United States Government Accountability Office

GAO Testimony 

Before the Subcommittee on Government 

Management, Finance, and Accountability, 

Committee on Government Reform, 

House of Representatives 

FISCAL YEAR 2005 

U.S. GOVERNMENT 

FINANCIAL STATEMENTS 

Sustained Improvement in 

Federal Financial 

Management Is Crucial to 

Addressing Our Nation’s 

Financial Condition and 

Long-term Fiscal Imbalance

Statement of David M. Walker 

Comptroller General of the United States 

For Release on Delivery

Expected at 2:00 p.m. EST 

Wednesday, March 1, 2006 

 

GAO-06-406T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

March 1, 2006

FISCAL YEAR 2005 U.S. GOVERNMENT 

FINANCIAL STATEMENTS 

Sustained Improvement in Federal 

Financial Management Is Crucial to 

Addressing Our Nation’s Financial 

Condition and Long-term Fiscal Imbalance 

Highlights of GAO-06-406T, testimony 

before the Subcommittee on Government 

Management, Finance, and Accountability,

Committee on Government Reform, 

House of Representatives

GAO is required by law to annually

audit the consolidated financial 

statements of the U.S. government. 

The Congress and the President 

need to have timely, reliable, and 

useful financial and performance 

information. Sound decisions on

the current results and future 

direction of vital federal 

government programs and policies 

are made more difficult without 

such information. 

Until the problems discussed in 

GAO’s audit report on the U.S.

government’s consolidated

financial statements are adequately

addressed, they will continue to 

(1) hamper the federal 

government’s ability to reliably

report a significant portion of its

assets, liabilities, costs, and other 

information; (2) affect the federal 

government’s ability to reliably

measure the full cost as well as the

financial and nonfinancial 

performance of certain programs 

and activities; (3) impair the federal

government’s ability to adequately 

safeguard significant assets and 

properly record various 

transactions; and (4) hinder the

federal government from having

reliable financial information to 

operate in an economical, efficient, 

and effective manner. 

For the ninth consecutive year, certain material weaknesses in internal 

control and in selected accounting and financial reporting practices resulted 

in conditions that continued to prevent GAO from being able to provide the 

Congress and American people an opinion as to whether the consolidated 

financial statements of the U.S. government are fairly stated in conformity 

with U.S. generally accepted accounting principles. Three major 

impediments to an opinion on the consolidated financial statements 

continued to be (1) serious financial management problems at the 

Department of Defense, (2) the federal government’s inability to adequately 

account for and reconcile intragovernmental activity and balances between 

federal agencies, and (3) the federal government’s ineffective process for 

preparing the consolidated financial statements. Further, in our opinion, as 

of September 30, 2005, the federal government did not maintain effective 

internal control over financial reporting and compliance with significant 

laws and regulations due to numerous material weaknesses. 

More troubling still is the federal government’s overall financial condition 

and long-term fiscal imbalance. While the fiscal year 2005 budget deficit was 

lower than 2004, it was still very high, especially given the impending 

retirement of the “baby boom” generation and rising health care costs. 

Importantly, as reported in the fiscal year 2005 Financial Report of the 

United States Government, the federal government’s accrual-based net 

operating cost—the cost to operate the federal government—increased to 

$760 billion in fiscal year 2005 from $616 billion in fiscal year 2004. This 

represents an increase of about $144 billion or 23 percent. The federal 

government’s gross debt was about $8 trillion as of September 30, 2005. This 

number excludes such items as the gap between the present value of future 

promised and funded Social Security and Medicare benefits, veterans’ health 

care, and a range of other liabilities, commitments, and contingencies that 

the federal government has pledged to support. Including these items, the 

federal government’s fiscal exposures now total more than $46 trillion, 

representing close to four times gross domestic product (GDP) in fiscal year 

2005 and up from about $20 trillion or two times GDP in 2000. Given these 

and other factors, a fundamental reexamination of major spending programs, 

tax policies, and government priorities will be important and necessary to 

put us on a prudent and sustainable fiscal path. This will likely require a

national discussion about what Americans want from their government and 

how much they are willing to pay for those things. 

We continue to have concerns about the identification of misstatements in 

federal agencies’ prior year financial statements. Frequent restatements to 

correct errors can undermine public trust and confidence in both the entity 

and all responsible parties. The material internal control weaknesses

discussed in this testimony serve to increase the risk that additional errors 

may occur and not be identified on a timely basis by agency management or 

their auditors, resulting in further restatements. 

www.gao.gov/cgi-bin/getrpt?GAO-06-406T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Jeffrey C. 

Steinhoff or Gary T. Engel at (202) 512-2600. 
Mr. Chairman and Members of the Subcommittee: 

I am most pleased to be here today and commend your subcommittee’s 

tradition of oversight hearings on this and other financial management 

issues throughout the year. Such hearings continue to play a vital role in 

ensuring that the federal government is held accountable to the American 

people. Today I will discuss our report on the U.S. government’s 

consolidated financial statements for fiscal years 2005 and 2004. Our work 

was conducted in accordance with U.S. generally accepted government 

auditing standards. 

Both the consolidated financial statements and our report on them are 

included in the fiscal year 2005 Financial Report of the United States 

Government. This most recent report was issued by the Department of the 

Treasury (Treasury) on December 15, 2005, and is available through GAO’s 

Internet site, at www.gao.gov/financial/fy2005financialreport.html, and 

Treasury’s Internet site, at www.fms.treas.gov/fr/index.html. I also would 

like to highlight a guide we issued in September 2005 titled Understanding

the Primary Components of the Annual Financial Report of the United 

States Government,

1

 which was prepared to help those who seek to obtain 

a better understanding of the Financial Report. This guide can also be 

found on GAO’s Internet site at 

www.gao.gov/financial/fy2005/guidetofrofusg.pdf. 

For the ninth consecutive year, certain material weaknesses2

 in internal 

control and in selected accounting and financial reporting practices 

resulted in conditions that continued to prevent us from being able to 

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

consolidated financial statements of the U.S. government were fairly 

stated in conformity with U.S. generally accepted accounting principles 

(GAAP). Further, we also reported that the federal government did not 

maintain effective internal control over financial reporting (including 

safeguarding assets) and compliance with significant laws and regulations 

as of September 30, 2005. Until the problems that I will discuss today and 

 1

GAO, Understanding the Primary Components of the Annual Financial Report of the 

United States Government, GAO-05-958SP (Washington, D.C.: September 2005). 

2

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 1 GAO-06-406T 
that are discussed in our audit report are adequately addressed, they will 

continue to have adverse implications for the federal government and the 

taxpayers. 

More troubling still is the federal government’s overall financial condition 

and long-term fiscal imbalance. While the fiscal year 2005 budget deficit 

was lower than 2004, it was still very high, especially given the impending 

retirement of the “baby boom” generation and rising health care costs. 

Importantly, as reported in the fiscal year 2005 Financial Report of the 

United States Government, the federal government’s accrual-based net 

operating cost—that is, the cost to operate the federal government—

increased to $760 billion in fiscal year 2005 from $616 billion in fiscal year 

2004. This represents an increase of about $144 billion or 23 percent. To 

make matters worse, the federal government’s liabilities and unfunded 

commitments, which include military and civilian retirement benefits and 

promised Social Security and Medicare payments, are growing rapidly. 

Simply put, our nation’s financial condition and long-term fiscal imbalance 

is on an imprudent and unsustainable course. 

In this testimony, I will discuss (1) the federal government’s long-term 

fiscal imbalance, (2) our continued concerns about the identification of 

misstatements in federal agencies’ prior year financial statements, and (3) 

the major issues relating to the consolidated financial statements for fiscal 

years 2005 and 2004. I will also discuss systems problems that continue to 

hinder federal agency accountability, and describe progress that has been 

made toward addressing major impediments to an opinion on the 

consolidated financial statements. 

The Financial Report of the United States Government provides useful 

information on the government’s financial position at the end of the fiscal 

year and changes that have occurred over the course of the year. However, 

in evaluating the nation’s fiscal condition, it is critical to look beyond the 

short-term results and consider the overall long-term financial condition 

and long-term fiscal imbalance of the government—that is, the 

sustainability of the federal government’s programs, commitments, and 

responsibilities in relation to the resources expected to be available. More 

important than the large increase in the government’s net operating cost in

fiscal year 2005 and persistent short-term budget deficits, fiscal 

simulations by GAO and others show that over the long term, we face large

and growing structural deficits due primarily to known demographic 

trends, rising health care costs, and lower federal revenues relative to the 

economy. 

The Nation’s Fiscal 

Imbalance 

Page 2 GAO-06-406T 
As I have testified before, the current financial reporting model does not 

clearly, comprehensively, and transparently show the wide range of 

responsibilities, programs, and activities that may either obligate the 

federal government to future spending or create an expectation for such 

spending. Thus, it provides a potentially unrealistic and misleading picture 

of the federal government’s overall performance, financial condition, and 

future fiscal outlook. The federal government’s gross debt3

 in the U.S. 

government’s consolidated financial statements was about $8 trillion as of 

September 30, 2005.4

 This number excludes such items as the current gap 

between the present value of future promised and funded Social Security 

and Medicare benefits, veterans’ health care, and a range of other 

liabilities (e.g., federal employee and veteran benefits payable), 

commitments, and contingencies that the federal government has pledged

to support.5

 Including these items, the federal government’s fiscal 

exposures now total more than $46 trillion, representing close to four 

times gross domestic product (GDP) in fiscal year 2005 and up from about 

$20 trillion or two times GDP in 2000. About one third of the 

approximately $26 trillion increase resulted from enactment of the 

Medicare prescription drug benefit in fiscal year 2004. (See table 1.) The

federal government’s current fiscal exposures translate into a burden of 

about $156,000 per American or approximately $375,000 per full-time 

worker, up from $72,000 and $165,000 respectively, in 2000. Furthermore, 

these amounts do not include future costs resulting from Hurricane 

Katrina or the conflicts in Iraq and Afghanistan. 

 3

The federal government’s gross debt consists of debt held by the public and 

intragovernmental debt holdings. 

4

On December 29, 2005, the Secretary of the Treasury (Secretary) notified the Congress 

that the statutory debt limit will be reached in mid-February 2006. On February 16, 2006, to 

avoid exceeding the debt limit, the Secretary began suspending investments in the

Government Securities Investment Fund of the Federal Employees’ Retirement System (GFund) and also suspended the sales of State and Local Government Series securities 

(SLGS). 

5

A broader discussion of fiscal exposures can be found in GAO, Fiscal Exposures:

Improving the Budgetary Focus on Long-Term Costs and Uncertainties, GAO-03-213 

(Washington, D.C.: Jan. 24, 2003). 

Page 3 GAO-06-406T 
Table 1: Estimated Fiscal Exposures 

Dollars in trillions 

2000 2005

Explicit liabilities $6.9 $9.9

• Publicly held debt 

• Military & civilian pensions & retiree health 

• Other 

Commitments & contingencies 0.5 0.9

• E.g., Pension Benefit Guarantee Corporation, undelivered 

orders 

Implicit exposures 13.0 35.6

• Future Social Security benefits 3.8 5.7

• Future Medicare Part A benefits 2.7 8.8

• Future Medicare Part B benefits 6.5 12.4

• Future Medicare Part D benefits -- 8.7

Total $20.4 $46.4

Source: U.S. government’s consolidated financial statements (CFS).

Note: Estimates for Social Security and Medicare are at present value as of January 1 of each year

as reported in the CFS and all other data are as of September 30. 

In addition to the approximately $46 trillion of estimated fiscal exposures 

discussed above, there are exposures that are not included in those figures 

because the amounts of the exposures are not currently estimable. For 

example, the Department of Energy, in the footnotes to its fiscal year 2005

financial statements, disclosed that its environmental liability estimates do 

not include cleanup costs at sites for which there is no current feasible 

remediation approach, such as the nuclear explosion test area at the 

Nevada Test Site. It is important to understand the nature and extent of 

these types of additional exposures in the long-term fiscal planning for the 

federal government.6

 6

For information on how agencies could better recognize, in the budget, the full costs of

environmental cleanup and disposal associated with asset acquisitions, see GAO, LongTerm Commitments: Improving the Budgetary Focus on Environmental Liabilities, 

GAO-03-219 (Washington, D.C.: Jan. 24, 2003). Also, at the request of this subcommittee and 

the House Subcommittee on Energy and Resources, Committee on Government Reform, 

GAO has ongoing work assessing the adequacy of agency processes and controls for 

estimating environmental liabilities and the nature and type of uncertainties that could 

impact the ultimate cost of cleanup. Our report on this study is expected to be issued by

the end of this month. 

Page 4 GAO-06-406T 
Additionally, tax expenditure amounts are not required to be disclosed, 

nor are they disclosed, in agency or the U.S. government’s consolidated 

financial statements. Tax expenditures are reductions in tax revenues that 

result from preferential provisions, such as tax exclusions, credits, and 

deductions. These revenue losses reduce the resources available to fund 

other programs or they require higher tax rates to raise a given amount of 

revenue. As we reported in September 2005, the number of tax 

expenditures more than doubled since 1974, and the sum of tax 

expenditure revenue loss estimates tripled in real terms to nearly $730 

billion in 2004.7

 Under the most recent estimates, this has risen to more 

than $775 billion in 2005. Enhanced reporting on tax expenditures would 

ensure greater transparency and accountability for revenue forgone by the 

federal government and provide a more comprehensive picture of the 

federal government’s policies and fiscal position.

Further, additional changes are needed to communicate important 

information to users about current operating results and the long-term 

financial condition of the U.S. government and annual changes therein. In

particular, the government’s financial statements should clearly 

communicate to the user: 

• the on-budget or operating results versus unified budget results for the 

year; 

• the long-term sustainability of federal government programs—areas to 

consider include 

• the relationship of the federal government’s existing 

commitments/responsibilities, including social insurance, to 

appropriate measures, such as GDP and per capita amounts, 

• the government's long-term fiscal imbalance in relation to appropriate 

measures, such as GDP, and 

• the magnitude of the potential alternatives for resolving the long term 

deficits, such as the rate of tax increases or spending reductions 

necessary to balance the government's long-term finances; 

 7

The sum of individual tax expenditure estimates is useful for gauging the general 

magnitude of the revenue involved, but does not take into account possible interactions

between individual provisions. For additional information, see GAO, Government 

Performance and Accountability: Tax Expenditures Represent a Substantial Federal 

Commitment and Need to Be Reexamined, GAO-05-690 (Washington, D.C.: September

2005). 

Page 5 GAO-06-406T 
• inter-generational equity issues, e.g., assessing the extent to which 

different age groups may be required to assume financial burdens for 

commitments already made; and 

• a liability at the governmentwide level for funds held by Social Insurance 

trust funds. 

Another tool that would serve to more effectively communicate the federal

government’s finances to the public would be a Summary Annual Report. 

Such a report would summarize, in a clear, concise, and transparent 

manner, key financial and performance information included in the 

Financial Report of the United States Government. 

The federal government’s financial condition and long-term fiscal 

imbalance present enormous challenges to the nation’s ability to respond 

to emerging forces reshaping American society, the United States’ place in

the world, and the future role of the federal government. GAO’s long-term 

simulations illustrate the magnitude of the fiscal challenges associated 

with an aging society and the significance of the related challenges the 

government will be called upon to address. Figures 1 and 2 present these 

simulations under two different sets of assumptions. In figure 1, we start 

with the Congressional Budget Office’s (CBO) 10-year baseline—

constructed according to the statutory requirements for that baseline.8

Consistent with these requirements, discretionary spending is assumed to 

grow with inflation for the first 10 years and all tax cuts currently 

scheduled to expire are assumed to expire. After 2016, discretionary 

spending is assumed to grow at the same rate as the economy, and 

revenue is held constant as a share of GDP at the 2016 level. In figure 2,

two assumptions are changed: (1) discretionary spending is assumed to 

grow at the same rate as the economy after 2006 rather than merely with 

inflation, and (2) all expiring tax provisions are extended. For both 

simulations, Social Security and Medicare spending is based on the 2005 

Trustees’ intermediate cost projections, and we assume that benefits 

continue to be paid in full after the trust funds are exhausted. Medicaid 

spending is based on CBO’s December 2005 long-term projections under 

midrange assumptions. 

 8

The Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2007 

to 2016 (Washington, D.C.: January 2006). 

Page 6 GAO-06-406T 
Figure 1: Composition of Spending as a Share of GDP under Baseline Extended 

Note: In addition to the expiration of tax cuts, revenue as a share of GDP increases through 2016 due

to (1) real bracket creep, (2) more taxpayers becoming subject to the alternative minimum tax (AMT), 

and (3) increased revenue from tax-deferred retirement accounts. After 2016, revenue as a share of 

GDP is held constant. 

Percent of GDP

Fiscal year

All other spending Medicare & Medicaid Social Security Net interest

Source: GAO’s January 2006 analysis.

0

10

20

30

40

50

2005 2015 2040 2030

Revenue

Page 7 GAO-06-406T 
Figure 2: Composition of Spending as a Share of GDP Assuming Discretionary 

Spending Grows with GDP after 2006 and All Expiring Tax Provisions Are Extended

Note: This includes certain tax provisions that expired at the end of 2005, such as the increased AMT

exemption amount. 

As these simulations illustrate, absent policy changes on the spending or 

revenue side of the budget, the growth in spending on federal retirement 

and health entitlements will encumber an escalating share of the 

government’s resources. Indeed, when we assume that all the temporary 

tax reductions are made permanent and discretionary spending keeps 

pace with the economy, our long-term simulations suggest that by 2040 

federal revenues would be adequate to pay only some Social Security 

benefits and interest on the federal debt. Neither slowing the growth in 

discretionary spending nor allowing the tax provisions to expire—nor both 

together—would eliminate the imbalance. 

Although revenues will be part of the debate about our fiscal future, 

assuming no changes to Social Security, Medicare, Medicaid, and other 

drivers of the long-term fiscal gap would require at least a doubling of 

taxes—and that seems to be highly implausible. Accordingly, substantive 

reform of Social Security and our major health programs is critical to 

recapturing our future fiscal flexibility. Ultimately, the nation will have to 

decide what level of federal benefits and spending it wants and how it will 

pay for these benefits. Our current path also will increasingly constrain 

Percent of GDP

Fiscal year

All other spending Medicare & Medicaid Social Security Net interest

Source: GAO’s January 2006 analysis.

0

10

20

30

40

50

2005 2015 2040 2030

Revenue

● ● ● ●

Page 8 GAO-06-406T 
our ability to address emerging and unexpected budgetary needs and 

increase the burdens that will be faced by future generations. Continuing 

on this fiscal path will mean escalating and ultimately unsustainable 

federal deficits and debt that will serve to threaten the standard of living 

for the American people and ultimately our national security. 

As these simulations illustrate, regardless of the assumptions used, the 

problem is too big to be solved by economic growth alone or by making 

modest changes to existing spending and tax policies. Rather, a 

fundamental reexamination, reprioritization, and reengineering of major 

spending programs, tax policies, and government priorities will be 

important to recapture our fiscal flexibility and update our programs and 

priorities to respond to emerging social, economic, and security changes. 

Ultimately, this will likely require a national discussion about what 

Americans want from their government and how much they are willing to 

pay for those things. 

According to Statement of Federal Financial Accounting Standards 

(SFFAS) No. 21, Reporting Corrections of Errors and Changes in 

Accounting Principles, prior period financial statements presented should 

only be restated for corrections of errors, when such errors caused the 

financial statements to be materially misstated. Errors in financial 

statements can result from mathematical mistakes, mistakes in the 

application of accounting principles, or oversight or misuse of facts that 

existed at the time the financial statements were prepared. 

We continue to have concerns about the identification of misstatements in 

federal agencies’ prior year financial statements. At least 79

 of the 24 CFO 

Act agencies restated certain of their fiscal year 2004 financial statements 

to correct errors. During fiscal year 2005, we reviewed the causes and 

nature of the restatements made by several Chief Financial Officers (CFO) 

Act agencies in fiscal year 2004 to their fiscal year 2003 financial 

statements and recommended improvements in internal controls and audit 

Restatements of 

Agencies’ Financial 

Statements 

 9

Three of these agencies had received an unqualified opinion on their originally issued 

fiscal year 2004 financial statements while the remaining four had received a disclaimer of

opinion on their financial statements. The auditor for one of the agencies withdrew the 

unqualified opinion that had been previously rendered on the agency’s fiscal year 2004

financial statements and issued a qualified opinion on the restated financial statements. 

Page 9 GAO-06-406T 
procedures to prevent or detect future similar errors.10 Generally, the 

reasons for the restatements we reviewed were agencies’ lack of effective 

internal controls over the processing and reporting of certain transactions

and the failure of the auditors to design and/or perform adequate audit 

procedures to detect such errors. During our review, we noted that the 

extent of the restatements to the agencies’ fiscal year 2003 financial 

statements varied from agency to agency, ranging from correcting two line

items on an agency’s balance sheet to correcting numerous line items on 

several of another agency’s financial statements. In some cases, the net 

operating results of the agency were affected by the restatement. The 

amounts of the agencies’ restatements ranged from several million dollars 

to more than $91 billion.

Frequent restatements to correct errors can undermine public trust and 

confidence in both the entity and all responsible parties. Material internal 

control weaknesses discussed in our fiscal year 2005 audit report serve to 

increase the risk that additional errors may occur and not be identified on 

a timely basis by agency management or their auditors, resulting in further 

restatements. 

 10GAO, Financial Audit: Restatements to the Department of State’s Fiscal Year 2003 

Financial Statements, GAO-05-814R (Washington, D.C.: Sep. 20, 2005); GAO, Financial

Audit: Restatements to the Nuclear Regulatory Commission’s Fiscal Year 2003 Financial 

Statements, GAO-06-30R (Washington, D.C.: Oct. 27, 2005); GAO, Financial Audit: 

Restatements to the General Services Administration’s Fiscal Year 2003 Financial 

Statements, GAO-06-70R (Washington, D.C.: Dec. 6, 2005); GAO Financial Audit: 

Restatements to the National Science Foundation’s Fiscal Year 2003 Financial 

Statements, GAO-06-229R (Washington, D.C.: Dec. 22, 2005); and GAO, Financial Audit: 

Restatements to the Department of Agriculture’s Fiscal Year 2003 Financial Statements,

GAO-06-254R (Washington, D.C.: Jan. 26, 2006). 

Page 10 GAO-06-406T 
As has been the case for the previous eight fiscal years, the federal 

government did not maintain adequate systems or have sufficient reliable

evidence to support certain material information reported in the U.S. 

government’s consolidated financial statements. These material 

deficiencies, which generally have existed for years, contributed to our 

disclaimer of opinion on the U.S. government’s consolidated financial 

statements for the fiscal years ended September 30, 2005, and 2004 and 

also constitute material weaknesses in internal control.11 Appendix I 

describes the material deficiencies in more detail and highlights the 

primary effects of these material weaknesses on the consolidated financial 

statements and on the management of federal government operations. 

These material deficiencies were the federal government’s inability to 

Highlights of Major 

Issues Related to the 

U.S. Government’s 

Consolidated 

Financial Statements 

for Fiscal Years 2005 

and 2004 

• satisfactorily determine that property, plant, and equipment and 

inventories and related property, primarily held by the Department of 

Defense (DOD), were properly reported in the consolidated financial 

statements; 

• reasonably estimate or adequately support amounts reported for certain 

liabilities, such as environmental and disposal liabilities, or determine 

whether commitments and contingencies were complete and properly 

reported; 

• support significant portions of the total net cost of operations, most 

notably related to DOD, and adequately reconcile disbursement activity at 

certain federal agencies;

• adequately account for and reconcile intragovernmental activity and 

balances between federal agencies; 

• ensure that the federal government’s consolidated financial statements 

were consistent with the underlying audited agency financial statements, 

balanced, and in conformity with GAAP; and 

• resolve material differences that exist between the total net outlays 

reported in federal agencies’ Statements of Budgetary Resources and the 

records used by Treasury to prepare the Statements of Changes in Cash 

Balance from Unified Budget and Other Activities. 

 11We previously reported that material deficiencies prevented us from expressing an 

opinion on the consolidated financial statements of the U.S. government for fiscal years 

1997 through 2004. 

Page 11 GAO-06-406T 
Due to the material deficiencies and additional limitations on the scope of

our work, as discussed in our audit report, there may also be additional 

issues that could affect the consolidated financial statements that have not 

been identified. 

In addition to the material weaknesses that represented material 

deficiencies, which were discussed above, we found the following four 

other material weaknesses in internal control as of September 30, 2005.

These weaknesses are discussed in more detail in appendix II, including 

the primary effects of the material weaknesses on the consolidated 

financial statements and on the management of federal government 

operations. These material weaknesses were the federal government’s 

inability to 

• implement effective processes and procedures for properly estimating the 

cost of certain lending programs, related loan guarantee liabilities, and 

value of direct loans; 

• determine the extent to which improper payments exist; 

• identify and resolve information security control weaknesses and manage

information security risks on an ongoing basis; and 

• effectively manage its tax collection activities. 

For fiscal year 2005, 18 of 24 CFO Act agencies were able to attain 

unqualified opinions on their financial statements by the November 15, 

2005, reporting deadline established by the Office of Management and 

Budget (OMB) (see app. III). The independent auditor of the Department 

of State subsequently withdrew its qualified opinion on the department’s 

fiscal year 2005 financial statements and reissued an unqualified opinion 

on such financial statements dated December 14, 2005. As a result, 19 CFO 

Act agencies received unqualified opinions on their fiscal year 2005 

financial statements. However, irrespective of these unqualified opinions,

many agencies do not have timely, reliable, and useful financial 

information and effective controls with which to make informed decisions 

and ensure accountability on an ongoing basis. The ability to produce the 

data needed for efficient and effective management of day-to-day 

operations in the federal government and provide the necessary 

accountability to taxpayers and the Congress has been a long-standing 

challenge at most federal agencies. 

Systems Problems at 

Agencies Continue to 

Hinder Accountability 

Page 12 GAO-06-406T 
The results of the fiscal year 2005 Federal Financial Managers Integrity Act 

of 1996 (FFMIA) assessments performed by agency inspectors general or

their contract auditors show that certain problems continue to affect 

financial management systems at most CFO Act agencies. These problems 

include nonintegrated financial systems, lack of accurate and timely 

recording of data, inadequate reconciliation procedures, and 

noncompliance with accounting standards and the U.S. Government 

Standard General Ledger (SGL).12 While the problems are much more 

severe at some agencies than at others, the nature and severity of the 

problems indicate that overall, management at most CFO Act agencies 

lack the complete range of information needed for accountability, 

performance reporting, and decision making. 

FFMIA requires auditors, as part of the 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, and (3) 

the SGL at the transaction level. The major barrier to achieving 

compliance with FFMIA continues to be the inability of agencies to meet 

federal financial management systems requirements, which involve not 

only core financial systems, but also administrative and programmatic 

systems. 

For fiscal year 2005, auditors for 18 of the 24 CFO Act agencies reported 

that the agencies’ financial management systems did not substantially 

comply with one or more of the FFMIA requirements noted above. For 5 of 

the remaining 6 CFO Act agencies, auditors provided negative assurance, 

meaning that nothing came to their attention indicating that the agencies’ 

financial management systems did not substantially meet FFMIA 

requirements. The auditors for these 5 agencies did not definitively state

whether the agencies’ systems substantially complied with FFMIA 

requirements, as is required under the statute. In contrast, auditors for the 

Department of Labor provided positive assurance by stating that, in their 

opinion, the department’s financial management systems substantially 

complied with the requirements of FFMIA. Further, auditors for the 

Department of Energy and the General Services Administration reported 

that those agencies’ financial management systems did not substantially 

comply with FFMIA requirements in fiscal year 2005 due to recently 

 12The United States Standard General Ledger provides a uniform Chart of Accounts and

technical guidance to be used in standardizing federal agency accounting. 

Page 13 GAO-06-406T 
identified internal control weaknesses over financial reporting. The 

auditors had not reported any FFMIA compliance issues at those 2 federal 

agencies in fiscal year 2004. 

As individual agencies move forward with various initiatives to address 

FFMIA-related problems, it is important that consideration be given to the 

numerous governmentwide initiatives under way to address long-standing

financial management weaknesses. OMB continues to move forward on 

new initiatives to enhance financial management and provide resultsoriented information in the federal government. Two ongoing 

developments in this area in fiscal year 2005 were the realignment of 

responsibilities formerly performed by the Joint Financial Management 

Improvement Program and its Program Management Office and the 

development of financial management lines of business. The overall vision

of these initiatives is to eliminate duplicative roles, streamline financial

management improvement efforts, and improve the cost, quality, and 

performance of financial management systems by leveraging shared 

services13 solutions. 

Three major impediments to our ability to render an opinion on the U.S. 

government’s consolidated financial statements continued to be: (1) 

serious financial management problems at DOD, (2) the federal 

government’s inability to adequately account for and reconcile 

intragovernmental activity and balances between federal agencies, and (3) 

the federal government’s ineffective process for preparing the 

consolidated financial statements. Extensive cooperative efforts between 

agency chief financial officers, inspectors general, Treasury officials, and 

OMB officials will be needed to resolve these serious obstacles to 

achieving an opinion on the U.S. government’s consolidated financial 

statements. 

Essential to improving financial management governmentwide and 

ultimately to achieving an opinion on the U.S. government’s consolidated 

Addressing Major 

Impediments to an 

Opinion on 

Consolidated 

Financial Statements 

Financial Management at 

DOD 

 13As defined by the Association of Government Accountants (AGA), shared services 

represent “financial and administrative services provided by a single organization 

established to provide such services efficiently and effectively for the benefit of multiple 

organizations or entities”. See AGA Corporate Partner Advisory Group Research, Financial

Management Shared Services: A Guide for Federal Users, AGA CPAG Research Series: 

Report No. 2, July 2005. 

Page 14 GAO-06-406T 
financial statements is the resolution of serious weaknesses in DOD’s 

business operations. DOD’s financial management weaknesses are 

pervasive, complex, long standing, and deeply rooted in virtually all 

business operations throughout the department. To date, none of the 

military services or major DOD components has passed the test of an 

independent financial audit14 because of pervasive weaknesses in business 

management systems, processes, and internal control. Of the 25 areas on 

GAO’s governmentwide high-risk list, 8 are DOD programs or operations, 

and the department shares responsibility for 6 other high-risk areas that 

are governmentwide in scope.15 These weaknesses adversely affect the 

department’s (and the federal government’s) ability to control costs; 

ensure basic accountability; anticipate future costs and claims on the 

budget; measure performance; maintain funds control; prevent fraud, 

waste, and abuse; and address pressing management issues. 

Effective management, reporting, and decision making depend upon 

information that is timely, reliable, and useful. Recent actions taken by the 

department to develop an integrated strategy to better understand and 

initiate efforts to systematically transform and address weaknesses in its 

business operations are encouraging. On September 28, 2005, DOD 

approved two key components of its transformation strategy: the Business 

Enterprise Architecture and the Business Transition Plan.16 An enterprise 

architecture should provide a clear and comprehensive picture of an 

entity, whether it is an organization (e.g., a federal department) or a 

functional or mission area that cuts across more than one organization 

(e.g., financial management). This picture consists of snapshots of both 

the enterprise’s current “As Is” operational and technological environment 

 14Although not major DOD components, the Military Retirement Fund received an

unqualified audit opinion on its fiscal year 2005 financial statements, and the DOD 

Medicare Eligible Retiree Health Care Fund received a qualified audit opinion on its fiscal 

year 2005 financial statements. 

15 GAO, High-Risk Series: An Update, GAO-05-207 (Washington, D.C.: January 2005). The 

eight specific DOD high-risk areas are: (1) approach to business transformation, (2)

business systems modernization, (3) contract management, (4) financial management, (5)

personnel security clearance program, (6) supply chain management, (7) support

infrastructure management, and (8) weapon systems acquisition. The six governmentwide 

high-risk areas are (1) disability programs, (2) interagency contracting, (3) information 

systems and critical infrastructure, (4) information sharing for homeland security, (5)

human capital, and (6) real property. 

16The Ronald W. Reagan National Defense Authorization Act for Fiscal Year 2005, Pub. L. 

No. 108-375, §332, 118 Stat. 1811, 1851-1856 (Oct. 28, 2004) (codified, in part, at 10 U.S.C. 

§2222) required DOD to develop a Business Enterprise Architecture and Transition Plan. 

Page 15 GAO-06-406T 
and its target or “To Be” environment. A transition plan should provide the 

capital investment roadmap for transitioning from the current to the target 

environment by describing how and when new business systems will be 

developed and implemented. In November 2005, we reported17 that while 

DOD had made important progress toward building a foundation upon 

which to improve its business operations, it did not fully satisfy the 

requirements of the Ronald W. Reagan National Defense Authorization Act 

for 2005.18 For example, we reported that the architecture did not address 

how DOD would comply with federal accounting, financial, and reporting 

requirements, such as the United States Government Standard General 

Ledger. 

In late December 2005, DOD issued its Financial Improvement and Audit

Readiness (FIAR) Plan, a third major component of its business 

transformation strategy. According to DOD briefings, the “purpose of the 

FIAR Plan is to provide a roadmap to guide the department in improving 

financial management and achieving a clean audit opinion.” Similar to an 

earlier DOD improvement effort, the Financial Improvement Initiative, the 

FIAR Plan utilizes an incremental approach to structure its process for 

examining its operations, diagnosing problems, planning corrective 

actions, and preparing for audit. However, unlike the previous plan, the

FIAR Plan does not establish an overall goal of achieving a clean audit

opinion on its departmentwide financial statements by a specific date.

Rather, the FIAR Plan appears to recognize that it will take several years 

before DOD is able to implement the systems, processes, and other 

changes necessary to fully address its financial management weaknesses. 

In the interim, DOD plans to focus its initial efforts on four areas: 

(1) military equipment, (2) real property, (3) military retiree eligible health 

care fund liabilities, and (4) environmental liabilities. The FIAR Plan also 

focuses on the U.S. Marine Corps and the U.S. Army Corps of Engineers, 

Civil Works because these organizations intend to be ready for audit in 

fiscal years 2007 and 2008, respectively. As the FIAR Plan evolves, DOD 

intends to refine or include additional goals to improve processes and 

systems related to other balance sheet line items and financial statements. 

 17GAO, DOD Business Systems Modernization: Important Progress Made in Establishing 

Foundational Architecture Products and Investment Management Practices, but Much

Work Remains, GAO-06-219 (Washington, D.C.: Nov. 23, 2005). 

18Pub. L. No. 108-375, §332, 118 Stat. 1811, 1851 (Oct. 28, 2004). 

Page 16 GAO-06-406T 
There will need to be ongoing and sustained top management attention to

business transformation at DOD to address what are some of the most 

difficult financial management challenges in the federal government. As 

we noted in our November 2005 testimony,19 we continue to believe that 

the implementation of a new Chief Management Officer position at DOD 

will be needed in order for the department to succeed in its overall 

business transformation strategy. We will continue to monitor DOD’s 

efforts to transform its business operations and address its financial 

management deficiencies as part of our continuing DOD business 

enterprise architecture work and our oversight of DOD’s financial 

statement audit. 

Federal agencies are unable to adequately account for and reconcile 

intragovernmental activity and balances. OMB and Treasury require the 

CFOs of 35 executive departments and agencies to reconcile, on a 

quarterly basis, selected intragovernmental activity and balances with 

their trading partners.20 In addition, these agencies are required to report 

to Treasury, the agency’s inspector general, and GAO on the extent and

results of intragovernmental activity and balances reconciliation efforts as 

of the end of the fiscal year. 

A substantial number of the agencies did not fully perform the required 

reconciliations for fiscal years 2005 and 2004. For fiscal year 2005, based 

on trading partner information provided in the Governmentwide Financial 

Reporting System discussed below, Treasury produced a “Material 

Difference Report” for each agency showing amounts for certain 

intragovernmental activity and balances that significantly differed from 

those of its corresponding trading partners. After analysis of the fiscal year 

2005 “Material Difference Reports”, we noted a significant number of 

CFOs were still unable to explain their material differences with their 

trading partners. For both fiscal years 2005 and 2004, amounts reported by 

federal agency trading partners for certain intragovernmental accounts 

were significantly out of balance. As a result, the federal government’s 

ability to determine the impact of these differences on the amounts 

Intragovernmental Activity 

and Balances 

 19GAO, Defense Management: Foundational Steps Being Taken to Manage DOD Business 

Systems Modernization, but Much Remains to be Accomplished to Effect True Business 

Transformation, GAO-06-234T (Washington, D.C.: Nov. 9, 2005). 

20Trading partners are U.S. government agencies, departments, or other components

included in the consolidated financial statements that do business with each other. 

Page 17 GAO-06-406T 
reported in the consolidated financial statements is impaired. Resolving 

the intragovernmental transactions problem remains a difficult challenge 

and will require a commitment by federal agencies and strong leadership 

and oversight by OMB. 

The federal government continued to have inadequate systems, controls, 

and procedures to ensure that the consolidated financial statements are 

consistent with the underlying audited agency financial statements, 

balanced, and in conformity with GAAP. During fiscal year 2005, Treasury 

continued the ongoing development of a new system, the Governmentwide

Financial Reporting System (GFRS), to collect agency financial statement 

information directly from federal agencies’ audited financial statements. 

The goal of GFRS is to be able to directly link information from federal 

agencies’ audited financial statements to amounts reported in the 

consolidated financial statements, a concept that we strongly support, and 

to resolve many of the weaknesses we have identified in the process for 

preparing the consolidated financial statements. For the fiscal year 2005

reporting process, Treasury’s GFRS was able to capture certain agency

financial information from agencies’ audited financial statements, but 

GFRS was still not at the stage that it could be used to fully compile the 

consolidated financial statements from the information captured. Treasury 

did, however, make progress in demonstrating that amounts in the 

consolidated Balance Sheet and Statement of Net Cost were consistent 

with federal agencies’ audited financial statements prior to eliminating 

intragovernmental activity and balances. 

In closing, given the federal government’s overall financial condition and 

long-term fiscal imbalance, the need for the Congress and the President to 

have timely, reliable, and useful financial and performance information is 

greater than ever. Sound decisions on the current results and future 

direction of vital federal government programs and policies are made 

more difficult without such information. Until the problems discussed in 

our audit report are adequately addressed, they will continue to have 

adverse implications for the federal government and the taxpayers. It will 

also be key that the appropriations, budget, authorizing, and oversight 

committees hold agency top leadership accountable for resolving these 

problems and that they support improvement efforts. 

Addressing the nation’s long-term fiscal imbalance constitutes a major 

transformational challenge that may take a generation or more to resolve. 

Preparing the 

Consolidated Financial 

Statements 

Closing Comments 

Page 18 GAO-06-406T 
Given the size of the projected deficit, the U.S. government will not be able

to grow its way out of this problem—tough choices will be required. 

Traditional incremental approaches to budgeting will need to give way to 

more fundamental and periodic reexaminations of the base of government. 

Our report, 21st Century Challenges: Reexamining the Base of the 

Federal Government,

21 is intended to support the Congress in identifying 

issues and options that could help address these fiscal pressures. 

Further, the Congress needs to have access to the long-term cost of 

selected spending and tax proposals before they enact related laws. The 

fiscal risks previously mentioned can be managed only if they are properly 

accounted for and publicly disclosed, including the many existing 

commitments facing the federal government. New reporting approaches, 

as well as enhanced budget processes and control mechanisms, are 

needed to better understand, monitor, and manage the impact of spending

and tax policies over the long term. In addition, a set of key national, 

outcome-based performance metrics would inform strategic planning, 

enhance performance and accountability reporting, and help to assess the 

impact of various spending programs and tax policies. 

Mr. Chairman, this concludes my prepared statement. I would be pleased

to respond to any questions that you or other members of the 

subcommittee may have at this time. 

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. 

GAO Contacts 

 21GAO, 21st Century Challenges: Reexamining the Base of the Federal Government, 

GAO-05-325SP (Washington, D.C.: February 2005). 

Page 19 GAO-06-406T 
Appendix I: Material Deficiencies 

The continuing material deficiencies discussed below contributed to our 

disclaimer of opinion on the federal government’s consolidated financial

statements for fiscal years 2005 and 2004. The federal government did not 

maintain adequate systems or have sufficient, reliable evidence to support 

information reported in the consolidated financial statements, as 

described below. 

The federal government could not satisfactorily determine that property, 

plant, and equipment (PP&E) and inventories and related property were 

properly reported in the consolidated financial statements. Most of the 

PP&E and inventories and related property are the responsibility of the 

Department of Defense (DOD). As in past years, DOD did not maintain 

adequate systems or have sufficient records to provide reliable 

information on these assets. Other agencies, most notably the National 

Aeronautics and Space Administration, reported continued weaknesses in

internal control procedures and processes related to PP&E. 

Without reliable asset information, the federal government does not fully 

know the assets it owns and their location and condition and cannot 

effectively (1) safeguard assets from physical deterioration, theft, or loss; 

(2) account for acquisitions and disposals of such assets; (3) ensure that 

the assets are available for use when needed; (4) prevent unnecessary 

storage and maintenance costs or purchase of assets already on hand; and 

(5) determine the full costs of programs that use these assets. 

The federal government could not reasonably estimate or adequately 

support amounts reported for certain liabilities. For example, DOD was 

not able to estimate with assurance key components of its environmental 

and disposal liabilities. In addition, DOD could not support a significant 

amount of its estimated military postretirement health benefits liabilities 

included in federal employee and veteran benefits payable. These 

unsupported amounts related to the cost of direct health care provided by 

DOD-managed military treatment facilities. Further, the federal 

government could not determine whether commitments and 

contingencies, including those related to treaties and other international 

agreements entered into to further the U.S. government’s interests, were 

complete and properly reported. 

Problems in accounting for liabilities affect the determination of the full 

cost of the federal government’s current operations and the extent of its 

liabilities. Also, improperly stated environmental and disposal liabilities 

Material Deficiencies 

Property, Plant, and 

Equipment and Inventories 

and Related Property 

Liabilities and 

Commitments and 

Contingencies 

Page 20 GAO-06-406T 
and weak internal control supporting the process for their estimation 

affect the federal government’s ability to determine priorities for cleanup 

and disposal activities and to appropriately consider future budgetary 

resources needed to carry out these activities. In addition, when 

disclosures of commitments and contingencies are incomplete or 

incorrect, reliable information is not available about the extent of the 

federal government’s obligations. 

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 operations, most notably related to DOD. 

With respect to disbursements, DOD and certain other federal agencies 

reported continued weaknesses in reconciling disbursement activity. For

fiscal years 2005 and 2004, there was unreconciled disbursement activity, 

including unreconciled differences between federal agencies’ and the 

Department of the Treasury’s records of disbursements and unsupported 

federal agency adjustments, totaling billions of dollars, which could also 

affect the balance sheet.

Unreliable cost information affects the federal government’s ability to 

control and reduce costs, assess performance, evaluate programs, and set 

fees to recover costs where required. Improperly recorded disbursements 

could result in misstatements in the financial statements and in certain 

data provided by federal agencies for inclusion in the President’s budget 

concerning obligations and outlays.

Federal agencies are unable to adequately account for and reconcile 

intragovernmental activity and balances. The Office of Management and 

Budget (OMB) and Treasury require the Chief Financial Officers (CFO) of 

35 executive departments and agencies to reconcile, on a quarterly basis, 

selected intragovernmental activity and balances with their trading 

partners.1

 In addition, these agencies are required to report to Treasury, 

Cost of Government 

Operations and 

Disbursement Activity 

Accounting for and 

Reconciliation of 

Intragovernmental Activity 

and Balances 

 1

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

included in the consolidated financial statements that do business with each other. 

Page 21 GAO-06-406T 
the agency’s inspector general, and GAO on the extent and results of 

intragovernmental activity and balances reconciliation efforts as of the 

end of the fiscal year. 

A substantial number of the agencies did not fully perform the required 

reconciliations for fiscal years 2005 and 2004. For these fiscal years, based

on trading partner information provided in the Governmentwide Financial 

Reporting System (GFRS), Treasury produced a “Material Difference 

Report” for each agency showing amounts for certain intragovernmental 

activity and balances that significantly differed from those of its 

corresponding trading partners. After analysis of the “Material Difference 

Reports” for fiscal year 2005, we noted a significant number of CFOs were

still unable to explain the differences with their trading partners. For both 

fiscal years 2005 and 2004, amounts reported by federal agency trading 

partners for certain intragovernmental accounts were significantly out of

balance. In addition, about 25 percent of the significant federal agencies 

reported internal control weaknesses regarding reconciliations of 

intragovernmental activity and balances. As a result, the federal 

government’s ability to determine the impact of these differences on the 

amounts reported in the consolidated financial statements is impaired. 

Fiscal year 2005 was the second year that Treasury used its GFRS to 

collect agency financial statement information taken directly from federal 

agencies’ audited financial statements. The goal of GFRS is to be able to 

directly link information from federal agencies’ audited financial 

statements to amounts reported in the U.S. government’s consolidated 

financial statements and resolve many of the weaknesses we previously 

identified in the process for preparing the consolidated financial 

statements. For both the fiscal year 2005 and 2004 reporting processes, 

GFRS was able to capture agency financial information, but GFRS was still 

not at the stage that it could be used to fully compile the consolidated 

financial statements from the information captured. Therefore, for fiscal

year 2005 Treasury continued to primarily use manual procedures to 

prepare the consolidated financial statements. As discussed in the scope 

limitations section of our audit report, Treasury could not produce the 

fiscal year 2005 consolidated financial statements and supporting 

documentation in time for us to complete all of our planned auditing 

procedures. In addition, the federal government continued to have 

inadequate systems, controls, and procedures to ensure that the 

consolidated financial statements are consistent with the underlying 

audited agency financial statements, balanced, and in conformity with U.S. 

Preparation of 

Consolidated Financial 

Statements 

Page 22 GAO-06-406T 
generally accepted accounting principles (GAAP). Specifically, during our 

fiscal year 2005 audit, we found the following2

• Treasury’s process for compiling the consolidated financial statements did 

not ensure that the information in all of the five principal financial 

statements and notes was fully consistent with the underlying information 

in federal agencies’ audited financial statements and other financial data. 

Treasury made progress in demonstrating amounts in the Balance Sheet 

and the Statement of Net Cost were consistent with federal agencies’

audited financial statements prior to eliminating intragovernmental 

activity and balances. However, about 25 percent of the significant federal 

agencies’ auditors reported internal control weaknesses related to the 

processes the agencies perform to provide financial statement information 

to Treasury for preparing the consolidated financial statements. 

• To make the fiscal years 2005 and 2004 consolidated financial statements 

balance, Treasury recorded a net $4.3 billion decrease and a net $3.4 

billion increase, respectively, to net operating cost on the Statements of 

Operations and Changes in Net Position, which it labeled “Unreconciled

Transactions Affecting the Change in Net Position.”3

 An additional net $3.2 

billion and $1.2 billion of unreconciled transactions were recorded in the 

Statement of Net Cost for fiscal years 2005 and 2004, respectively. 

Treasury is unable to fully identify and quantify all components of these 

unreconciled activities. 

• The federal government did not have an adequate process to identify and

report items needed to reconcile the operating results, which for fiscal 

year 2005 showed a net operating cost of $760 billion, to the budget 

results, which for the same period showed a unified budget deficit of 

$318.5 billion. In addition, a net $13.2 billion “net amount of all other 

differences” was needed to force this statement into balance. 

 2

Most of the issues we identified in fiscal year 2005 existed in fiscal year 2004, and many 

have existed for a number of years. In May 2005, we reported in greater detail on the issues 

we identified in GAO, Financial Audit: Process for Preparing the Consolidated Financial 

Statements of the U.S. Government Continues to Need Improvement, GAO-05-407 

(Washington, D.C.: May 4, 2005). This report includes numerous recommendations to

Treasury and OMB. 

3

Although Treasury was unable to determine how much of the unreconciled transactions, if 

any, relate to operations, it reported unreconciled transactions as a component of net

operating cost in the consolidated financial statements. 

Page 23 GAO-06-406T 
• Treasury’s ability to eliminate certain intragovernmental activity and 

balances continues to be impaired by the federal agencies’ problems in 

handling their intragovernmental transactions. As discussed above, 

amounts reported for federal agency trading partners for certain 

intragovernmental accounts were significantly out of balance, resulting in

the need for unsupported intragovernmental elimination entries in order to 

force the Statement of Operations and Changes in Net Position into 

balance. In addition, significant differences in other intragovernmental 

accounts, primarily related to transactions with the General Fund, have 

not been reconciled and still remain unresolved. Therefore, the federal

government continues to be unable to determine the impact of

unreconciled intragovernmental activity and balances on the consolidated

financial statements. 

• Treasury lacked a process to ensure that fiscal years 2005 and 2004 

consolidated financial statements and notes were comparable. Certain 

information reported for fiscal 2004 may require reclassification to be 

comparable to the fiscal year 2005 amounts. However, Treasury did not 

analyze this information or reclassify amounts within various financial 

statement line items and notes to enhance comparability. For example, the 

Reconciliations of Net Operating Cost and Unified Budget Deficit showed 

$47.8 billion and $.2 billion for property, plant, and equipment disposals 

and revaluations for fiscal years 2005 and 2004, respectively. However, 

based on the financial information provided by agencies to Treasury in 

GFRS, the fiscal year 2004 amount would be $25.4 billion. The difference 

would be reclassified from the net amount of all other differences line item 

on the Reconciliations of Net Operating Cost and Unified Budget Deficit. 

• Treasury did not have an adequate process to ensure that the financial 

statements, related notes, Stewardship Information, and Supplemental 

Information are presented in conformity with GAAP. For example, we 

found that certain financial information required by GAAP was not 

disclosed in the consolidated financial statements. Treasury submitted a 

proposal to the Federal Accounting Standards Advisory Board (FASAB) 

seeking to amend previously issued standards and eliminate or lessen the 

disclosure requirements for the consolidated financial statements so that 

GAAP would no longer require certain of the information that Treasury 

has not been reporting. Comments are due to the FASAB today, on an

exposure draft of a proposed FASAB standard, based on the Treasury 

proposal. Treasury stated that it is waiting for FASAB approval and 

issuance of this proposed standard to determine the disclosures that will 

be required in future consolidated financial statements. As a result of 

Treasury not providing us with adequate documentation of its rationale for 

excluding the currently required information and certain of the material 

Page 24 GAO-06-406T 
deficiencies noted above, we were unable again to determine if the 

missing information was material to the consolidated financial statements. 

• Information system weaknesses existed within the segments of GFRS that 

were used during the fiscal years 2005 and 2004 reporting processes. We 

found that the GFRS database (1) was not configured to prevent the 

alteration of data submitted by federal agencies and (2) was used for both 

production and testing during the reporting processes. Therefore, 

information submitted by federal agencies within GFRS is not adequately 

protected against unauthorized modification or loss. In addition, Treasury 

was unable to explain why numerous GFRS users appeared to have 

inappropriate access to GFRS agency information or demonstrate the 

appropriate segregation of duties exist. 

• Although Treasury made progress in addressing them, certain other 

internal control weaknesses in its process for preparing the consolidated

financial statements continued to exist and involved a lack of (1) 

appropriate documentation of certain policies and procedures for 

preparing the consolidated financial statements, (2) adequate supporting 

documentation for certain adjustments made to the consolidated financial

statements, and (3) necessary management reviews. 

• The consolidated financial statements include financial information for the 

executive, legislative, and judicial branches, to the extent that federal 

agencies within those branches have provided Treasury such information. 

However, there are undetermined amounts of assets, liabilities, costs, and 

revenues that are not included, and the federal government did not 

provide evidence or disclose in the consolidated financial statements that 

the excluded financial information was immaterial. 

• Treasury did not have the infrastructure to address the magnitude of the 

fiscal year 2005 financial reporting challenges it was faced with, such as an 

incomplete financial reporting system, compressed time frames for 

compiling the financial information, and lack of adequate internal control 

over the financial statement preparation process. We found that personnel

at Treasury’s Financial Management Service had excessive workloads that 

required an extraordinary amount of effort and dedication to compile the 

consolidated financial statements; however, there were not enough 

personnel with specialized financial reporting experience to ensure 

reliable financial reporting by the reporting date.

• Treasury, in coordination with OMB, had not provided us with adequate 

documentation evidencing an executable plan of action and milestones for 

short-term and long-range solutions for certain internal control 

Page 25 GAO-06-406T 
weaknesses we have previously reported regarding the process for 

preparing the consolidated financial statements. 

OMB Circular A-136, Financial Reporting Requirements, which 

incorporated and updated OMB Bulletin No. 01-09, Form and Content of 

Agency Financial Statements, states that outlays in federal agencies’ 

Statement of Budgetary Resources (SBR) should agree with the net 

outlays reported in the Budget of the United States Government. In 

addition, Statement of Federal Financial Accounting Standards No. 7, 

Accounting for Revenue and Other Financing Sources and Concepts for 

Reconciling Budgetary and Financial Accounting, requires explanation

of any material differences between the information required to be 

disclosed (including net outlays) in the financial statements and the 

amounts described as “actual” in the Budget of the United States 

Government. 

The federal government reported in the Statement of Changes in Cash 

Balance from Unified Budget and Other Activities (Statement of Changes 

in Cash Balance) and the Reconciliations of Net Operating Cost and 

Unified Budget Deficit (Reconciliation Statement) budget deficits for fiscal 

years 2005 and 2004 of $318.5 billion and $412.3 billion, respectively. The 

budget deficit is calculated by subtracting actual budget outlays from 

actual budget receipts.4

 As we have reported since fiscal year 2003, we 

found material unreconciled differences between the total net outlays 

reported in selected federal agencies’ SBRs and Treasury’s central 

accounting records, which it uses to prepare the Statement of Changes in 

Cash Balance. Treasury’s processes for preparing the Statement of 

Changes in Cash Balance do not include procedures for identifying and

resolving differences between its central accounting records and net 

outlay amounts reported in agencies’ SBRs. 

In fiscal year 2004, we noted reported internal control weaknesses 

regarding certain agencies’ SBRs. In fiscal year 2005, several agencies’ 

Net Outlays-A Component 

of the Budget Deficit 

 4

In previous years, the Statement of Changes in Cash Balance reported actual budget

outlays and actual budget receipts; however, beginning in fiscal year 2004, the federal 

government chose not to disclose budget outlays and budget receipts in this financial 

statement and only included the budget deficit. Receipts and net outlays (unified budget

amounts) are also reported in governmentwide reports--specifically, in the President’s

Budget (annually); Treasury’s Final Monthly Treasury Statement, as part of leading 

economic indicators on federal finances (quarterly); and Treasury’s annual Combined

Statement of Receipts, Outlays, and Balances of the United States Government. 

Page 26 GAO-06-406T 
auditors reported internal control weaknesses (1) affecting the agencies’ 

SBRs, and (2) relating to monitoring, accounting, and reporting of 

budgetary transactions. These weaknesses could affect the reporting and

calculation of the net outlay amounts in the agencies’ SBRs. In addition, 

such weaknesses transcend to agencies’ ability to also report reliable 

budgetary information to Treasury and OMB and may affect the unified 

budget outlays reported by Treasury in its Combined Statement of 

Receipts, Outlays, and Balances,

5

 and certain amounts reported in the 

Budget of the United States Government. 

OMB has been working with agencies to reduce the differences between 

the total net outlays reported in the federal agencies’ SBRs and the 

Statement of Changes in Cash Balance. In June 2005, OMB issued its 

Differences Between FY 2004 Budget Execution Reports and Financial 

Statements for CFO Act Agencies report which discusses various types of 

differences in federal agency financial statements and budget execution

reports, including net outlays, and makes recommendations for OMB and 

federal agencies to consider in improving both sets of reports in the future. 

Until the material differences between the total net outlays reported in the 

federal agencies’ SBRs and the records used to prepare the Statement of 

Changes in Cash Balance are timely reconciled, the effect of these 

differences on the U.S. government’s consolidated financial statements 

will be unknown. 

 5

Treasury’s Combined Statement of Receipts, Outlays, and Balances presents budget 

results and cash-related assets and liabilities of the federal government with supporting

details. Treasury represents this report as the recognized official publication of receipts

and outlays of the federal government based on agency reporting. 

Page 27 GAO-06-406T 
Appendix II: Other Material Weaknesses 

The federal government did not maintain effective internal control over 

financial reporting (including safeguarding assets) and compliance with 

significant laws and regulations as of September 30, 2005. In addition to 

the material deficiencies discussed in appendix I, we found the following 

four other material weaknesses in internal control. 

Federal agencies continue to have material weaknesses and reportable 

conditions related to their lending activities. The Department of Housing 

and Urban Development lacked adequate management reviews of 

underlying data and cost estimation methodologies that resulted in 

material errors being undetected, and significant adjustments were 

needed. In addition, the Department of Education’s processes do not 

provide for a robust budget-to-actual cost comparison or facilitate 

assessments of the validity of its lending program cost estimates. While the 

Small Business Administration made substantial progress to improve its 

cost-estimation processes, additional improvements are still needed to 

ensure that year-end reporting is accurate. These deficiencies plus others 

at the Department of Agriculture relating to the processes and procedures 

for estimating program costs continue to adversely affect the federal 

government’s ability to support annual budget requests for these 

programs, make future budgetary decisions, manage program costs, and 

measure the performance of lending activities. Further, these weaknesses 

and the complexities associated with estimating the costs of lending 

activities greatly increase the risk that significant errors in agency and 

governmentwide financial statements could occur and go undetected.

While agencies have made progress in implementing processes and 

controls to identify, estimate, and reduce improper payments,1

 such 

improper payments are a long-standing, widespread, and significant 

problem in the federal government. The Congress acknowledged this 

problem by passing the Improper Payment Information Act of 2002 (IPIA).2

The IPIA requires agencies to review all programs and activities, identify 

Other Material Weaknesses 

Loans Receivable and Loan 

Guarantee Liabilities 

Improper Payments 

 1

Improper 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.

2

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

Page 28 GAO-06-406T 
those that may be susceptible to significant improper payments,

3

 estimate 

and report the annual amount of improper payments for those programs, 

and implement actions to cost-effectively reduce improper payments. 

Further, in fiscal year 2005, the Office of Management and Budget (OMB) 

began to separately track the elimination of improper payments under the 

President’s Management Agenda. 

Significant challenges remain to effectively achieve the goals of the IPIA. 

From our review of agencies’ fiscal year 2005 Performance and 

Accountability Reports (PARs), we noted that some agencies still have not 

instituted a systematic method of reviewing all programs and activities, 

have not identified all programs susceptible to significant improper 

payments, and/or have not annually estimated improper payments for their 

high-risk programs. For example, seven major agency programs with 

outlays totaling about $280 billion, including Medicaid and the Temporary 

Assistance For Needy Families programs, still cannot annually estimate 

improper payments, even though they were required by OMB to report 

such information beginning with their fiscal year 2003 budget submissions. 

In addition, two agency auditors that tested compliance with IPIA cited 

agency noncompliance with the act in their annual audit reports. 

Federal agencies’ estimates of improper payments, based on available 

information, for fiscal year 2005 exceeded $38 billion, a net decrease of 

about $7 billion, or 16 percent, from the prior year improper payment 

estimate of $45 billion.4

 This decrease was attributable to the following 

factors. In fiscal year 2005, the Department of Health and Human Services

reported a $9.6 billion decrease in its Medicare program improper payment 

estimate, principally due to improvements in its due diligence with 

providers to ensure the necessary documentation is in place to support 

payment claims. However, in fiscal year 2005, this decrease was partially 

offset as a result of more programs reporting estimates of improper 

payments. 

 3

OMB defines the term “significant improper payments” as “annual erroneous payments in 

the program exceeding both 2.5 percent of program payments and $10 million.” 

4

In their fiscal year 2005 PARs, selected agencies updated their fiscal year 2004 improper

payment estimates to reflect changes since issuance of their fiscal year 2004 PARs. These 

updates increased the governmentwide improper payment estimate for fiscal year 2004

from $45 billion to $46 billion. 

Page 29 GAO-06-406T 
Although progress has been made, serious and widespread information 

security control weaknesses continue to place federal assets at risk of 

inadvertent or deliberate misuse, financial information at risk of 

unauthorized modification or destruction, sensitive information at risk of 

inappropriate disclosure, and critical operations at risk of disruption. GAO 

has reported information security as a high-risk area across government 

since February 1997. Such information security control weaknesses could 

result in compromising the reliability and availability of data that are 

recorded in or transmitted by federal financial management systems. A 

primary reason for these weaknesses is that federal agencies have not yet

fully institutionalized comprehensive security management programs, 

which are critical to identifying information security control weaknesses, 

resolving information security problems, and managing information 

security risks on an ongoing basis. The Congress has shown continuing 

interest in addressing these risks, as evidenced with hearings on Federal 

Information Security Management Act of 20025

 implementation and 

information security. In addition, the administration has taken important 

actions to improve information security, such as revising agency internal

control requirements in OMB Circular A-1236

 and issuing extensive 

guidance on information security. 

Material internal control weaknesses and systems deficiencies continue to 

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

collection activities,7

 an issue that has been reported in our financial 

statement audit reports for the past 8 years. Due to errors and delays in 

recording taxpayer information, payments, and other activities, taxpayers 

were not always credited for payments made on their taxes owed, which 

could result in undue taxpayer burden. 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. 

Information Security 

Tax Collection Activities 

 5

Title III of the E-Government Act of 2002, Pub. L. No. 107-347, 116 Stat. 2899, 2946 (Dec. 

17, 2002). 

6

OMB Circular No. A-123, Management’s Responsibility for Internal Control (Revised 

December 21, 2004). 

7

GAO, Financial Audit: IRS’s Fiscal Years 2005 and 2004 Financial Statements, 

GAO-06-137 (Washington, D.C.: Nov. 10, 2005). 

Page 30 GAO-06-406T 
Weaknesses in controls over tax collection activities continue to affect the 

federal government’s ability to efficiently and effectively account for and 

collect revenue. Additionally, weaknesses in financial reporting of 

revenues affect the federal government’s ability to make informed 

decisions about collection efforts. As a result, the federal government is 

vulnerable to loss of tax revenue and exposed to potentially billions of 

dollars in losses due to inappropriate refund disbursements. 

Page 31 GAO-06-406T 
Page 32 GAO-06-406T 

Appendix III: Fiscal Year 2005 Audit Results 

Table 2: CFO Act Agencies: Fiscal Year 2005 Audit Results, Principal Auditors, and Number of Other Audit Contractors 

CFO Act agencies 

Opinion

rendered by

agency auditor 

Agencies’ auditors 

reported material 

weaknesses or

noncompliance Principal auditor

Number of other 

audit contractors

Agency for International 

Development 

Unqualified √ OIG 2

Agriculture Unqualified √ OIG 3

Commerce Unqualified √ KPMG LLP 0

Defense Disclaimer √ OIG 1

Education Unqualified √ Ernst & Young, LLP 0

Energy Disclaimer √ KPMG LLP 0

Environmental Protection 

Agency 

Unqualified √ OIG 0

General Services 

Administration

(a) √ PricewaterhouseCoopers LLP 0

Health and Human 

Services 

Unqualified √ Ernst & Young, LLP 2

Homeland Security Disclaimer √ KPMG LLP 0

Housing and Urban 

Development 

Unqualified √ OIG 1

Interior Unqualified √ KPMG LLP 0

Justice Unqualified √ KPMG LLP 2

Labor Unqualified R. Navarro & Associates, Inc. 1

National Aeronautics and 

Space Administration 

Disclaimer √ Ernst & Young, LLP 0

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

Unqualified √ Cotton and Company LLP 0

Social Security

Administration

Unqualified PricewaterhouseCoopers LLP 2

State (b) √ Leonard G. Birnbaum and 

Company, LLP

4

Transportation Unqualified √ OIG 3

Treasury Unqualified √ KPMG LLP 5

Veterans Affairs Unqualified √ Deloitte & Touche LLP 0

Source: GAO.
a

In 2005, GSA received an unqualified opinion on its Balance Sheet, Statement of Changes in Net

Position, and Statement of Net Cost, and a disclaimer of opinion on its Statement of Budgetary 

Resources and Statement of Financing. 

b

The independent auditors of the Department of State's fiscal year 2005 financial statements issued a 

qualified opinion because they were not able to examine evidence regarding personal property in time 

to meet the November 15, 2005, reporting deadline. In late December, GAO was informed by the 

Acting Chief Financial Officer for the Department of State that subsequent to the issuance of the 

qualified opinion, the independent auditors satisfied themselves about the amounts presented as

personal property. As a result, the auditors issued an unqualified opinion on the Department of State's 

fiscal year 2005 financial statements dated December 14, 2005. 

Page 33 GAO-06-406T (198413) 
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