For Release on Delivery

Expected at

9:30 a.m.

Tuesday,

September 19, 2000

GAO/T-AIMD-00-323

FINANCIAL

MANAGEMENT

Financial Management

Challenges Remain at the

Department of Education

Statement of Gloria L. Jarmon

Director, Health, Education, and Human Services

Accounting and Financial Management Issues

Accounting and Information Management Division

Testimony

Before the Subcommittee on Oversight and Investigations,

Committee on Education and the Workforce, House of

Representatives

United States General Accounting Office

GAO
Page 1 GAO/T-AIMD-00-323

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss (1) the Department of Education’s

current financial management status as evidenced by its fiscal year 1999

financial audit results1 and the corrective actions it has taken to resolve

weaknesses identified in that audit and (2) the relationship between the

audit findings and the potential for waste, fraud, and abuse. Much of the

testimony today reflects my May 24, 2000, testimony on these issues.2

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

because Education is the primary agency responsible for overseeing the

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

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

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

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

federal student financial aid through programs administered by Education.

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

as the agency has experienced persistent financial management

weaknesses. Beginning with its first agencywide financial audit effort in

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

same serious internal control weaknesses, which have affected the

Department’s ability to provide reliable financial information to

decisionmakers both inside and outside the agency.

Federal decisionmakers need reliable and timely financial management

information to ensure adequate accountability, manage for results, and

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

financial management information has not been available across the

government. Agency Inspector General (IG) reports, independent public

accountants’ reports, and our own work have identified persistent

limitations in the availability of quality financial data for decision-making.

Audits have shown that federal financial management is in serious

disrepair, which results in incorrect financial information being provided

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

February 2000.

2Financial Management: Education’s Financial Management Problems Persist (GAO/T-AIMD-00-180,

May 24, 2000).

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

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

agencywide financial audit.

Background
Error! No text of specified style in document.

Page 2 GAO/T-AIMD-00-323

to the Congress and the administration. Without reliable financial

information, government leaders do not have the full facts necessary to

make investments of scarce resources or direct programs. Creating a

government that runs more efficiently and effectively has been a public

concern for decades.

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

financial management in response to the most comprehensive

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

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

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

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

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

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

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

Efforts to continue to build the foundation for generating accurate

financial information through lasting financial management reform are

essential. Only by generating reliable and useful information can the

government ensure adequate accountability to taxpayers, manage for

results, and help decisionmakers make timely, well-informed judgments.

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

independent auditors contracted for by the Education Inspector General.

We reviewed the independent auditors’ reports and workpapers. We also

interviewed Education officials to obtain the status of corrective actions

and reviewed available corrective action plans. We shared a draft of this

statement with Education officials, who provided technical comments. We

have incorporated their comments where appropriate. Our work was

conducted in accordance with generally accepted government auditing

standards.

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

for audited financial statements requires the 24 CFO Act agencies to

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

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

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

regulations. As of August 2000, 15 of the 24 CFO Act agencies had received

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

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

because of its financial management weaknesses.

Fiscal Year 1999 Audit

Results
Error! No text of specified style in document.

Page 3 GAO/T-AIMD-00-323

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

prepare Education’s fiscal year 1999 financial statements before the

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

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

and financial management systems weaknesses continued to plague the

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

around these weaknesses and produce financial statements. These efforts

enabled its auditors to issue qualified opinions4 on four of its five required

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

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

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

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

budgetary resources in conformity with generally accepted accounting

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

qualification:

• The Department had significant systems weaknesses during fiscal year

1999 affecting its financial management systems. The new accounting

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

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

consolidated financial statements. Through its efforts and those of its

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

correct, certain aspects of the material weaknesses in its financial

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

experienced significant turnover of financial management staff, which also

contributed to the overall weakness in financial reporting.

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

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

statements, and the auditors were unable to perform other audit

procedures to satisfy themselves that this amount was correct.

• Education processed many transactions from prior fiscal years as fiscal

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

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

not determine if these adjustments for certain costs and obligations were

correct.

4Such an opinion is expressed when (1) there is a lack of sufficient competent evidential matter or

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

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

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

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

has concluded not to express an adverse opinion.

Report on the Financial

Statements
Error! No text of specified style in document.

Page 4 GAO/T-AIMD-00-323

• The auditors were unable to determine whether beginning balances for

accounts payable and related accruals were accurate.

In addition, the auditors did not issue an opinion (referred to as a

disclaimer of an opinion) on the Department’s Statement of Financing. The

Statement of Financing provides a reconciliation or “translation” from the

budget to the financial statements. The statement is intended to help those

who work with the budget to understand the financial statements and the

cost information they provide. The auditors stated that the reason for this

disclaimer was that the Department did not perform adequate

reconciliations and present support for amounts on the Statement of

Financing in a timely manner.

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

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

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

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

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

the preparation of additional reconciliations and the financial statements.

This approach does not produce the timely and reliable financial and

performance information Education needs for decision-making on an

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

The Department also receives annually from its auditors a report on

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

internal control weaknesses that increase its risk of mismanagement that

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

year 1999, the Department’s auditors reported four material5 internal

control weaknesses—three continuing from fiscal year 1998 and one

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

weaknesses persist.

The specific material internal control weaknesses cited by the

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

5A material internal control weakness is a reportable condition that precludes the entity’s internal

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

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

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

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

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

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

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

applicable laws and regulations.

Report on Internal

Controls
Error! No text of specified style in document.

Page 5 GAO/T-AIMD-00-323

financial reporting process, (2) inadequate reconciliations of financial

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

The independent auditors also identified a new material internal control

weakness related to accounting for certain loan transactions. Summaries

of the material internal control weaknesses follow:

• Education did not have adequate internal controls over its financial

reporting process. Its general ledger system was not able to perform an

automated year-end closing process and directly produce consolidated

financial statements as would normally be expected from such systems.

Because of these weaknesses, Education had to resort to a costly, laborintensive, and time-consuming process involving manual and automated

procedures to prepare financial statements for fiscal year 1999. In

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

perform reconciliations among the various data sources used. In one

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

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

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

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

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

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

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

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

could retain funds inappropriately that should be returned to Treasury.

In response to the auditors’ findings, Education officials told us that they

have developed an implementation plan for the replacement of the general

ledger system. The officials further stated that Education had purchased a

new general ledger system and completed all the planned corrective

actions in response to the auditors’ recommendations related to financial

reporting weaknesses. However, this new general ledger system will not

be fully implemented for fiscal year 2000, and Education will continue to

work around the system to produce consolidated financial statements.

Education officials said that the Department plans to fully implement the

new general ledger system by August 2001 and to eliminate the current

general ledger system by January 2002. To facilitate the fiscal year 2000

consolidated audit, Education officials told us they prepared and analyzed

interim financial statements as of March 31, 2000, and June 30, 2000.

• Education again did not properly or promptly reconcile its financial

accounting records during fiscal year 1999 and could not provide sufficient

documentation to support some of its financial transactions. Weaknesses

in the Department’s internal controls over the reconciliation process

prevented timely detection and correction of errors in its underlying
Error! No text of specified style in document.

Page 6 GAO/T-AIMD-00-323

accounting records. In some instances, Education adjusted its general

ledger to reflect the balance per the subsidiary records, without

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

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

differences between its accounting records and cash transactions reported

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

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

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

Reconciling agencies’ accounting records with relevant Treasury records

is required by Treasury policy and is analogous to individuals reconciling

their checkbooks to monthly bank statements. In another instance, as we

recently reported,6 Education used its grantback account as a suspense

account beginning in 1993 for hundreds of millions of dollars of activity

related to grant reconciliation efforts. We also reported that Education did

not maintain adequate detailed records for certain grantback account

activity by the applicable fiscal year and appropriation. In addition,

Education used the grantback account to clear unreconciled differences in

various grant appropriation fund balance accounts and adjust certain

appropriation fund balances to ensure that they did not become negative.

In response to the auditors’ findings, Education has purchased a software

tool to help enhance its ability to reconcile its account balances with the

corresponding Treasury account balances on a monthly basis. Education

has also developed web-based policies and procedures for reconciling the

Department’s material accounts and programs.

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

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

net collections specific to its liquidating account to Treasury as required

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

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

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

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

Further, Education did not sufficiently analyze the balances reflected on

the financial statements to ensure that the FFELP balances agreed with

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

stated that this situation resulted in an unexplained difference of about

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

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

accounting for and analyzing its FFELP transactions as required by the

6Financial Management: Review of Education’s Grantback Account (GAO/AIMD-00-228 August 18,

2000).
Error! No text of specified style in document.

Page 7 GAO/T-AIMD-00-323

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

financial or budgetary reports were accurate.

Education returned the $2.7 billion to the Treasury in February 2000. The

Department also established policies and procedures to ensure

compliance with the Credit Reform Act.

• Education had information systems control deficiencies in

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

requesting, authorizing, and revalidating access to computing resources,

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

(3) documenting the approach and methodology for the design and

maintenance of its information technology architecture, and

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

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

The Department places significant reliance on its financial management

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

and maintaining budget controls. Consequently, continued weaknesses in

information systems controls increase the risk of unauthorized access or

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

vulnerable to inadvertent or deliberate misuse, fraudulent use, improper

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

According to Education officials, the Department has developed and

implemented a formal approach and methodology for designing and

maintaining an entity-wide security program technology architecture and

has updated its security policies and procedures for its financial

management system to ensure that changing system security needs are

reflected, access authorizations are documented, and access rights are

revalidated periodically. The Department has developed a disaster

recovery plan for Education’s Central Automated Processing System

(EDCAPS), the accounting system implemented by the Department in

fiscal year 1998.

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

financial audit report results but are also facing material internal control

weaknesses. A number of other agencies have focused their efforts

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

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

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

these agencies continue to experience pervasive material weaknesses in

the design and operation of their financial management and related

operational systems, accounting procedures, documentation,

recordkeeping, and internal controls, including computer security
Error! No text of specified style in document.

Page 8 GAO/T-AIMD-00-323

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

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

produce the timely and reliable financial and performance information

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

inherently incapable of addressing the underlying financial management

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

their missions.

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

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

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

noted below.

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

not in compliance with FFMIA because it lacked adequate, integrated

financial management systems, reports, and oversight to prepare timely

and accurate financial statements. Many agencies have significant

financial management systems weaknesses, and, in fiscal year 1999, 21 of

24 agencies’ systems did not comply with FFMIA. However, it is

imperative that these problems be resolved so that agencies can produce

needed financial information on a day-to-day basis in a timely and accurate

manner. FFMIA requires that agency financial management systems

substantially comply with (1) federal financial management systems

requirements,7 (2) federal accounting standards, and (3) the U.S.

Government Standard General Ledger8 at the transaction level.

• The Department had neither fully implemented a capital planning and

investment process nor performed an assessment of the information

resource management knowledge and skills of agency personnel, including

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

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

have processes and information in place to help ensure that information

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

within reasonable and expected time frames and that they are contributing

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

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

7The financial management systems requirements have been developed by the Joint Financial

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

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

8The Standard General Ledger provides a standard chart of accounts and standardized transactions

that agencies are to use in all their financial systems.

Report on Compliance

With Laws and Regulations
Error! No text of specified style in document.

Page 9 GAO/T-AIMD-00-323

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

investments.

Education officials told us that the Department has since established an

Investment Review Board that assesses information technology

investments.

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

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

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

Education officials stated that they believe the noncompliance with the

Credit Reform Act issue will be resolved for the fiscal year 2000 audit

because they have developed and implemented policies and procedures to

respond to this issue.

Education continues to have serious internal control and system

deficiencies that hinder its ability to achieve lasting financial management

improvements. The internal control weaknesses discussed above and in

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

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

vulnerabilities identified in the audit report include weaknesses in the

financial reporting process, inadequate reconciliations of financial

accounting records, information systems weaknesses, and property

management weaknesses. Specific examples of vulnerabilities related to

these weaknesses follow:

• The material internal control weakness related to financial reporting

highlights the fact that managers do not receive accurate and timely

financial information, such as information on disbursements made and

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

other anomalies.

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

report on internal controls could have been identified earlier if proper

reconciliations had been performed. The auditors stated that the

Department has procedures in place that should detect duplicate

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

reviewed these procedures.

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

policies and procedures to reconcile grant expenditures between its

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

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

Potential for Fraud,

Waste, and Abuse
Error! No text of specified style in document.

Page 10 GAO/T-AIMD-00-323

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

over $30 billion per year.

In response to this issue, Education has developed policies and

procedures to reconcile grant expenditures to the general ledger.

• The information systems weaknesses highlight some of the computer

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

security violations on all critical systems of the Department. Information

systems control weaknesses increase the risk of unauthorized access or

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

vulnerable to inadvertent or deliberate misuse, fraudulent use, improper

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

report issued by the Department’s Inspector General in February9

emphasizes the need for the Department to focus on addressing its

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

House recognized the importance of strengthening the nation’s defenses

against threats to public and private sector information systems that are

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

National Plan for Information Systems Protection.

10 In the aftermath of the

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

large corporations, governments, and media organizations worldwide, we

recently testified11 about the need for federal agencies to promptly

implement a comprehensive set of security controls. We also recently

reported12on the results of information security audits at federal agencies

that show that federal computer systems are riddled with weaknesses that

continue to put critical operations and assets at risk. These types of

concerns led us, in 1997 and 1999 reports to the Congress, to identify

information security as a high-risk issue.13

9Review of Security Posture, Policies and Plans (ED-OIG/A11-90013) February 2000.

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

Invitation to a Dialogue, released January 7, 2000, the White House.

11Critical Infrastructure Protection: “ILOVEYOU” Computer Virus Highlights Need for Improved Alert

and Coordination Capabilities (GAO/T-AIMD-00-181, May 18, 2000) and Information Security:

“ILOVEYOU” Computer Virus Emphasizes Critical Need for Agency and Governmentwide

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

12Computer Security: Critical Federal Operations and Assets Remain at Risk (GAO/T-AIMD-00-314,

September 11, 2000) and Information Security: Serious and Widespread Weaknesses Persist at Federal

Agencies (GAO/AIMD-00-295, September 6, 2000).

13High- Risk Series: Information Management and Technology (GAO/HR-97-9, February 1, 1997) and

High-Risk Series: An Update (GAO/HR-99-1, January 1999).
Error! No text of specified style in document.

Page 11 GAO/T-AIMD-00-323

In response to the IG’s February report, Education’s Chief Information

Officer has developed a corrective action plan to address these

weaknesses. This plan proposes developing security plans for the 6

mission-critical systems that did not have them. Education envisions that

the plans will meet the requirements of OMB Circular A-130 and the

Computer Security Act of 1987. The plan also calls for establishing

requirements for security training and a monitoring process to ensure that

security personnel receive adequate training. We did not evaluate the

effectiveness of these corrective actions.

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

comprehensive physical inventory of property and equipment for at least

the past 2 years. Comprehensive inventories improve accountability for

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

hardware, and establish accurate property records. Without such an

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

or resources could be wasted by purchasing duplicate equipment already

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

OIG and the Department of Justice.

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

programs have led us since 1990 to designate this a high-risk area14 for

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

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

Department’s IG have found instances in which students fraudulently

obtained grants and loans.

In response to your request, we are auditing selected Education accounts

that are deemed particularly susceptible to improper payments based on a

risk assessment that takes into account previous findings by GAO, the IG,

and Education’s independent public accountants. This work is in the initial

planning phase and is expected to focus primarily on the Department’s

disbursement processes and EDP controls. We plan on using various

electronic auditing techniques to determine whether the Department has

inappropriately disbursed funds. We also plan to evaluate the vulnerability

of the Department’s EDP systems to fraud, misuse, and disruption.

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

timely information on an ongoing basis to ensure adequate accountability

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

14High-Risk Series: An Update (GAO/HR-99-1, January 1999).
Error! No text of specified style in document.

Page 12 GAO/T-AIMD-00-323

well-informed judgments. While Education has planned and begun

implementing many actions to resolve its financial management problems,

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

Education rise to the challenges posed by its financial management

weaknesses because its success in achieving all aspects of its strategic

objectives depends in part upon reliable financial management

information and effective internal controls. It is also important to

recognize that several of the financial management issues that have been

raised in reports emanating from reviews of Education’s financial

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

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

Mr. Chairman, this concludes my statement. I would be happy to answer

any questions you or other Members of the Subcommittee may have.

For information about this statement, please contact Gloria Jarmon at

(202) 512-4476 or at jarmong.aimd@gao.gov. Individuals making key

contributions to this statement included Dan Blair, Anh Dang, Cheryl

Driscoll, and Meg Mills.

(916379)

Contact and

Acknowledgments
Orders by Internet

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

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

Info@www.gao.gov

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

http://www.gao.gov

Contact one:

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

E-mail: fraudnet@gao.gov

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

Ordering Information

To Report Fraud,

Waste, and Abuse in

Federal Programs