a

GAO

United States General Accounting Office

Testimony

Before the Subcommittee on Financial Management, the 

Budget, and International Security, Committee on 

Governmental Affairs, U.S. Senate

For Release on Delivery

Expected at 10:30 a.m. EDT

Thursday, July 8, 2004

FISCAL YEAR 2003 

U.S. GOVERNMENT 

FINANCIAL 

STATEMENTS

Sustained Improvement in 

Federal Financial 

Management Is Crucial to 

Addressing Our Nation’s 

Future Fiscal Challenges

Statement of David M. Walker

Comptroller General of the United States

GAO-04-886T
www.gao.gov/cgi-bin/getrpt?GAO-04-886T.

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. 

Highlights of GAO-04-886T, testimony 

before the Subcommittee on Financial 

Management, the Budget, and 

International Security, Committee on 

Governmental Affairs, U.S. Senate 

July 8, 2004

FISCAL YEAR 2003 U.S. GOVERNMENT 

FINANCIAL STATEMENTS 

Sustained Improvement in Federal 

Financial Management Is Crucial to 

Addressing Our Nation's Future Fiscal 

Challenges 

As in the 6 previous fiscal years, certain material weaknesses in internal 

control and in selected accounting and reporting practices resulted in 

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

Congress and American citizens 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 

continue to be (1) serious financial management problems at DOD, (2) the 

federal government’s inability to fully account for and reconcile transactions 

between federal government entities, and (3) the federal government’s 

ineffective process for preparing the consolidated financial statements. 

For fiscal year 2003, 20 of 23 Chief Financial Officers (CFO) Act agencies 

received unqualified opinions, the same number received by these agencies 

in fiscal year 2002, up from 6 for fiscal year 1996. However, only 3 of the CFO

Act agencies had neither a material weakness in internal control, an issue 

involving compliance with applicable laws and regulations, nor an instance 

of lack of substantial compliance with Federal Financial Management 

Improvement Act requirements. 

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

management information is greater than ever as our nation faces major longterm fiscal challenges that will require tough choices in setting priorities and 

linking resources to results. Given the nation’s large and growing long-term 

fiscal imbalance, which is driven largely by known demographic trends and 

health care costs, coupled with new homeland security and defense 

commitments, the status quo is unsustainable. Current financial reporting 

does not clearly 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 and provides an 

unrealistic and even misleading picture of the federal government’s overall 

performance and financial condition. In addition, too many significant 

federal government commitments and obligations, such as Social Security 

and Medicare, are not adequately addressed in the federal government’s 

financial statements and budget process, and current federal financial 

reporting standards do not require such disclosure. 

A top-to-bottom review of government activities to ensure their relevance 

and fit for the 21st century and their relative priority is long overdue. The 

federal government needs a three-pronged approach to (1) restructure 

existing entitlement programs, (2) reexamine the base of discretionary and 

other spending, and (3) review and revise the federal government’s tax 

policy and enforcement programs. New accounting and reporting 

approaches, budget control mechanisms, and metrics are needed for 

considering and measuring the impact of spending and tax policies and 

decisions over the long term. 

GAO is required to annually audit 

the consolidated financial 

statements of the U.S. government. 

Proper accounting and reporting 

practices are essential in the public 

sector. The U.S. government is the 

largest, most diverse, most 

complex, and arguably the most 

important entity on earth today. Its 

services—homeland security, 

national defense, Social Security, 

mail delivery, and food inspection, 

to name a few—directly affect the 

well-being of almost every 

American. But sound decisions on 

the future direction of vital federal 

government programs and policies 

are made more difficult without 

timely, accurate, and useful 

financial and performance 

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 accurately 

report a significant portion of its 

assets, liabilities, and costs; (2) 

affect the federal government’s 

ability to accurately measure the 

full cost as well as the financial and 

nonfinancial performance of 

certain programs while effectively 

managing related operations; and 

(3) significantly impair the federal 

government’s ability to adequately 

safeguard certain significant assets 

and properly record various 

transactions. 
Page 1 GAO-04-886T 

Mr. Chairman and Members of the Subcommittee:

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

government’s consolidated financial statements for fiscal years 2003 and 

2002.1

 Both the consolidated financial statements and our report are 

included in the fiscal year 2003 Financial Report of the United States 

Government, which was issued by the Department of the Treasury 

(Treasury) on February 27, 2004, and is available through GAO’s Internet 

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

www.fms.treas.gov/fr/index.html. 

As in the 6 previous fiscal years, certain material weaknesses2 in internal 

control and in selected accounting and reporting practices resulted in 

conditions that continued to prevent us from being able to provide the 

Congress and American citizens 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 (GAAP). Until the 

problems discussed in our report are adequately addressed, they will 

continue to (1) hamper the federal government’s ability to accurately report 

a significant portion of its assets, liabilities, and costs; (2) affect the federal 

government’s ability to accurately measure the full cost as well as the 

financial and nonfinancial performance of certain programs while 

effectively managing related operations; and (3) significantly impair the 

federal government’s ability to adequately safeguard certain significant 

assets and properly record various transactions.

While the federal government has not yet been able to prepare auditable 

financial statements, the requirement to do so at the consolidated level as 

well as at the agency level has already yielded important results. We see 

continuous movement toward the ultimate goals of annual accountability 

1

In addition, GAO is providing separate statements today on problems related to financial 

and business management systems and processes at the Department of Defense and the 

Department of Homeland Security. See U.S. General Accounting Office, Department of 

Defense: Financial and Business Management Transformation Hindered by Longstanding Problems, GAO-04-941T (Washington, D.C.: July 8, 2004), and Department of 

Homeland Security: Financial Management Challenges, GAO-04-945T (Washington, D.C.: 

July 8, 2004).

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 2 GAO-04-886T 

and, more importantly, of development of the day-to-day financial 

information that the federal government will need to best address today’s 

budgetary challenges and the looming longer-term fiscal imbalance driven 

by demographic trends, rising health care costs, and new homeland 

security and defense commitments. Across government, financial 

management improvement initiatives are under way that, if effectively 

implemented, have the potential to appreciably improve the quality of the 

federal government’s financial management and reporting. Federal 

agencies continue to make progress in their efforts to modernize their 

financial management systems and improve financial management 

performance as called for in the President’s Management Agenda.3

The Principals of the Joint Financial Management Improvement Program 

(JFMIP)4

 agreed with the Office of Management and Budget’s (OMB) 

initiative to accelerate the agency financial statements reporting date to 

November 15 for fiscal year 2004. For fiscal year 2003, OMB required the 

Chief Financial Officers (CFO) Act agencies5

 to deliver their Performance 

and Accountability Reports, including their audited financial statements, to 

OMB by January 30, 2004. However, to prepare for meeting the required 

November 15 accelerated reporting date for fiscal year 2004, OMB 

encouraged the CFO Act agencies to accelerate the issuance of their fiscal 

year 2003 audited financial statements to November 15, 2003, or as close to 

that date as possible. OMB reported that 8 CFO Act agencies—the 

Department of Education, the Environmental Protection Agency, the 

Department of Health and Human Services, the National Science 

Foundation, the Social Security Administration, the Department of the 

3

The President’s Management Agenda is the Bush administration’s strategy for improving 

the management and performance of the federal government. Its purpose is to identify and 

address the most significant problems facing the federal government. It contains five 

governmentwide and nine agency-specific goals to improve federal management and deliver 

results to the American people.

4

JFMIP is a joint and cooperative undertaking of the Department of the Treasury, GAO, the 

Office of Management and Budget (OMB), and the Office of Personnel Management working 

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

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

four Principals of the JFMIP—the Comptroller General of the United States, the Secretary of 

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

5

31 U.S.C. § 901(b). One of the 24 CFO Act agencies, the Federal Emergency Management 

Agency, was transferred to the new Department of Homeland Security effective March 1, 

2003. With this transfer, the Federal Emergency Management Agency will no longer be 

required to prepare and have audited stand-alone financial statements under the CFO Act, 

leaving 23 CFO Act agencies. 
Page 3 GAO-04-886T 

Treasury, the Agency for International Development, and the Department 

of Veterans Affairs—were able to issue their fiscal year 2003 financial 

statements with unqualified audit opinions by mid-November 2003. 

Another 10 CFO Act agencies issued their financial statements by 

December 31, 2003, and the remaining 5 CFO Act agencies issued by the 

end of January 2004. A 24th major agency, the Department of Homeland 

Security (DHS),6

 issued its financial statements on February 13, 2004. DHS 

faced a herculean challenge with respect to issuing audited financial 

statements, since the department had been in operation only for the last 7 

months of the fiscal year and involved a transfer of operations from a 

number of diverse entities, some with known financial management 

problems. 

While these results represent a significant improvement over previous 

years in the timeliness of CFO Act agencies’ issuance of audited financial 

statements, they also demonstrate the significant challenges that the 

federal government will face in meeting the November 15 accelerated 

reporting date for fiscal year 2004. Auditors at several of the CFO Act 

agencies reported that the agencies may not be able to produce auditable 

financial statements within the accelerated time frame for fiscal year 2004 

without making fundamental changes to improve a number of their 

financial management practices. For example, certain federal agency 

auditors reported that major improvements are needed in (1) management 

controls to monitor established policies and procedures for conducting 

financial analyses and reconciliations throughout the year, (2) fully 

integrating financial management systems, and (3) providing adequate and 

skilled staff to support efficient, effective preparation of federal agency 

consolidated financial statements. Our experience as the auditor of the 

financial statements of the Internal Revenue Service, which successfully 

accelerated its reporting to November 15 beginning with its fiscal year 2002 

financial statements, showed that significant changes had to be made to 

improve routine financial management procedures in order to be able to 

accelerate reporting. 

6

DHS is not a CFO Act agency and is therefore not subject to CFO Act requirements. 

However, along with most other executive branch agencies not covered by the CFO Act, 

DHS is required to prepare and have audited financial statements under the Accountability 

of Tax Dollars Act of 2002, Pub. L. No. 107-289, 116 Stat. 2049 (Nov. 7, 2002). For fiscal year 

2003, the act provided that OMB could grant executive branch agencies’ requests for 

waivers from having audited financial statements for fiscal year 2003. However, DHS and 

certain other agencies chose to prepare and have their fiscal year 2003 financial statements 

audited.
Page 4 GAO-04-886T 

For fiscal year 2003, as in fiscal year 2002, 20 of 23 CFO Act agencies were 

able to attain unqualified audit opinions on their financial statements (see 

table 1 and app. I),7

 up from 6 agencies for fiscal year 1996. This is the same 

number of unqualified opinions received by these CFO Act agencies for 

fiscal year 2002. However, 2 agencies’ fiscal year 2003 opinions were 

different from those they received for fiscal year 2002. The Agency for 

International Development received an unqualified opinion on all of its 

fiscal year 2003 financial statements for the first time, while the National 

Aeronautics and Space Administration (NASA), which for fiscal year 2002 

received an unqualified opinion on its financial statements, received a 

disclaimer of opinion for fiscal year 2003. DHS, which as I mentioned 

before prepared consolidated financial statements for fiscal year 2003 

covering its first 7 months of operations, received a qualified opinion on 

two of the six required financial statements.8

In identifying improved financial performance as one of its five 

governmentwide initiatives, the President’s Management Agenda 

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

prescription for any well-managed organization. At the same time, it 

recognized that “most federal agencies that obtain clean audits only do so 

after making extraordinary, labor-intensive assaults on financial records” at 

or after year-end. The President’s Management Agenda further recognized 

that without sound internal control and accurate and timely financial 

information, it is not possible to accomplish the agenda and secure the best 

performance and highest measure of accountability for the American 

people. The JFMIP Principals have defined certain measures, in addition to 

receiving an unqualified financial statement opinion, for achieving financial 

7

At least 4 CFO Act agencies restated certain of their audited fiscal year 2002 financial 

statements to correct misstatements in such financial statements. All 4 of the agencies had 

received unqualified opinions on their fiscal year 2002 financial statements. These 

restatements were not material to the consolidated financial statements.

8

DHS began operations as an agency 5 months after the start of the fiscal year, on March 1, 

2003. Transfers of funds, assets, liabilities, and obligations from 22 existing federal agencies 

to DHS began on March 1, 2003. DHS’s auditors issued a qualified opinion on the 

consolidated balance sheet and statement of custodial activity as of September 30, 2003, and 

disclaimed on the consolidated statement of net cost, consolidated statement of changes in 

net position, combined statement of budgetary resources, and consolidated statement of 

financing for the 7 months ended September 30, 2003. In accordance with Federal 

Accounting Standards Advisory Board Technical Bulletin 2003-1, Certain Questions and 

Answers Related to the Homeland Security Act of 2002, the fiscal year 2003 activities that 

occurred prior to the transfer of operations to DHS were to be reflected in the transferring 

agencies’ financial statements.
Page 5 GAO-04-886T 

management success. These additional measures include being able to 

routinely provide timely, accurate, and useful financial and performance 

information and having no material internal control weaknesses or material 

noncompliance with laws and regulations and the requirements of the 

Federal Financial Management Improvement Act of 1996 (FFMIA).9

 As 

shown in table 1, while the severity and magnitude of the problems 

identified vary greatly, reports of inspectors general and their contract 

auditors indicated that for fiscal year 2003 only 3 of the 23 CFO Act 

agencies had neither a material weakness in internal control, an issue 

involving compliance with applicable laws and regulations, nor an instance 

of lack of substantial compliance with the requirements of FFMIA.

Table 1: Fiscal Year 2003 CFO Act Agency Results Reported by Auditors

Source: GAO.

a

Agriculture, Commerce, Education, Energy, Health and Human Services, Housing and Urban 

Development, Interior, Justice, Labor, State, Transportation, Treasury, Veterans Affairs, Agency for 

International Development, Environmental Protection Agency, General Services Administration, 

National Science Foundation, Nuclear Regulatory Commission, Office of Personnel Management, and 

Social Security Administration.

b

Energy, National Science Foundation, and Social Security Administration.

In this testimony, I will highlight the major issues relating to the 

consolidated financial statements for fiscal years 2003 and 2002, 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. I will 

also discuss why sound financial management today and in the future is 

critical to meeting tomorrow’s fiscal needs and the need for “truth and 

transparency” in connection with our nation’s financial condition and fiscal 

outlook.

9

FFMIA, Pub. L. No. 104-208, div. A, § 101(f), title VIII, 110 Stat. 3009, 3009-389 (Sept. 30, 

1996).

Agencies with unqualified opinions

Agencies with unqualified opinions and 

no material weaknesses or 

noncompliances

20a 3b
Page 6 GAO-04-886T 

Highlights of Major 

Issues Related to the 

U.S. Government’s 

Consolidated Financial 

Statements for Fiscal 

Years 2003 and 2002 

As I mentioned earlier, as has been the case for the previous 6 fiscal years, 

the federal government continues to have a significant number of material 

weaknesses related to financial systems, fundamental recordkeeping and 

financial reporting, and incomplete documentation. Several of these 

material weaknesses (referred to hereafter as material deficiencies) 

resulted in conditions that continued to prevent us from forming and 

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

statements for the fiscal years ended September 30, 2003 and 2002.10 There 

may also be additional issues that could affect the consolidated financial 

statements that have not been identified.

Major challenges include the federal government’s inability to

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

inventories and related property, primarily at the Department of Defense 

(DOD);

• reasonably estimate or adequately support amounts reported for certain 

liabilities, such as environmental and disposal liabilities and related 

costs at DOD, and ensure complete and proper reporting for 

commitments and contingencies;

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

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

properly recorded;

• fully account for and reconcile intragovernmental activity and balances;

• demonstrate how net outlay amounts reported in the consolidated 

financial statements were related to net outlay amounts reported in the 

underlying federal agencies’ financial statements; and

• effectively prepare the federal government’s financial statements, 

including ensuring that the consolidated financial statements are 

consistent with the underlying audited agency financial statements, 

balanced, and in conformity with GAAP. 

10We previously reported that material deficiencies prevented us from expressing an opinion 

on the fiscal years 1997, 1998, 1999, 2000, 2001, and 2002 consolidated financial statements 

of the U.S. government.
Page 7 GAO-04-886T 

In addition to these material deficiencies, we identified four other material 

weaknesses in internal control related to loans receivable and loan 

guarantee liabilities, improper payments, information security, and tax 

collection activities. 

The material weaknesses identified by our work are discussed in more 

detail in appendix II, and their primary effects are described in appendix 

III. 

Recurring Systems 

Problems Hinder 

Accountability

The ability to produce the data needed to efficiently and effectively manage 

the day-to-day operations of the federal government and provide 

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

challenge at most federal agencies. The results of the fiscal year 2003 

assessments performed by agency inspectors general or their contract 

auditors under FFMIA show that these problems continue to plague the 

financial management systems used by most of the CFO Act agencies. 

While the problems are much more severe at some agencies than at others, 

their nature and severity indicate that overall, management at most CFO 

Act agencies lacks the full range of information needed for accountability, 

performance reporting, and decision making. 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).

Agencies’ inability to meet the federal financial management systems 

requirements continues to be the major barrier to achieving compliance 

with FFMIA. Under FFMIA, CFO Act agency auditors are required to 

report, as part of the agencies’ financial statement audits, 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. As shown in 

figure 1, auditors most frequently reported instances of noncompliance 

with federal financial management systems requirements. These instances 

of noncompliance involved not only core financial systems, but also 

administrative and programmatic systems.
Page 8 GAO-04-886T 

Figure 1: Auditors’ FFMIA Assessments for Fiscal Years 2000, 2001, 2002, and 2003

For fiscal year 2003, auditors for 17 of the 23 CFO Act agencies reported 

that the agencies’ financial management systems did not comply 

substantially with one or more of FFMIA’s three requirements. For 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 6 agencies did not definitively state 

whether the agencies’ systems substantially complied with FFMIA 

requirements, as is required under the statute. DHS is not subject to the 

requirements of the CFO Act and, consequently, is not required to comply 

with FFMIA. Accordingly, DHS’s auditors did not report on DHS’s 

compliance with FFMIA. However, the auditors identified and reported 

deficiencies that related to the aforementioned three requirements of 

FFMIA. 

Federal agencies have recognized the seriousness of their financial systems 

weaknesses and have efforts under way to implement or upgrade their 

financial systems to alleviate long-standing problems, but some of these 
Page 9 GAO-04-886T 

efforts face significant challenges. For example, as we testified in May 

2004,11 we have identified several issues related to NASA’s financial 

management systems modernization effort: (1) NASA did not involve key 

stakeholders in the design and implementation of the agency’s new 

financial management system’s core financial module; (2) NASA did not 

follow key best practices for acquiring and implementing this system; and 

(3) the new system lacks key external reporting capabilities for property 

and budgetary data. In addition, as I will discuss later in this testimony, 

DOD faces major challenges in its efforts to develop a business enterprise 

architecture. We recognize that it will take time, investment, and sustained 

emphasis to improve agencies’ underlying financial management systems. 

Addressing Major 

Impediments to an 

Opinion on 

Consolidated Financial 

Statements 

As I mentioned earlier, for the past 7 fiscal years, the federal government 

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

statements. Successfully meeting this requirement is tightly linked to the 

requirements for the CFO Act agencies to also have audited financial 

statements. This has stimulated extensive cooperative efforts and 

considerable attention by agency chief financial officers, inspectors 

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

7 years’ experience by the federal government in having the required 

financial statements subjected to audit, more intensified attention will be 

needed on the most serious obstacles to achieving an opinion on the U.S. 

government’s consolidated financial statements. Three major impediments 

to an opinion on the consolidated financial statements are (1) serious 

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

inability to fully account for and reconcile transactions between federal 

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

for preparing the consolidated financial statements.

Financial Management at 

DOD

Essential to achieving an opinion on the consolidated financial statements 

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

11U.S. General Accounting Office, National Aeronautics and Space Administration: 

Significant Actions Needed to Address Long-standing Financial Management Problems, 

GAO-04-754T (Washington, D.C.: May 19, 2004).
Page 10 GAO-04-886T 

we have designated as high risk12 since 1995. In accordance with section 

1008 of the National Defense Authorization Act for Fiscal Year 2002,13 DOD 

reported that for fiscal year 2003, it was not able to provide adequate 

evidence supporting material amounts in its financial statements. DOD 

stated that it is unable to comply with applicable financial reporting 

requirements for (1) property, plant, and equipment (PP&E); (2) inventory 

and operating materials and supplies; (3) environmental liabilities; (4) 

intragovernmental eliminations and related accounting adjustments; (5) 

disbursement activity; and (6) cost accounting by responsibility segment. 

Although DOD represented that the military retirement health care liability 

data had improved for fiscal year 2003, the cost of direct health care 

provided by DOD-managed military treatment facilities was a significant 

amount of DOD’s total recorded health care liability and was based on 

estimates for which adequate support was not available. 

DOD continues to confront pervasive decades-old financial management 

and business problems related to its systems, processes (including internal 

controls), and people (human capital). These problems preclude the 

department from producing accurate, reliable, and timely information to 

make sound decisions and to accurately report on its billions of dollars of 

assets. DOD’s long-standing business management systems problems 

adversely affect the economy, effectiveness, and efficiency of its operations 

and have resulted in a lack of adequate accountability across all major 

business areas. 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 financial management systems, operations, and 

controls.

Additionally, the department’s stovepiped, duplicative, and nonintegrated 

systems contribute to its vulnerability to fraud, waste, and abuse. In this

12GAO identifies areas at high risk due to either their greater vulnerabilities to waste, fraud, 

abuse, and mismanagement or major challenges associated with their economy, efficiency, 

or effectiveness.

13Pub. L. No. 107-107, § 1008, 115 Stat. 1012, 1204 (Dec. 28, 2001).

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

unqualified opinion on its fiscal year 2003 financial statements, and the DOD MedicareEligible Retiree Health Care Fund received a qualified opinion on its fiscal year 2003 

financial statements.
Page 11 GAO-04-886T 

regard, we have recently testified on problems related to military pay15 and 

unused airline tickets.16 Vulnerability to fraud, waste, and abuse continues 

despite substantial systems investment. For fiscal year 2004, DOD 

requested approximately $19 billion to operate, maintain, and modernize its 

reported 2,274 business systems. The duplicative and stovepiped nature of 

DOD’s systems environment is illustrated by the numerous systems it has in 

the same functional areas. For example, DOD reported that it has 565 

systems to support logistics functions. These systems are not integrated 

and thus have multiple points of data entry, which can result in significant 

data integrity problems.

Further, DOD continues to lack effective management oversight and 

control over business systems modernization investments. The actual 

funding continues to be distributed among the military services and 

defense agencies, thereby enabling the numerous DOD components to 

continue to develop stovepiped, parochial solutions to the department’s 

long-standing financial management and business operation challenges. 

Lacking a departmentwide focus and effective management oversight and 

control of business systems investment, DOD continues to invest billions of 

dollars in systems that fail to provide integrated corporate solutions to its 

long-standing business operations problems.

Over the past 14 years, DOD has initiated several broad-based reform 

efforts intended to fundamentally reform its business operations and 

improve the reliability of information used in the decision-making process. 

While these initiatives produced some incremental improvements, they did 

not result in the fundamental reform necessary to resolve the department’s 

long-standing management challenges. Secretary Rumsfeld has made 

business transformation a priority. For example, through its Business 

Management Modernization Program, DOD is continuing its efforts to 

develop and implement a business enterprise architecture and establish 

effective management and control over its business system modernization 

investments. 

15U.S. General Accounting Office, Military Pay: Army National Guard Personnel 

Mobilized to Active Duty Experienced Significant Pay Problems, GAO-04-413T

(Washington, D.C.: Jan. 28, 2004).

16U.S. General Accounting Office, DOD Travel Cards: Control Weaknesses Led to Millions 

in Fraud, Waste, and Improper Payments, GAO-04-825T (Washington, D.C.: June 9, 2004).
Page 12 GAO-04-886T 

However, we recently reported17 that after about 3 years of effort and over 

$203 million in obligations, we have not seen significant change in the 

content of DOD’s architecture or in DOD’s approach to investing billions of 

dollars annually in existing and new systems. Few actions have been taken 

to address the recommendations we made in our previous reports,18 which 

were aimed at improving DOD’s plans for developing the next version of 

the architecture and implementing the institutional means for selecting and 

controlling both planned and ongoing business systems investments. To 

date, DOD has not addressed 22 of our 24 recommendations.

Currently, DOD has various initiatives under way to support its efforts to 

obtain an unqualified audit opinion on its fiscal year 2007 financial 

statements. Because there are not yet detailed plans guiding these 

activities, however, it is unclear whether and how they support each other 

and whether they support this goal. Therefore, the feasibility of meeting 

this goal is as yet unknown.

The seriousness of DOD’s business management weaknesses underscores 

the importance of no longer condoning “status quo” business operations at 

DOD. Cultural resistance to change, military service parochialism, and 

stovepiped operations have all contributed significantly to the failure of 

previous attempts to implement broad-based management reforms at DOD. 

The department has acknowledged that it confronts decades-old problems 

deeply grounded in the bureaucratic history and operating practices of a 

complex, multifaceted organization and that many of these practices were 

developed piecemeal and evolved to accommodate different organizations, 

each with its own policies and procedures. 

17U.S. General Accounting Office, DOD Business Systems Modernization: Limited 

Progress in Development of Business Enterprise Architecture and Oversight of 

Information Technology Investments, GAO-04-731R (Washington, D.C.: May 17, 2004). 

18U.S. General Accounting Office, DOD Business Systems Modernizations: Improvements 

to Enterprise Architecture Development and Implementation Efforts Needed, GAO-03-458

(Washington, D.C.: Feb. 28, 2003), and DOD Business Systems Modernizations: Important 

Progress Made to Develop Business Enterprise Architecture, but Much Work Remains,

GAO-03-1018 (Washington, D.C.: Sept. 19, 2003).
Page 13 GAO-04-886T 

To improve the likelihood that the department’s current business 

transformation efforts will be successful, we have previously suggested19

that a chief management official20 position be created. Previous failed 

attempts to improve DOD’s business operations illustrate the need for 

sustained involvement of DOD leadership in helping to assure that DOD’s 

financial and overall business process transformation efforts remain a 

priority. While the Secretary and other key DOD leaders have demonstrated 

their commitment to the current business transformation efforts, the longterm nature of these efforts requires the development of an executive 

position capable of providing strong and sustained executive leadership 

over a number of years and various administrations.

This position would provide the sustained attention essential for 

addressing key stewardship responsibilities such as strategic planning, 

performance and financial management, and business systems 

modernization in an integrated manner. This position could be filled by an 

individual, appointed by the President and confirmed by the Senate, for a 

set term of 7 years with the potential for reappointment. Such an individual 

should have a proven track record as a business process change agent in 

large, complex, and diverse organizations—experience necessary to 

spearhead business process transformation across the department, and 

potentially administrations, and serve as an integrator for the needed 

business transformation efforts.

Further, in a recent report21 we also suggest that to improve management 

oversight, accountability, and control of the department’s business systems 

funding, Congress may wish to consider providing the funds to operate, 

maintain, and modernize DOD’s business systems to the functional areas, 

19U.S. General Accounting Office, Department of Defense: Further Actions Needed to 

Establish and Implement a Framework for Successful Financial and Business Management 

Transformation, GAO-04-551T (Washington, D.C.: Mar. 23, 2004), and Department of 

Defense: Further Actions Needed to Establish and Implement a Framework for Successful 

Business Transformation, GAO-04-626T (Washington, D.C.: Mar. 31, 2004).

20On September 9, 2002, GAO convened a roundtable of executive branch leaders and 

management experts to discuss the Chief Operating Officer concept. For more information, 

see U.S. General Accounting Office, Highlights of a GAO Roundtable: The Chief Operating 

Officer Concept: A Potential Strategy to Address Federal Governance Challenges, GAO-03-

192SP (Washington, D.C.: Oct. 4, 2002).

21U.S. General Accounting Office, DOD Business Systems Modernization: Billions Continue 

to Be Invested with Inadequate Management Oversight and Accountability, GAO-04-615

(Washington, D.C.: May 27, 2004).
Page 14 GAO-04-886T 

known as domains, rather than the military services and the defense 

agencies. Currently, each military service and defense agency receives its 

own funding and is largely autonomous in deciding how to spend these 

funds, thereby hindering the development of broad-based, integrated 

corporate system solutions to common DOD-wide problems. We believe it 

is critical that funds for DOD business systems be appropriated to the 

domain owners in order to provide for accountability and the ability to 

prevent the continued parochial approach to systems investment that 

exists today. The domains would establish a hierarchy of investment review 

boards with DOD-wide representation, including the military services and 

defense agencies. These boards would be responsible for reviewing and 

approving investments to develop, operate, maintain, and modernize 

business systems for the domain portfolio, including ensuring that 

investments were consistent with DOD’s business enterprise architecture. 

DOD still has a long way to go, and top leadership must continue to stress 

the importance of achieving lasting improvement that truly transforms the 

department’s business systems and operations. Only through major 

transformation, which will take time and sustained leadership from top 

management, will DOD be able to meet the mandate of the CFO Act and 

achieve the President’s Management Agenda goal of improved financial 

performance.

Intragovernmental 

Transactions

OMB and Treasury require the CFOs of 35 executive departments and 

agencies, including the 23 CFO Act agencies, to reconcile selected 

intragovernmental activity and balances with their “trading partners”22 and 

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

extent and results of intragovernmental activity and balances 

reconciliation efforts. A substantial number of the agencies continue to be 

unable to fully perform reconciliations of intragovernmental activity and 

balances with their trading partners, citing reasons such as (1) trading 

partners not providing needed data; (2) limitations and incompatibility of 

agency and trading partner information systems; and (3) lack of human 

resources. Amounts reported for federal agency trading partners for 

certain intragovernmental accounts were significantly out of balance in the 

aggregate for both fiscal years 2003 and 2002.

22Trading partners are U.S. government agencies, departments, or other components 

included in the consolidated financial statements that do business with each other.
Page 15 GAO-04-886T 

We reported in previous years that the heart of the intragovernmental 

transactions issue was that the federal government lacked clearly 

articulated business rules for these transactions so that they would be 

handled consistently by agencies. In this regard, at the start of fiscal year 

2003, OMB issued business rules to transform and standardize 

intragovernmental ordering and billing. To address long-standing problems 

with intragovernmental exchange transactions between federal agencies, 

Treasury provided federal agencies with quarterly detailed trading partner 

information during fiscal year 2003 to help them better perform their 

trading partner reconciliations. In addition, the federal government began a 

three-phase Intragovernmental Transactions e-gov project to define a 

governmentwide data architecture and provide a single source of detailed 

trading partner data. On April 20, 2004, however, OMB announced that it 

was appropriate to pause and evaluate the results of the project to date. 

OMB estimated that the evaluation will take 120 days and will be followed 

by a phased deployment. Resolving the intragovernmental transactions 

problem remains a difficult challenge and will require a commitment by the 

CFO Act agencies and continued strong leadership by OMB. 

Preparing the Consolidated 

Financial Statements

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

procedures to ensure that the consolidated financial statements are 

consistent with the underlying audited agency financial statements, 

balanced, and in conformity with GAAP. In this regard, Treasury is 

developing a new system and procedures to prepare the consolidated 

financial statements beginning with the statements for fiscal year 2004. 

Treasury officials have stated that these actions are intended to, among 

other things, directly link information from federal agencies’ audited 

financial statements to amounts reported in the consolidated financial 

statements and resolve many of the issues we identified in the process for 

preparing the consolidated financial statements. As part of our fiscal year 

2004 audit, we will evaluate the new system and procedures as they are 

fully developed and implemented and determine the extent of linkage 

accomplished for the fiscal year 2004 financial statements. Resolving issues 

surrounding preparing the consolidated financial statements has been a 

significant challenge and will require continued strong leadership by 

Treasury management.
Page 16 GAO-04-886T 

Truth and 

Transparency in the 

Fiscal Outlook

Our nation’s large and growing long-term fiscal imbalance, which is driven 

largely by known demographic trends and rising health care costs—coupled 

with new homeland security and defense commitments—serves to sharpen 

the need to fundamentally review and re-examine basic federal 

entitlements, as well as other mandatory and discretionary spending, and 

tax policies. As we look ahead, our nation faces an unprecedented 

demographic challenge with significant implications, among them 

budgetary and economic. Between now and 2035, the number of people 

who are 65 years old or over will double, driving federal spending on the 

elderly to a larger and ultimately unsustainable share of the federal budget. 

As a result, tough choices will be required to address the resulting 

structural imbalance. 

GAO prepares long-term budget simulations that seek to illustrate the likely 

fiscal consequences of the coming demographics and rising health care 

costs. Our latest long-term budget simulations reinforce the need for 

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

programs. As shown in figure 2, by 2040, absent reform of these entitlement 

programs, projected federal revenues may be adequate to pay little beyond 

interest on the debt. 
Page 17 GAO-04-886T 

Figure 2: Composition of Spending as a Share of GDP Assuming Discretionary 

Spending Grows with GDP after 2004 and All Expiring Tax Provisions Are Extended

Note: Although expiring tax provisions are extended, revenue as a share of gross domestic product 

(GDP) increases through 2014 due to (1) real bracket creep, (2) more taxpayers becoming subject to 

the alternative minimum tax, and (3) increased revenue from tax-deferred retirement accounts. After 

2014, revenue as a share of GDP is held constant.

Current financial reporting does not clearly 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 and provides an unrealistic and even 

misleading picture of the federal government’s overall performance and 

financial condition. Few agencies adequately show the results they are 

getting with the taxpayer dollars they spend. In addition, too many 

significant federal government commitments and obligations, such as 

Social Security and Medicare, are not fully and consistently disclosed in the 

0

10

20

30

40

50

2003 2015 2030 2040

Fiscal year

Percent of GDP

Net interest

Social Security

Medicare & Medicaid

All other spending

Source: GAO’s March 2004 analysis.

Revenue
Page 18 GAO-04-886T 

federal government’s consolidated financial statements and budget, and 

current federal financial reporting standards do not require such 

disclosure.23 Figure 3 shows some selected fiscal exposures. The spectrum 

of these exposures ranges from covering only the explicit liabilities that are 

shown on the consolidated financial statements to implicit promises 

embedded in current policy or public expectations. These liabilities, 

commitments, and promises have created a fiscal imbalance that will put 

unprecedented strains on the nation’s spending and tax policies. Although 

economic growth can help, the projected fiscal gap is now so large that the 

federal government will not be able to simply grow its way out of the 

problem. Tough choices are inevitable.

23The Federal Accounting Standards Advisory Board has a project under way to consider 

recognition, measurement, and display of social insurance obligations.
Page 19 GAO-04-886T 

Figure 3: Selected Fiscal Exposures: Sources and Examplesa

a

All figures are as of the end of fiscal year 2003, except Social Security and Medicare estimates, which 

are as of the end of calendar year 2003.

b

This amount includes $774 billion held by military and civilian pension funds that would offset the 

explicit liabilities reported by those funds.

c

Figures for Social Security and Medicare are net of debt held by the trust funds ($1,531 billion for 

Social Security, $256 billion for Medicare Part A, and $24 billion for Medicare Part B) and represent net 

present value estimates over a 75-year period. Over an infinite horizon, the estimate for Social Security 

would be $10.4 trillion, $21.8 trillion for Medicare Part A, $23.2 trillion for Medicare Part B, and $16.5 

trillion for Medicare Part D.

Particularly troubling are the many big-ticket items that taxpayers will 

eventually have to deal with. The federal government has pledged its 

support to a long list of programs and activities, including pension and 

health care benefits for senior citizens, medical care for veterans, and 

contingencies associated with various government-sponsored entities, 

Debt held by government accounts ($2,859)

Future Social Security benefit payments ($3,699)

Future Medicare Part A benefit payments ($8,236)

Future Medicare Part B benefit payments ($11,416)

Future Medicare Part D benefit payments ($8,119) 

Life-cycle cost, including deferred and future maintenance and 

 operating costs (amount unknown)

Government-Sponsored Enterprises, e.g., Fannie Mae and Freddie Mac

Implicit exposures implied by 

current policies or the public's

expectations about the role of 

government 

Unadjudicated claims ($9)

Pension Benefit Guaranty Corporation ($86)

Other national insurance programs ($7)

Government corporations, e.g., Ginnie Mae

Undelivered orders ($596)

Long-term leases ($47)

b

c

c

c

c

Explicit financial contingencies

Explicit financial commitments

Publicly held debt ($3,913)

Military and civilian pension and post-retirement health ($2,857)

Veterans benefits payable ($955)

Environmental and disposal liabilities ($250)

Loan guarantees ($35)

Explicit liabilities

Type Example (dollars in billions)

Source: GAO analysis of data from the Department of the Treasury; the Office of the Chief Actuary, Social Security Administration; and 

the Office of the Actuary, Centers for Medicare and Medicaid Services.
Page 20 GAO-04-886T 

whose claims on future spending total trillions of dollars. Despite their 

serious implications for future budgets, tax burdens, and spending 

flexibilities, these unfunded commitments get short shrift in the federal 

government’s current financial statements and in budgetary deliberations.

The federal government’s gross debt as of September 2003 was about $7 

trillion, or about $24,000 for every man, woman, and child in this country 

today. But that number excludes many big-ticket items, including the gap 

between promised and funded Social Security and Medicare benefits, 

veterans’ health care, and a range of other commitments and contingencies. 

If these items are factored in, the total burden in current dollars is at least 

$42 trillion. To put that number into perspective, $42 trillion is 18 times the 

current federal budget, or 3.5 times our current annual gross domestic 

product. One of the biggest contributors to this total bill will be the new 

Medicare prescription drug benefit, whose estimated current-dollar cost 

over the next 75 years is more than $8 trillion. Stated differently, the 

current total burden for every American is more than $140,000—and every 

day that burden is growing larger. GAO’s long-term budget simulations 

show that by 2040, the federal government may have to cut federal 

spending by 60 percent or raise taxes to about 2.5 times today’s level to pay 

for the mounting cost of the federal government’s current unfunded 

commitments. Either would be devastating.

Proper accounting and reporting practices are essential in the public 

sector. After all, the U.S. government is the largest, most diverse, most 

complex, and arguably the most important entity on earth today. Its 

services—homeland security, national defense, Social Security, mail 

delivery, and food inspection, to name a few—directly affect the well-being 

of almost every American. But sound decisions on the future direction of 

vital federal government programs and policies are made more difficult 

without timely, accurate, and useful financial and performance 

information. 

Fortunately, we are starting to see efforts to address the shortcomings in 

federal financial reporting. The President’s Management Agenda, which 

closely reflects GAO’s list of high-risk government programs, is bringing 

attention to troubled areas across the federal government and is taking 

steps to better assess the results that programs are getting with the 

resources they are given. The Federal Accounting Standards Advisory 

Board is also making progress on many key financial reporting issues.
Page 21 GAO-04-886T 

In addition to these efforts, we have published frameworks for analyzing 

various Social Security reform proposals24 and for analyzing health care 

reform proposals.25 We have also helped to create a consortium of “good 

government” organizations to stimulate the development of a set of key 

national indicators to assess the United States’ overall position and 

progress over time and in comparison to those of other industrialized 

nations. 

Budget experts at the Congressional Budget Office (CBO) and GAO 

continue to encourage reforms to the federal budget process to better 

reflect the federal government’s commitments and signal emerging 

problems. Among other things, we have recommended that the federal 

government issue an annual report on major fiscal exposures. The 

President’s fiscal year 2005 budget also proposes that future President’s 

budgets report on any enacted legislation in the past year that worsens the 

unfunded obligations of programs with long-term actuarial projections, 

with CBO to make a similar report. Such reporting could be a good starting 

point.

Although these are positive initial steps, much more must be done given the 

magnitude of the federal government’s fiscal challenge. A top-to-bottom 

review of government activities to ensure their relevance and fit for the 

21st century and their relative priority is long overdue. As I have spoken 

about in the past, the federal government needs a three-pronged approach 

to (1) restructure existing entitlement programs, (2) reexamine the base of 

discretionary and other spending, and (3) review and revise the federal 

government’s tax policy, including major tax preferences, and enforcement 

programs. New accounting and reporting approaches, budget control 

mechanisms, and metrics are needed for considering and measuring the 

impact of spending and tax policies and decisions over the long term. 

24U.S. General Accounting Office, Social Security Reform: Analysis of Reform Models 

Developed by the President’s Commission to Strengthen Social Security, GAO-03-310

(Washington, D.C.: Jan. 15, 2003).

25GAO’s health care framework can be found at www.gao.gov/cghome/hccrisis/health.pdf. 

See also Comptroller General’s Forum on Health Care: Unsustainable Trends Necessitate 

Comprehensive and Fundamental Reforms to Control Spending and Improve Value, GAO04-793SP (Washington, D.C.: May 1, 2004).
Page 22 GAO-04-886T 

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

fiscal years 2003 and 2002 highlights the need to continue addressing the 

federal government’s serious financial management weaknesses. With the 

significantly accelerated financial reporting time frame for fiscal year 2004 

and beyond, it is essential that the federal government move away from the 

extraordinary efforts many federal agencies continue to make to prepare 

financial statements and toward giving prominence to strengthening the 

federal government’s financial systems, reporting, and controls. This is the 

only way the federal government can meet the end goal of making timely, 

accurate, and useful financial and performance information routinely 

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

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

management information is greater than ever as our nation faces major 

long-term fiscal challenges that will require tough choices in setting 

priorities and linking resources to results. 

The Congress and the President face the challenge of sorting out the many 

claims on the federal budget without the budget enforcement mechanisms 

or fiscal benchmarks that guided the federal government through the 

previous years of deficit reduction into the brief period of surplus. While a 

number of steps will be necessary to address this challenge, truth and 

transparency in federal government reporting are essential elements of any 

attempt to address the nation’s long-term fiscal challenges. The fiscal risks 

I mentioned earlier can be managed only if they are properly accounted for 

and publicly disclosed. A crucial first step will be to face facts and identify 

the significant commitments facing the federal government. If citizens and 

federal government officials come to understand various fiscal exposures 

and their potential claims on future budgets, they are more likely to insist 

on prudent policy choices today and sensible levels of fiscal risk in the 

future. In addition, new budget control mechanisms will be required, along 

with effective approaches to successfully engage in a fundamental review, 

reassessment, and reprioritization of the base of federal government 

programs and policies that I have recommended previously. 

Public officials will have more incentive to make difficult but necessary 

choices if the public has the facts and comes to support serious and 

sustained action to address the nation’s fiscal challenges. Without 

meaningful public debate, however, real and lasting change is unlikely. 

Clearly, the sooner action is taken, the easier it will be to turn things 

around.
Page 23 GAO-04-886T 

I believe that nothing less than a national education campaign and outreach 

effort is needed to help the public understand the nature and magnitude of 

the long-term financial challenge facing this nation. An informed electorate 

is essential for a healthy democracy. Members of Generations X and Y 

especially need to become active in this discussion because they and their 

children will bear the heaviest burden if policymakers fail to act in a timely 

and responsible manner. 

We at GAO are committed to doing our part, but others also need to step up 

to the plate. By working together, I believe we can make a meaningful 

difference for our nation, fellow citizens, and future generations of 

Americans. 

In closing, Mr. Chairman, I want to reiterate the value of sustained 

congressional interest in these issues, as demonstrated by the Congress’s 

annual hearings on the results of our audit of the consolidated financial 

statements and of audits of certain federal agencies’ financial statements. 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.

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

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

Management and Assurance, at (202) 512-2600.
Page 24 GAO-04-886T 

Appendix I

Selected Major Federal Agencies: Fiscal Year 

2003 Audit Results, Principal Auditors, and 

Number of Other Audit Contractors ApendxiI

Source: GAO.

a

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

Federal Debt Managed by the Bureau of the Public Debt.

b

DHS began operations as an agency 5 months after the start of the fiscal year, on March 1, 2003. 

Transfers of funds, assets, liabilities, and obligations from 22 existing federal agencies to DHS began 

on March 1, 2003. DHS’s auditors issued a qualified opinion on the consolidated balance sheet and 

statement of custodial activity as of September 30, 2003, and disclaimed on the consolidated 

statement of net cost, consolidated statement of changes in net position, combined statement of 

budgetary resources, and consolidated statement of financing for the 7 months ended September 30, 

2003. 

23 CFO Act agencies Audit results Principal auditor

Number of 

other audit 

contractors

Agency for International Development Unqualified Inspector General 1

Agriculture Unqualified Inspector General 3

Commerce Unqualified KPMG LLP 0

Defense Disclaimer Inspector General 1

Education Unqualified Ernst & Young LLP 0

Energy Unqualified KPMG LLP 0

Environmental Protection Agency Unqualified Inspector General 0

General Services Administration Unqualified PricewaterhouseCoopers LLP 0

Health and Human Services Unqualified Inspector General 4

Housing and Urban Development Unqualified Inspector General 1

Interior Unqualified KPMG LLP 0

Justice Unqualified PricewaterhouseCoopers LLP 2

Labor Unqualified R. Navarro & Associates, Inc. 2

National Aeronautics and Space Administration Disclaimer PricewaterhouseCoopers LLP 2

National Science Foundation Unqualified KPMG LLP 0

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

Office of Personnel Management Unqualified KPMG LLP 0

Small Business Administration Disclaimer Cotton & Company LLP 0

Social Security Administration Unqualified PricewaterhouseCoopers LLP 0

State Unqualified Leonard G. Birnbaum and Company, LLP 2

Transportation Unqualified Inspector General 2

Treasury Unqualified Inspector General 6a

Veterans Affairs Unqualified Deloitte & Touche LLP 0

Other major agency

Homeland Security Disclaimerb KPMG LLP 0
Page 25 GAO-04-886T 

Appendix II

Material Deficiencies ApendxiI

The federal government did not maintain adequate systems or have 

sufficient, reliable evidence to support information reported in the 

consolidated financial statements of the U.S. government, as described 

below. These material deficiencies contributed to our disclaimer of opinion 

on the consolidated financial statements and also constitute material 

weaknesses in internal control.

Property, Plant, and 

Equipment and Inventories 

and Related Property 

The federal government could not satisfactorily determine that all PP&E 

and inventories and related property were included in the consolidated 

financial statements, verify that certain reported assets actually exist, or 

substantiate the amounts at which they were valued. Most of the PP&E and 

inventories and related property are the responsibility of 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.

Liabilities and 

Commitments and 

Contingencies 

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 DODmanaged 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.

Cost of Government 

Operations and 

Disbursement Activity 

The previously discussed material deficiencies in reporting assets and 

liabilities, material deficiencies in financial statement preparation, as 

discussed below, and the lack of adequate disbursement reconciliations at 

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

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

of operations, most notably related to DOD.
Appendix II

Material Deficiencies

Page 26 GAO-04-886T 

With respect to disbursements, DOD and certain other federal agencies did 

not adequately reconcile disbursement activity. For fiscal years 2003 and 

2002 there were unsupported adjustments to federal agencies’ records and 

unreconciled disbursement activity, including unreconciled differences 

between federal agencies’ and Treasury’s records of disbursements, 

totaling billions of dollars, which could also affect the balance sheet. 

Accounting for and 

Reconciliation of 

Intragovernmental Activity 

and Balances

OMB and Treasury require the CFOs of 35 executive departments and 

agencies, including the 23 CFO Act agencies, to reconcile selected 

intragovernmental activity and balances with their “trading partners”1

 and 

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

extent and results of intragovernmental activity and balances 

reconciliation efforts. A substantial number of the agencies did not fully 

perform the required reconciliations for fiscal years 2003 and 2002, citing 

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

limitations and incompatibility of agency and trading partner information 

systems, and (3) lack of human resources. For both of these years, amounts 

reported for federal agency trading partners for certain intragovernmental 

accounts were significantly out of balance. Treasury’s ability to eliminate 

certain intragovernmental activity and balances is impaired by these 

federal agencies’ problems in handling their intragovernmental 

transactions.

Net Outlays OMB Bulletin 01-09, Form and Content of Agency Financial Statements,2

states that outlays in federal agencies’ Statements of Budgetary Resources 

(SBR) should agree with the respective agency’s net outlays reported in the 

budget of the U.S. government. In addition, Statement of Federal Financial 

Accounting Standards (SFFAS) 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) 

1

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

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

2

Office of Management and Budget Bulletin No. 01-09, Form and Content of Agency 

Financial Statements (Washington, D.C.: Sept. 25, 2001). This bulletin is OMB’s official 

guidance for the form and content of federal agencies’ financial statements. 
Appendix II

Material Deficiencies

Page 27 GAO-04-886T 

and the amounts described as “actual” in the budget of the U.S. 

government.

We found material differences between the total net outlays reported in 

selected federal agencies’ audited SBRs and the records used to prepare 

the Statement of Changes in Cash Balance from Unified Budget and Other 

Activities (Statement of Changes in Cash Balance),3

 totaling about $140 

billion and $186 billion for fiscal years 2003 and 2002, respectively.4 Two 

agencies (Treasury and the Department of Health and Human Services 

(HHS)) accounted for about 83 percent and 75 percent of the differences 

identified in fiscal years 2003 and 2002, respectively. We found that the 

major cause of the differences for the two agencies was the treatment of 

offsetting receipts.5

 Some offsetting receipts for these two agencies had not 

been included in the agencies’ SBRs, which would have reduced the 

agencies’ net outlays and made the amounts more consistent with the 

records used to prepare the Statement of Changes in Cash Balance.6

 For 

example, we found that HHS reported net outlays for fiscal year 2003 as 

$596 billion on its audited SBR, while the records that Treasury uses to 

prepare the Statement of Changes in Cash Balance showed $505 billion for 

fiscal year 2003 for this agency. Until these 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 reconciled, the 

effect that these differences may have on the U.S. government’s 

consolidated financial statements will be unknown. OMB has stated that it 

plans to work with the agencies to address this issue.

3

OMB and U.S. generally accepted accounting principles (GAAP) require agencies to report 

net outlays in the SBR. The Statement of Changes in Cash Balance also reports unified 

budget outlays-actual. Both are intended to represent the same amount and be consistent 

with the information presented in the budget of the U.S. government. 

4

In some agencies’ fiscal year 2003 financial statements, the comparable fiscal year 2002 

amounts were restated.

5

Offsetting receipts are collections that are credited to general fund, special fund, or trust 

fund receipt accounts and that offset gross outlays at the agency or governmentwide level.

6

These two agencies did not adequately explain their fiscal year 2002 differences between 

the net outlays reported on the SBR and the budget of the U.S. government in their notes to 

the fiscal year 2003 financial statements.
Appendix II

Material Deficiencies

Page 28 GAO-04-886T 

Preparation of Consolidated 

Financial Statements

The federal government did not have adequate 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 generally accepted accounting principles 

(GAAP). During our fiscal year 2003 audit, we found the following:7

• The process for compiling the consolidated financial statements does 

not directly link information from federal agencies’ audited financial 

statements to amounts reported in the consolidated financial 

statements, and therefore does not ensure that the information in the 

consolidated financial statements is consistent with the underlying 

information in federal agencies’ audited financial statements and other 

financial data.

• Internal control weaknesses exist in Treasury’s process for preparing 

the consolidated financial statements, such as a lack of (1) segregation 

of duties and (2) appropriate documentation of certain policies and 

procedures for preparing the consolidated financial statements.

• The net position reported in the consolidated financial statements is 

derived by subtracting liabilities from assets, rather than through 

balanced accounting entries. To make the fiscal years 2003 and 2002 

consolidated financial statements balance, Treasury recorded a net 

$24.5 billion and a net $17.1 billion decrease, 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.”8

 An additional net $11.3 billion and $12.5 billion 

of unreconciled transactions were recorded in the Statements of Net 

Cost for fiscal years 2003 and 2002, respectively. Treasury does not 

7

The same issues we identified in fiscal year 2003 existed in fiscal year 2002, and some have 

existed for a number of years. In October 2003, we reported in greater detail on the issues 

we identified, in U.S. General Accounting Office, Financial Audit: Process for Preparing 

the Consolidated Financial Statements of the U.S. Government Needs Improvement, GAO04-45 (Washington, D.C.: Oct. 30, 2003). This report included 44 recommendations to 

address weaknesses we identified. It also included recommendations related to 16 

disclosure areas that are required by GAAP. We recommended that the 16 disclosures that 

are not included in the consolidated financial statements either be included or that the 

rationale for their exclusion be documented.

8

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.
Appendix II

Material Deficiencies

Page 29 GAO-04-886T 

identify and quantify all components of these unreconciled activities, 

nor does Treasury perform reconciliation procedures, which would aid 

in understanding and controlling the net position balance as well as 

eliminating the unreconciled transactions associated with compiling the 

consolidated financial statements. 

• Significant differences in other intragovernmental accounts, primarily 

related to appropriations, still remain unresolved. Intragovernmental 

activity and balances are “dropped” or “offset” in the preparation of the 

consolidated financial statements rather than eliminated through 

balanced accounting entries. This contributes to the federal 

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

amounts reported in the consolidated financial statements.

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

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

fiscal year 2003 showed a net operating cost of $665 billion, to the 

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

deficit of $374.8 billion.

• The consolidated financial statements include certain 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 such excluded financial 

information was immaterial.

• Treasury lacks an adequate process to ensure that the financial 

statements, related notes, Stewardship Information, and Supplemental 

Information are presented in conformity with GAAP. We found that 

certain financial information required by GAAP was not disclosed in the 

consolidated financial statements. Treasury did not provide us with 

documentation of its rationale for excluding this information. As a result 

of this and certain material deficiencies noted above, we were unable to 

determine if the missing information was material to the consolidated 

financial statements. 
Appendix II

Material Deficiencies

Page 30 GAO-04-886T 

Other Material 

Weaknesses

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

material weaknesses in internal control as of September 30, 2003: (1) 

several federal agencies continue to have deficiencies in the processes and 

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

their related loans receivable; (2) most federal agencies have not reported 

the magnitude of improper payments in their programs and activities; (3) 

federal agencies have not yet fully institutionalized comprehensive security 

management programs; and (4) material internal control weaknesses and 

systems deficiencies continue to affect the federal government’s ability to 

effectively manage its tax collection activities.

Loans Receivable and Loan 

Guarantee Liabilities

In general, federal agencies continue to make progress in reducing the 

number of material weaknesses and reportable conditions9 related to their 

lending activities. However, significant deficiencies in the processes and 

procedures used to estimate the costs of certain lending programs and 

value the related loans receivable still remain. These deficiencies continue 

to adversely affect the 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. The 

most notable deficiencies existed at the Small Business Administration 

(SBA), which, while improved from last year, continues to have a material 

weakness related to this area. For example, SBA did not adequately 

document its estimation methodologies, lacked the management controls 

necessary to ensure that appropriate estimates were prepared and reported 

based on complete and accurate data, and could not fully support the 

reasonableness of the costs of its lending programs and valuations of its 

loan portfolio. We are currently assessing SBA’s actions to resolve certain 

of these deficiencies related to accounting for previous loan sales and cost 

estimates for disaster loans.

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

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

9

Reportable conditions are matters coming to our attention that, in our judgment, should be 

communicated because they represent significant deficiencies in the design or operation of 

internal control that could adversely affect the federal government’s ability to meet the 

internal control objectives relating to financial reporting and compliance with laws and 

regulations.
Appendix II

Material Deficiencies

Page 31 GAO-04-886T 

management, federal financial assistance, and tax refunds.10 While 

complete information on the magnitude of improper payments is not yet 

available, based on available data, OMB has estimated that improper 

payments exceed $35 billion annually. Many improper payments occur in 

federal programs that are administered by entities other than the federal 

government, such as states. Improper payments often result from a lack of 

or an inadequate system of internal controls. Although the President’s 

Management Agenda includes an initiative to reduce improper payments, 

most federal agencies have not reported the magnitude of improper 

payments in their programs and activities.

The Improper Payments Information Act of 200211 provides for federal 

agencies to estimate and report on their improper payments. It requires 

federal agencies to (1) annually review programs and activities that they 

administer to identify those that may be susceptible to significant improper 

payments, (2) estimate improper payments in susceptible programs and 

activities, and (3) provide reports to the Congress that discuss the causes 

of improper payments identified and the status of actions to reduce them. 

In accordance with the legislation, OMB issued guidance for federal 

agencies’ use in implementing the act. Among other things, the guidance 

requires federal agencies to report on their improper payment-related 

activities in the Management Discussion and Analysis section of their 

annual Performance and Accountability Reports (PAR). While the act does 

not require such reporting by all federal agencies until fiscal year 2004, 

OMB required 44 programs and 14 CFO Act agencies to report improper 

payment information in their fiscal year 2003 PARs. Our preliminary review 

of the PARs found that 12 of the 14 agencies reported improper payment 

amounts for 27 of the 44 programs identified in the guidance. We also found 

that, for the programs where improper payments were identified, the 

reports often contained information on the causes of the payments but 

little information that addressed the other reporting requirements cited in 

the legislation.

10Improper 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. 

11Pub. L. No. 107-300, 116 Stat. 2350 (Nov. 26, 2002). The act's reporting requirement on 

actions taken by agencies to reduce improper payments applies only to an agency program 

or activity with estimated improper payments exceeding $10 million.
Appendix II

Material Deficiencies

Page 32 GAO-04-886T 

Information Security Although progress has been made, serious and widespread information 

security 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 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 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 by recent hearings on information security and 

enactment of the Federal Information Security Management Act of 200212

and the Cyber Security Research and Development Act.13 In addition, the 

administration has taken important actions to improve information 

security, such as integrating information security into the Executive Branch 

Management Scorecard.14

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

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

collection activities.15 Due to errors and delays in recording activity in 

taxpayer accounts, 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.

12E-Government Act of 2002, Pub. L. No. 107-347, title III, 116 Stat. 2899, 2946 (Dec. 17, 2002). 

13Pub. L. No. 107-305, 116 Stat. 2367 (Nov. 27, 2002).

14The Executive Branch Management Scorecard highlights agencies’ progress in achieving 

management and performance improvements embodied in the President’s Management 

Agenda.

15U.S. General Accounting Office, Financial Audit: IRS’s Fiscal Years 2003 and 2002 

Financial Statements, GAO-04-126 (Washington, D.C.: Nov. 13, 2003).
Page 33 GAO-04-886T 

Appendix III

Primary Effects of the Material Weaknesses 

Described in This Report ApendxiI

Areas Involving Material 

Weaknesses

Primary Effects on the Fiscal Years 2003 and 2002 Consolidated Financial Statements and 

the Management of Government Operations

Property, plant, and equipment 

and inventories and related 

property

Without accurate 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 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.

Liabilities and commitments and 

contingencies

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 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 allow for appropriate consideration of 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.

Cost of government operations 

and disbursement activity

Inaccurate 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.

Accounting for and 

reconciliation of 

intragovernmental activity and 

balances

Problems in accounting for and reconciling intragovernmental activity and balances impair the 

government’s ability to account for billions of dollars of transactions between governmental entities.

Net outlays Until the differences between the total net outlays reported in federal agencies’ Statements of 

Budgetary Resources and the records used by the Department of the Treasury to prepare the 

Statement of Changes in Cash Balance from Unified Budget and Other Activities are reconciled, the 

effect that these differences may have on the U.S. government’s consolidated financial statements 

will be unknown.

Preparation of consolidated 

financial statements

Because the federal government did not have adequate systems, controls, and procedures to 

prepare its consolidated financial statements, the federal government’s ability to ensure that the 

consolidated financial statements are consistent with the underlying audited agency financial 

statements, balanced, and in conformity with U.S. generally accepted accounting principles was 

impaired.

Improper payments Without a systematic measurement of the extent of improper payments, federal agency 

management cannot determine (1) if improper payment problems exist that require corrective 

action, (2) mitigation strategies and the appropriate amount of investments to reduce them, and 

(3) the success of efforts implemented to reduce improper payments.

Loans receivable and loan 

guarantee liabilities

Weaknesses in the processes and procedures for estimating credit program costs affect the 

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. 

Information security weaknesses Information security weaknesses over computerized operations are placing enormous amounts of 

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.
Appendix III

Primary Effects of the Material Weaknesses 

Described in This Report

Page 34 GAO-04-886T 

Source: GAO.

Tax collection activities 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 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.

(Continued From Previous Page)

Areas Involving Material 

Weaknesses

Primary Effects on the Fiscal Years 2003 and 2002 Consolidated Financial Statements and 

the Management of Government Operations

(198304)
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