GAO

United States General Accounting Office

A

Testimony

Before the Subcommittee on Government Efficiency and 

Financial Management, Committee on Government 

Reform, House of Representatives

For Release on Delivery 

Expected at 10:30 a.m. 

Tuesday, April 8, 2003

FISCAL YEAR 2002 

U.S. GOVERNMENT 

FINANCIAL STATEMENTS 

Sustained Leadership and 

Oversight Needed for 

Effective Implementation 

of Financial Management 

Reform 

Statement of David M. Walker

Comptroller General of the United States

GAO-03-572T
As in the 5 previous fiscal years, the federal government continues to have a 

significant number of material weaknesses related to financial systems, 

fundamental recordkeeping and financial reporting, and incomplete 

documentation. Several of these material weaknesses resulted in conditions 

that continued to prevent us from expressing an opinion on the U.S. 

government’s consolidated financial statements for the fiscal years ended 

September 30, 2002 and 2001. 

Three major impediments to an opinion on the consolidated financial 

statements are (1) serious financial management problems at DOD, (2) the 

federal government’s inability to fully account for and reconcile billions of 

dollars of transactions between federal entities, and (3) the federal 

government’s inability to properly prepare the consolidated financial 

statements. 

Federal agencies have continued to make progress in obtaining unqualified 

audit opinions—21 of 24 Chief Financial Officers (CFO) Act agencies for 

fiscal year 2002 (see table), up from 6 for fiscal year 1996. Irrespective of the 

unqualified opinions, many federal agencies do not have timely, accurate, 

and useful financial information and sound controls with which to make 

informed decisions and to ensure accountability on an ongoing basis. 

Building on the success achieved in obtaining unqualified audit opinions, 

federal agency management must continue to work toward fully resolving 

the pervasive and generally long-standing material weaknesses that have 

been reported for the past 6 fiscal years. The President’s Management 

Agenda stated that without sound internal control and accurate and timely 

financial information, it is not possible to accomplish the President’s agenda 

to secure the best performance and highest measure of accountability for the 

American people. 

Fiscal Year 2002 CFO Act Agency Results Reported by Auditors 

Agencies with unqualified opinions 

Agencies with unqualified opinions and no 

material weaknesses or noncompliances 

21a 4b

Source: GAO. 

a Agriculture, Commerce, Education, Energy, Federal Emergency Management Agency, Health and 

Human Services, Housing and Urban Development, Interior, Justice, Labor, State, Transportation, 

Treasury, Veterans Affairs, Environmental Protection Agency, General Services Administration, 

National Aeronautics and Space Administration, National Science Foundation, Nuclear Regulatory 

Commission, Office of Personnel Management, and Social Security Administration. b Energy, General Services Administration, National Science Foundation, and Social Security 

Administration. 

GAO is required by law to audit the 

consolidated financial statements 

of the U.S. government. 

Timely, accurate, and useful 

financial information is essential 

for making informed operating 

decisions day to day, managing the 

federal government’s operations 

more efficiently and effectively, 

meeting the goals of federal 

financial management reform 

legislation, supporting resultsoriented management approaches, 

and ensuring accountability on an 

ongoing basis. 

The importance of such 

information is heightened by the 

unprecedented demographic 

challenge of an aging population. 

Federal spending on the elderly, 

health care, and new homeland 

security and defense commitments 

increases the need to look at 

competing claims on the budget 

and at new priorities. 

Over the past year, the Principals of 

the Joint Financial Management 

Improvement Program continued 

efforts to accelerate progress in 

financial management reform. Also, 

President Bush has implemented 

the President’s Management 

Agenda to provide direction to, and 

closely monitor, management 

reform across government, which 

encompasses improved financial 

management performance. To 

effectively implement federal 

financial management reform, 

sustained leadership and oversight

are essential. 

www.gao.gov/cgi-bin/getrpt?GAO-03-572T.

To view the full report, including the scope 

and methodology, click on the link above. 

For more information, contact Jeffrey 

Steinhoff or Gary Engel at (202) 512-2600. 

Highlights of GAO-03-572T, testimony 

before the Subcommittee on Government 

Efficiency and Financial Management, 

Committee on Government Reform, 

House of Representatives 

April 8, 2003

FISCAL YEAR 2002 U.S. GOVERNMENT 

FINANCIAL STATEMENTS 

Sustained Leadership and Oversight 

Needed for Effective Implementation of 

Financial Management Reform 
Page 1 GAO-03-572T 

Mr. Chairman and Members of the Subcommittee:

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

government’s consolidated financial statements for fiscal years 2002 and 

2001. Both the consolidated financial statements and our report are 

included in the fiscal year 2002 Financial Report of the United States 

Government, which was issued by the Department of the Treasury 

(Treasury) on March 31, 2003, and is available through GAO’s Internet site, 

at www.gao.gov, and Treasury’s Internet site, at

www.fms.treas.gov/fr/index.html. At the outset, I would like to thank the 

subcommittee for continuing an annual tradition of oversight hearings on 

this important subject. The work of the former Subcommittee on 

Government Efficiency, Financial Management, and Intergovernmental 

Relations, along with its leader, former Congressman Stephen Horn, has 

been a catalyst to facilitate government management reform over the past 6 

years. The continued involvement of this subcommittee will be critical to 

ultimately restoring public confidence in the federal government as a 

financial steward that is accountable for its finances. 

As in the 5 previous fiscal years, certain material weaknesses1 in internal 

control and in accounting and reporting prevented us from being able to 

provide the Congress and American citizens an opinion as to whether the 

consolidated financial statements are fairly stated in conformity with U.S. 

generally accepted accounting principles. Until the problems discussed in 

our report are adequately addressed, they will continue to (1) hamper the 

federal government’s ability to accurately report a significant portion of its 

assets, liabilities, and costs, (2) affect the federal government’s ability to 

accurately measure the full cost and financial performance of certain 

programs and effectively manage related operations, and (3) significantly 

impair the federal government’s ability to adequately safeguard certain 

significant assets and properly record various transactions.

Across government, financial management improvement initiatives are 

under way that, if effectively implemented, have the potential to 

appreciably improve the quality of the federal government’s financial 

management and reporting. A number of federal agencies have started to 

1

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

providing reasonable assurance that misstatements, losses, or noncompliance material in 

relation to the financial statements or to stewardship information would be prevented or 

detected on a timely basis.
Page 2 GAO-03-572T 

make progress in their efforts to modernize their financial management 

systems and improve financial management performance as called for in 

the President’s Management Agenda. For example, the Department of the 

Treasury’s Internal Revenue Service (IRS) has made significant progress in 

addressing its financial management weaknesses, including addressing 

controls over budgetary activity and its accountability over property and 

equipment. Resolving many of IRS’s most serious financial management 

weaknesses—identified by GAO as a high-risk area since 1995—will require 

a sustained, long-term commitment of resources, continued strong 

involvement of senior IRS management, and sustained progress in systems 

modernization.

This year marks the earliest that federal agencies’ audited financial 

statements have ever been available. For the first time, Chief Financial 

Officers Act (CFO) Act agencies were required to combine their audited 

financial statements with performance reports and deliver both to the 

Office of Management and Budget (OMB) by February 1, a month earlier 

than last year. Furthermore, the Principals of the Joint Financial 

Management Improvement Program (JFMIP)2

—the Secretary of the 

Treasury, the Directors of OMB and the Office of Personnel Management 

(OPM), and I, as Comptroller General of the United States—have agreed to 

accelerate the agency financial statement reporting date to November 15 

for fiscal year 2004. The Social Security Administration (SSA), which has a 

long-standing record of delivering its audited financial statements well 

before the mandated deadline, issued its fiscal year 2002 audited financial 

statements on November 19, 2002. Treasury also accelerated its time frame 

and issued its fiscal year 2002 audited financial statements on November 

15, 2002, which was more than 3 months earlier than for fiscal year 2001. 

For fiscal year 2002, 21 of the 24 CFO Act agencies were able to attain 

unqualified audit opinions on their financial statements (the appendix lists 

the 24 CFO Act agencies, their audit results, and auditors), up from 6 

agencies for fiscal year 1996. Also, 4 CFO Act agencies showed 

improvement by receiving unqualified opinions from their auditors this 

year—the Department of Education, the National Aeronautics and Space 

Administration (NASA), the Federal Emergency Management Agency, and 

2

JFMIP is a joint and cooperative undertaking of Treasury, GAO, OMB, and OPM working in 

cooperation with each other and other federal agencies to improve financial management 

practices in the federal government. Leadership and program guidance are provided by the 

four JFMIP Principals.
Page 3 GAO-03-572T 

the Department of Agriculture (USDA), which received an unqualified audit 

opinion for the first time. On the other hand, after receiving unqualified 

opinions on its financial statements since fiscal year 1996, the Small 

Business Administration’s (SBA) independent auditor withdrew its 

unqualified audit opinions on the agency’s fiscal years 2001 and 2000 

financial statements and issued disclaimers of opinion on the agency’s 

fiscal years 2002 and 2001 financial statements.

Although obtaining unqualified audit opinions is important, according to 

the President’s Management Agenda, “most federal agencies that obtain 

clean audits only do so after making extraordinary, labor-intensive assaults 

on financial records.” Further, the President’s Management Agenda stated 

that without sound internal control and accurate and timely financial 

information, it is not possible to accomplish the President’s agenda to 

secure the best performance and highest measure of accountability for the 

American people. It will be increasingly difficult for federal agencies to 

continue to rely on significant costly and time-intensive manual efforts to 

achieve or maintain unqualified opinions until automated, integrated 

processes and systems are implemented that readily produce the necessary 

information. As a result, many federal agencies must accelerate their 

efforts to improve underlying financial management systems and controls, 

which is consistent with reaching the financial management success 

measures envisioned by the JFMIP Principals and called for by the 

President’s Management Agenda.

Before discussing the results of the audit of the U.S. government’s 

consolidated financial statements in more detail, I would like to discuss 

why sound financial management is especially necessary for the future, as 

well as for today, to meet tomorrow’s fiscal needs. I then will highlight the 

major issues relating to the consolidated financial statements for fiscal 

years 2002 and 2001. I will then discuss the urgency of providing sustained 

leadership and oversight for effective implementation of financial 

management reform, provide my perspectives on the importance of federal 

agencies’ building on the success of their unqualified audit opinions by 

significantly improving underlying financial management systems, and 

underscore the need to address major impediments to an opinion on the 

consolidated financial statements. Also, I will present my observations on 

selected audit matters that are key to protecting the public interest.
Page 4 GAO-03-572T 

Meeting Tomorrow’s 

Fiscal Needs

The requirement for timely, accurate, and useful financial and performance 

management information is greater than ever. The long-term fiscal 

pressures created by the retirement of the baby boom generation and new 

homeland security and defense commitments, including the ongoing 

Operation Iraqi Freedom, sharpen the need to look at competing claims on 

federal budgetary resources and new priorities. In previous testimony, I 

noted that it should be the norm to reconsider the relevance or “fit ” of any 

federal program or activity in today’s world and for the future.3

 Such a 

fundamental review is necessary both to increase fiscal flexibility and to 

make government fit the modern world. Stated differently, there is a need 

to consider what the proper role of the federal government will be in the 

21st century and how the government should do business in the future. 

The budget and performance integration initiative undertaken as part of the 

President’s Management Agenda should help provide information for use in 

conducting such reviews. OMB’s Program Assessment Rating Tool (PART) 

represents a step toward more structured involvement of program and 

performance analysis in the budget. PART includes general questions on 

(1) program purpose and design, (2) strategic planning, (3) program 

management, and (4) program results. It also includes a set of more 

specific questions that vary according to the type of delivery mechanism or 

approach the program uses.

As we look ahead, the federal government faces an unprecedented 

demographic challenge. A nation that has prided itself on its youth will 

become older. Between now and 2035, the number of people who are 65 

years old or over will double. As the share of the population over 65 

climbs, federal spending on the elderly will absorb larger and ultimately 

unsustainable shares of the federal budget. Federal spending on health and 

entitlement programs for the elderly is expected to surge as people live 

longer and spend more time in retirement. In addition, advances in medical 

technology are likely to keep pushing up the cost of providing health care. 

Moreover, the baby boomers will have left behind fewer workers to support 

them in retirement, prompting a slower rate of economic growth from 

which to finance these higher costs. Absent substantive reform of related 

entitlement programs and/or dramatic changes in tax or discretionary 

spending policies, we will face large, escalating, and persistent deficits. 

3

U.S. General Accounting Office, Budget Issues: Long-Term Fiscal Challenges, GAO-02-

467T (Washington, D.C.: Feb. 27, 2002) and U.S. General Accounting Office, Budget Issues: 

Effective Oversight and Budget Discipline are Essential—Even in a Time of Surplus,

GAO/T-AIMD-00-73 (Washington, D.C.: Feb. 1, 2000).
Page 5 GAO-03-572T 

These trends have widespread implications for our society, our economy, 

and the federal budget.

On March 17, 2003, the Trustees of the Social Security and Medicare trust 

funds reported on the current and projected status of these programs over 

the next 75 years. The Trustees report that the fundamentals of the 

financial status of both Social Security and Medicare remain highly 

problematic. However, they stated that Medicare faces financial difficulties 

that are more severe than those confronting Social Security because costs 

of the Medicare program are projected to rise faster than costs of the Social 

Security program. The projections show a 20 percent increase to about 

$6.2 trillion over the prior year in the Present Value of Resources Needed 

Over the 75-Year Projection Period for Federal Hospital Insurance 

(Medicare Part A), while the Social Security projection showed an 8 

percent increase to about $4.9 trillion. Once again, the Trustees state that 

action to address the financial difficulties facing Social Security and 

Medicare must be taken in a timely manner and that the sooner these 

financial challenges are addressed, the more varied and less disruptive the 

solutions can be.

Early action to change these programs would yield the highest fiscal 

dividends for the federal budget and would provide a longer period for 

prospective beneficiaries to make adjustments in their own planning. 

Waiting to take action entails risks. First, we lose an important window 

where today’s relatively large workforce can increase saving and enhance 

productivity, two elements critical to growing the future economy. Second, 

we lose the opportunity to reduce the burden of interest in the federal 

budget, thereby creating a legacy of higher debt as well as elderly 

entitlement spending for the relatively smaller workforce of the future. 

Third, and most critically, we risk losing the opportunity to phase in 

changes gradually so that all can make the adjustments needed in private 

and public plans to accommodate this historic shift. 

We prepare long-term budget simulations that seek to illustrate the likely 

fiscal consequences of the coming demographic tidal wave and rising 

health care costs. Our latest long-term budget simulations reinforce the 

need for change in the major cost drivers—Social Security and health care 

programs. As shown in figure 1, by midcentury, absent reform of these 

entitlement programs, projected federal revenues may be adequate to pay 

little beyond interest on the debt and Social Security benefits. Further, the 

shift from surplus to deficit means that the nation will move into the future 

in a weaker fiscal position than was previously the case.
Page 6 GAO-03-572T 

Figure 1: 

Note: Assumes currently scheduled Social Security benefits are paid in full throughout the simulation 

period. 

Although the need for structural change in Social Security is widely 

recognized, this change would not be sufficient to overcome the long-term 

fiscal challenges confronting the nation. For example, the long-term fiscal 

imbalance would not come close to being eliminated even if Social Security 

benefits were to be limited to currently projected trust fund revenues, 

because Medicare and Medicaid—spending for which is driven by both 

demographics and rising health care costs—present an even greater 

problem. 

While addressing the challenges of Social Security and Medicare is key to 

ensuring future fiscal flexibility, a fundamental review of major programs, 

policies, and operations can create much-needed fiscal flexibility to 

address emerging needs. As I have stated previously, it is healthy for the 

nation periodically to review and update its programs, activities, and 

priorities.4

 Many federal programs and policies were designed years ago to 

respond to earlier challenges. Ultimately, the federal government should 

strive to hand to the next generation the legacy of a government that is 

effective and relevant to a changing society—a government that is as free 

0

10

20

30

40

50

2000 2015 2030 2050

Fiscal year

Percent of GDP

Net interest Social Security Medicare & Medicaid All other spending

Composition of Spending as a Share of GDP

Assuming Discretionary Spending Grows with GDP after 2003

and the 2001 Tax Cuts Do Not Sunset

Revenue

Source: GAO’s March 2003 analysis.
Page 7 GAO-03-572T 

as possible of outmoded commitments and operations that can 

inappropriately encumber the future. 

A reexamination of existing programs and policies could help weed out 

items that have proven to be outdated or persistently ineffective or 

alternatively could prompt us to update and modernize activities through 

such actions as improving program targeting and efficiency, consolidation, 

or reengineering of processes and operations. Such a review should not be 

limited to only spending programs but should include the full range of tools 

of governance that the federal government uses to address national 

objectives. These tools include loans and loan guarantees, tax 

expenditures, and regulations.

In the last decade the Congress put in place a series of laws designed to 

improve information about cost and performance. This framework and the 

information it provides can help structure and inform the debate about 

what the federal government should do. In addition, GAO has identified a 

number of areas warranting reconsideration based on program 

performance, targeting, and costs. 

The events of the past few years have served to highlight the benefits of 

fiscal flexibility. Addressing the long-term drivers in the budget is essential 

to preserving any flexibility in the long term. In the nearer term, a 

fundamental review of existing programs and policies can also create 

much-needed fiscal flexibility. In this regard, the federal government must 

determine how best to address the necessary structural challenges in a 

reasonably timely manner in order to identify specific actions that need to 

be taken. As steward of the nation’s future, the federal government must 

begin to prepare for tomorrow.

Need for New Metrics and 

Mechanisms

Today’s budget decisions shape, in part, the choices and resources 

available to future decision makers and taxpayers. Accordingly, today’s 

budget decisions involve tradeoffs between meeting current needs and 

fulfilling stewardship responsibilities. The government undertakes a wide 

range of responsibilities, programs, and activities that may call for future 

spending or create an expectation for such spending. Figure 2 illustrates 

some of these claims on future federal resources. 

4

GAO/T-AIMD-00-73.
Page 8 GAO-03-572T 

Figure 2: 
Page 9 GAO-03-572T 

A better understanding and more transparency about these “fiscal 

exposures” is needed. The budget needs to employ new metrics and 

measures and processes—relying more on long-term estimates and present 

value concepts in making resource allocation decisions. Neither current 

budget reporting nor financial statements are designed to promote the 

recognition and explicit consideration of all of these exposures. Our 

nation’s fiscal exposures cover a wide range: from explicit liabilities to 

implicit promises embedded in current policy or public expectations. 

Some, like accounts payable and loan guarantees, are included in both the 

budget and financial statements and some are not. Others, such as liability 

for environmental cleanup, are reported in the financial statements, but 

only a single year’s figures are in the budget. Some implicit exposures, 

such as future Social Security and Medicare benefits, are not included in 

the budget or reported as liabilities in the financial statements5

 but are 

captured in long-range budget projections. Other implicit exposures, such 

as the risk assumed by insurance programs, may not be captured in either 

budget or financial reporting. 

The failure to understand and address these fiscal exposures can have 

significant consequences, encumbering future budgets and reducing fiscal 

flexibility. Further, the failure to capture the long-term costs of a proposal 

or decision limits the Congress’s ability to control fiscal exposures at the 

time it is being asked to make the decision. 

As the figure makes clear, there is wide diversity in the nature of these 

fiscal exposures. This diversity suggests that it would be most useful to 

look at different types of fiscal exposures and tailor metrics and changes to 

address each type. We recently recommended6

 that OMB report annually 

on fiscal exposures, including a concise list and description and cost 

estimates where possible. We also recommended that, where possible, 

OMB report the estimated costs associated with certain exposures as a new 

budget concept—“exposure level”—as a notational item in the President’s 

budget. These two steps would help alert both the public and policy 

makers about the long-term implications of programs, policies and 

activities. 

5

The stewardship information section of the U.S. government’s consolidated financial 

statements presents the present value of long-range actuarial projections for the Social 

Security and Medicare programs, together with related information.

6

U.S. General Accounting Office, Fiscal Exposures: Improving the Budgetary Focus on 

Long-Term Costs and Uncertainties, GAO-03-213 (Washington, D.C.: Jan. 24, 2003).
Page 10 GAO-03-572T 

It is important to recognize that for trust funds, greater transparency and 

fuller disclosure means going beyond trust fund balances or solvency 

measures. For federal trust funds the balances do not provide meaningful 

information about program sustainability. These balances do not increase 

the government’s ability to meet long-term commitments. Nor do they 

necessarily represent the full future cost of existing promises. For example, 

the projected exhaustion date of the Hospital Insurance (HI) Trust Fund is 

a commonly used indicator of HI’s financial condition. Under the Trustees’ 

2003 intermediate estimates, the HI Trust Fund is projected to exhaust its 

assets in 2026. Long before that, however, HI’s program outlays will exceed 

program tax revenues. Under the Trustees’ 2003 intermediate estimates, 

this will begin in 2013. To finance program cash deficits, HI will need to 

draw on the special-issue Treasury securities acquired during the years of 

cash surpluses. For HI to “redeem” its securities, the government will need 

to obtain cash through some combination of increased taxes, spending 

cuts, and/or increased borrowing from the public (or, if the unified budget 

is in surplus, less debt reduction than would otherwise have been the case). 

HI’s negative cash flow will place increased pressure on the federal budget 

to raise the resources necessary to meet the program’s ongoing costs. 

Ultimately, the critical question is not how much a trust fund has in assets, 

but whether the government as a whole and the economy can afford the 

promised benefits now and in the future and at what cost to other claims on 

available resources. Extending a trust fund’s solvency without reforms to 

make the underlying program more sustainable can create a false sense of 

security and delay needed reform. Because the balances can be 

misleading, we need to reconsider how trust funds, and the nonmarketable 

federal government securities contained therein, are treated in both the 

budget and the federal government’s financial statements.

Today the Congress and President Bush face the challenge of sorting out 

these many claims on the federal budget without the budget enforcement 

mechanisms or fiscal benchmarks that guided the federal government 

through the years of deficit reduction.7

 However, it is still the case that the 

federal government needs a decision-making framework that permits it to 

evaluate choices against both today’s needs and the longer-term fiscal 

future that will be handed to future generations. More complete, visible, 

7

We have recently issued a report offering some suggestions on how to better improve 

information about the long-term cost implications of various programs and activities. See 

GAO-03-213.
Page 11 GAO-03-572T 

and transparent reporting of fiscal exposures can better position decision 

makers to do this.

Highlights of Major 

Issues Relating to the 

U.S. Government’s 

Consolidated Financial 

Statements for Fiscal 

Years 2002 and 2001 

As I mentioned earlier, as has been the case for the past 5 fiscal years, the 

federal government continues to have a significant number of material 

weaknesses related to financial systems, fundamental recordkeeping and 

financial reporting, and incomplete documentation. Several of these 

material weaknesses (referred to hereafter as material deficiencies) 

resulted in conditions that continued to prevent us from expressing an 

opinion on the U.S. government’s consolidated financial statements for the 

fiscal years ended September 30, 2002 and 2001.8

 There may also be 

additional issues that could affect the consolidated financial statements 

that have not been identified. 

Major challenges include the federal government’s inability to

• properly account for and report property, plant, and equipment and 

inventories and related property, primarily at the Department of Defense 

(DOD);

• reasonably estimate or adequately support amounts reported for certain 

liabilities, such as environmental and disposal liabilities and related 

costs at DOD, and ensure complete and proper reporting for 

commitments and contingencies;

• support major portions of the total net cost of government operations, 

most notably related to DOD, and ensure that all disbursements are 

properly recorded;

• fully account for and reconcile intragovernmental activity and balances; 

and

• properly prepare the federal government’s financial statements, 

including fully ensuring that the information in the consolidated 

financial statements is consistent with the underlying agency financial 

statements, balancing the statements, adequately reconciling the results 

8

We previously reported that material deficiencies prevented us from expressing an opinion 

on the fiscal years 1997, 1998, 1999, and 2000 consolidated financial statements.
Page 12 GAO-03-572T 

of operations to budget results, and eliminating transactions between 

governmental entities. 

In addition, we identified material weaknesses in internal control related to 

loans receivable and loan guarantee liabilities, improper payments, tax 

collection activities, and information security. 

I would now like to discuss in more detail the material deficiencies 

identified by our work.

Property, Plant, and 

Equipment and Inventories 

and Related Property

The federal government could not satisfactorily determine that all such 

assets were included in the consolidated financial statements, verify that 

certain reported assets actually exist, or substantiate the amounts at which 

they were valued. A significant portion of the property, plant, and 

equipment and the vast majority of inventories and related property are the 

responsibility of DOD. DOD did not maintain adequate systems or have 

sufficient records to provide reliable information on these assets. Other 

agencies, most notably NASA, reported continued weaknesses in internal 

control procedures and processes related to property, plant, and 

equipment.

Liabilities and 

Commitments and 

Contingencies

The federal government could not reasonably estimate or adequately 

support amounts reported for certain liabilities. For example, the federal 

government was not able to reliably estimate key components of DOD’s 

environmental and disposal liabilities and could not support its estimate of 

military postretirement health benefits liabilities included in federal 

employee and veteran benefits payable. Further, the federal government 

could not determine whether commitments and contingencies, including 

those related to treaties and other agreements entered into to further the 

U.S. government’s interest, were complete and properly reported.

Cost of Government 

Operations and 

Disbursement Activity

The previously discussed material deficiencies in reporting assets and 

liabilities, material deficiencies in financial statement preparation, as 

discussed below, and the lack of adequate disbursement reconciliations at 

certain federal agencies affect reported net costs. As a result, the federal 

government was unable to support significant portions of the total net cost 

of government operations, most notably related to DOD. As it relates to 

disbursement reconciliations, some federal agencies did not adequately 
Page 13 GAO-03-572T 

reconcile disbursements to Treasury’s records of disbursements, which is 

intended to be a key control to detect and correct errors and other 

misstatements in financial records in a timely manner. We have seen 

progress in this area over the past 6 years. However, for fiscal years 2002 

and 2001 there were unsupported adjustments and unreconciled 

differences between federal agencies’ and Treasury’s records of 

disbursements totaling billions of dollars. 

Accounting for and 

Reconciliation of 

Intragovernmental Activity 

and Balances

OMB and Treasury require CFO Act agencies to reconcile selected 

intragovernmental activity and balances with their “trading partners”9

 and 

to report on the extent and results of intragovernmental activity and 

balances reconciliation efforts. However, a substantial number of the CFO 

Act agencies did not fully perform such reconciliations for fiscal years 2002 

and 2001. For both of these years, amounts reported for federal agency 

trading partners for certain intragovernmental accounts were significantly 

out of balance. I will discuss these issues further later in this testimony, as 

well as certain related corrective actions being taken.

Preparation of Consolidated 

Financial Statements

The federal government did not have adequate systems, controls, and 

procedures to properly prepare its consolidated financial statements. 

Specifically, we identified problems with compiling the consolidated 

financial statements, such as adequately ensuring that the information for 

each federal agency that was included in the consolidated financial 

statements was consistent with the underlying agency financial statements. 

In addition, we identified problems with the elimination of 

intragovernmental activity and balances. Later in this testimony, these 

matters are discussed further, along with certain corrective actions being 

taken. Also, disclosure of certain financial information was not presented 

in the consolidated financial statements in conformity with U.S. generally 

accepted accounting principles.

Ineffective Internal Control In addition to the material deficiencies noted above, we found four other 

material weaknesses in internal control as of September 30, 2002: (1) 

several federal agencies continue to have significant deficiencies in the 

9

Trading partners are U.S. government agencies, departments, or other components 

included in the consolidated financial statements that do business with each other.
Page 14 GAO-03-572T 

processes and procedures used to estimate the costs of their lending 

programs and value their loan receivables; (2) most federal agencies have 

not estimated or reported the magnitude of improper payments in their 

programs; (3) material internal control weaknesses and systems 

deficiencies continue to affect the federal government’s ability to 

effectively manage its tax collection activities; and (4) federal agencies 

have not yet institutionalized comprehensive information security 

management programs.

Loans Receivable and Loan 

Guarantee Liabilities

Prior to fiscal year 2001, we cited accounting for loans receivable and loan 

guarantee liabilities as a material deficiency contributing to our disclaimer 

of opinion because certain key federal credit agencies could not reliably 

estimate the costs of their lending programs or determine the net loan 

amounts expected to be collected. In fiscal year 2001, due to significant 

improvements at USDA, we removed this area from the list of issues 

contributing to our disclaimer. Nevertheless, several federal agencies 

continue to have significant deficiencies in the processes and procedures 

used to estimate the costs of their lending programs and value their loan 

receivables.

In a recent report on SBA's loan asset sale program,10 we reviewed SBA’s 

budgeting and accounting for loan sales and found that SBA incorrectly 

calculated the accounting losses on the loan sales and lacked reliable 

financial data to determine the overall financial impact of the sales. 

Further, because SBA did not analyze the effect of loan sales on its 

remaining portfolio, its reestimates of loan program costs for the budget 

and financial statements may contain significant errors. In addition, SBA 

could not explain significant declines in its loss allowance account for 

disaster loans. SBA’s inspector general and its independent auditor agreed 

with our findings, and the independent auditor withdrew its unqualified 

audit opinions on SBA’s fiscal years 2001 and 2000 financial statements. 

Until SBA corrects these errors and determines the cause of the precipitous 

decline in the loss allowance account for disaster loans, SBA’s financial 

statements cannot be relied upon. Further, the reliability of current and 

future subsidy cost estimates will remain unknown. These errors and the 

lack of key analyses also mean that congressional decision makers are not 

10U.S. General Accounting Office, Small Business Administration: Accounting Anomalies 

and Limited Operational Data Make Results of Loan Sales Uncertain, GAO-03-87

(Washington, D.C.: Jan. 3, 2003).
Page 15 GAO-03-572T 

receiving accurate financial data to make informed decisions about SBA’s 

budget and the level of appropriations the agency should receive.

In addition, we again noted that certain other federal credit agencies 

continue to require significant adjustments to the estimates of program 

costs, net loan amounts to be collected, and related notes. Auditors for 

these agencies reported related material internal control weaknesses.

Improper Payments Across the federal government, improper payments occur in a variety of 

programs and activities, including those related to health care, contract 

management, federal financial assistance, and tax refunds. 11 Many 

improper payments occur in federal programs that are administered by 

entities other than the federal government. In general, improper payments 

often result from a lack of or an inadequate system of internal controls. 

While estimates of improper payments disclosed in federal agency financial 

statements totaled approximately $20 billion for both fiscal years 2002 and 

2001, the federal government did not estimate the full extent of improper 

payments. The President’s Management Agenda includes addressing 

erroneous payments (a term we consider synonymous with improper 

payments) as one of the key elements for improving financial performance.

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

national estimate of improper Medicare fee-for-service payments as part of 

its annual financial statements since fiscal year 1996. In fiscal year 2002, 

HHS reported estimated improper Medicare fee-for-service payments of 

approximately $13.3 billion, or about 6.3 percent of such benefits. HHS’s 

Centers for Medicare and Medicaid Services (CMS) has initiated projects to 

improve the precision of Medicare fee-for-service improper payment 

estimates and aid in the development of corrective actions to reduce 

improper payment losses. For example, CMS developed a comprehensive 

error-testing program that will produce contractor-, provider-, and benefitspecific error rates. These error rates can be aggregated to add greater 

precision to the national Medicare fee-for-service error rate estimates. 

However, most federal agencies have not estimated or reported the 

magnitude of improper payments in their programs and comprehensively 

11Improper payments include inadvertent errors, such as duplicate payments and 

miscalculations, payments for unsupported or inadequately supported claims, payments for 

services not rendered, payments to ineligible beneficiaries, and payments resulting from 

fraud and abuse by program participants and/or federal employees.
Page 16 GAO-03-572T 

addressed this issue in their annual performance plans under the 

Government Performance and Results Act (GPRA) of 1993. For example, 

IRS follows up on only a portion of the suspicious Earned Income Tax 

Credit (EITC) claims it identifies, although the EITC has historically been 

vulnerable to high rates of invalid claims. In February 2002, IRS estimated 

that taxpayers filed returns for tax year 1999 claiming at least $8.5 billion in 

invalid EITCs, of which only $1.2 billion (14 percent) either was recovered 

or was expected to be recovered through compliance efforts. Although the 

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

routinely estimated the potential magnitude of invalid refunds and has not 

disclosed an annual estimate of improper payments in its financial reports. 

As a result, the amount of improper payments included in the almost $28 

billion IRS disbursed for EITCs for fiscal year 2002 is unknown. 

Without systematically measuring the extent of improper payments, federal 

agency management cannot determine (1) whether problems exist that 

merit agency action, (2) what mitigation strategies are appropriate and the 

amount to invest in them, and (3) whether efforts implemented to reduce 

improper payments are successful. OMB, which has shown leadership in 

this area, now requires annual submissions on improper payments from 15 

federal agencies. Specifically, OMB requires actual and projected 

information on erroneous payment rates and the status of actions taken to 

reduce improper payments. Further, the Improper Payments Information 

Act of 200212 requires federal agencies to (1) annually review programs and 

activities that they administer to identify those that may be susceptible to 

significant improper payments, (2) estimate improper payments in 

susceptible programs and activities, and (3) provide reports to the 

Congress that include such information as the status of actions to reduce 

improper payments for programs and activities with estimated improper 

payments of $10 million or more.

Tax Collection Activities Material internal control weaknesses and systems deficiencies continue to 

affect the federal government’s ability to effectively manage its tax 

collection activities.13 This situation continues to result in the need for 

extensive, costly, and time-consuming ad hoc programming and analyses, 

as well as material audit adjustments, to prepare basic financial 

12Pub. L. No. 107-300, 116 Stat. 2350 (Nov. 26, 2002).

13U.S. General Accounting Office, Financial Audit: IRS's Fiscal Years 2002 and 2001 

Financial Statements, GAO-03-243 (Washington, D.C.: Nov. 15, 2002).
Page 17 GAO-03-572T 

information. As further discussed later in this testimony, this approach 

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 on taxpayers and lost revenue.

The lack of appropriate subsidiary systems to track the status of taxpayer 

accounts and material weaknesses in financial reporting affect the 

government’s ability to make informed decisions about collection efforts. 

Due to errors and delays in recording activity in taxpayer accounts, 

taxpayers were not always being credited for payments made on their tax 

liabilities. In addition, the federal government did not always follow up on 

potential unreported or underreported taxes and did not always pursue 

collection efforts against taxpayers owing taxes to the federal government. 

This could result in billions of dollars not being collected and adversely 

affect future compliance.

The federal government continues to be vulnerable to lost tax revenue due 

to weaknesses in controls intended to maximize the government’s ability to 

collect what is owed and to minimize the risk of payment of improper 

refunds. The federal government identifies billions of dollars of potentially 

underreported taxes and improper refunds each year. However, due in 

large part to perceived resource constraints, the federal government 

selects only a portion of the questionable cases it identifies for follow-up 

investigation and action. In addition, the federal government often does 

not initiate follow-up on the cases it selects until months after the related 

tax returns have been filed and any related refunds disbursed, affecting its 

chances of collecting amounts due on these cases. Consequently, the 

federal government is exposed to potentially significant losses from 

reduced revenue and disbursements of improper refunds. Finally, 

continued weaknesses in physical controls over cash, checks, and sensitive 

data received from taxpayers increase both the federal 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 continues to be committed to addressing 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.
Page 18 GAO-03-572T 

Information Security 

Weaknesses

GAO has reported information security over computerized operations as a 

governmentwide high-risk area since February 1997.14 Information security 

weaknesses are placing enormous amounts of federal government 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. The 

federal government is not in a position to estimate the full magnitude of 

actual damage and loss resulting from federal information security 

weaknesses because it is likely that many such incidents are either not 

detected or not reported. Although progress has been made, federal 

agencies have not yet institutionalized comprehensive security 

management programs, which are critical to resolving information security 

problems and managing information security risk on an ongoing basis.

The information security weaknesses continue to cover the full range of 

information security controls. For example, access controls were not 

effective in limiting or detecting inappropriate access to information 

resources, such as ensuring that only authorized individuals can read, alter, 

or delete data. In addition, software change controls were ineffective in 

ensuring that only properly authorized and tested software programs were 

implemented. Further, duties were not appropriately segregated to reduce 

the risk that one individual could conduct unauthorized transactions 

without being detected. Finally, sensitive operating system software was 

not adequately controlled, and adequate steps had not been taken to ensure 

continuity of operations. 

14U.S. General Accounting Office, High-Risk Series: An Update, GAO-03-119 (Washington, 

D.C.: January 2003).
Page 19 GAO-03-572T 

Through the recently enacted Federal Information Security Management 

Act of 2002 (FISMA),15 the Congress has continued its efforts to improve 

federal information security by permanently authorizing and strengthening 

the information security program, evaluation, and reporting requirements 

established by federal government information security reform 

legislation.16 This information security reform legislation has been a 

significant step in improving federal agencies’ information security 

programs and addressing their serious, pervasive information security 

weaknesses, and, among other benefits, has increased management 

attention to and accountability for information security. FISMA will further 

strengthen federal information security by requiring the National Institute 

of Standards and Technology to develop mandatory minimum information 

security requirements.

The administration has also taken actions to improve information security. 

For example, OMB created an annual reporting process that includes 

federal agency preparation of corrective action plans to track progress in 

correcting identified weaknesses. Further, in February 2003, the President 

issued the National Strategy to Secure Cyberspace, which sets national 

priorities for reducing threats from and vulnerabilities to cyberattacks and 

improving the nation’s response to cyberincidents.

Providing Sustained 

Leadership and 

Oversight for Effective 

Implementation of 

Financial Management 

Reform 

Over the past year, the JFMIP Principals continued our efforts, begun in 

August 2001, to accelerate progress in financial management reform. This 

involved our personal commitment to provide the leadership necessary to 

address pressing governmentwide financial management issues. Also, 

President Bush has implemented the President’s Management Agenda to 

provide direction to, and to closely monitor, management reform across 

government, which encompasses improved financial performance. Actions 

such as these are important elements of ensuring the government’s full and 

effective implementation of the federal financial management reforms 

enacted by the Congress.

15Pub. L. No. 107-347, Title III, 116 Stat. 2946 (Dec. 17, 2002).

16Floyd D. Spence National Defense Authorization Act for Fiscal Year 2001, Pub. L. No. 106-

398, Title X, Subtitle G, 114 Stat. 1654A-266 (Oct. 30, 2000).
Page 20 GAO-03-572T 

The JFMIP Principals’ 

Initiative

Since August 2001, the JFMIP Principals have established an excellent 

working relationship, a basis for action, and a sense of urgency through 

which significant and meaningful progress can be achieved. In fiscal year 

2002, JFMIP Principals continued the series of regular, deliberative 

meetings that focused on key financial management reform issues such as

• defining success measures for financial management performance that 

go far beyond an unqualified audit opinion on financial statements and 

include measures such as financial management systems that routinely 

provide timely, reliable, and useful financial information and no material 

internal control weaknesses or material noncompliance with laws and 

regulations and Federal Financial Management Improvement Act of 

1996 (FFMIA) requirements;17

• restructuring the Federal Accounting Standards Advisory Board’s 

(FASAB) composition to enhance the independence of the Board and 

increase public involvement in setting standards for federal financial 

accounting and reporting;

• significantly accelerating financial statement reporting to improve 

timeliness for decision making and to discourage costly efforts designed 

to obtain unqualified opinions on financial statements without 

addressing underlying systems challenges;

• establishing audit advisory committees for selected major federal 

agencies; and 

• addressing difficult accounting and reporting issues, including 

impediments to an audit opinion on the U.S. government's consolidated 

financial statements and reporting updated social insurance financial 

information in the U.S. government’s consolidated financial statements.

Continued personal involvement of the JFMIP Principals is critical to the 

full and successful implementation of federal financial management reform 

and to providing greater transparency and accountability in managing 

17FFMIA requires auditors, as part of CFO Act agencies’ financial statement audits, to report 

whether agencies’ financial management systems substantially comply with (1) federal 

financial management systems requirements, (2) applicable federal accounting standards 

(U.S. generally accepted accounting principles), and (3) the federal government’s SGL at the 

transaction level.
Page 21 GAO-03-572T 

federal programs and financial resources. At the end of fiscal year 2002, I 

ended my 2-year term as Chair of the JFMIP Principals, and the Chair 

rotated to Office of Management and Budget Director Daniels. I look 

forward to working with the new Chair, Treasury Secretary Snow, and 

Office of Personnel Management Director James in the upcoming months 

to continue this important dialogue and build on the strong working 

relationships that we have established.

The President’s 

Management Agenda

President Bush has established an agenda for improving the management 

and performance of the federal government that targets the most apparent 

deficiencies where the opportunity to improve performance is the greatest. 

It is no accident that the President’s Management Agenda has a strong 

correlation to GAO’s high-risk list. This is just one example of how GAO 

and OMB have worked constructively to identify key issues deserving 

increased attention throughout government. As stated in the President’s 

Management Agenda—and we wholeheartedly agree—there are few items 

more urgent than ensuring that the federal government is well run and 

results-oriented.

The President’s Management Agenda, which is a starting point for 

management reform, includes improved financial management 

performance as one of the five governmentwide management goals. Other 

governmentwide initiatives of the President’s Management Agenda include 

strategic management of human capital, competitive sourcing, expanded 

electronic government, and budget and performance integration. 

In particular, the improved financial management performance initiative is 

aimed at ensuring that federal financial systems produce accurate and 

timely information to support operating, budget, and policy decisions. 

Also, this initiative focuses special attention on addressing erroneous 

payments, credit card abuse in the federal government, and asset 

management, areas for which we have reported problems and challenges.18

18U.S. General Accounting Office, Financial Management: Coordinated Approach Needed 

to Address the Government’s Improper Payments Problems, GAO-02-749 (Washington, 

D.C.: Aug. 9, 2002); Government Purchase Cards: Control Weaknesses Expose Agencies to 

Fraud and Abuse, GAO-02-676T (Washington, D.C.: May 1, 2002); High-Risk Series: Federal 

Real Property, GAO-03-122 (Washington, D.C.: January 2003).
Page 22 GAO-03-572T 

Under the improved financial management performance initiative, agencies 

are expected to improve the timeliness, enhance the usefulness, and ensure 

the reliability of financial information. The expected result is integrated 

financial and performance management systems that routinely produce 

information that is (1) timely, to measure and effect performance 

immediately, (2) useful, to make more informed operational and investing 

decisions, and (3) reliable, to ensure consistent and comparable trend 

analysis over time and to facilitate better performance measurement and 

decision making. This result is a key to successfully achieving the goals set 

out by the Congress in the CFO Act and other federal financial management 

reform legislation.

Central to effectively addressing the federal government’s management 

problems and providing a solid base for successful transformation efforts is 

recognition that the five governmentwide initiatives cannot be addressed in 

an isolated or piecemeal fashion from other major management challenges 

and high risks facing federal agencies. Rather, these efforts are mutually 

reinforcing and must be addressed in an integrated way to ensure that they 

drive a broader transformation of the cultures of federal agencies.

The Executive Branch 

Management Scorecard

The administration is using the Executive Branch Management Scorecard 

to highlight federal agencies’ progress in achieving management and 

performance improvements embodied in the President’s Management 

Agenda. The Executive Branch Management Scorecard grades selected 

federal agencies’ performance regarding the five governmentwide 

initiatives by using broad standards and a red-yellow-green coding system 

to indicate the level at which agencies are meeting the standards.
Page 23 GAO-03-572T 

In the financial management area, while recognizing the importance of 

achieving an unqualified opinion from auditors on financial statements, the 

scorecard focuses on the fundamental and systemic issues that must be 

addressed in order to generate timely, accurate, and useful financial 

information. The scorecard also measures whether agencies have any 

material internal control weaknesses or material noncompliances with 

laws and regulations, and whether agencies meet FFMIA requirements. 

The December 31, 2002, scorecard’s results show dramatically the extent of 

work remaining across government to improve financial and other 

management areas. For financial performance, most of the selected federal 

agencies were scored in the red category. This is not surprising, 

considering the well-recognized need to transform financial management 

and other business processes at federal agencies such as DOD, the results 

of our analyses under FFMIA, and the various financial management 

operations we have designated as high risk.19 Some of the selected 

agencies improved their scores from the initial baseline evaluation as of 

September 30, 2001; however, other agencies’ scores declined, reflecting 

increased challenges.

The focus that the administration’s scorecard approach brings to improving 

management and performance, including financial management 

performance, is certainly a step in the right direction. The value of the 

scorecard is not in the scoring per se, but in the degree to which scores 

lead to sustained focus and demonstrable improvements. This will depend 

on continued efforts to assess progress and maintain accountability to 

ensure that agencies are able to, in fact, improve their performance. It will 

be important that there be continuous rigor in the scoring process in order 

for this approach to be credible and effective in providing the proper 

incentives that produce lasting results. Also, it is important to recognize 

that many of the challenges the federal government faces, such as 

improving financial management, are long-standing and complex, and will 

require sustained attention.

19As reported in GAO-03-119, we have identified financial management as a high-risk area at 

DOD, Treasury’s IRS, USDA’s Forest Service, and the Department of Transportation’s 

Federal Aviation Administration.
Page 24 GAO-03-572T 

Building on the 

Success of Unqualified 

Audit Opinions

Building on the success that has been achieved in obtaining unqualified 

audit opinions, federal agency management must continue to work toward 

fully resolving the pervasive and generally long-standing material 

weaknesses that have been reported for the past 6 fiscal years. The 

underlying causes of these issues are significant financial management 

systems weaknesses, problems with fundamental recordkeeping and 

financial reporting, incomplete documentation, and weak internal control. 

In identifying improved financial management performance as one of its 

five governmentwide initiatives, the President’s Management Agenda 

stated that a clean (unqualified) financial audit opinion is a basic 

prescription for any well-managed organization. It recognized that “most 

federal agencies that obtain clean audits only do so after making 

extraordinary, labor-intensive assaults on financial records.” Further, the 

President’s Management Agenda stated that without sound internal control 

and accurate and timely financial information, it is not possible to 

accomplish the President’s agenda to secure the best performance and 

highest measure of accountability for the American people.

Irrespective of the unqualified opinions on their financial statements, many 

federal agencies do not have timely, accurate, and useful financial 

information and sound controls with which to make informed decisions 

and to ensure accountability on an ongoing basis. While federal agencies 

have continued to make progress in obtaining unqualified audit opinions on 

annual financial statements, many of these opinions were obtained by 

expending significant resources on extensive ad hoc procedures and 

making billions of dollars in adjustments to derive the financial statements 

months after the end of a fiscal year. Several examples follow. The need 

for such resource-intensive procedures primarily results from inadequate 

financial management systems. 

• After receiving a disclaimer of opinion for fiscal year 2001, NASA was 

able to produce auditable financial statements for fiscal year 2002; 

however, the auditors reported that significant weaknesses still existed 

in NASA’s internal controls related to accounting for the International 

Space Station and for equipment and materials held by contractors. 

Because of these control weaknesses, the auditors found numerous 

errors in property records and had to significantly expand the scope of 

their testing. To correct auditor-identified errors, NASA had to make 

about $11 billion of adjustments to its records. The auditors also 

identified a material weakness related to NASA’s process for preparing 

its financial statements and performance and accountability report. 
Page 25 GAO-03-572T 

Deficiencies included errors made in recording significant adjustments 

to the statements and reports. Auditors attributed the errors to 

insufficient resources to address the volume of work needed to compile 

the financial statements, lack of an integrated financial management 

system, lack of understanding by NASA staff of new federal reporting 

requirements, and lack of quality controls over financial reporting.

• After 8 consecutive years of disclaimers of opinion, USDA received an 

unqualified opinion on its fiscal year 2002 financial statements. While 

we consider this a positive step toward achieving financial 

accountability, it took extraordinary efforts outside the normal business 

processes by the department and its auditors, particularly at the Forest 

Service. The USDA Office of Inspector General’s transmittal letter for 

the fiscal year 2002 Forest Service audit report stated that “the Forest 

Service does not yet operate as an effective, sustainable, and 

accountable financial management organization. The fiscal year 2002 

ending account balances were primarily derived from a 2-year audit 

effort on beginning balances and numerous statistical samples of fiscal 

year 2002 transactions. As a result of these efforts, multiple adjustments 

were processed to the general ledger and/or subsidiary ledgers. For 

example, the financial statement line item General Property, Plant and 

Equipment, Net, was reduced by over $1 billion based on audit coverage. 

The achievement of an unqualified opinion, therefore, did not 

necessarily result from improvement in underlying financial 

management systems, but rather as an extensive ad hoc effort.” If USDA 

is to achieve and sustain financial accountability, it must fundamentally 

improve its underlying internal controls, financial management systems, 

and operations to allow for the routine production of accurate, relevant, 

and timely data to support program management. 

• Our unqualified opinions on IRS’s fiscal years 2002 and 2001 financial 

statements were made possible by the extraordinary efforts of IRS 

senior management and staff to develop processes to compensate for 

serious internal control and systems deficiencies. As noted earlier in 

this testimony, IRS made significant progress during fiscal year 2002. 

Nonetheless, it continued to require costly, resource-intensive 

processes; statistical projections; external contractors; substantial 

adjustments; and monumental human efforts to derive reliable year-end 

balances for its financial statements. For example, IRS still does not 

have a detailed record, or subsidiary ledger, for taxes receivable to allow 

it to track and manage amounts due from taxpayers. To enable it to 

report a reliable taxes receivable balance in the absence of a subsidiary 
Page 26 GAO-03-572T 

ledger, IRS has, for the last 6 years, relied on a complex statistical 

sampling approach that requires substantial human and financial 

resources to conduct, takes months to complete, and yields tens of 

billions of dollars of adjustments. Similarly, while progress has been 

made, IRS does not have an integrated property management system 

that appropriately records property and equipment additions and 

disposals as they occur and links costs on the accounting records to the 

property records. 

It will be increasingly difficult for federal agencies to continue to rely on 

significant costly and time-intensive manual efforts to achieve or maintain 

unqualified opinions until automated, integrated processes and systems are 

implemented that readily produce the necessary information. As a result, 

many federal agencies must accelerate their efforts to improve underlying 

financial management systems and controls, which is consistent with 

reaching the financial management success measures envisioned by the 

JFMIP Principals and called for by the President’s Management Agenda.

FFMIA requires auditors, as part of CFO Act agencies’ financial statement 

audits, to report whether agencies’ financial management systems 

substantially comply with (1) federal financial management systems 

requirements, (2) applicable federal accounting standards (U.S. generally 

accepted accounting principles), and (3) the federal government’s Standard 

General Ledger (SGL) at the transaction level. For fiscal year 2002, 

auditors for 19 CFO Act agencies reported that the agencies’ financial 

management systems did not comply substantially with one or more of 

these three FFMIA requirements. For the remaining 5 CFO Act agencies, 

auditors provided negative assurance, meaning that nothing came to their 

attention indicating that these agencies’ financial management systems did 

not substantially meet FFMIA requirements. The auditors for these 5 

agencies did not definitively state whether these agencies’ systems 

substantially complied with FFMIA requirements, as is required under the 

statute. Meeting the requirements of FFMIA has presented long-standing, 

significant challenges. These challenges will be resolved only through 

time, investment, and sustained emphasis on correcting deficiencies in 

federal financial management systems. GAO plans to report to the 

Congress by October 1, 2003, on CFO Act agencies’ FFMIA implementation 

for fiscal year 2002, as required by the act. 

While federal agencies continue to make progress in addressing 

weaknesses in their financial management systems, the serious 

shortcomings reported for these systems result in the lack of reliable 
Page 27 GAO-03-572T 

financial information needed for making operating decisions day to day, 

managing the federal government’s operations more efficiently and 

effectively, measuring program performance, executing the budget, 

maintaining accountability, and preparing financial statements.

For example, federal agency financial management systems are required to 

produce information on the full cost of programs and projects. This is not a 

new expectation—the requirement for managerial cost information has 

been in place for more than a decade, since 1990 under the CFO Act and 

since 1998 stemming from applicable accounting standards. Currently, 

some federal agencies are only able to provide cost accounting information 

at the end of the fiscal year through periodic cost surveys. Some federal 

agencies, such as the Department of the Interior’s Bureau of Land 

Management, are experimenting with methods of accumulating and 

assigning costs to obtain the managerial cost information needed to 

enhance programs, improve processes, establish fees, develop budgets, 

prepare financial reports, and report on performance. Having such 

financial information is the goal of FFMIA and the CFO Act, necessary for 

implementing GPRA, and critical to the transition to a more resultsoriented federal government as envisioned in the President’s Management 

Agenda. 

To remedy financial management systems weaknesses and carry out the 

President’s Management Agenda for improving financial management, 

OMB, and the CFO Act agencies will need to aggressively and rigorously 

collaborate. Our work to identify financial management best practices in 

world-class organizations20 has identified key factors for successfully 

modernizing financial systems, including (1) reengineering business 

processes in conjunction with implementing new technology, (2) 

developing systems that support the partnership between finance and 

operations, and (3) translating financial data into meaningful data. We 

identified other financial management best practices as well, such as 

(1) providing clear, strong executive leadership, (2) making financial 

management an entitywide priority, and (3) building a culture of control 

and accountability.

The size and complexity of many federal agencies and the discipline 

needed to overhaul or replace their financial management systems present 

20U.S. General Accounting Office, Executive Guide: Creating Value Through World-class 

Financial Management, GAO/AIMD-00-134 (Washington, D.C.: April 2000).
Page 28 GAO-03-572T 

a significant challenge—not simply a challenge to overcome a technical 

glitch, but a demanding management challenge that requires attention from 

the highest levels of the federal government along with sufficient human 

capital resources to effect lasting change. This will be a particular 

challenge at the new Department of Homeland Security (DHS), where 

federal agencies, many of which have ongoing challenges in their systems, 

processes, or internal controls over financial information, are becoming 

part of the new department. DHS, along with other federal agencies, has a 

stewardship obligation to prevent fraud, waste, and abuse, to use tax 

dollars appropriately, and to ensure financial accountability to the 

President, the Congress, and the American people. In addition to 

addressing incoming agencies’ challenges, DHS will need to focus on 

building future systems as part of its enterprise architecture approach to 

ensure an overarching framework for the agency’s integrated financial 

management processes. Plans must be developed and implemented to 

bridge the many financial environments in which incoming agencies 

currently operate to an integrated DHS system.

We recognize that it will take time, investment, and sustained emphasis on 

correcting deficiencies to improve federal financial management systems 

at DHS and other federal agencies to the level required by FFMIA. The 

JFMIP Principals’ leadership, commitment, and oversight will be important 

to provide the needed impetus to meet this challenge.

Addressing Major 

Impediments to an 

Opinion on 

Consolidated Financial 

Statements 

As I mentioned earlier, for the past 6 fiscal years, the federal government 

has been required to prepare, and have audited, consolidated financial 

statements. Successfully meeting this requirement is tightly linked to the 

requirement for the 24 CFO Act agencies to also have audited financial 

statements. This has stimulated extensive cooperative efforts and 

considerable attention by agency chief financial officers, inspectors 

general, Treasury and OMB officials, and GAO. With the benefit of several 

years’ experience by the federal government in having the required 

financial statements subjected to audit, the time has come to focus even 

more intensified attention on the most serious obstacles to achieving an 

opinion on the U.S. government’s consolidated financial statements. In this 

regard, the JFMIP Principals have discussed plans and strategies for 

addressing impediments to an opinion on the U.S. government’s 

consolidated financial statements. Three major impediments to an opinion 

on the consolidated financial statements are (1) serious financial 

management problems at DOD, (2) the federal government’s inability to 

fully account for and reconcile billions of dollars of transactions between 
Page 29 GAO-03-572T 

federal entities, and (3) the federal government’s inability to properly 

prepare the consolidated financial statements.

Reforming Financial 

Management at DOD

Essential to achieving an opinion on the consolidated financial statements 

is resolution of the serious financial management problems at DOD, which 

we have designated as high risk since 1995. In accordance with provisions 

of the National Defense Authorization Act for fiscal year 2002,21 DOD 

reported that the department’s financial management systems were not 

able to provide adequate evidence supporting material amounts in its fiscal 

year 2002 financial statements. DOD asserted that it is unable to comply 

with applicable financial reporting requirements for (1) property, plant, and 

equipment, (2) inventory and operating materials and supplies, (3) military 

retirement health care actuarial liability, (4) environmental liabilities, (5) 

intragovernmental eliminations and related accounting adjustments, and 

(6) cost accounting by suborganization/responsibility segment and major 

program. Based largely on DOD’s assertion, the DOD inspector general 

again disclaimed an opinion on DOD’s financial statements for fiscal year 

2002 as it had for the previous 6 fiscal years. 

To date, none of the military services or major DOD components has 

passed the test of an independent financial audit because of pervasive 

weaknesses in DOD’s financial management systems, operations, and 

internal control, including an inability to compile financial statements that 

comply with generally accepted accounting principles. The department 

has made progress in a number of areas but is far from solving a range of 

serious financial management problems. Their resolution, however, is key 

to having auditable consolidated financial statements because DOD had 

budget authority of $385 billion for fiscal year 2002, or about 18 percent of 

the entire federal budget; is accountable for a vast amount of government 

assets worldwide; and incurs a substantial amount of the reported 

liabilities. 

21Section 1008 of the National Defense Authorization Act for fiscal year 2002, Pub. L. No. 

107-107, 115 Stat. 1012 (Dec. 28, 2001), provides a framework for redirecting the 

department’s resources from the preparation and audit of financial statements to 

improvement of DOD’s financial management systems and financial management policies, 

procedures, and internal controls. Under this legislation, the department will also be 

required to report to the Congress on how resources have been redirected and the progress 

that has been achieved.
Page 30 GAO-03-572T 

DOD’s financial management deficiencies adversely affect not only the 

department’s ability to prepare auditable financial statements, but also its 

ability to control costs, ensure basic accountability, anticipate future costs 

and claims on the budget (such as for health care, weapons systems, and 

environmental liabilities), measure performance, maintain control of funds, 

prevent fraud, and address pressing management issues. For example, we 

recently reported on fundamental flaws in DOD’s systems, processes, and 

overall internal control environment, such as those related to

• pervasive purchase and travel card breakdowns that resulted in 

numerous instances of potentially fraudulent, improper, and abusive 

transactions and increased DOD’s vulnerability to theft and misuse of 

government property;

• adjustments to DOD’s closed appropriations that resulted in about $615 

million in adjustments that should not have been made, including $146 

million that were illegal; and

• accountability over critical items, such as chemical and biological 

protective garments, that resulted in DOD’s excessing and selling 

unused garment sets for about $3 each, while simultaneously procuring 

hundreds of thousands of similar garment sets for over $200 per set.

As discussed in our recent reporting22 on the management challenges 

facing the government, overhauling DOD’s financial management 

operations represents a major challenge that goes far beyond financial 

accounting to the very fiber of the department’s range of business 

operations and management culture. In prior years, DOD expended 

significant resources and made material amounts of adjustments to derive 

its financial statements. However, such statements were determined to be 

unauditable. In this regard, as previously mentioned, section 1008 of the 

National Defense Authorization Act for fiscal year 2002 provides a 

framework for redirecting the department’s resources from the preparation 

and audit of financial statements to improving DOD’s financial 

management systems and financial management policies, procedures, and 

internal controls. Administrations over the past 12 years have attempted to 

address these problems in various ways but have largely been unsuccessful 

despite good intentions and significant effort. 

22U.S. General Accounting Office, Major Management Challenges and Program Risks: 

Department of Defense, GAO-03-98 (Washington, D.C.: January 2003).
Page 31 GAO-03-572T 

As we testified in March 2002 and highlighted in our more recent reports, 

four underlying causes of problems have impeded past reform efforts at 

DOD: 

• The lack of accountability and sustained top-level leadership hinders 

DOD’s ability to meet its performance goals. Major improvement 

initiatives must have the direct, active support and involvement of 

the Secretary and Deputy Secretary of Defense to ensure that daily 

activities throughout the department remain focused on achieving 

shared, agencywide outcomes and success. Furthermore, sustaining 

commitment by top leadership to performance goals is a particular 

challenge for DOD because the average tenure of DOD’s top political 

appointees is only 1.7 years. Based on our survey of best practices of 

world-class financial management organizations, it is clear that 

strong executive leadership is essential to (1) making financial 

management an entitywide priority, (2) redefining the role of finance, 

(3) providing meaningful information to decision makers, and (4) 

building a team of people that delivers results.

• Cultural resistance to change and stovepiped operations have 

impeded DOD’s ability to implement broad-based management 

reforms. We found that the effectiveness of the Defense Management 

Council, established in 1997, was impaired because members were 

not able to put aside their particular military services’ or DOD 

agencies’ interests to focus on departmentwide approaches. DOD’s 

stovepiped approach is most evident in its current financial 

management systems environment, which DOD recently estimated to 

include 1,800 systems and system development projects—many of 

which were developed in piecemeal fashion and evolved to 

accommodate different organizations, each with its own policies and 

procedures.

• Lack of clear, linked goals and performance measures impedes 

DOD’s ability to attain strategic goals with the risk that units are 

operating autonomously, rather than collectively. In our assessment 

of DOD’s fiscal year 2000 Financial Management Improvement 

Plan—its most recent plan—we found that it presented the military 

services’ and DOD components’ individual improvement initiatives 

but did not clearly articulate how their individual efforts would result 

in a collective, integrated DOD-wide approach to financial 

management improvement. In addition, the plan did not include 

performance measures to assess DOD’s progress in resolving 
Page 32 GAO-03-572T 

financial management problems. Furthermore, while DOD plans to 

invest billions of dollars in modernizing its financial management 

systems, it is in the initial stages of developing an overall blueprint, 

or enterprise architecture, to guide and direct these investments. 

• Lack of incentives to change existing “business-as-usual” processes, 

systems, and structures contributes to DOD’s inability to carry out 

needed fundamental reform. Traditionally, DOD has focused more 

on justifying its need for more funding and moving programs and 

operations through the process than on achieving better program 

outcomes. It does not (1) reward behaviors that contribute to DODwide and congressional goals, (2) develop motivational incentives for 

decision makers to guide them toward better program outcomes, or 

(3) provide congressional focus on more results-oriented and 

resource allocation decisions. 

On September 10, 2001, Secretary of Defense Rumsfeld recognized the farreaching nature of DOD’s financial management problems and announced a 

broad, top-priority initiative intended to “transform the way the department 

works and what it works on.” This new broad-based business 

transformation initiative, led by DOD’s Senior Executive Council and the 

Business Initiative Council, incorporates a number of defense reform 

initiatives begun under previous administrations but also encompasses 

additional fundamental business reform proposals. In announcing his 

initiative, Secretary Rumsfeld recognized that transformation would be 

difficult and expected the needed changes would take 8 or more years to 

complete. The Secretary’s initiative is consistent with the findings of an 

independent study he commissioned that concluded that DOD would have 

to undergo “a radical financial management transformation” and that it 

would take more than a decade to achieve. Secretary Rumsfeld recently 

included improving DOD’s financial management as one of his top 10 

priorities, and DOD has already taken a number of actions intended to 

address its serious financial management problems. In addition, as I 

previously mentioned, DOD has a major effort under way to develop a DOD 

enterprise architecture that is intended to prescribe a blueprint for 

operational and technological changes in its financial and related business 

systems operations. While DOD has a long way to go, its efforts over the 

past year represent important progress. The level of top leadership that 

has been brought to bear on this challenge will have to be sustained with a 

goal of achieving lasting improvement that truly transforms DOD’s business 

systems and operations and enables the department to meet the mandate of 
Page 33 GAO-03-572T 

the CFO Act and achieve the President’s Management Agenda’s goal of 

improved financial management performance.

Addressing 

Intragovernmental 

Transactions

OMB and Treasury require CFO Act agencies to reconcile selected 

intragovernmental activity and balances with their “trading partners” and 

to report on the extent and results of intragovernmental activity and 

balances reconciliation efforts. The inspectors general reviewed these 

reports and communicated the results of their reviews to OMB, Treasury, 

and GAO. A substantial number of the CFO Act agencies did not fully 

perform the required reconciliations for fiscal years 2002 and 2001, citing 

reasons such as (1) trading partners not providing needed data, (2) 

limitations and incompatibility of agency and trading partner systems, and 

(3) human resource issues. For both of these years, amounts reported for 

federal agency trading partners for certain intragovernmental accounts 

were significantly out of balance. In addition, significant differences in 

other intragovernmental accounts, primarily related to appropriations, will 

need to be resolved.

As we reported last year, the heart of the intragovernmental transactions 

issue is that the federal government lacked clearly articulated business 

rules for these transactions so that they would be handled consistently by 

agencies. To address certain issues that contributed to the out of balance 

condition for intragovernmental activity and balances, OMB has 

established a set of standard business rules for governmentwide 

transactions among trading partners and is requiring quarterly 

reconciliations of intragovernmental activity and balances beginning in 

fiscal year 2003. For example, in accordance with one of the business 

rules, beginning in fiscal year 2003 for intragovernmental investments with 

Treasury’s Bureau of the Public Debt (BPD), BPD and trading partner 

agencies are required to use the same method for recording amortization 

on market-based notes, bonds, and zero coupon securities. In the past, 

differences in the amortization methods being used have caused out of 

balance conditions for related intragovernmental activity and balances. 

Resolving the intragovernmental transactions problem remains a difficult 

challenge and will require a commitment by the CFO Act agencies and 

continued strong leadership by OMB.

Preparing the Consolidated 

Financial Statements

The federal government did not have adequate systems, controls, and 

procedures to properly prepare its consolidated financial statements, as 

described below. Also, disclosure of certain financial information was not 
Page 34 GAO-03-572T 

presented in the consolidated financial statements in conformity with U.S. 

generally accepted accounting principles.

Consolidated Financial 

Statement Compilation

Due to the current financial statement compilation process, the federal 

government could not adequately ensure that the information for each 

federal agency included in the consolidated financial statements was 

consistent with the underlying agency financial statements. This process 

also requires significant human and financial resources and does not 

adequately leverage the existing work and work products resulting from 

federal agencies’ audited financial statements. The problems are further 

compounded by the need for broad changes in the structure of the 

government’s SGL accounts and the process for maintaining the SGL. 

The net position reported in the consolidated financial statements is 

derived by subtracting liabilities from assets, rather than through balanced 

accounting entries. To make the fiscal years 2002 and 2001 consolidated 

financial statements balance, Treasury recorded a net $17.1 billion and 

$17.3 billion decrease to net operating cost, respectively, on the Statement 

of Operations and Changes in Net Position, which it labeled unreconciled 

transactions. An additional net $12.5 billion and $3.9 billion of 

unreconciled transactions were improperly recorded in net cost for fiscal 

years 2002 and 2001, respectively. Treasury attributes these net 

unreconciled transaction amounts primarily to the federal government’s 

inability to properly identify and eliminate transactions between 

governmental entities, federal agency adjustments that affected net 

position, and other errors. Treasury was unable to adequately identify and 

explain the gross components of such amounts. Unreconciled transactions 

also may exist because the federal government does not have effective 

controls over reconciling net position. 

The federal government did not have an adequate process to reconcile the 

operating results, which for fiscal year 2002 showed a net operating cost of 

$364.9 billion, to the budget results, which for the same period showed a 

unified budget deficit of $157.7 billion.23

23Statement of Federal Financial Accounting Standards No. 24, Selected Standards for the 

Consolidated Financial Report of the United States Government, issued January 2003, 

requires the federal government to provide a financial statement that reconciles net 

operating revenue (or cost) and the annual unified budget surplus (or deficit).
Page 35 GAO-03-572T 

Treasury is currently developing a new system and procedures to prepare 

the consolidated financial statements beginning with fiscal year 2004. 

These actions are intended to, among other things, directly link information 

from federal agencies’ audited financial statements to amounts reported in 

the consolidated financial statements and facilitate the reconciliation of net 

position. Resolving the consolidated financial statement compilation 

process issues will require continued strong leadership by Treasury 

management. 

Elimination of 

Intragovernmental Activity and 

Balances from the Consolidated 

Financial Statements

Consolidated financial statements are intended to present the results of 

operations and financial position of the components that make up a 

reporting entity as if the entity were a single enterprise. When preparing 

the consolidated financial statements, the preparer must eliminate 

intragovernmental activity and balances between the federal agencies. 

Because of federal agencies’ problems in handling their intragovernmental 

transactions, Treasury’s ability to eliminate these transactions is impaired. 

Significant differences reported in intragovernmental accounts, as noted 

above, have been identified. To help federal agencies better perform their 

reconciliations, Treasury recently began providing agencies with detailed 

trading partner information. Intragovernmental activity and balances are 

“dropped” or “offset” in the preparation of the consolidated financial 

statements rather than eliminated through balanced accounting entries. 

This contributes to the federal government’s inability to determine the 

impact of these differences on amounts reported in the consolidated 

financial statements. The continued strong leadership of Treasury will be 

important to resolving the issues surrounding the elimination of 

intragovernmental activity and balances from the consolidated financial 

statements.

Protecting the Public 

Interest 

Two audit matters have come to the fore and are key to protecting the 

public interest. One matter involves auditors’ responsibilities for reporting 

on internal control, and the other concerns auditor independence.
Page 36 GAO-03-572T 

Auditors’ Responsibilities 

for Reporting on Internal 

Control

We have long believed that auditors have an important responsibility to 

provide an opinion on the effectiveness of internal control over financial 

reporting and compliance with laws and regulations. Currently, this is not 

required by American Institute of Certified Public Accountants (AICPA) 

auditing standards or by OMB in its guidance24 to auditors conducting 

federal agency financial statement audits. 

For financial statements audits that we conduct—which include the U.S. 

government’s consolidated financial statements, the financial statements of 

the IRS, the Schedules of Federal Debt managed by the Bureau of the 

Public Debt, and the financial statements of the Federal Deposit Insurance 

Corporation Funds and numerous small entities’ operations and funds—we 

issue a separate opinion on the effectiveness of internal control over 

financial reporting and compliance with laws and regulations.

For years we have provided opinions on internal control effectiveness 

because of the importance of internal control to protecting the public’s 

interest. Our reports have engendered major improvements in internal 

control. As you might expect, as part of the annual audit of our own 

financial statements, we practice what we recommend to others and 

contract with an independent public accounting firm for both an opinion on 

our financial statements and an opinion on the effectiveness of our internal 

control over financial reporting and compliance with laws and regulations.

Although OMB requires testing of these internal controls, auditors are not 

required to provide an opinion on internal control effectiveness. However, 

we found that 3 of the 24 CFO Act agency auditors (those for the General 

Services Administration, SSA, and the Nuclear Regulatory Commission) 

provided an opinion on the effectiveness of internal control as of 

September 30, 2002. Our hope is that all CFO Act agencies and the new 

DHS will follow suit in future years. In this regard, last year, in response to 

major breakdowns in corporate accountability, auditing, and corporate 

governance in the private sector, the Congress passed the Sarbanes-Oxley 

Act of 200225 to, among other things, improve quality and transparency in 

financial reporting and independent audits of publicly traded companies 

(“issuers”). In the area of internal control reporting, issuers are required to 

24Office of Management and Budget, Audit Requirements for Federal Financial 

Statements, Bulletin 01-02 (Washington, D.C.: Oct. 19, 2000).

25Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (July 30, 2002).
Page 37 GAO-03-572T 

establish and maintain adequate internal control structure and procedures 

for financial reporting and include in the annual report a statement of 

management’s responsibility for and management’s assessment of the 

effectiveness of those controls and procedures. In addition, an issuer’s 

auditor is required to attest to, and report on, the assessment made by the 

management of the issuer on the effectiveness of internal control over 

financial reporting. In other words, an issuer’s auditor will provide an 

attestation, or opinion, on management’s assertions about the effectiveness 

of internal controls over financial reporting. 

“Internal controls and procedures for financial reporting” is generally 

defined as controls that pertain to the preparation of external financial 

statements that are fairly presented in conformity with generally accepted 

accounting principles. Specifically, controls over financial reporting 

include the objectives of ensuring that transactions are properly recorded, 

processed, and summarized to permit the preparation of financial 

statements in conformity generally accepted accounting principles.

GAO strongly believes that auditor reporting on internal control is a critical 

component of monitoring the effectiveness of an organization’s internal 

control and accountability. By giving assurance about internal control, 

auditors of federal financial statements can better serve their clients and 

other financial statements users and better protect the public interest by 

having a greater role in providing assurances of the effectiveness of 

internal control in deterring fraudulent financial reporting, protecting 

assets, and providing an early warning of internal control weaknesses.

Auditor Independence and 

Government Auditing 

Standards

The independence of auditors—both in fact and appearance—is critical to 

the credibility of financial reporting. Auditors have the capability of 

performing a range of valuable services for their clients, and providing 

certain nonaudit services can ultimately be beneficial to federal entities. 

However, in some circumstances, it is not appropriate for auditors to 

perform both audit and certain nonaudit services for the same client. In 

these circumstances, the auditor, the client, or both will have to make a 

choice as to which of these services the auditor will provide.
Page 38 GAO-03-572T 

These concepts, which I continue to strongly believe are in the public 

interest, were reflected in the revisions to auditor independence 

requirements for government audits,26 which GAO issued last year as part 

of Government Auditing Standards.27 The standard, among other things, 

strengthens the rules associated with providing nonaudit services and 

includes a principle-based approach to addressing this issue, supplemented 

with certain safeguards. The two overarching principles in the standard for 

nonaudit services are that 

• auditors should not perform management functions or make 

management decisions, and

• auditors should not audit their own work or provide nonaudit services 

in situations where the amounts or services involved are significant or 

material to the subject matter of the audit.

In making judgments on independence under Government Auditing 

Standards and applying the independence standard’s principles and 

safeguards, audit organizations should take a “substance over form” 

approach and consider the nature and significance of the services provided 

to the audited entity—the facts and circumstances. Before an audit 

organization agrees to perform nonaudit services, it should carefully 

consider the need to avoid situations that could lead reasonable third 

parties with knowledge of the facts and circumstances to conclude that the 

auditor is not able to maintain independence in conducting audits. It is 

imperative that auditors always be viewed as independent in fact and 

appearance.

26U.S. General Accounting Office, Government Auditing Standards, Amendment No. 3, 

Independence, GAO-02-388G (Washington, D.C.: January 2002). 

27Government Auditing Standards was first published in 1972 and is commonly referred to 

as the “Yellow Book.” It covers federal entities and organizations that receive federal funds. 

Various laws require compliance with the standards in connection with audits of federal 

entities and funds. Further, many states and local governments and other entities, both 

domestically and internationally, have voluntarily adopted these standards.
Page 39 GAO-03-572T 

Understandably, GAO received many inquiries about the new independence 

standard due to its significant effect on auditors in connection with audits 

of those who are required to use or have adopted the use of Government 

Auditing Standards. Working with the Comptroller General’s Advisory 

Council on Government Auditing Standards28 and other interested parties, 

we issued further guidance in the form of questions and answers related to 

the independence standard’s implementation time frame, underlying 

concepts, and application in specific nonaudit circumstances.29

The independence standard and the recently issued question and answer 

document are the initial steps in GAO’s continuing efforts to enhance 

Government Auditing Standards and educate auditors on revisions to 

these standards and on implementation issues surrounding the 

independence standard. Within the next several months, GAO will issue 

revisions to Government Auditing Standards to help ensure that the 

standards continue to meet the needs of the audit community and the 

public it serves. The revision will expand and change (1) the types of 

audits and services that can be performed under the standards and (2) the 

application of the standards, where relevant, to be consistent with the 

various types of audits. Changes are also being made to enhance the 

understandability of the standards. To educate the audit community about 

the revised standards as well as the independence standard, GAO 

continues to provide many presentations to government auditors and 

private practitioners, in addition to answering hundreds of questions 

regarding implementation issues.

Closing Comments Our report on the U.S. government’s consolidated financial statements for 

fiscal years 2002 and 2001 highlights the need to continue addressing the 

government’s serious financial management weaknesses. Looking beyond 

current progress by federal agencies in attaining unqualified opinions on 

financial statements, it will be essential for the federal government to begin 

moving away from the extraordinary efforts many federal agencies 

continue to use to prepare financial statements and toward giving 

28The Advisory Council includes 21 experts in financial and performance auditing and 

reporting—drawn from all levels of government, academia, private enterprise, and public 

accounting—who advise the Comptroller General on Government Auditing Standards.

29U.S. General Accounting Office, Government Auditing Standards, Answers to 

Independence Standard Questions, GAO-02-870G (Washington, D.C.: July 2002).
Page 40 GAO-03-572T 

prominence to strengthening the government’s financial systems, reporting, 

and controls. This approach becomes even more critical as the federal 

government progresses to an accelerated financial statement reporting 

time frame, and it is the only way the government can meet the end goal of 

making timely, accurate, and useful financial information routinely 

available to the Congress, other policymakers, and the American public. 

The requirement for timely, accurate, and useful financial and performance 

management information is greater than ever, as the Congress and the 

administration prepare to meet tomorrow’s fiscal challenges. This type of 

financial information is central to managing the federal government’s 

operations more efficiently, effectively, and economically and in supporting 

GPRA. Moreover, meaningful financial and performance information can 

form the basis for reconsidering the relevance or “fit” of any federal 

program or activity in today’s world and for the future.

In closing Mr. Chairman, I want to underscore the importance of the 

additional impetus provided by President Bush through his President’s 

Management Agenda and the Executive Branch Management Scorecard for 

coming to grips with federal financial management problems, indeed 

management problems across the board. Regarding DOD in particular, 

Secretary of Defense Rumsfeld’s vision and approach for transforming the 

department’s full range of business processes is serious and encouraging. 

These efforts will be key to fulfilling the President’s Management Agenda 

and addressing the largest obstacle to an opinion on the U.S. government’s 

consolidated financial statements. The cooperative efforts spearheaded by 

the JFMIP Principals have been most encouraging in developing the shortand long-term strategies and plans necessary to address many of the 

problems I have discussed this morning. In addition, GAO has probably 

never had a better working relationship with OMB and cabinet level and 

other key officials on a range of “good government issues” that are of 

critical importance and are inherently non-partisan in nature. While these 

and other factors provide an enhanced likelihood for success, in the end it 

is results that count.

Finally, I want to reiterate the value of sustained congressional interest in 

these issues, as demonstrated by this hearing and those the former 

Subcommittee on Government Efficiency, Financial Management, and 

Intergovernmental Relations held over the past several years to oversee 

financial management reform. It will also be key that the appropriations, 

budget, authorizing, and oversight committees hold agency top leadership 
Page 41 GAO-03-572T 

accountable for resolving these problems and that they support 

improvement efforts.

Contacts For further information regarding this testimony, please contact Jeffrey C. 

Steinhoff, Managing Director, and Gary T. Engel, Director, Financial 

Management and Assurance, at (202) 512-2600.
Page 42 GAO-03-572T 

Appendix I

CFO Act Agencies: Fiscal Year 2002 Audit 

Results, Principal Auditors, and Number of 

Other Audit Contractors ApendxiI

a

Qualified for the Statement of Net Cost; unqualified for all other statements.

b

In addition, GAO audited the Internal Revenue Service’s financial statements and the Schedules of 

Federal Debt Managed by the Bureau of the Public Debt. 

24 CFO Act agencies Audit results Principal auditor

Number of 

other audit 

contractors

Agency for International Development Qualifieda Inspector General 1

Agriculture Unqualified Inspector General 2

Commerce Unqualified KPMG LLP 1

Defense Disclaimer Inspector General 1

Education Unqualified Ernst & Young LLP 0

Energy Unqualified KPMG LLP 4

Environmental Protection Agency Unqualified Inspector General 0

Federal Emergency Management Agency Unqualified KPMG LLP 0

General Services Administration Unqualified PricewaterhouseCoopers LLP 0

Health and Human Services Unqualified Inspector General 4

Housing and Urban Development Unqualified Inspector General 1

Interior Unqualified KPMG LLP 0

Justice Unqualified PricewaterhouseCoopers LLP 2

Labor Unqualified Inspector General 5

National Aeronautics and Space 

Administration

Unqualified PricewaterhouseCoopers LLP 1

National Science Foundation Unqualified KPMG LLP 0

Nuclear Regulatory Commission Unqualified R. Navarro & Associates, Inc. 0

Office of Personnel Management Unqualified KPMG LLP 0

Small Business Administration Disclaimer Cotton & Company LLP 0

Social Security Administration Unqualified PricewaterhouseCoopers LLP 0

State Unqualified Leonard G. Birnbaum and Company, LLP 0

Transportation Unqualified Inspector General 2

Treasury Unqualified Inspector General 6b

Veterans Affairs Unqualified Deloitte & Touche LLP 0

(198183)
United States

General Accounting Office

Washington, D.C. 20548-0001

Official Business

Penalty for Private Use $300

Address Service Requested

Presorted Standard

Postage & Fees Paid

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