In the aftermath of the

recent attack by the “ILOVEYOU” virus, which disrupted operations at

14Review of Security Posture, Policies and Plans (ED-OIG/A11-90013) February 2000.

15Defending America’s Cyberspace: National Plan for Information Systems Protection: Version 1.0: An

Invitation to a Dialogue, released January 7, 2000, the White House.
Page 10 GAO/T-AIMD-00-180

large corporations, governments, and media organizations worldwide, we

recently testified16 about the need for federal agencies to promptly

implement a comprehensive set of security controls.

• The auditors reported that Education had not taken a complete,

comprehensive physical inventory of property and equipment for at least

the past 2 years. Comprehensive inventories improve accountability for

safeguarding the government’s assets, such as computer software and

hardware, and establish accurate property records. Without such an

inventory, property or equipment could be stolen or lost without detection

or resources could be wasted by purchasing duplicate equipment already

on hand. An alleged equipment theft is currently under investigation by the

OIG.

In addition, vulnerabilities in the Department’s student financial assistance

programs have led us since 1990 to designate this a high-risk17 area for

waste, fraud, abuse, and mismanagement. As we reported in our high-risk

series update in January 1999, our audits as well as those by the

Department’s IG have found instances in which students fraudulently

obtained grants and loans.

The grantback account holds certain funds recovered from grant

recipients following an audit determination that the recipients had made

an expenditure of funds that was not allowable or failed to account

properly for the funds. A portion of these funds could be returned to the

recipients if and when the problem that led to the recovery of the funds

has been corrected. Any amounts not returned to the grant recipients

should revert to Treasury. For the grantback account, which is part of

Education’s Fund Balance with Treasury, its auditors reported that

approximately 97 percent of the balance at September 30, 1998, was

composed of adjustments that had accumulated since fiscal year 1993 for

reconciling differences of various appropriations that could not be

identified with any specific program. The auditors also reported for fiscal

year 1999 that Education could not readily determine to which

appropriations the adjustments balance belongs. Education’s general

ledger as of September 30, 1999, showed approximately $314 million in

Fund Balance with Treasury related to the grantback account, of which

approximately $297 million related to the adjustments. In January 2000,

16Information Security: “ILOVEYOU” Computer Virus Emphasizes Critical Need for Agency and

Governmentwide Improvements (GAO/T-AIMD-00-171, May 10, 2000).

17High-Risk Series: An Update (GAO/HR-99-1, January 1999).

Review of the

Grantback Account
Page 11 GAO/T-AIMD-00-180

Education returned to Treasury approximately $146 million of the

adjustments balance. The auditors reported that Education is working

with Treasury to determine the appropriate accounting for the remaining

adjustments balance.

Mr. Chairman, at your request and that of the Vice Chairman of the

Subcommittee on Oversight and Investigations of the House Committee on

Education and the Workforce, we reviewed Education’s grantback

account. We briefed you and Education officials on our findings earlier

this month and plan to issue our detailed report in the near future. In our

review of the grantback account, we found that although the account was

established for grantback activities, Education also used it as a suspense

account for hundreds of millions of dollars of activity related to grant

reconciliation efforts. We also found that Education could not provide

adequate documentation to support the validity of certain adjustments

related to the reconciliation efforts and other activity in the grantback

account. For example, out of a sample of 92 grantback transactions

totaling $128 million, Education could not locate or provide any

documentation to support the validity of 39 of these transactions totaling

$47 million. In addition, out of 20 adjustment transactions we selected for

testing, Education could not provide adequate documentation to support

the validity of 6 transactions.

Further, Education did not maintain adequate detailed records for certain

grantback account activity by the applicable fiscal year and appropriation.

Such detailed records are needed to have an adequate system of funds

control and help protect against Anti-Deficiency Act violations. For

example, an adjustment we tested totaling $111 million reduced the

grantback account balance and increased the balance of six

appropriations to ensure that projected negative balances for such

appropriations did not occur. However, Education could not provide any

documentation to show that the increases to the appropriation accounts to

prevent the negative balances were valid. As a result of financial

management systems deficiencies, inadequate systems of funds control,

and manual internal control weaknesses, which we and other auditors

identified, there is increased risk of fraud, waste, and mismanagement of

grant funds, as well as increased risk of noncompliance with the

requirements of the Anti-Deficiency Act.

We noted in our briefing that Education had taken or plans to take actions

to address the grantback account issues. In addition, our briefing included

recommendations to Education to strengthen internal controls related to

documentation and policies and procedures for grant reconciliations and
Page 12 GAO/T-AIMD-00-180

to develop and implement a formal, detailed plan to eliminate the

remaining portion of the adjustments balance.

In summary, Education needs to be able to generate reliable, useful, and

timely information on an ongoing basis to ensure adequate accountability

to taxpayers, manage for results, and help decisionmakers make timely,

well-informed judgments. While Education has planned and begun

implementing many actions to resolve its financial management problems,

it is too early to tell whether they will be successful. It is critical that

Education rise to the challenges posed by its financial management

weaknesses because its success in achieving all aspects of its strategic

objectives depends in part upon reliable financial management

information and effective internal controls. It is also important to

recognize that several of the financial management issues that have been

raised in reports emanating from reviews of Education’s financial

statements directly or indirectly affect Education’s ability to meet its

obligations to its loan and grant recipients and responsibilities under law.

Mr. Chairman, this concludes our statement. We would be happy to

answer any questions you or other Members of the Task Force may have.

For information about this statement, please contact Gloria Jarmon at

(202) 512-4476 or at jarmong.aimd@gao.gov or Gary Engel at (202) 512-

3406 or at engelg.aimd@gao.gov. Individuals making key contributions to

this statement included Chinero Nwaigwe, Cheryl Driscoll, Anh Dang, Meg

Mills, and Christine Robertson.

(916362)

Contact and

Acknowledgement
Orders by Internet

For information on how to access GAO reports on the Internet, send

an e-mail message with “info” in the body to:

Info@www.gao.gov

or visit GAO’s World Wide Web home page at:

http://www.gao.gov

Contact one:

Web site: http://www.gao.gov/fraudnet/fraudnet.htm

E-mail: fraudnet@gao.gov

1-800-424-5454 (automated answering system)

Ordering Information

To Report Fraud,

Waste, and Abuse in

Federal Programs