GAO-02-746R IRS Management Report

United States General Accounting Office

Washington, DC 20548

July 18, 2002

The Honorable Charles O. Rossotti

Commissioner of Internal Revenue

Subject: Management Report: Improvements Needed in IRS's Accounting

Procedures and Internal Controls

Dear Mr. Rossotti:

In February 2002, we issued our report on the results of our audit of the Internal

Revenue Service’s (IRS’s) financial statements as of, and for the fiscal years ending,

September 30, 2001, and 2000,1

 and on the effectiveness of its internal controls as of

September 30, 2001. We also reported our conclusions on IRS’s compliance with

significant provisions of selected laws and regulations and on whether IRS’s financial

management systems substantially comply with requirements of the Federal

Financial Management Improvement Act of 1996. A separate report on the

implementation status of recommendations from our prior IRS financial audits and

related financial management reports will be issued shortly.

The purpose of this report is to discuss additional matters identified during our fiscal

year 2001 audit regarding accounting procedures and internal controls that could be

improved. These matters are not considered material in relation to the financial

statements; however, they warrant management’s consideration.

Results in Brief

During fiscal year 2001, IRS had a number of internal control issues that affected

financial reporting, including safeguarding of assets. These issues concern policies

and procedures over (1) receipt of taxpayer payments, (2) courier services that

transport taxpayer data, (3) employee fingerprint records, (4) issuance of manual

refunds, (5) release of tax liens, (6) recording of property and equipment (P&E)

transactions, (7) linking of property and accounting records, (8) software licenses,

 1

U.S. General Accounting Office, Financial Audit: IRS’s Fiscal Year 2001 and 2000

Financial Statements, GAO-02-414 (Washington D.C.: Feb. 27, 2002).
Page 2 GAO-02-746R IRS Management Report

(9) reimbursable receivables,2

 and (10) recording changes in administrative account

balances.

Specifically, we found the following.

• IRS did not have adequate controls over taxpayer payments received at

certain field locations. We found that (1) although receipts were usually

issued, notices reminding taxpayers to obtain receipts for payments were not

present, (2) at two field office locations, payments placed in drop boxes were

processed by only one employee, and (3) payment logs were not reconciled to

taxpayer documents. As a result, IRS’s risk of theft, loss, or misuse of

taxpayer deposits was increased.

• IRS service center campuses did not ensure that couriers had undergone

background checks. As a result, IRS’s risk of theft, loss, or misuse of deposits

and taxpayer information was increased.

• IRS’s database to track fingerprint results was subject to technical constraints

and human error. These issues resulted in numerous instances of erroneous

or missing data. Incomplete and inaccurate fingerprint data may hamper IRS’s

investigations of security violations.

• IRS staff did not always perform or document required monitoring of

manually processed tax refunds. As a result, the risk that other staff or IRS’s

automated tax system could issue duplicate refunds was increased.

• IRS did not record the dates on which certificate of lien releases were mailed

to courts and we noted long delays between the date of the IRS certificate of

lien release and the date the local jurisdiction recorded its receipt. Delays in

releasing tax liens could cause undue hardship and burden to taxpayers who

are attempting to sell property or apply for commercial credit.

• IRS did not follow procedures for promptly recording assets on its property

management system, resulting in delays in the proper accounting for

hundreds of P&E items, such as microcomputers.

• IRS’s asset acquisition costs on the accounting records could not always be

linked to assets recorded on the inventory records. Consequently, the

existence of certain property acquired and recorded on accounting records

during fiscal year 2001 was not verifiable.

 2

IRS provides goods and services to federal agencies, state and foreign governments, and

private organizations on a reimbursable cost basis. Payments due to IRS for these activities

are referred to as reimbursable receivables.
Page 3 GAO-02-746R IRS Management Report

• IRS’s property management system did not maintain an inventory of software

or software licenses. As a result, IRS could not determine its compliance with

software licenses or effectively account for and manage acquired software.

• IRS did not adequately monitor and review reimbursable receivables to

determine their validity or collectibility. As a result, certain amounts

recorded as reimbursable receivables reported on IRS’s financial statements

were not valid or were uncollectible.

• IRS did not have procedures to estimate and accrue material changes in

administrative account balances throughout the fiscal year. The lack of these

procedures going forward may preclude IRS from having assurance that

interim financial statements it is required to prepare for fiscal year 2002 per

the Office of Management and Budget (OMB) Bulletin 01-09, Form and

Content of Agency Financial Statements, are reliable.

At the end of our discussion on each of these issues, we offer recommendations for

strengthening IRS’s internal controls.

In its comments, IRS agreed with our recommendations and described actions it was

taking or had planned to address several of the control weaknesses described in this

report. At the end of our discussion of each of the issues in this report, we have

summarized IRS’s related comments and provided our evaluation. We also

considered IRS’s feedback on our findings and have made revisions as appropriate.

Scope and Methodology

As part of our audit of IRS’s fiscal years 2001 and 2000 financial statements, we

evaluated IRS’s internal controls and its compliance with selected provisions of laws

and regulations. We designed our audit procedures to test relevant controls and

included tests for proper authorization, execution, accounting, and reporting of

transactions.

We conducted our audit in accordance with U.S. generally accepted government

auditing standards. Further details on our scope and methodology are included in

our February 2002 report on the results of our fiscal years 2001 and 2000 financial

statement audit.3

 We requested comments on a draft of this report from the

Commissioner of IRS or his designee. We received written comments from the

Deputy Commissioner and have reprinted the comments in enclosure I to this report.

 3

GAO-02-414.
Page 4 GAO-02-746R IRS Management Report

IRS Needs to Strengthen

Controls Over Taxpayer Receipts

During our fiscal year 2001 financial audit, we identified several issues related to

IRS’s controls over taxpayer receipts that increased the risk that such receipts could

be lost or stolen and that the theft would not be timely detected. GAO’s Standards

for Internal Controls in the Federal Government requires agencies to establish

controls to safeguard valuable assets and reduce the risk of error or fraud. The

standards state that such controls should include 1) periodic comparisons between

resources and records to ensure proper accountability and 2) segregation of duties so

that no one individual controls all aspects of a transaction.

In prior audits, we had noted weaknesses in IRS’s physical controls over service

center campus and field office taxpayer receipts.4

 We recommended that IRS (1)

establish procedures to provide receipts to walk-in taxpayers5

 at IRS service center

campuses regardless of the method of payment, and (2) post signs at the campuses to

remind taxpayers to ask for receipts. We also recommended that IRS record

remittances made by walk-in taxpayers in control logs prior to depositing them in a

locked container, and that IRS reconcile the control log information to the tax

receipts prior to processing. As a result of our recommendations, IRS issued

guidance in 1999 and updated its procedures in 2000 on controls over receipts.

Specifically, these procedures required IRS to (1) post signs in all service center

campus lobbies to remind taxpayers to request a receipt, (2) record payments made

by walk-in taxpayers on control logs, and (3) establish segregation of duties for

recording and reconciling taxpayer receipts.

During our fiscal year 2001 audit, we found that service center campuses no longer

accepted walk-in payments, but rather directed taxpayers to field offices. At the field

offices we visited, we found that although IRS employees usually issued a receipt for

walk-in payments, IRS had no policy requiring that field offices issue a receipt for all

payments. Additionally, IRS had no requirement that signs be posted in field office

lobbies to remind taxpayers to request receipts. One field office we visited had not

posted such signs. The issuance of receipts for all payments, followed by timely and

 4

U.S. General Accounting Office, Internal Revenue Service: Physical Security Over

Taxpayer Receipts and Data Needs Improvement, GAO/AIMD-99-15 (Washington D.C.: Nov.

30, 1998); U.S. General Accounting Office, Internal Revenue Service: Custodial Financial

Management Weaknesses, GAO/AIMD-99-193 (Washington D.C.: Aug. 4, 1999); U.S. General

Accounting Office, Internal Revenue Service: Recommendations to Improve Financial and

Operational Management, GAO-01-42 (Washington D.C.: Nov. 17, 2000); and U.S. General

Accounting Office, Internal Revenue Service: Progress Made, but Further Actions Needed to

Improve Financial Management, GAO-02-35 (Washington D.C.: Oct. 19, 2001).

5

Walk-in taxpayers are individual taxpayers who choose to conduct business with IRS in

person. Generally, these individuals are directed to the IRS field offices which have units set

up to handle questions and accept payments from such taxpayers.
Page 5 GAO-02-746R IRS Management Report

thorough management reviews of receipts issued, provides better accountability for

walk-in payments received by IRS.

Additionally, we found control issues related to drop boxes maintained at field offices

for walk-in taxpayers to deposit payments. At each of the two offices we visited, we

found that only one employee emptied the drop box and recorded the payments on a

log. At one of the offices, the same employee later reconciled the payments to the

log. Requiring two employees to retrieve and record payments from drop boxes

establishes better control and accountability for these receipts. However, IRS

currently does not have a policy requiring dual control over drop box receipts.

Additionally, IRS did not provide adequate oversight to ensure that its employees

adhered to its policy regarding segregation of duties over the reconciliation of

receipts. This increases the risk of theft of taxpayer payments.

IRS did not have policies/procedures to reconcile receipts found during final candling

to the final candling log.6

 As a result, we found that two IRS service center campuses

and one of two lockbox banks7 we visited did not reconcile receipts found during

final candling to the candling logs. At the lockbox bank, we noted that two separate

logs were used to record checks found during final candling. Employees performing

final candling recorded only the number of checks found on the initial log while a

supervisor prepared a second more detailed log several hours later that identified the

taxpayer and the amount of the check. However, the supervisor did not reconcile the

number of checks indicated on the initial log with the checks on hand. Consequently,

bank managers were unable to explain differences we noted between the number of

checks on the initial log and the detailed log. The failure to maintain adequate

control logs of all checks found during final candling increases the risk that not all

checks will be accounted for and eventually credited to taxpayers’ accounts.

Recommendations

We recommend that you direct IRS management to develop policies and procedures

to require that

• field office employees provide taxpayers receipts for all walk-in payments;

 6

Final candling occurs at the end of the mail extraction process. After contents from

envelopes are extracted, IRS staff illuminate, or “candle” all envelopes which have already

gone through the extraction process to ensure that all contents are actually removed prior to

the envelopes’ destruction.

7

A lockbox refers to a commercial bank with a designated post office box to which taxpayers

are instructed to mail their payments and related tax documents. These lockbox banks

process the documents, deposit the payments, then forward the documents and data to IRS

service center campuses to update the taxpayers’ accounts. Treasury’s Financial

Management Service (FMS) has agreements with nine lockbox bank locations on IRS’s

behalf.
Page 6 GAO-02-746R IRS Management Report

• field offices post signs in the most visible locations to remind taxpayers to obtain

receipts for payments;

• two employees be present when payments are collected and logged from drop

boxes;

• IRS and lockbox employees performing final candling record receipts in a control

log at the time of discovery, recording at a minimum the total number of

payments found, the amount of each payment, and the taxpayer who submitted

the payment; and

• IRS and lockbox managers or designated officials reconcile logs of payments

found during final candling to the related receipts and documents.

We also recommend that you direct IRS headquarters management to ensure that

field office management comply with existing receipt control policies that require a

segregation of duties between employees who prepare control logs for walk-in

payments and employees who reconcile the control logs to the actual payments.

IRS’s Comments and Our Evaluation

In its comments, IRS noted that it had taken several actions to address this finding.

Specifically, IRS stated that it (1) revised signs and posted them in all Taxpayer

Assistance Centers or field offices notifying taxpayers that they may request a

receipt, (2) distributed to Taxpayer Assistance Center sites or field offices a

procedural memo outlining separation of duties to emphasize the need to have more

than one employee process drop box payments, and (3) established a task force to

develop procedures to reconcile payment logs. We will evaluate the effectiveness of

IRS’s efforts during our fiscal year 2002 financial audit.

IRS Needs Better Enforcement

Of Courier Service Policy

During our fiscal year 2001 audit, we found that IRS did not have effective controls in

place to ensure that new courier service requirements were enforced. Since

November 1998, we reported that IRS did not have effective controls over courier

services responsible for transporting taxpayer receipts.8 This increased IRS’s risk of

theft, loss, or misuse of deposits and taxpayer information. We recommended that

IRS develop policies to ensure that contracts related to courier services do not

unduly expose the government or taxpayers to losses in the event of lost, stolen, or

damaged deposits in transit. In response, IRS issued courier service standards that

require that courier service employees pass a limited background investigation.

During our fiscal year 2001 audit, we identified weaknesses in IRS’s enforcement of

its courier service standards. Specifically, at the two IRS service center campuses we

 8

GAO/AIMD-99-15, GAO/AIMD-99-193, GAO-01-42, and GAO-02-35.
Page 7 GAO-02-746R IRS Management Report

visited, we found that background checks for couriers were not performed or were

performed too late. At one campus, managers did not believe a background check

was required because their couriers did not physically enter the campus facility and

the courier policy only required couriers given access to campus premises to pass a

background check. The courier policy limits background check requirements to

couriers given access to campus premises. However, to better protect the

government and taxpayers against theft and losses, background checks should be

performed on IRS couriers entrusted with deposits because they are given access to

the deposits, which contain taxpayer data. Managers at another campus understood

the intent of the courier policy and obtained background checks for its couriers even

though they did not enter campus premises. However, the background checks for

these couriers were not performed prior to entrusting them with deposits and

taxpayer data because campus managers did not know how to initiate the

background check process for couriers and did not know who was responsible for

ensuring that this process was performed. As a result, fingerprints and background

investigations on the couriers were not initiated until the latter part of fiscal year

2001. This increased IRS’s risk of theft, loss, or misuse of deposits and taxpayer

information.

Recommendation

To ensure that service center campus management and the courier service meet the

intent of minimum courier policy requirements, we recommend that you direct IRS

headquarters management to clarify that the requirement for background

investigations is meant to apply to personnel being entrusted with taxpayer receipts

and information, rather than just personnel being granted access to an IRS facility.

IRS’s Comments and Our Evaluation

IRS agreed that courier service employees should undergo background checks. IRS

noted it is working with FMS to modify courier service contracts and is amending the

IRM to require the courier service to satisfy requirements for a basic investigation,

which includes a Federal Bureau of Investigation (FBI) fingerprint and name check.

We will evaluate the effectiveness of IRS’s efforts during our fiscal year 2002 financial

audit.

IRS Needs to Work With

The National Finance Center

To Correct Fingerprint System

During our fiscal year 2001 financial audit, we identified problems with the integrity

of certain information in a key database system IRS uses to track compliance with its

employee fingerprinting requirement. Specifically, we found numerous instances of

missing or erroneous data in the National Finance Center’s (NFC) Security Entry and

Tracking System (SETS) database. According to IRS staff, these problems are due to

both technical limitations in SETS and human error. Tracking fingerprint results
Page 8 GAO-02-746R IRS Management Report

provides an important internal control for IRS to prevent the hiring of applicants with

inappropriate backgrounds.

In response to issues we raised in previous audits concerning physical security of

taxpayer receipts and data, IRS issued a directive in April 2000 that prohibited the

hiring and placement of an applicant at any IRS location until the applicant’s

fingerprint check had been received and case disposition evaluated. An IRS

memorandum issued April 23, 2001, provided guidance on monitoring IRS’s

background investigation program, including fingerprint results. The memorandum

states, “It is critical to the integrity of the system that the information entered in

SETS is timely and accurately entered.” Based on the guidance, IRS officials are

required to review a SETS report that tracks records that have missing fingerprint

results or that indicate employees began work before their fingerprint results were

received. The officials are required to follow up on these records, and update the

SETS system accordingly.

Our analysis of over 20,500 employee records in the SETS system identified 411

records with missing or erroneous data. Specifically, there were 231 employee

records with blank fields for the date fingerprint results were received and 180

employee records where the dates the fingerprint results were received were earlier

than the dates the fingerprint checks were completed per information from the Office

of Personnel Management (OPM). SETS data for 42 of the 180 employee records

showed that the employees entered on duty after fingerprint results were received,

while OPM data indicated that fingerprint results were not provided by OPM until

after the employees began working at IRS facilities.

According to IRS officials, many of these discrepancies are due to technical

constraints within SETS. For example,

• SETS did not always retain data fields when a person’s status was changed

from applicant to employee.

• The SETS database allows only one record or line entry per employee or

social security number. Therefore, when subsequent fingerprint/background

results are received and entered, SETS eliminates the initial fingerprint record

and replaces it with the new data.

• The “enter-on-duty” dates for seasonal employees are “locked” in SETS for a

period of time. When subsequent fingerprint checks are processed, the SETS

system will show the most recent date that these subsequent fingerprint

checks are initiated and completed. However, the system will not allow a

change to the enter-on-duty date until the seasonal employee actually returns

to IRS employment.

Additionally, IRS officials indicated that in some instances human error contributed

to missing or erroneous information in SETS. Because of the constraints of the SETS
Page 9 GAO-02-746R IRS Management Report

system, staff were using local tools for spreadsheet analysis to ensure that missing or

misleading information was researched and pertinent data annotated accordingly, so

that the local hiring and personnel officials could address questions regarding missing

or erroneous information.

Because of the data integrity issues with respect to certain information in the SETS

database, IRS’s national office cannot effectively monitor servicewide compliance

with its employee fingerprinting requirement. This increases the risk that employees

without fingerprint results may have unsuitable backgrounds to handle cash, checks,

and sensitive taxpayer information, thus increasing the risk of potential theft and for

misuse of proprietary taxpayer information.

Recommendation

We recommend that you direct IRS management to work with the NFC to resolve the

technical limitations that exist within the SETS database and continue to periodically

review SETS data to detect and correct errors.

IRS’s Comments and Our Evaluation

In commenting on this section, IRS stated that it will work through the Department of

the Treasury in establishing a dialogue with NFC to address SETS issues. IRS also

stated that it had recently trained its personnel on analyzing SETS data to ensure its

accuracy and compliance with IRS’s fingerprint policies. We will evaluate the

effectiveness of IRS’s efforts during our fiscal year 2002 financial audit.

IRS Needs to Ensure

Compliance With Manual

Refund Procedures

During our fiscal year 2001 audit, we found that IRS staff did not always comply with

the agency’s procedures designed to reduce the risk of issuance of duplicate refunds.

In our prior audits of IRS’s financial statements, we identified and reported

weaknesses in IRS’s controls over manual refunds that resulted in instances in which

IRS issued duplicate refunds to taxpayers. 9 This situation occurred because IRS’s (1)

automated and manual refund processes are not adequately coordinated to prevent

duplicate refunds,10 (2) manual refunds bypass most of IRS’s automated validity

 9

U.S. General Accounting Office, Internal Revenue Service: Immediate and Long-Term

Actions Needed to Improve Financial Management, GAO/AIMD-99-16 (Washington D.C.:

Oct. 30, 1998) and GAO-01-42.

10IRS issues most refunds through an automated system; however, refunds meeting certain

criteria are separated for manual processing, including (1) refunds over $1 million,

(2) refunds below $1, and (3) refunds based on a taxpayer’s request for immediate payment

due to hardship.
Page 10 GAO-02-746R IRS Management Report

checks, and (3) manual refunds may not be recorded in the taxpayer’s account until 6

weeks after the refund has been issued.

In response to our findings, IRS implemented a series of written procedures to reduce

the risk of issuing duplicate refunds. These procedures require employees initiating a

manual refund to (1) monitor the taxpayer’s master file11 account until the refund is

recorded in the account, and (2) document their monitoring actions on case history

sheets. The procedures also require that supervisors review the initiator’s monitoring

actions and document this review. By monitoring the taxpayer’s master file account,

the employee can detect the recording of subsequent computer-generated or other

manual refunds and take action to stop duplicate refunds from being issued.

Documenting the monitoring action allows supervisors to verify and ensure that the

monitoring is being performed.

In our fiscal year 2001 financial audit, we found that IRS personnel were not always

following IRS’s manual refund procedures. Specifically, we found that employees

initiating manual refunds did not always monitor accounts or document their

monitoring actions, and that supervisors did not always review the initiator’s

monitoring actions. At the two service center campuses we visited, employees and

supervisors stated they were unaware of the agency’s manual refund requirements.

At one of these campuses, local procedures required clerks, rather than the staff

initiating the manual refund, to monitor accounts. However, the clerks did not

document their monitoring actions, and supervisors did not review these actions.

The failure to follow IRS’s refund monitoring procedures increases the risk that a

duplicate refund will be issued.

Recommendation

We recommend that you direct IRS management to issue a formal reminder of

existing IRS manual refund procedures to supervisors and staff.

IRS’s Comments and Our Evaluation

In its comments, IRS noted that it sent a communication to all service center

campuses and field offices requiring that the appropriate IRS division monitor all

manual refunds to ensure that no duplicate refunds are issued and to ensure that

manual refunds are recorded in the taxpayer’s account. IRS stated that this

communication also required management to document their review. We will

evaluate the effectiveness of IRS’s efforts during our fiscal year 2002 financial audit.

 11The master file is a detailed database containing taxpayer information.
Page 11 GAO-02-746R IRS Management Report

IRS Needs Procedures to Track

Status of Lien Releases

In previous audits and again during our fiscal year 2001 audit, we found that IRS did

not comply with certain provisions of the Internal Revenue Code (IRC) regarding the

timely release of federal tax liens. However, because IRS lacks procedures to

adequately track the lien release process, neither we nor IRS were able to determine

the full extent of the problem. The failure to promptly release tax liens could cause

undue hardship and burden to taxpayers who are attempting to sell property or apply

for commercial credit.

The IRC grants IRS the power to file a lien against the property of any taxpayer who

neglects or refuses to pay all assessed federal taxes. The lien becomes effective

when it is filed with a designated office, such as a courthouse in the county where the

taxpayer’s property is located. The lien serves to protect the interest of the federal

government and serves as a public notice to current and potential creditors of the

government’s interest in the taxpayer’s property. For example, federal tax liens are

disclosed in credit reports of individuals. Under Section 6325 of the IRC, IRS is

required to release a federal tax lien within 30 days after the date the tax liability is

satisfied or has become legally unenforceable or the Secretary of the Treasury has

accepted a bond for the assessed tax.

In our fiscal year 2001 financial audit, we tested a statistical sample of 59 tax cases

with liens in which the taxpayers’ total outstanding tax liabilities were either paid off

or abated during fiscal year 2001. We found 5 instances in which IRS’s Automated

Lien System (ALS)12 clearly indicated that IRS had not released the applicable federal

tax lien within the statutory requirement. Based on these 5 cases, we estimated that

8 percent of all liens were not released timely.13 However, we also identified 9

additional cases where the liens may not have been effectively released within the

required period. In these cases, the time between the date on the IRS lien release

certificate and the date when the jurisdiction handling the lien stamped the form as

received exceeded 30 days, in some instances substantially. For 5 of these 9 cases,

the period between the date on IRS’s lien release certificate document and the date of

 12IRS uses ALS to issue and release federal tax liens. ALS is updated for new liens and tax

accounts by revenue officers at IRS’s field offices. ALS generates a certificate of release of

lien automatically for liens that expire after a set period of time or when the statutory

collection period for an account expires. For accounts that are fully paid or otherwise

satisfied, ALS generates the certificate of release of lien only after it receives the “fully paid”

status of the account through a weekly interface with the master file. The certificate of

release of lien is sent to the county courthouse where the lien was originally filed for formal

release of the lien.

13We are 95 percent confident that the confidence interval around this estimate ranges from 3

to 19 percent.
Page 12 GAO-02-746R IRS Management Report

the receipt by the local jurisdiction exceeded 90 days. In 1 of these, the lien release

was not recorded by the local jurisdiction until 9 months after the date on the lien

release certificate.

Currently, the only information IRS has to determine whether a lien was released

timely is the date on the certificate of release of lien. However, this is the date on

which ALS generates the document and does not necessarily represent the date when

the authorizing IRS official signed it or when IRS mailed it to the local jurisdiction.

IRS procedures currently do not require employees to track the status of lien releases

up to the point of delivery to the local jurisdiction. As a result, both we and IRS were

unable to determine whether delays took place at IRS, the local jurisdiction, or a

combination of the two, and thus devise a strategy to address these delays. However,

since the lien is not legally released until recorded by the local jurisdiction, these

delays could cause undue hardship and burden on taxpayers who want to sell

property or apply for commercial credit.

Recommendation

We recommend that you direct IRS management to establish procedures to track the

release of liens up to the point of delivery to the local jurisdiction to ensure liens are

released timely to avoid unduly burdening taxpayers once they have satisfied their

tax liability.

IRS’s Comments and Our Evaluation

In commenting on this section, IRS agreed that the failure to timely release liens

could cause undue hardship and additional burden on taxpayers, and that existing

procedures should be strengthened to include monitoring the mailing of certificates

of release. While IRS noted that the timely release of liens also depends upon the

United States Postal Service delivering the release to the recording jurisdictions

within established timeframes and the jurisdiction recording the certificates of

release promptly after receipt, IRS accepted responsibility for generating certificates

of release and transmitting them to the appropriate recording official. To ensure it

accomplishes these actions within established timeframes, IRS stated that it is

formulating procedures requiring a date stamp (mailing date) on the billing voucher,

which lists each lien release IRS sends to the recording official. IRS stated it would

also reemphasize to staff the importance of timely accomplishing all other lien

processing steps. We will evaluate the effectiveness of IRS’s efforts during our fiscal

year 2002 financial audit.

IRS Needs to Improve

Procedures for Recording P&E

Acquisitions On Inventory Records

During our fiscal year 2001 audit, we continued to find issues with IRS’s procedures

for recording assets on its inventory records that inhibit IRS’s ability to properly
Page 13 GAO-02-746R IRS Management Report

account for and manage its assets. Specifically, we found that the P&E inventory did

not always contain valid records. In addition, we found that assets were not always

recorded promptly upon receipt. Accurate records are essential for maintaining

control over P&E to ensure that assets are properly accounted for and safeguarded.

While we noted progress in IRS’s efforts to promptly and accurately record P&E on

its inventory records in fiscal year 2001, we nonetheless continued to find errors in

IRS’s property records, the most significant of which were discussed in our recently

issued report on the results of our fiscal year 2001 audit.14 In addition to the issues

discussed in that report, we also found that 12 of 210 (6 percent) randomly selected

assets from the floor at 21 IRS facilities were not recorded on IRS’s inventory

records.15 Of the 21 buildings sampled, 7 (33 percent) had at least 1 asset in our

sample of 10 items that was not recorded on the inventory records. Items not

recorded included a vehicle, a laptop computer, a microcomputer, and printers.

While we were unable to determine the exact reason these specific assets were not

recorded, IRS personnel at 4 other sites we visited stated that procedures for

recording P&E acquisitions did not function adequately to ensure that assets were

promptly recorded on inventory records.

IRS’s procedures for recording P&E acquisitions provide that the IRS National Office

create “due-in” or skeletal property records in its property management system based

on information extracted from IRS’s procurement systems. The objective is to build

an inventory template record with key information that Single Point Inventory

Function (SPIF) personnel in the field offices can update upon receipt of the assets.

Based on our work, we found that improvements are needed to fully achieve this

objective. SPIF personnel at four sites where we conducted testing noted that the

National Office did not always create skeletal inventory records prior to the receipt of

assets. If a skeletal record was not available upon the receipt of an asset, recording

the asset on the inventory records was delayed because procedures do not allow

SPIF units to create an inventory record. Before an asset could be added to the

inventory records, it was necessary for the SPIF unit to research IRS’s procurement

system to identify requisition information and provide the information to the National

Office with a request to create a skeletal asset record. As a result, delays occurred in

recording some assets, and some assets were not recorded until they were discovered

by IRS personnel during an annual inventory.

 14GAO-02-414. As explained in this report, in a book-to-floor sample, we were unable to

locate 25 of 210 recorded assets and concluded that IRS’s P&E records were not adequate to

maintain accountability over its property.

15For our floor-to-book sample, we obtained a representative selection of P&E items with a

two-stage cluster sample. In the first stage, we selected a representative sample of 21

buildings. In the second stage, we selected a sample of 10 assets located at each of the 21

buildings and traced them to the inventory records.
Page 14 GAO-02-746R IRS Management Report

For example, at one site, 178 computers received on September 10, 2001, were not

recorded on the inventory records until October 1, 2001, because a skeletal record

was not available when the assets were delivered. SPIF units at the sites we visited

discovered hundreds of unrecorded items, such as microcomputers and monitors,

during the fiscal year 2001 inventory. Not only were skeletal records not available

when assets were delivered, but skeletal records were also initiated but not

completed, resulting in invalid records. During our fiscal year 2001 audit, we found

461 invalid property records on IRS’s inventory system because a skeletal record had

been created but not completed. This reduces the reliability of the information

maintained in the inventory system and impedes IRS management’s ability to control

and account for federal property.

Recommendations

We recommend that you direct IRS management to

• ensure that complete skeletal records are created and available for the SPIF

units to update upon receipt of P&E, and

• develop procedures and edit checks to reduce the likelihood of invalid

property records.

IRS’s Comments and Our Evaluation

In its comments, IRS stated that it agreed with our recommendations and is taking

actions to address this issue. IRS stated that it is developing a system and procedures

to create skeletal records and to ensure timely updates to inventory records. We will

evaluate the effectiveness of IRS’s efforts during our fiscal year 2002 financial audit.

IRS Needs to Improve

Its Process for Linking P&E

Acquisitions to Property Records

During our fiscal year 2001 audit, we found that asset acquisition transactions

recorded on accounting records could not always be linked to assets recorded on the

property records. The ability to link costs recorded on the accounting records to

property records is essential to verify the existence of assets purchased.

IRS’s property management system does not capture the acquisition cost of P&E. As

a result, the property management system does not provide either the detailed

subsidiary records to support the general ledger control balances or the detailed

information needed for financial reporting. To compensate for this deficiency, IRS

extracts the acquisition costs of P&E from expense records at fiscal year end and

accumulates the costs into pools of similar assets. Costs accumulated into asset

pools are to be linked to assets recorded on the property records through IRS’s

procurement systems using procurement award numbers and requisition numbers.
Page 15 GAO-02-746R IRS Management Report

However, we found that costs recorded in the accounting records could not always

be linked to items recorded on the property records because the procurement award

numbers and requisition numbers recorded on the property records were invalid or

incomplete.

Although IRS was eventually able to link a majority of the P&E acquisitions we

selected for testing during our fiscal year 2001 audit, this process took 6 weeks to

complete. Additionally, IRS was unable to link a number of the P&E acquisition

items to the property records. Specifically, IRS was unable to link 4 of 17 P&E

acquisition transactions we tested to the property records and could only partially

link the assets purchased in 3 other transactions. For example, IRS was able to link

90 of 180 computers purchased in 1 transaction to the property records.16

Consequently, the existence of all property acquired and recorded on the accounting

records during fiscal year 2001 could not be verified.

Recommendation

We recommend that you direct IRS management to develop procedures to ensure

that procurement award and requisition numbers recorded on property records are

complete, accurate, and linked to the accounting records.

IRS’s Comments and Our Evaluation

In commenting on this section, IRS stated that it agreed with our recommendation.

IRS noted that it is developing procedures and systems to capture more detailed

information on property records and that this process will require vendors to include

requisition and procurement numbers of equipment purchases at the time of

shipment. IRS also noted that the full integration of inventory procurement and

accounting would occur with the implementation of its Integrated Financial System.

We will evaluate the effectiveness of IRS’s efforts during our fiscal year 2002 financial

audit.

IRS Needs Records to Adequately

Account for and Manage Software

During our fiscal year 2001 audit, we found that IRS’s property management system

did not capture information, such as the licenser, contract period, and number of

authorized users essential to ensure that software and software licenses are

controlled and utilized in accordance with software license contracts. The Joint

Financial Management Improvement Program (JFMIP) Property Management

Systems Requirements state that property management systems should capture

information essential to ensuring that software and software licenses are controlled

 16In some cases, sample transactions, which are disbursement amounts, were payments for

multiple P&E items. For example, one sample transaction totaling $466,020 was a

disbursement for purchase of 180 computers with keyboards, mouses, and monitors.
Page 16 GAO-02-746R IRS Management Report

and in compliance with contractual licenses and agreements with software

developers, vendors, or software licensers.

IRS’s property management system did not provide an inventory of the number of

software licenses or the number of software installations. To properly account for

compliance with software license agreements, IRS must determine if the number of

installations exceeds the number of licenses. IRS is in the process of identifying the

number of software licenses to record in its property management system. However,

as of the end of our audit, IRS had not yet recorded software licenses in its property

management system nor had it developed an approach to assess if the number of

installations are in compliance with the terms of these software licenses.

Recommendations

We recommend that you direct IRS management to

• record software licenses in IRS’s property management system, and

• develop an approach to assess IRS’s compliance with the terms of these

software licenses.

IRS’s Comments and Our Evaluation

In its comments, IRS stated that it agreed with our recommendations. IRS stated that

it is executing an action plan that will allow it to record existing software data into its

property management database and establish a process that will inform the Asset

Management office of new licenses purchased so they can be recorded within

established timeframes. IRS stated that it is also developing an action plan that will

set procedures and policies for the review and compliance to the terms of the

licenses. We will evaluate the effectiveness of IRS’s efforts during our fiscal year

2002 financial audit.

IRS Needs to Review and Properly Adjust

Receivables in Its Accounting Records

During our fiscal year 2001 audit, we continued to find control weaknesses over IRS’s

accounting for reimbursable activities, which resulted in IRS overstating its

receivables for reimbursable activities. During fiscal year 2000, we reported that the

records IRS maintained regarding reimbursable receivables were not reliable.17 We

recommended IRS routinely review and age open reimbursable receivables to identify

accounts that are no longer valid or collectible. During fiscal year 2001, we did find

that IRS began aging accounts for the purpose of writing off older transactions and

that IRS revised loss percentages that it applied to receivable accounts to determine

 17U.S. General Accounting Office, Management Letter: Improvements Needed in IRS’

Accounting Procedures and Internal Controls, GAO-01-880R (Washington D.C.: July 30,

2001).
Page 17 GAO-02-746R IRS Management Report

the net realizable value of these receivables. However, we found that IRS was still

reporting reimbursable receivable amounts that were not valid receivables or that

should have been written off as uncollectible.

GAO’s Standards for Internal Control in the Federal Government states that internal

controls should generally be designed to assure that ongoing monitoring occurs in the

course of normal operations. This includes regular management and supervisory

activities, comparisons, reconciliations, and other actions people take in performing

their duties. Monitoring of receivables would include assessing receivables to

determine both the accuracy of the recorded balance and the potential to collect the

balance.

We tested a nonrepresentative selection of the five largest reimbursable receivables

at the end of fiscal year 2001 and found exceptions involving two of the accounts.

Specifically, we found that one of these accounts was not a valid receivable at fiscal

year end, and the other receivable was not collectible and should therefore have been

written off.

In the first instance, IRS improperly reported as receivables $711,000 of fees charged

to taxpayers for photocopying tax documents. IRS staff at service center campuses

had collected these fees when services were provided and had recorded the

collections in the IRS custodial accounting general ledger. IRS’s general ledger

system comprises both an independent administrative and a custodial general ledger

that are not integrated with each other nor with their supporting records for material

balances. Service center campus staff reported the revenue of the photocopy fees

from the custodial general ledger to the administrative accounting staff prior to the

closing of the accounting records at fiscal year end. However, the actual transfer of

funds from the custodial system to the administrative accounting general ledger did

not take place until after the end of the fiscal year. When IRS’s administrative

accounting staff recorded the fees in the administrative general ledger to recognize

the revenue in the proper period, they recorded them as uncollected fees as of fiscal

year end. As a result, the amount was erroneously included in the financial

statements as a receivable.

In the second instance, IRS reported in its fiscal year 2001 financial statements a

receivable totaling $405,000 that represented an outstanding charge that had been

disputed by another government agency. IRS had billed and collected $2.1 million

from the agency for services provided by IRS staff. However, the agency disputed

$405,000 of the billed amount and initiated actions to reclaim the disputed amount.

Based on actions by the agency, Treasury applied the $405,000 of charges against the

IRS Treasury account and IRS agreed the amount was not collectible. Nonetheless, it

was erroneously reported as a fully collectible receivable in IRS’s financial

statements. IRS noted that the methodology it uses to recognize uncollectible

amounts resulted in the actual overstatement of receivables at fiscal year end being

$243,000.
Page 18 GAO-02-746R IRS Management Report

Recommendation

In addition to fully implementing our previous recommendations regarding more

effective review of reimbursable receivables,18 we recommend that you direct IRS

management to ensure that, in the absence of an integrated general ledger system for

IRS’s custodial and administrative activities, IRS strengthen monitoring and analysis

of receivables to ensure that receivables are not being erroneously recorded as a

result of the lack of integration between these two activities.

IRS’s Comments and Our Evaluation

In its comments, IRS stated that it agreed with our recommendation and that it is

taking steps to better manage reimbursable activity. IRS noted for example, that it is

now reconciling all reimbursable receivable accounts with the appropriate general

ledger accounts monthly and is monitoring activities between custodial and

administrative accounts as part of this reconciliation process. Additionally, IRS

noted that it has implemented a process to routinely review open receivables and

take action to write off amounts as appropriate. We will evaluate the effectiveness of

IRS’s efforts during our fiscal year 2002 financial audit.

IRS Needs to Develop Procedures

to Estimate and Accrue Operating

Revenue and Expenses

During our fiscal year 2001 financial audit, we noted that IRS continued to record

material administrative transactions only at the end of the fiscal year. IRS’s imputed

costs19 and other benefit-related expenses are determined by other federal agencies,

and IRS is informed of the annual amount only at the end of the fiscal year. In

addition, its administrative operations receive exchange revenues from installment

agreements and other types of user fees and these amounts are also recorded in the

administrative accounts as exchange revenue only at the end of the fiscal year. IRS

does not have a methodology for identifying operating activities and estimating

reasonable monthly accruals for recognizing costs and exchange revenues for its

administrative operations at interim periods. As a result, IRS’s financial records for

these activities were misstated at interim periods and the significance of these

misstatements increases over the course of the fiscal year until IRS records these

transactions at the end of the fiscal year.

GAO’s Standards for Internal Control in the Federal Government requires agencies

to implement internal control procedures to ensure ongoing reliability of its financial

reporting. The standards also require that transactions be promptly recorded to

maintain their relevance and value to management in controlling operations and

 18GAO-01-880R. 19Imputed costs are IRS costs that have been paid in part or in full by other entities.
Page 19 GAO-02-746R IRS Management Report

making decisions. Additionally, for fiscal year 2002, OMB Bulletin 01-09, Form and

Content of Agency Financial Statements, requires agencies to report interim

financial statements for the 6-month period ending March 31, 2002.

Even though IRS could readily estimate the annual amount of imputed costs and

prepare monthly accruals, it did not have procedures for doing this during fiscal year

2001. Specifically, we found that imputed costs on IRS’s general ledger were

understated by $406 million until IRS made an adjusting entry after September 30,

2001. In addition, employee benefit payment expenses were understated by $73

million until IRS made a year-end adjusting entry. Exchange revenues for its

administrative operations were also understated at interim periods because these

revenues were not being estimated and accrued regularly in the administrative

operations financial records when the amounts to accrue were readily available.

Exchange revenues totaling over $108 million were not recognized in the

administrative accounting records until the end of the fiscal year. These revenues

related primarily to user fees for the processing of installment agreements and

reviews of exempt organizations/employer benefit plans.

Had IRS prepared interim financial statements during fiscal year 2001, the effect of

these omissions described above would have been interim information that contained

material misstatements for net cost and exchange revenue. Until IRS establishes

procedures for estimating and accruing imputed administrative costs and exchange

revenues, it will not be able to produce reliable interim financial information.

We have made recommendations to address this weakness in our previous report20

and thus we are not making any new recommendations. However, we wanted to

bring to your attention the significance of this matter in light of the fiscal year 2002

requirement under OMB Bulletin 01-09.

IRS’s Comments and Our Evaluation

In its comments, IRS agreed that it needs to estimate and accrue operating expenses

in a timely manner. IRS stated that it began recording quarterly expense accruals in

fiscal year 2002. Additionally, IRS stated that in fiscal year 2002, it began recording

actual quarterly user fee revenues in its administrative accounts. We will evaluate the

effectiveness of IRS’s efforts during our fiscal year 2002 financial audit.

- - - - -

This report contains recommendations to you. The head of a federal agency is

required by 31 U.S.C. 720 to submit a written statement on actions taken on these

recommendations. You should submit your statement to the Senate Committee on

Governmental Affairs and the House Committee on Government Reform within 60

days of the date of this report. A written statement must also be sent to the House

 20GAO-02-35.
Page 20 GAO-02-746R IRS Management Report

and Senate Committees on Appropriations with the agency’s first request for

appropriations made more than 60 days after the date of the report.

This report is intended for use by the management of IRS. We are sending copies to

Chairmen and Ranking Minority Members of the Senate Committee on

Appropriations; Senate Committee on Finance; Senate Committee on Governmental

Affairs; Senate Committee on the Budget; Subcommittee on Treasury and General

Government, Senate Committee on Appropriations; Subcommittee on Taxation and

IRS Oversight, Senate Committee on Finance; and the Subcommittee on Oversight of

Government Management, Restructuring, and the District of Columbia, Senate

Committee on Governmental Affairs. We are also sending copies to the Chairmen and

Ranking Minority Members of the House Committee on Appropriations; House

Committee on Ways and Means; House Committee on Government Reform; House

Committee on the Budget; Subcommittee on Treasury, Postal Service, and General

Government, House Committee on Appropriations; Subcommittee on Government

Efficiency, Financial Management, and Intergovernmental Relations, House

Committee on Government Reform; and the Subcommittee on Oversight, House

Committee on Ways and Means. In addition, we are sending copies of this report to

the Chairman and Vice-Chairman of the Joint Committee on Taxation, the Secretary

of the Treasury, the Director of the Office of Management and Budget, the Chairman

of the IRS Oversight Board, and other interested parties. Copies will be made

available to others upon request. The report is also available on GAO’s internet

homepage at http://www.gao.gov.

We acknowledge and appreciate the cooperation and assistance provided by IRS

officials and staff during our audit of IRS’s fiscal year 2001 and 2000 financial

statements. If you have any questions or need assistance in addressing these matters,

please contact Charles Payton, Assistant Director, at (213) 830-1084.

Sincerely yours,

Steven J. Sebastian

Director

Financial Management and Assurance
Enclosure I

Page 21 GAO-02-746R IRS Management Report
Enclosure I

Page 22 GAO-02-746R IRS Management Report

See comment 1.
Enclosure I

Page 23 GAO-02-746R IRS Management Report
Enclosure I

Page 24 GAO-02-746R IRS Management Report
Enclosure I

Page 25 GAO-02-746R IRS Management Report
Enclosure I

Page 26 GAO-02-746R IRS Management Report

The following is GAO’s comment on the Internal Revenue Service’s letter dated June

20, 2002.

GAO Comment

1. We have deleted material on this topic from our report.
Enclosure II

Page 27 GAO-02-746R IRS Management Report

GAO Contacts and Staff Acknowledgments

GAO Contacts

Ted Hu, (213) 830-1108

David Elder, (213) 830-1112

Acknowledgments

Staff making key contributions to this report were: Beverly Burke, Gloria Cano,

William Cordrey, John Davis, Charles R. Fox, Meafelia Gusukuma, Eric D. Johns,

George Jones, Delores Lee, Angel Sharma, and Leonard Zapata.

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