GAO

United States General Accounting Office

Report to the Secretary of the Treasury

March 2001 FINANCIAL AUDIT

IRS’ Fiscal Year 2000 

Financial Statements

GAO-01-394

Page 1 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

Contents

Letter 3

Auditor’s Report 5

Management 

Discussion and 

Analysis

16

Financial Statements 54

Balance Sheet 54

Statement of Net Cost 55

Statement of Changes in Net Position 56

Statement of Budgetary Resources 57

Statement of Financing 58

Statement of Custodial Activity 59

Notes to the Financial Statements 60

Supplemental and 

Other Accompanying 

Information

77

Appendixes Appendix I: Material Weaknesses and Management Challenges, 

Reportable Conditions, and Compliance Issues 84

Appendix II: Details on Audit Methodology 106

Appendix III: Comments From the Internal Revenue Service 107
Contents

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Abbreviations

EITC Earned Income Tax Credit

FFMIA Federal Financial Management Improvement Act of 1996

FFMSR Federal Financial Management Systems Requirements

FIA Federal Managers' Financial Integrity Act

IRS Internal Revenue Service

JFMIP Joint Financial Management Improvement Program

OMB Office of Management and Budget

P&E property and equipment

SFFAS Statement of Federal Financial Accounting Standards

SGL U.S. Government Standard General Ledger

SSA Social Security Administration

TIGTA Treasury Inspector General for Tax Administration
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United States General Accounting Office

Washington, D.C. 20548

Comptroller General

of the United States

Letr

March 1, 2001

The Honorable Paul H. O’Neill

The Secretary of the Treasury

Dear Mr. Secretary:

The accompanying report presents the results of our audit of the financial 

statements of the Internal Revenue Service (IRS) as of and for the fiscal 

year ending September 30, 2000. Our audit was required by the Chief 

Financial Officers Act of 1990, as expanded by the Government 

Management Reform Act of 1994. This report contains our (1) unqualified 

opinion on IRS’ financial statements, (2) opinion that internal controls at 

IRS as of September 30, 2000, were not effective, and (3) report on IRS’ 

noncompliance with two provisions of laws and regulations that we tested 

and IRS’ financial management systems’ lack of substantial compliance 

with the requirements of the Federal Financial Management Improvement 

Act of 1996. 

Our unqualified opinion on IRS’ fiscal year 2000 financial statements was 

due to the extraordinary efforts of IRS senior management and staff to 

compensate for serious internal control and systems deficiencies. There 

has been a tremendous amount of hard work and commitment over the last 

2 years, and there have been some significant improvements. Such efforts 

will be needed to sustain this result in future years until lasting solutions to 

IRS’ internal controls and systems deficiencies are fully achieved. Despite 

these significant efforts and the resulting unqualified opinion on its fiscal 

year 2000 financial statements, IRS does not have timely, accurate, and 

useful financial information and sound controls with which to make 

informed decisions and to ensure accountability on an ongoing basis.

The accompanying report also discusses other significant issues that we 

considered in performing our audit and in forming our conclusions that we 

believe should be brought to the attention of IRS management and users of 

IRS’ financial statements. We will report our recommendations for 

corrective actions to address the weaknesses in IRS’ internal controls and 

compliance with law and regulation issues in a separate report to be issued 

at a later date.
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We are sending copies of this report to the Chairmen and Ranking Members 

of the Senate Committee on Appropriations; Senate Committee on Finance; 

Senate Committee on Governmental Affairs; Senate Committee on the 

Budget; Subcommittee on Treasury, General Government, and Civil 

Service, Senate Committee on Appropriations; Subcommittee on Taxation 

and IRS Oversight, Senate Committee on Finance; Subcommittee on 

Oversight of Government Management, Restructuring, and the District of 

Columbia, Senate Committee on Governmental Affairs. We are also sending 

copies of this report to the Chairmen and Ranking Minority Members of the 

House Committee on Appropriations; House Committee on Ways and 

Means; House Committee on Government Reform; House Committee on 

the Budget; Subcommittee on Government Efficiency, Financial 

Management, and Intergovernmental Relations, House Committee on 

Government Reform; and Subcommittee on Oversight, House Committee 

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

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

Commissioner of Internal Revenue, the Director of the Office of 

Management and Budget, the Chairman of the IRS Oversight Board, and 

other interested parties. Copies will be made available to others upon 

request.

This report was prepared under the direction of Steven J. Sebastian, Acting 

Director, Financial Management and Assurance, who can be reached at 

(202) 512-3406. If I can be of further assistance, please call me at 

(202) 512-5500.

Sincerely yours,

David M. Walker

Comptroller General

of the United States
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United States General Accounting Office

Washington, D.C. 20548

Comptroller General

of the United States

AudtRosir’eport

To the Commissioner of Internal Revenue

In accordance with the Chief Financial Officers (CFO) Act of 1990, as 

expanded by the Government Management Reform Act of 1994, this report 

presents the results of our audit of the financial statements of the Internal 

Revenue Service (IRS) for fiscal year 2000. The financial statements report 

the assets, liabilities, net position, net costs, changes in net position, 

budgetary resources, reconciliation of net costs to budgetary obligations, 

and custodial activity related to IRS’ administration of its responsibilities 

for implementing federal tax legislation. The financial statements do not 

include a measurement of the amount of taxes legally owed the federal 

government but which have not been identified by IRS, often referred to as 

the “tax gap.”

In its role as the nation’s tax collector, IRS has a demanding responsibility 

in collecting taxes, processing tax returns, and enforcing the nation’s tax 

laws. The size and complexity of IRS’ operations present additional 

challenges to management. IRS is a large, complex, decentralized 

organization with about 100,000 people in 10 service centers,1

 3 computing 

centers, and many other field offices throughout the United States. 

Historically, most IRS offices other than headquarters have had 

responsibilities tied to their geographical locations. However, in response 

to congressional concerns about IRS’ operations embodied in the Internal 

Revenue Service Restructuring and Reform Act of 1998, IRS is undergoing a 

reorganization that is significantly affecting the past roles and 

responsibilities of these offices. In fiscal year 2000, IRS collected over 

$2 trillion in taxes, processed over 210 million tax returns, and paid about 

$194 billion in refunds to taxpayers. 

1

As part of its ongoing reorganization, IRS now calls these offices “campuses.”
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IRS continues to face most of the pervasive systems and internal control 

weaknesses that we have reported each year since we began auditing IRS’ 

financial statements in fiscal year 1992.2

 Despite these weaknesses, in fiscal 

year 2000, IRS was able to produce for the first time combined financial 

statements covering its tax custodial and administrative activities that are 

fairly stated in all material respects.3

 This achievement was the culmination 

of 2 years of extraordinary effort on the part of IRS to develop 

compensating processes to work around its serious systems and control 

weaknesses to derive year-end balances for its financial statements and 

address several of the management issues we raised in previous reports. 

IRS laid the groundwork for sustainable improvements in several critical 

areas. However, IRS’ approach to obtaining this unqualified opinion on its 

fiscal year 2000 financial statements relied heavily on costly, timeconsuming processes; statistical projections; external contractors; 

substantial adjustments; and monumental human efforts that extended 

well after the September 30, 2000, fiscal year-end. The tremendous 

commitment on the part of both IRS senior management and staff was the 

key to IRS’ ability to achieve its goal of receiving an unqualified audit 

opinion on its financial statements for fiscal year 2000. At the same time, 

these costly efforts would not be necessary if IRS’ systems and controls 

operated effectively. In addition, the absence of effective systems and 

controls means that IRS lacks the timely, accurate, and useful information 

to make informed management decisions and ensure adequate 

accountability on an ongoing basis.

IRS’ achievement is an important milestone. At the same time, sustaining 

this success will require a continued high level of involvement by IRS 

senior management and further efforts to obtain lasting solutions to its 

fundamental systems and internal control deficiencies. IRS has made 

notable progress in several areas. Specifically, we noted significant 

improvements in IRS’ policies and procedures over its fund balance with 

Treasury and transactions held in suspense and in its documentation of 

2

Financial Audit: Examination of IRS’ Fiscal Year 1992 Financial Statements

(GAO/AIMD-93-2, June 30, 1993).

3

In fiscal year 1997, IRS received for the first time unqualified audit opinions on separate 

financial statements covering its tax custodial activities (by GAO) and its administrative 

activities (by the Department of Treasury Office of Inspector General). In fiscal year 1998, 

IRS combined its tax custodial and administrative activities in one set of financial 

statements. GAO was able to determine in fiscal years 1998 and 1999 that the taxes 

receivable balance reported on the balance sheet and the tax revenue and refunds reported 

in the statement of custodial activity were fairly stated.
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unpaid tax assessments that, if effectively sustained in the future, should 

prevent a reemergence of the problems that we found in these areas in 

prior years. IRS also made improvements in computer security and 

handling of taxpayer receipts and data, although further improvement is 

needed in each of these areas. In addition, IRS is working aggressively to 

address issues we have raised regarding controls over its budgetary 

activity. While more efforts are needed in this area, measurable progress 

has been made. 

IRS senior management has continued to demonstrate a strong 

commitment to address the operational and financial management issues 

discussed in this report. This high level of involvement by IRS senior 

management has greatly contributed to actions taken to resolve some of 

the issues we have raised. Continued involvement at this level is critical to 

IRS’ success in addressing the serious internal control and systems 

problems that remain. While IRS was able to produce financial statements 

that were fairly stated in all material respects using compensating 

processes, this approach does not produce the reliable, useful, and timely 

financial and performance information IRS needs for decision-making on 

an ongoing basis which is the goal of the CFO Act. Also, this approach does 

not address the underlying financial management and operational issues 

that adversely affect IRS’ ability to effectively fulfill its responsibilities as 

the nation’s tax collector. We reported on these continuing significant 

challenges for IRS in our recently issued high-risk and performance and 

accountability series4

 and other reports. 

The challenge for IRS will be to build on the improvements made in fiscal 

year 2000 to not only improve its compensating processes but, more 

importantly, to develop and implement the fundamental long-term 

solutions that are needed to address the management challenges we have 

identified. Some of these solutions can be addressed in the near term 

through the continued efforts and commitment of IRS senior management 

and staff. Others, which involve modernizing IRS’ financial and operational 

systems, will take years to fully achieve. Until IRS’ systems and processes 

are overhauled and internal controls are strengthened, “heroic” efforts will 

have to be sustained for IRS to continue to receive an unqualified audit 

opinion in future years.

4

High-Risk Series: An Update (GAO-01-263, January 2001) and Major Management 

Challenges and Program Risks: Department of the Treasury (GAO-01-254, January 2001). 
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Opinion on IRS’ 

Financial Statements

IRS’ financial statements, including the accompanying notes, present fairly, 

in all material respects, in conformity with U.S. generally accepted 

accounting principles, IRS’ assets, liabilities, net position, net costs, 

changes in net position, budgetary resources, reconciliation of net costs to 

budgetary obligations, and custodial activity, as of and for the fiscal year 

ended September 30, 2000.

However, misstatements may nevertheless occur in other financial 

information reported by IRS as a result of the internal control weaknesses 

described in this report.

IRS’ financial statements report tax revenues collected during the fiscal 

year and the cumulative amounts of unpaid taxes where there is agreement 

with IRS, either by the taxpayer or court, as to the amounts owed. 

Cumulative unpaid tax assessments where there is no future collection 

potential or where there is no agreement as to the amounts owed are not 

reported in the financial statements, but are reported as write-offs and 

compliance assessments, respectively, in supplemental information to IRS’ 

financial statements. However, to the extent that taxes owed in accordance 

with the nation’s tax laws are not reported by taxpayers and are not 

identified through IRS’ various enforcement programs, in accordance with 

U.S. generally accepted accounting principles, they are not reported in the 

financial statements nor in supplemental information to the financial 

statements. As IRS discusses in the other accompanying information to the 

financial statements, IRS does not have current information upon which to 

base a reasonable estimate of the magnitude of these unidentified and 

unpaid taxes—referred to as the “tax gap.” We have discussed this issue in 

our recently issued high risk series.5

5

High Risk Series: An Update (GAO-01-263, January 2001).
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Opinion on Internal 

Controls

Because of the material weaknesses6 in internal controls discussed below, 

IRS did not maintain effective internal controls over financial reporting 

(including safeguarding of assets) or compliance with laws and regulations, 

and thus did not provide reasonable assurance that losses, misstatements, 

and noncompliance with laws material in relation to the financial 

statements would be prevented or detected in an ongoing manner and on a 

timely basis. 

Despite the material weaknesses in internal controls, IRS was able to 

prepare, through compensating processes and approaches to work around 

its serious internal control and systems deficiencies, financial statements 

that were fairly stated in all material respects for fiscal year 2000. 

Nonetheless, IRS continues to face the following key issues which 

represent material weaknesses in internal controls and management 

challenges: 

• an inadequate financial reporting process, resulting in IRS not having 

current and reliable ongoing information to support management 

decision-making and to prepare cost-based performance measures;

• weaknesses in controls and other limitations affecting its ability to 

properly manage unpaid assessments, resulting in both taxpayer burden 

and potentially billions of dollars in lost revenue to the government;

• weaknesses in controls over tax refunds, permitting the disbursement of 

potentially billions of dollars of improper refunds;

• inadequate controls over property and equipment, resulting in IRS’ 

inability to reasonably ensure that its property and equipment is 

safeguarded and used only in accordance with management policy;

• inadequate budgetary controls, resulting in IRS’ inability to routinely 

ensure that its budgetary resources are being properly accounted for, 

reported, and controlled; and

• weaknesses in computer security controls that may allow unauthorized 

individuals to access, alter, or abuse proprietary IRS programs and 

electronic data and taxpayer information.

6

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

providing reasonable assurance that material misstatements in the financial statements 

would be prevented or detected on a timely basis. 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 controls that could adversely 

affect IRS’ ability to meet the objectives described in this report.
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The material weaknesses in internal control noted above may adversely 

affect any decision by IRS’ management that is based, in whole or in part, 

on information that is inaccurate because of these weaknesses. In addition, 

unaudited financial information reported by IRS, including budget and 

performance information, may also contain misstatements resulting from 

these weaknesses. 

In addition to the material weaknesses discussed above, we identified two 

reportable conditions which, although not material weaknesses, represent 

significant deficiencies in the design or operation of internal controls that 

could adversely affect IRS’ ability to meet the internal control objectives 

described in this report. These conditions concern:

• deficiencies in controls over hardcopy tax receipts and taxpayer data 

that increase the government’s and taxpayers’ risk of loss or 

inappropriate disclosure of taxpayer data; and

• deficiencies and limitations in revenue reporting and excise tax 

distributions, resulting in IRS’ inability to separately report revenue 

collected for three of the federal government’s four largest revenue 

sources and errors in quarterly distributions of excise tax revenue to 

trust funds.

We have reported on these material weaknesses and reportable conditions 

in prior audits and have provided IRS numerous recommendations to 

address these issues, of which over 80 were still open as of the date of this 

letter. We will follow up in future audits to monitor IRS’ progress in 

implementing these recommendations. For more details on these issues, 

see appendix I.

Compliance with Laws 

and Regulations and 

FFMIA Requirements

Our tests of compliance with selected provisions of laws and regulations 

disclosed two instances of noncompliance with laws and regulations that 

are reportable under U.S. generally accepted government auditing 

standards or OMB guidance. These relate to IRS’ structuring of installment 

agreements to collect delinquent taxes and the timing of the release of tax 

liens on taxpayers’ property. Also, IRS’ financial management systems did 

not substantially comply with the following requirements of the Federal 

Financial Management Improvement Act of 1996 (FFMIA): (1) Federal 

Financial Management Systems Requirements, (2) applicable federal 

accounting standards (U.S. generally accepted accounting principles), and 

(3) the U.S. Government Standard General Ledger (SGL) at the transaction 

level. IRS has readily acknowledged that its financial management systems 
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do not comply with FFMIA and the need to overhaul these systems as part 

of its broader systems modernization efforts. For more details on these 

issues, see appendix I.

Except as noted above, our tests for compliance with the laws and 

regulations disclosed no other instances of noncompliance that would be 

reportable under U.S. generally accepted government auditing standards or 

OMB audit guidance. However, the objective of our audit was not to 

provide an opinion on overall compliance with laws and regulations. 

Accordingly, we do not express such an opinion.

Consistency of Other 

Information

Management’s Discussion and Analysis, required supplemental 

information, and other accompanying information contain a wide range of 

data, some of which are not directly related to the financial statements. We 

did not audit and do not express an opinion on this information. However, 

we compared this information for consistency with the financial 

statements and discussed the methods of measurement and presentation 

with IRS officials. Based on this limited work, we found no material 

inconsistencies with the financial statements or nonconformance with 

OMB guidance. Under OMB Bulletin 97-01, as amended, agencies are asked 

to strive to develop and report objective measures that, to the extent 

possible, provide information about the cost-effectiveness of their 

programs. However, we found that IRS cannot report reliable cost-based 

performance measures relating to its various programs in accordance with 

the Government Performance and Results Act of 1993. 

Objectives, Scope, and 

Methodology

Management is responsible for (1) preparing the annual financial 

statements in conformity with U.S. generally accepted accounting 

principles, (2) establishing, maintaining, and assessing internal control to 

provide reasonable assurance that the broad control objectives of 31 U.S.C. 

§3512, (c), (d), (Federal Managers’ Financial Integrity Act (FIA)) are met, 

(3) complying with applicable laws and regulations, and (4) ensuring that 

the agency’s financial management systems substantially comply with the 

requirements of FFMIA. 

We are responsible for obtaining reasonable assurance about whether 

(1) the financial statements are presented fairly, in all material respects, in 

conformity with U.S. generally accepted accounting principles and 
Page 12 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

(2) management maintained effective internal controls, the objectives of 

which are the following: 

• Financial reporting—transactions are properly recorded, processed, 

and summarized to permit the preparation of financial statements in 

conformity with U.S. generally accepted accounting principles and 

assets are safeguarded against loss from unauthorized acquisition, use, 

and disposition. 

• Compliance with laws and regulations—transactions are executed in 

accordance with laws governing the use of budget authority and with 

other laws and regulations that could have a direct and material effect 

on the financial statements and any other laws, regulations, and 

governmentwide policies identified by OMB audit guidance. 

We are also responsible for testing compliance with (1) selected provisions 

of laws and regulations that have a direct and material effect on the 

financial statements, (2) laws for which OMB audit guidance requires 

testing, and (3) FFMIA requirements. In addition, we are responsible for 

performing limited procedures with respect to certain other information 

appearing in these annual financial statements. For more details on our 

methodology, see appendix II.

We did not evaluate all internal controls relevant to operating objectives as 

broadly described by FIA, such as controls relevant to preparing statistical 

reports and ensuring efficient operations. We limited our internal control 

testing to testing controls over financial reporting and compliance. 

We did not test compliance with all laws and regulations applicable to IRS. 

We limited our tests of compliance to legal provisions that we considered 

applicable to the financial statements for the fiscal year ended September 

30, 2000, and were either included in the Internal Revenue Code or required 

to be tested by OMB guidance. We caution that noncompliance other than 

that discussed in this report may occur and not be detected by these tests 

and that such testing may not be sufficient for other purposes. 

We performed our work in accordance with U.S. generally accepted 

government auditing standards and OMB audit guidance. 

Agency Comments and 

Our Evaluation

In responding to this report, IRS recognized the extraordinary efforts 

necessary to overcome its serious systems deficiencies and internal control 

weaknesses in order to prepare financial statements for fiscal year 2000 
Page 13 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

that were fairly stated in all material respects. IRS also acknowledged the 

need to sustain these efforts and to continue to address its systems and 

control deficiencies but noted that ultimately, long-term resolutions to 

many of these issues can only be addressed through its ongoing systems 

modernization efforts. IRS highlighted its accomplishments thus far in 

addressing these issues, and summarized many of the corrective actions it 

has in progress or planned which it believes will ultimately achieve this 

goal. For example, IRS cited improvements in areas such as routine 

reconciliations of its fund balance, proper classification of program costs, 

review and management of its suspense accounts, and substantiation of 

unpaid assessments through better documentation. IRS also cited 

continuing efforts to address issues such as accountability over property 

and equipment, computer security, and security of hard copy tax receipts 

and taxpayer data. We will evaluate the effectiveness of these efforts during 

future audits. 

IRS generally agreed with our discussion of its problems with financial 

reporting, but believed that our discussion of the quality of the data in its 

general ledger systems could mislead readers. We clarified our discussion 

of this issue to address IRS’ concern. However, we did not accept IRS’ 

suggested alternate language because we believe it gives the impression 

that the problem with IRS’ general ledger data integrity relates primarily to 

IRS’ practice of not posting certain types of transactions until year-end, 

such as the capitalization of costs incurred in purchasing property and 

equipment (P&E). However, as discussed in appendix I to this report, as of 

September 30, 2000, IRS’ general ledger did not include material amounts of 

fiscal year 2000 transactions, and in fact, these transactions were not 

recorded until months after the end of the year. In addition to the 

capitalization of P&E and related depreciation expense, these included 

many other material transactions, such as recognition of expenses for 

goods and services received during fiscal year 2000 but not yet recorded. 

IRS also recorded material adjustments to correct misstatements caused by 

previous delays in recording transactions, such as fiscal year 1999 

expenses that were not recorded until fiscal year 2000. 

In commenting on this report’s discussion of unpaid assessments, IRS 

noted that the cost-benefit analysis discussed in this report would not 

produce more resources nor necessarily indicate that the programs subject 

to such an analysis should be expanded. The purpose of such analysis is 

not to increase resources. Rather, the objective is to provide IRS 

management with the basic information needed to make decisions 

involving allocation of limited resources among competing priorities, and 
Page 14 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

once such decisions are made, to enable IRS to justify its decisions. This 

analysis would also better position IRS to determine if increases in total 

resources are warranted and to support related budgetary requests to 

Congress. IRS indicated a preference for addressing this issue through its 

strategic planning and budgeting process. However, in the absence of basic 

cost-benefit information to support this process, the basis for IRS’ 

decisions will remain unclear. 

IRS generally agreed with the report’s discussion of weaknesses in controls 

over P&E, but believed that our report did not put into proper perspective 

the progress IRS believes it achieved in P&E management in fiscal year 

2000. As we state in appendix I, we noted progress in IRS’ efforts to 

improve the timeliness and accuracy of its P&E records, nonetheless, while 

improvements were made, we found that these efforts were not fully 

effective as demonstrated by the significant number of errors in IRS’ 

property records we continued to find during our testing. In addition, it was 

only through an interim process involving enormous manual efforts by IRS 

employees, and the costly assistance of a contractor, that IRS was able to 

report a reliable P&E balance in its financial statements. Throughout fiscal 

year 2000, the lack of an integrated property management system 

precluded IRS’ ability to report timely, reliable P&E information. We 

recognize the extraordinary efforts of IRS staff and we applaud 

management’s commitment to working to correct the long-standing 

weaknesses that we identified. However, the progress that IRS made in 

fiscal year 2000 was not sufficient to correct the fundamental deficiencies 

in its property management system. We will continue to evaluate the 

effectiveness of IRS’ initiatives to correct deficiencies during future audits 

and to assist it in its efforts with suggestions and recommendations.
Page 15 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

IRS had several other specific comments to the draft report. These 

comments, along with the complete text of IRS’ response, are included in 

appendix III. 

David M. Walker

Comptroller General

of the United States

February 9, 2001
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Management Discussion and Analysis
Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Management Discussion and Analysis

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Financial Statements

Balance Sheet
Financial Statements

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Statement of Net Cost
Financial Statements

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Statement of Changes in Net Position
Financial Statements

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Statement of Budgetary Resources
Financial Statements

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Statement of Financing
Financial Statements

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Statement of Custodial Activity
Financial Statements

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Notes to the Financial Statements
Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Financial Statements

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Supplemental and Other Accompanying 

Information
Supplemental and Other Accompanying 

Information

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Supplemental and Other Accompanying 

Information

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Supplemental and Other Accompanying 

Information

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Supplemental and Other Accompanying 

Information

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Information

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Appendix I

Material Weaknesses and Management Apendxies

Challenges, Reportable Conditions, and 

Compliance Issues ApendxiI

Material Weaknesses 

and Management 

Challenges

During our audit of IRS’ fiscal year 2000 financial statements, we identified 

six material weaknesses in internal controls. Some of these material 

weaknesses and their related management challenges have allowed 

inappropriate refunds to be paid, reduced IRS’ effectiveness in enforcing 

the tax code, and resulted in errors in taxpayer accounts and increased 

taxpayer burden. The issues that we have identified and discuss in this 

report relate to IRS’ controls over (1) the financial reporting process, 

(2) management of unpaid assessments, (3) refunds, (4) property and 

equipment, (5) budgetary activities, and (6) computer security. We reported 

on each of these issues last year.1

 We highlight these issues in the following 

sections and plan to provide more details on them, as well as 

recommendations for corrective actions, in a subsequent report. Less 

significant matters involving IRS’ system of internal controls and its 

operation will be separately reported in a management letter to IRS.

In our previous report on the results of our audit of IRS’ fiscal year 1999 

financial statements, we reported on a material weakness with respect to 

IRS’ failure to routinely reconcile its fund balance with Treasury. During 

fiscal year 2000, IRS implemented monthly reconciliation procedures for its 

fund balance with Treasury that were operating effectively during fiscal 

year 2000. Accordingly, we no longer consider this to be a material 

weakness.

Financial Reporting In fiscal year 2000, as in prior years, IRS did not have adequate internal 

controls over its financial reporting process. IRS was unable to routinely, 

reliably, and timely generate the information needed to prepare its financial 

statements and manage operations on an ongoing basis. IRS does not 

(1) have an adequate general ledger system for financial reporting and 

management purposes, (2) record material transactions in its general 

ledger system in a timely manner, and (3) have adequate detailed 

supporting records for several material accounts. To compensate for these 

weaknesses, IRS depended on extensive, labor-intensive ad hoc procedures 

to enable it to report reliable balances in its financial statements. 

1

Financial Audit: IRS’ Fiscal Year 1999 Financial Statements (GAO/AIMD-00-76, February 29, 

2000).
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IRS’ general ledger system (1) comprises two independent general ledgers 

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

for material balances,2

 (2) is not current or accurate, and (3) is not 

supported by adequate audit trails for property and equipment, federal tax 

revenue, federal tax refunds, taxes receivable, or budgetary activity. In 

addition, IRS’ general ledger for its custodial activities does not use the 

standard federal accounting classification structure. Because of these 

deficiencies, IRS’ general ledger system does not conform with the U.S. 

Government Standard General Ledger (SGL) as required by the Core 

Financial System Requirements of the Joint Financial Management 

Improvement Program3

 or the requirements of FFMIA. Consequently, IRS 

continued to be unable to rely on its general ledger system to fully support 

its financial statements.

IRS often does not record material transactions in its general ledger system 

until months after they occur. As a result, material balances in the general 

ledger systems cannot be used by managers as a reliable source of current 

financial data at interim periods. Consequently, for IRS to use its general 

ledger system for financial reporting or other management purposes, IRS 

must first supplement it with extensive analysis and material adjustments 

to recognize transactions that have not yet been recorded. This approach is 

costly, labor-intensive, and typically requires several months to complete. 

For fiscal year 2000, this process was not completed until February 2001, 

and required billions of dollars in adjustments to recognize fiscal year 2000 

transactions that were not yet recorded in the general ledger. This 

approach is also prone to errors that are not always caught and corrected 

by management. For fiscal year 2000, substantial additional audit 

adjustments were necessary to prevent the resultant financial statements 

from being materially misstated. As a result of these problems, IRS cannot 

produce reliable financial statements or financial performance information 

throughout the year as a management tool, as is standard practice in 

private industry and some federal entities.

2

IRS’ two independent general ledgers support its administrative and custodial operations. 

3

The Joint Financial Management Improvement Program (JFMIP) is a cooperative 

undertaking of the Office of Management and Budget, the Department of the Treasury, the 

Office of Personnel Management, and GAO working in cooperation with each other and 

with operating agencies to improve financial management practices.
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We previously reported that IRS commingled customer service and 

compliance costs on its statement of net costs.4

 To address this issue, IRS 

revised the format of its statement of net cost and significantly expanded 

and enhanced the related disclosures in fiscal year 2000. The resulting 

presentation appropriately classified the cost of IRS’ programs.

Management of Unpaid Tax 

Assessments

During fiscal year 2000, we found that serious internal control issues and 

other management challenges continued to affect IRS’ management of 

unpaid assessments. IRS was able to report amounts for taxes receivable 

and other unpaid assessments5

 in its financial statements and supplemental 

information that were fairly stated in all material respects, using statistical 

sampling techniques and estimation procedures. However, the lack of an 

effective subsidiary ledger; errors and delays in recording taxpayer 

information, payments, and other activities; and the inability to actively 

pursue significant amounts in outstanding taxes owed to the federal 

government continue to hinder IRS’ ability to effectively manage unpaid 

assessments. 

4

 GAO/AIMD-00-76, February 29, 2000.

5

Unpaid assessments consist of (1) taxes due from taxpayers for which IRS can support the 

existence of a receivable through taxpayer agreement or a favorable court ruling (federal 

taxes receivable), (2) compliance assessments where neither the taxpayer nor the court has 

affirmed that the amounts are owed, and (3) write-offs, which represent unpaid assessments 

for which IRS does not expect further collections due to factors such as the taxpayer’s 

death, bankruptcy, or insolvency. Of these three classifications of unpaid assessments, only 

federal taxes receivable are reported on the principal financial statements. As of September 

30, 2000, IRS reported $22 billion (net of an allowance for doubtful accounts of $59 billion), 

$30 billion, and $129 billion in these three categories, respectively.
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Page 87 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

IRS continues to lack a detailed listing, or subsidiary ledger, that tracks and 

accumulates unpaid assessments and their status on an ongoing basis. The 

lack of such a subsidiary ledger renders IRS unable to promptly identify 

and focus collection efforts on accounts most likely to prove collectible6

and impedes its ability to prevent or detect and correct errors in taxpayers’ 

accounts. As in prior years,7

 IRS’ records contained errors and there were 

significant delays in IRS recording activity in taxpayer accounts. While 

these conditions in isolation may not rise to the level of material weakness, 

collectively they are indications of serious internal control deficiencies. 

These conditions continued to result in instances of unnecessary taxpayer 

burden and lost opportunities to collect outstanding taxes owed. 

During our testing of statistical samples of 5088

 unpaid tax assessment 

cases as part of our fiscal year 2000 audit, we found the following:

• Significant delays—of up to 12 years—in recording payments made by 

taxpayers to related taxpayer accounts. We also found payments that 

were not recorded at all in related taxpayer accounts. Some of these 

delayed or unrecorded payments were made in the late 1980s.

• Delays in updating information in taxpayer accounts. In some instances, 

because IRS delayed entering taxpayer information such as bankruptcy 

status or codes to prevent the release of refunds, it lost opportunities to 

offset refunds owed to taxpayers for subsequent tax periods against 

their outstanding tax liabilities. In two cases, IRS’ failure to input or 

reverse information resulted in refunds that should not have been issued 

because the taxpayer had other outstanding tax liabilities. In each of 

these cases, the inappropriate refund was for more than $4,000.

• Other errors in taxpayer’s accounts. We found at least eight cases in our 

sample in which errors other than those noted above existed in taxpayer 

accounts. In some cases, the errors directly affected the taxpayer. In one 

6

It should be noted that although certain taxpayer accounts have little likelihood of 

collection, IRS would generally continue some collection efforts to reinforce continued 

compliance by taxpayers who appropriately report and pay their tax obligations and to 

increase compliance by taxpayers who are delinquent in reporting and paying their tax 

obligations.

7

GAO/AIMD-00-76, February 29, 2000; and Financial Audit: IRS’ Fiscal Year 1998 Financial 

Statements (GAO/AIMD-99-75, March 1, 1999).

8

These statistical samples were selected primarily to substantiate, and in some cases derive, 

balances and activity reported on IRS’ financial statements. Consequently, dollar errors or 

amounts can and have been statistically projected to the population of transactions from 

which they were selected. 
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case, we found that a deceased individual’s estate sent a payment of 

$68 million to IRS in January 1999, but IRS recorded the payment to the 

wrong taxpayer account. The taxpayer’s estate was actually owed a 

refund of almost $7 million. This input error was not corrected until 

almost 2 years later. Consequently, IRS did not pay the refund to the 

estate for nearly 2 years after it was owed. 

We have found and reported on these issues in previous audits.9

 IRS has 

acknowledged the seriousness of these issues and continues to take 

remedial steps to correct them, but has noted in the past and continues to 

note that the ultimate solution to many of these issues is modernization of 

its systems. As in prior years, the unpaid assessment accounts in which we 

found significant delays in recording payments primarily were those 

representing unpaid payroll taxes, where separate accounts are established 

and assessments recorded for a related tax liability.10 IRS’ current systems 

cannot automatically link each of the multiple assessments made for the 

one tax liability. Consequently, if the business or an officer pays some or all 

of the outstanding taxes, IRS’ systems are unable to automatically reflect 

the payment as a reduction in the related account or accounts. In 29 of 68 

(43 percent) unpaid payroll tax cases we reviewed involving multiple 

assessments, we found that payments were not accurately recorded to 

reflect each responsible party’s reduction in tax liability. This is 

approximately the same rate of occurrence that we identified during our 

1999 audit (45 percent). IRS has attempted to compensate for the lack of an 

automated link between related accounts by manually inputting a code in 

each account that cross-references it to other related accounts. However, 

in the 29 cases mentioned above, 28 (96 percent) had cross-references, yet 

the payments still were not accurately recorded. 

9

GAO/AIMD-00-76, February 29, 2000; GAO/AIMD-99-75, March 1, 1999.

10When a company does not pay the taxes that have been withheld from employees’ wages, 

such as Social Security or individual income tax withholdings, IRS has the authority to 

assess the responsible officers individually for the taxes withheld from employees. Thus, 

IRS may record the assessments against each of several individuals for the employeewithholding component of the payroll tax liability of a given business in an effort to collect 

the total tax liability of the business. While the assessments made against business 

officers—known as trust fund recovery penalties—are a necessary enforcement tool, IRS 

should only collect the unpaid tax once. 
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Compliance Issues

Page 89 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

As with any large agency, IRS is confronted by the ongoing management 

challenge of allocating its limited resources among competing priorities. As 

we reported previously, IRS does not have the management data necessary 

to prepare reliable cost-benefit analyses to ensure that its resource 

allocation decisions are appropriate. Consequently, IRS is hindered in its 

ability to determine whether it is devoting an appropriate level of resources 

to collecting unpaid taxes relative to the costs and potential benefits 

involved. During fiscal year 2000, we found potential additional collection 

opportunities that IRS was not pursuing, according to IRS, due to resource 

constraints. We continued to identify instances in which IRS was not 

actively pursuing accounts that appeared to have some collection potential. 

IRS officially stopped collection efforts on some of these cases11 while 

other cases remained unworked although collection efforts were not 

officially stopped. In our review of one of our statistical samples of unpaid 

tax assessments consisting of 474 cases, we found (1) 9 cases in which IRS 

officially stopped collection activity due to resource constraints and 

(2) several other cases for which information in the case files we reviewed 

indicated some collection potential but on which IRS had not taken 

collection action. For example, in one case, a taxpayer owed over $23,000 

in taxes, and despite this taxpayer’s annual income in subsequent years of 

over $110,000, IRS was not actively pursuing collection. There is a point at 

which pursuing collection on a case ceases to be cost effective, and clearly 

many cases in our sample provided little or no hope of future collections. 

IRS’ challenge is to determine the appropriate level of resources needed to 

fulfill its mission and the most appropriate utilization of its existing 

resources. Without sound management data in which to make these 

decisions, IRS is hindered in its ability to justify its resource utilization 

decisions, which could result in billions of dollars in outstanding amounts 

going uncollected and could affect future compliance.

In fiscal year 2000, we noted substantial improvement in IRS’ ability to 

locate and provide adequate supporting documentation for unpaid 

assessments. The cases we reviewed in fiscal year 2000 generally contained 

sufficient detailed information to determine the appropriate classification 

11These accounts had been designated by IRS as “currently not collectible.” Until recently, 

the designation “currently not collectible” was typically used for cases in which the taxpayer 

was experiencing financial difficulties or other hardships that made collection highly 

unlikely. However, during fiscal year 1999, IRS modified the criteria under which unpaid 

assessment cases could be designated as currently not collectible in response to an 

increasing inventory workload and its judgment that resource constraints would not permit 

the agency to actively pursue the cases.
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Page 90 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

of the unpaid assessment and to provide a basis for estimating collectibility 

for cases determined to be taxes receivable. We identified only one case 

this year in which IRS’ inability to provide documentation resulted in the 

need to reclassify the case.

Controls Over Refunds As we have reported in previous audits, weaknesses in IRS’ controls over 

refund disbursements and other management challenges expose the 

federal government to material losses due to disbursing improper 

refunds.12 During fiscal year 2000, IRS disbursed tax refunds totaling about 

$194 billion. IRS has implemented various controls, such as electronic 

screening, that prevent thousands of improper refunds from being 

disbursed each year. However, time constraints,13 high volume, and reliance 

on information supplied by taxpayers affected the options available to IRS 

in its efforts to prevent improper refunds from being disbursed. 

Consequently, IRS relies extensively on postrefund (detective) controls, 

such as automated matching of returns with third-party data such as W-2s 

(wage and tax statements), to identify for collection improper refunds that 

have been disbursed. However, each year, IRS does not apply these 

controls to millions of tax returns it estimates to have billions of dollars of 

underreported tax liabilities. Consequently they cannot be considered 

effective detective controls. Inevitably, IRS must balance the cost of all its 

refund controls against the benefits to be realized through their use. 

However, as we previously reported,14 IRS’ financial management systems 

do not provide the reliable information needed to support such decisions. 

12An improper refund is defined as any refund of tax payments from IRS to which the 

taxpayer is not entitled. The taxpayer may or may not have made an intentional 

misstatement on his or her return.

13By statute, IRS must pay interest on refunds not paid within 45 days of receipt or due date, 

whichever is later (26 U.S.C. 6611).

14Internal Revenue Service: Recommendations to Improve Financial and Operational 

Management (GAO-01-42, November 17, 2000).
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IRS does not always review Earned Income Tax Credit (EITC) claims in 

time to identify invalid claims before issuing refunds. Historically, EITCs 

have been vulnerable to high rates of invalid claims,15 and because most 

EITCs result in refunds,16 the risk of disbursing improper refunds is 

significantly increased. In an effort to minimize this risk, IRS, relying on 

past experience, screens tax returns claiming EITCs to identify (for 

detailed examination) those considered most likely to be invalid. During 

fiscal year 2000, IRS examiners completed the detail examinations of about 

257,000 tax returns claiming approximately $587 million in EITC and found 

that about 173,000 of these tax returns claiming $395 million in EITC 

(67 percent) were invalid. When performed before refunds are disbursed, 

these examinations are an important control to prevent disbursement of 

improper refunds. However, because IRS often performs them after any 

related refunds are disbursed, they are not an effective preventive control 

overall.17 The full magnitude of refunds resulting from invalid EITCs is 

unknown. However, in September 2000, IRS estimated that in tax year 1997, 

taxpayers filed about $9.3 billion in invalid EITCs,18 of which $1.5 billion 

(16 percent) either was recovered or was expected to be recovered through 

compliance efforts. The dollar amount of improper refunds disbursed 

related to these EITCs is unknown. However, based on the refund rate of 

about 78 percent of EITC in tax year 1997, IRS may have disbursed 

approximately $7.3 billion in improper refunds for EITC in tax year 1997, 

about $6.1 billion (84 percent) of which may never be recovered. IRS began 

implementing a 5-year initiative in fiscal year 1998 to address 

noncompliance problems with EITCs. 

To compensate for the inherent limitations of its preventive controls, IRS 

performs automated matches between tax returns and related third-party 

data to identify underreported taxes, improper refunds, and other errors. 

However, these programs are not run until months after the returns have 

15High-Risk Series: An Update (GAO-01-263, January 2001); Major Management Challenges 

and Program Risks: Department of the Treasury (GAO-01-254, January 2001); and 

GAO/AIMD 00-76, February 29, 2000.

16During fiscal year 2000, IRS processed about $31 billion in EITCs. Of this amount, about 

$26 billion (84 percent) was refunded, and the rest reduced tax assessments.

17IRS estimated that of the 573,000 EITC tax returns examined in fiscal year 1999, 

approximately 172,000 (30 percent) were conducted after the refund had been disbursed 

(GAO/AIMD-00-76, February 29, 2000). 

18Compliance Estimates for Earned Income Tax Credit Claimed on 1997 Returns (Internal 

Revenue Service, September 2000).
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been filed. As a result, they are used too late to prevent improper refunds 

from being disbursed. There are factors that affect IRS’ ability to accelerate 

the timing of its automated matches, such as the limitations of its current 

automated systems and the timing of filing requirements for preparers of 

third-party documents, which are beyond IRS’ control. In response to a 

previous GAO recommendation, IRS indicated that it has incorporated in 

its systems modernization blueprint the capability to perform automated 

matching against available data before issuing refunds. However, 

implementing this feature is still years in the future.

As noted above, IRS does not have the management data necessary to 

prepare reliable cost-benefit analyses to ensure that its resource allocation 

decisions are appropriate. Consequently, IRS is hindered in its ability to 

determine the appropriate level of resources to devote to following up on 

the underreported taxes and improper refunds identified by its automated 

matching programs. However, the results of IRS efforts to follow up on the 

findings of its automated matches in recent years suggests that a 

substantial amount of additional revenue might be realized if additional 

resources were devoted to these efforts.19 For example, for tax year 1998, 

IRS’ screening program for individuals identified 14.1 million individual tax 

returns that had potential underreported taxes totaling at least 

$15.4 billion. IRS investigated about 2.5 million (18 percent) of these cases 

accounting for about $6.5 billion (42 percent) of the total potential 

underreported taxes. Also, IRS did not investigate any of the 636,000 

discrepancies its matching program found for employment tax returns filed 

by employers during tax year 1998. According to IRS, resource constraints 

prevented it from investigating more of these discrepancies. However, 

because of the lack of management information discussed above, IRS 

cannot determine whether it would be cost beneficial to allocate more 

resources to its automated matching programs and related follow-up. 

As previously discussed, we also continued to find instances in which 

inappropriate refunds were issued as a result of delays in recording 

information in taxpayers’ accounts. IRS also continued to be vulnerable to 

issuing duplicate refunds allowed by gaps in its internal controls. IRS’ 

manual and automated systems are not properly coordinated to prevent 

identical refunds from being processed through both systems, and controls 

designed to compensate for this are not always effective. All the above19GAO-01-42, November 17, 2000.
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mentioned conditions expose the government to potentially significant 

losses due to inappropriate refund disbursements.

Property and Equipment During fiscal year 2000, IRS continued to work to compensate for serious 

deficiencies in systems and controls over its property and equipment 

(P&E). Specifically, IRS worked hard to improve the reliability of its P&E 

inventory records by conducting physical inventories at its headquarters 

and its field offices, and used the results of these physical inventories to 

update its P&E inventory records. Also, IRS worked to sustain a reliable 

balance for P&E on its fiscal year 2000 financial statements by engaging the 

services of a contractor to extract and compile P&E transaction data for 

year-end financial reporting. IRS’ efforts resulted in it being able to report a 

balance for P&E on its financial statements at September 30, 2000, that was 

fairly stated in all material respects. Nonetheless, serious weaknesses in its 

P&E systems and controls continue to prevent it from having P&E 

information available on an ongoing basis for management purposes and 

from having reasonable assurance that its assets are properly safeguarded 

and used only in accordance with management policy. IRS has reported a 

material weakness in its controls over P&E in its assurance statement to 

Treasury under 31 U.S.C. §3512 (c), (d) (Federal Managers’ Financial 

Integrity Act (FIA)) every year since 1983.

In prior years, IRS’ procedures were not effective in ensuring that 

acquisitions, disposals, and transfers were promptly and accurately 

recorded in its P&E inventory records. As a result, IRS’ P&E records were 

not adequate to maintain accountability over its property. While we noted 

progress in IRS’ efforts to improve the timeliness and accuracy of recording 

P&E activity, we nonetheless continued to find a significant number of 

errors in IRS’ property records. Specifically, IRS was unable to locate 35 of 

220 sample items (16 percent) selected from P&E records, including 

computers, monitors, printers, and computer software. IRS later 

determined that 23 of these 35 items had been disposed of months earlier, 

but P&E records had not been updated to reflect the disposal. In addition, 

we found that 14 of 219 sample items (6 percent) selected at 22 sites we 

visited could not be traced to IRS’ P&E records. At 18 of the 22 IRS 

buildings we visited, we found inaccurate P&E records consisting of either 

items not at the site as recorded or items at the site but not on the records. 

Accurate records are essential for maintaining control over P&E to ensure 

that assets are properly accounted for and safeguarded. 
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As we have previously reported, IRS does not have an integrated property 

management system that appropriately records P&E additions and 

disposals as they occur and links cost recorded in the accounting records 

to property records. Instead, IRS expenses property purchases during the 

year, and then records adjustments at year-end to remove property 

purchases from expenses and capitalize them as P&E based on analyses of 

expense records. For its September 30, 1999, P&E balance, IRS recorded a 

balance based primarily on a statistical estimation process developed and 

implemented by a contractor.20 While the effort resulted in a reasonable 

estimate of the September 30, 1999, P&E balance, it did nothing to address 

the fundamental deficiencies in IRS’ accounting and property management 

systems. Consequently, for fiscal year 2000, IRS hired a contractor to 

develop and implement an interim process to enable IRS to continue to 

report a reliable P&E balance in its financial statements until it has an 

integrated accounting and property system.21

Although we determined through detailed tests of transactions and 

analyses of the contractor’s work that IRS’ reported September 30, 2000, 

P&E balance was fairly stated, longstanding weaknesses in IRS’ property 

and accounting systems continue to affect IRS’ ability to account for its 

property and report a reliable P&E balance. In addition, these weaknesses 

result in a recurring annual expense of hiring a contractor to develop a P&E 

balance at fiscal year-end. 

Budgetary Controls During fiscal year 2000, IRS devoted substantial effort to addressing the 

budgetary control weaknesses that we reported in fiscal year 1999.22 For 

example, during the fiscal year, IRS significantly reduced the number of 

employees with authority to override automated spending controls. Also, 

IRS substantially reduced the dollar amount and duration of transactions 

held in suspense. Finally, IRS issued numerous policy memoranda and 

implemented procedures to deobligate funds no longer required for a 

specific purpose. However, IRS’ internal controls continued to be 

inadequate in providing reasonable assurance that its budgetary resources 

20GAO/AIMD-00-76, February 29, 2000.

21IRS plans to acquire and install, in October 2003, an integrated financial system that will 

include recording P&E as assets when purchased and generating detailed records for P&E 

that reconcile to the financial records. 

22GAO/AIMD-00-76, February 29, 2000.
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were routinely accounted for, reported, and controlled. These weaknesses 

significantly affect the reliability of key budgetary information IRS needs 

on an ongoing basis to effectively manage its operations and ensure that its 

resources do not exceed budgetary authority. 

We found that undelivered orders23 were not always reduced to reflect 

goods and services received or were understated due to inappropriate 

deobligating of funds. For example, in our testing of statistical samples of 

both the beginning and ending balances of undelivered orders, we found 

error rates of 32 and 25 percent, respectively, for the transactions tested. 

These errors were primarily due to goods and services having been 

received but not deducted from undelivered orders. For example, in testing 

one fiscal year 2000 undelivered order totaling $7.9 million for computer 

equipment, we found that approximately $3.4 million of the equipment had 

been delivered but had not been removed from the undelivered orders 

balance. We also found instances in which IRS incurred costs before the 

obligations were recorded in the accounting system. In one case tested in 

our sample of beginning year undelivered orders, an obligation for over $9 

million for software and maintenance was not recorded in the accounting 

system until September 30, 1999, although the software was received and 

maintenance commenced by the end of July 1999. Incurring costs without 

timely recording obligations in the accounting system creates the risk that 

IRS personnel could rely on an overstatement of available budget authority 

to enter into additional obligations for which there is inadequate budget 

authority to cover. We also found that IRS’ efforts to address the need to 

deobligate amounts no longer needed resulted in instances in which the 

amounts were prematurely deobligated. In testing a separate statistical 

sample of deobligations, we found that in 17 percent of the cases, IRS later 

had to reobligate funds in whole or in part. These errors resulted in 

misstatements of IRS’ beginning and ending undelivered orders balances 

and its records of outstanding obligations.

Also, we found significant errors in IRS’ accrued expenses recorded at the 

end of fiscal year 1999, which resulted in misstating the beginning balance 

of undelivered orders for fiscal year 2000. In testing a statistical sample of 

these accruals, we identified errors in 36 percent of the sample cases. For 

example, IRS allocated $209,500 of the total invoice cost of $260,130 related 

to an information systems service contract to fiscal year 1999, and the 

23Undelivered orders represent the value of goods and services ordered that have been 

obligated but have not been received.
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remaining $50,630 to fiscal year 2000. However, based on the terms of the 

service contract, we determined that only $1,724 of the invoice cost related 

to services for fiscal year 1999, while the remaining $258,406 related to 

services to be rendered in fiscal year 2000. This resulted in an 

overstatement of the expense for fiscal year 1999 and an understatement of 

the beginning undelivered order balance for fiscal year 2000. We identified 

errors throughout IRS’ $121 million of accruals that resulted in both 

understatements and overstatements of the beginning undelivered orders 

balance. 

We also found that, during fiscal year 2000, IRS recorded incorrect activity 

as adjustments to obligations.24 IRS recorded a total of $277 million in 

adjustments to obligations in fiscal year 2000. However, in reviewing 

statistical samples of these adjustments, we found that 61 percent of the 

items we reviewed were not valid adjustments and, in fact, many were 

simply changes in internal accounting codes. For example, in one case we 

reviewed, IRS recorded a change in an internal accounting code as a new 

$15 million obligation and erroneously adjusted the original $15 million 

obligation downward, thereby misstating its reported level of adjustments 

to obligations. While adjustments were made to correct the amounts 

recorded in the financial statements, errors such as these affect the 

accuracy and reliability of routine information on both total budgetary 

resources and obligations. 

Computer Security IRS has corrected a significant number of the computer security 

weaknesses identified in our previous reports and is implementing a 

servicewide computer security planning and management program that 

should, when fully implemented, help IRS effectively manage its computer 

security risks. However, IRS has not yet fully implemented its security 

program across the service. 

Much remains to be done to resolve the significant control weaknesses that 

continue to exist within the IRS computing environment. IRS places 

extensive reliance on computer information systems to perform basic 

functions such as processing tax returns and payments, maintaining 

sensitive taxpayer data, calculating interest and penalties, and generating 

refunds. These computer control weaknesses could impair IRS’ ability to 

24An adjustment to an obligation is recorded when the dollar amount previously recorded is 

affected by a subsequent event, such as a change in the price of goods or services.
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Page 97 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

perform these vital functions and increase the risk of the unauthorized 

disclosure, modification, or destruction of taxpayer data.

We found that IRS continued to have serious weaknesses with general 

controls designed to protect computing resources such as networks, 

computer equipment, software programs, data, and facilities from 

unauthorized use, modification, loss, and disclosure. IRS did not always 

• effectively implement physical controls to prevent or detect individuals 

from gaining unauthorized access to its data processing facilities, 

• adequately restrict logical access to its computer networks and systems, 

• appropriately segregate system administration and security 

administration responsibilities, 

• optimally configure system software to ensure the security and integrity 

of system programs, files, and data, 

• sufficiently plan or test the activities required to restore critical business 

systems when unexpected events occur, and 

• adequately monitor key networks and systems to identify unauthorized 

activities and inappropriate system configurations. 

In addition, internal controls over IRS’ key computer applications that IRS 

personnel used to process tax returns, research and adjust taxpayer 

records, generate notices, and detect and investigate fraudulent tax returns 

do not provide adequate assurance that only authorized personnel have 

access to the application and related taxpayer data. 

These weaknesses increased the risk that data processed by IRS’ computer 

systems were not reliable and were vulnerable to unauthorized disclosure. 

For example, IRS did not promptly revoke the access privileges of 

separated employees to a key system used to view and adjust taxpayer 

records. Weak physical security at one of IRS’ data processing facilities 

could have allowed separated employees to enter the facility without 

challenge, gain physical access to the system’s terminals, and use their 

unrevoked system access privileges to make unauthorized changes to 

taxpayer records. If IRS does not adequately mitigate these weaknesses, 

unauthorized individuals could gain access to critical hardware and 

software where they may intentionally or inadvertently add, alter, or delete 

sensitive data or computer programs. Such individuals could also obtain 

personal taxpayer information and use it to commit financial crimes in the 

taxpayer’s name (identity fraud), such as fraudulently establishing credit 

and running up debts. 
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Compliance Issues

Page 98 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

Reportable Conditions In addition to the material weaknesses and management challenges 

discussed above, we identified two reportable conditions. These conditions 

concern weaknesses in IRS’ (1) internal controls over manually processed 

tax receipts and taxpayer information and (2) revenue reporting and 

distribution process. We reported on both issues in prior years.25

Manual Tax Receipts and 

Taxpayer Information

IRS has acted to address some of its control deficiencies related to 

safeguarding cash, checks, and related hardcopy taxpayer data it manually 

receives from taxpayers. For example, IRS has significantly reduced the 

average amount of time it takes to obtain the results of employee applicant 

fingerprint checks, now requires the use of two bonded or insured couriers 

to transport service center deposits, and has limited courier access within 

service center premises. However, weaknesses that we have reported in 

prior years continue to exist. To address these issues, IRS issued new 

policies and procedures regarding handling of taxpayer receipts and data at 

sites that collect and process tax revenue. However, we found that some of 

these sites were not aware of the new policies, other sites did not adhere to 

them, and some sites were not covered by the new policies and procedures 

because they were not contractually bound to IRS. 

We previously reported that IRS was hiring individuals and allowing them 

access to cash, checks, and other taxpayer data before it received 

satisfactory results of their fingerprint checks.26 In response, IRS issued a 

new policy in April 2000 prohibiting the hiring of applicants in any IRS 

office until fingerprint checks were completed. However, we found that 

throughout the rest of the fiscal year, some new employees began working 

before the hiring office received the results of fingerprint checks. Because 

most of IRS’ hiring occurs in the several months leading up to the April 

peak processing period, the policy was not yet in place to affect most of its 

fiscal year 2000 hiring. However, we found that 83 of the 2,526 staff hired 

from the time the policy was issued through September 30, 2000, began 

working before IRS received the results of their fingerprint checks.

IRS also issued a new policy in fiscal year 2000 strengthening its courier 

requirements for all IRS locations, and we noted marked improvements at 

25GAO/AIMD-00-76, February 29, 2000; GAO/AIMD-99-75, March 1, 1999.

26GAO/AIMD-00-76, February 29, 2000.
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Page 99 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

most sites we visited. The new policy’s requirements include that the 

courier services use two bonded or insured couriers, that all courier 

service employees with IRS access pass a limited background investigation 

and have the courier company be insured for $1 million. 

We did continue to find other weaknesses in controls over taxpayer 

receipts and taxpayer data that have not yet been adequately addressed. 

For example, we continued to find field office receipts and discovered 

remittances stored in open, unlocked containers, contrary to IRS policy. 

Also, we noted that certain problem areas have been addressed at service 

centers but not at other field offices that handle taxpayer receipts. For 

example, although IRS installed lockers at service centers for employees 

that handle receipts to store their personal belongings, we continued to 

find personal belongings such as handbags stored in receipt processing 

areas at several field offices. 

These inconsistencies by type of location are further illustrated by 

weaknesses found at commercial lockbox banks that process tax receipts 

on behalf of IRS. Since these lockbox banks operate under contract with 

Treasury’s Financial Management Service (FMS), many of IRS policies are 

not applicable to their operations. For example, under their contract with 

FMS, the lockbox banks are not required to follow IRS’ policy prohibiting 

the hiring of any new employee before the results of fingerprint checks are 

received and reviewed. Consequently, at the lockbox banks we visited, we 

found that fingerprint checks were not required for either permanent or 

temporary employees. Similarly, IRS’ new courier policy that applies to all 

IRS locations has not been extended to the lockbox banks.

These weaknesses increase IRS’ vulnerability to theft or loss and expose 

taxpayers to increased risk of losses from financial crimes committed by 

individuals who inappropriately gain access to confidential information 

entrusted to IRS. Although we do not consider these to be material 

weaknesses for financial reporting purposes, it is important that IRS 

continue efforts to address these matters because they are critical to IRS’ 

successfully meeting its customer service goals. 

Revenue Reporting and 

Distribution 

IRS continues to be unable to determine the specific amount of revenue it 

actually collects for three of the federal government’s four largest revenue 

sources—Social Security, Hospital Insurance, and individual income taxes. 

In addition, IRS continues to be unable to determine, at the time payments 

are received, collections for the Highway Trust Fund or other trust funds 
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Compliance Issues

Page 100 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

that receive excise tax receipts. This is primarily because the accounting 

information needed to validate the taxpayer’s liability and record the 

payment to the proper trust fund is provided on the tax return, which is 

received months after the payment is submitted. Further, the information 

on the return pertains only to the amount of the tax liability, not to the 

distribution of the amount previously collected. As a result, IRS cannot 

report the specific amount of revenue it actually collected for these large 

revenue sources without first requiring taxpayers to submit the needed 

information at the time of payment. IRS believes that imposing such a 

requirement could create an additional burden to taxpayers.

Because collection data are not available to allocate excise taxes to the 

appropriate trust funds when deposits are made, Treasury’s Office of Tax 

Analysis uses economic models to estimate the initial distribution of excise 

tax receipts. Six months later, to prepare adjustments to the initial 

distribution, IRS certifies the amounts that should have been distributed to 

the excise-tax-related trust funds using its records of payments received 

and the subsequently provided tax returns. This certification process is 

complex, cumbersome, and error-prone. Because of continued weaknesses 

in fundamental internal controls, such as inadequate reviews, undetected 

errors in the certification process occurred that directly affected the 

distribution of revenue to the trust funds. Although IRS had implemented 

additional review procedures over its certification process in response to 

our previous reports, these reviews have not been fully effective. For 

example, IRS’ failure to follow required review procedures at the service 

center resulted in unsubstantiated credits or reductions made to the tax 

liability of taxpayers who had not submitted required documentation with 

their return. 
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Compliance Issues

Page 101 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

Also, we continued to find delays in posting tax returns that resulted in IRS 

omitting collections from certifications for a given quarter. For example, 

the amount IRS certified to the Highway Trust Fund for the quarter ended 

September 30, 1999,27 included nearly $346 million in collections from 

previous quarters, and the amount it certified for the Airport and Airway 

Trust Fund for the quarter ended June 30, 2000, included nearly $34 million 

in collections from previous quarters. Delays by IRS in processing tax 

returns and late filing of returns by taxpayers, the latter of which is outside 

IRS’ control, are factors that contributed to delays in posting return 

information. 

Taxpayers are not required to provide detailed information on the type of 

tax when they pay their taxes. Also, IRS officials stated that their systems 

cannot capture the additional detailed information. Consequently, IRS is 

working on systems improvements to accommodate this type of 

information in the future. In addition, IRS plans to initiate in 3 to 4 years a 

follow-up study to a previous study to gauge taxpayer ability and readiness 

to provide detailed information by type of tax at the time of payment 

without imposing an additional burden on taxpayers. Until IRS has the 

systems capability to record, and makes a decision with respect to whether 

taxpayers should provide, specific information on the type of taxes being 

paid at the time of payment, it will continue to be unable to report revenue 

actually collected for three of the federal government’s four largest revenue 

sources and continue using a process for distributing excise tax revenue to 

trust funds that is susceptible to errors.

Noncompliance With 

Laws and Regulations 

and FFMIA 

Requirements

Our tests of compliance with selected provisions of laws and regulations 

disclosed two instances of noncompliance that are reportable under U.S. 

generally accepted government auditing standards and OMB guidance. 

These relate to IRS’ structuring of installment agreements to collect 

delinquent taxes and the timing of the release of federal tax liens against 

taxpayers’ property. We also found that IRS’ financial management systems 

do not substantially comply with the requirements of FFMIA. 

27Since certifications usually are not completed until 6 months after the end of the quarter, 

the certification for the quarter ended September 30, 1999, was actually performed in fiscal 

year 2000 and thus affected excise tax distributions in fiscal year 2000.
Appendix I

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Challenges, Reportable Conditions, and 

Compliance Issues

Page 102 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

IRS’ Structuring of 

Installment Agreements Did 

Not Always Comply With 

the Internal Revenue Code

Section 6159 of the Internal Revenue Code authorizes IRS to enter into 

installment agreements with taxpayers to fully satisfy the taxpayer’s 

liability. During two previous audits,28 we identified instances in which IRS 

entered into installment agreements with payments and terms that would 

not be sufficient to satisfy the taxpayers’ outstanding tax liability, including 

future interest accruals, before the statutory collection period for these tax 

liabilities expires.29 In March 1998, IRS issued a memorandum requiring 

that installment agreements provide for the full payment of a taxpayer’s 

outstanding tax liability. However, as in our fiscal year 1999 audit, we 

continued to find that these guidelines were not consistently followed in 

fiscal year 2000. Consequently, IRS continued to be noncompliant with 

Section 6159 of the Internal Revenue Code.

In fiscal year 1999, we found that of 40 unpaid tax cases involving new 

installment agreements, 8 (20 percent) did not comply with the Internal 

Revenue Code. In our testing of 86 unpaid assessments involving taxpayers 

who entered into installment agreements to pay their outstanding tax 

liabilities in fiscal year 2000, we found 2 cases (2 percent) that contained 

payment terms that will be insufficient to satisfy the full tax liability before 

the statutory collection period for these tax liabilities expires. The 

presence of such cases in fiscal year 2000 indicates that IRS continues to be 

noncompliant with this provision of the Internal Revenue Code. 

IRS Did Not Always Release 

Federal Tax Liens in 

Accordance With the 

Internal Revenue Code

The Internal Revenue Code grants IRS the power to file a lien against the 

property of any taxpayer who neglects or refuses to pay all assessed federal 

taxes. The lien becomes effective when it is filed with a designated office, 

such as a courthouse in the county where the taxpayer’s property is 

located. The lien serves to protect the interest of the federal government 

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

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

liens are disclosed in credit reports of individuals. Under Section 6325 of 

the Internal Revenue Code, IRS is required to release a federal tax lien 

within 30 days after the date the tax liability is satisfied or has become 

28GAO/AIMD-00-76, February 29, 2000 and Financial Audit: IRS’ Fiscal Year 1998 Financial 

Statements (GAO/AIMD-99-75, March 1, 1999).

29The statutory collection period for taxes is generally 10 years from the date of the tax 

assessment. However, this period can be extended by agreement with the taxpayer.
Appendix I

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Compliance Issues

Page 103 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

legally unenforceable or the Secretary of the Treasury has accepted a bond 

for the assessed tax.

During our fiscal year 1999 audit, we found that IRS did not release the 

applicable federal tax lien within the 30-day requirement stipulated in the 

Internal Revenue Code for 26 percent of the cases we reviewed where the 

tax liability was either paid off or abated. While we noted significant 

improvement, we found that this condition continued to exist during fiscal 

year 2000. Specifically, in our testing of 38 tax cases with liens in which the 

taxpayers’ total outstanding tax liabilities were either paid off or abated 

during fiscal year 2000, we found 3 instances (8 percent) in which IRS did 

not release the applicable federal tax lien within the 30-day statutory 

requirement. The time between satisfaction of the liability and release of 

the lien ranged from about 100 to over 500 days. In one case, we found that 

although the taxpayer had paid off the outstanding tax liability by August 

1998, IRS did not formally release the lien against the taxpayer’s property 

until March 2000—583 days later. The failure to promptly release tax liens 

could cause undue burden to taxpayers who are attempting to sell property 

or apply for commercial credit.

IRS’ Financial Management 

Systems Are Not in 

Compliance With FFMIA 

Requirements

In fiscal year 2000, we continued to find that IRS’ financial management 

systems did not substantially comply with the requirements of the Federal 

Financial Management Improvement Act of 1996. Specifically, IRS’ systems 

did not comply with Federal Financial Management Systems Requirements, 

federal accounting standards (U.S. generally accepted accounting 

principles), and the SGL at the transaction level. We found that IRS 

(1) cannot rely on information from its general ledger to prepare its 

financial statements, (2) does not have a general ledger that conforms to 

the SGL, (3) lacks a subsidiary ledger for its unpaid assessments, (4) lacks a 

reliable subsidiary ledger for its P&E, and (5) lacks an effective audit trail 

from its general ledger back to subsidiary detailed records and transaction 

source documents for material balances. Other material weaknesses we 

discussed earlier—controls over refunds, P&E, budget, and computer 

security—are also conditions indicating that IRS’ systems do not comply 

with FFMIA. 

As a result, IRS’ financial management systems cannot produce auditable 

financial statements and related disclosures in conformance with federal 

accounting standards (U.S. generally accepted accounting principles) 

without substantial compensating processes and significant adjustments. 

These weaknesses also indicate that IRS’ systems cannot routinely 
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Compliance Issues

Page 104 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

accumulate and report the full cost of its activities. Since IRS’ systems do 

not comply with FFMSR, federal accounting standards (U.S. generally 

accepted accounting principles), and the SGL, they also do not comply with 

OMB Circular A-127, Financial Management Systems. In its FIA assurance 

statement to Treasury, IRS reported that its financial management systems 

did not substantially comply with FFMIA in fiscal year 2000. 

IRS’ FFMIA remediation plan issued on September 30, 2000, did not always 

describe the resources devoted to address the issues that prevent IRS’ 

financial management systems from complying with the requirements of 

the act. FFMIA requires that if the head of an agency determines that its 

financial management systems do not substantially comply with the act, a 

remediation plan must be developed, in consultation with OMB, that 

describes the resources, remedies, and intermediate target dates for 

achieving substantial compliance. The act also requires OMB concurrence 

with any plan not expected to bring the agency’s systems into substantial 

compliance with the act no later than 3 years after a determination of 

noncompliance is made. IRS structures its FFMIA remediation plan to 

respond to the recommendations of GAO and other auditors, such as the 

Treasury Inspector General for Tax Administration (TIGTA), who review 

various aspects of IRS’ operations. However, of the 16 GAO 

recommendations that IRS and GAO considered open at the time this 

remediation plan was issued, 8 (50 percent) did not specify the resources to 

be devoted to the actions planned. These include recommendations related 

to IRS’ weaknesses in controls over P&E, operating funds, and refunds. In 

addition, IRS’ remediation plan did not specify steps to ensure that 

adequate security is built into new systems and networks before they are 

placed in operation to prevent future recurrence of the computer security 

weaknesses in its existing systems that we have been reporting. Also, 

although some of IRS’ remedial actions were not scheduled for completion 

within the 3-year statutory time frame, IRS had requested but not yet 

received OMB concurrence with the extended time frames of these plans as 

of the end of our fieldwork.

These findings are consistent with those of TIGTA, which reported similar 

deficiencies in IRS’ December 31, 1999, FFMIA remediation plan.30 When 

IRS updated its remediation plan on December 31, 2000, we noted marked 

30Improvements Are Needed in the Internal Revenue Service’s Federal Financial 

Management Improvement Act Remediation Plan (Reference Number 2000-10-105, August 

2000). 
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Page 105 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

improvement, and IRS considered two additional recommendations to 

have been closed. However, of the 14 remaining recommendations, IRS’ 

plans to address 2 (14 percent) still did not indicate the resources to be 

devoted to implementing them.
Page 106 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

Appendix II

Details on Audit Methodology ApendxiI

To fulfill our responsibilities as the auditor of IRS’ financial statements, we 

• examined, on a test basis, evidence supporting the amounts and 

disclosures in the financial statements, 

• assessed the accounting principles used and significant estimates made 

by management, 

• evaluated the overall presentation of the financial statements, 

• obtained an understanding of internal controls related to financial 

reporting (including safeguarding assets and compliance with laws and 

regulations, including the execution of transactions in accordance with 

budget authority), and performance measures reported in Management’s 

Discussion and Analysis, 

• tested relevant internal controls over financial reporting (including 

safeguarding assets) and compliance, and evaluated the design and 

operating effectiveness of internal controls, 

• considered compliance with the process for evaluating and reporting on 

internal controls and financial management systems under FIA, 

• tested compliance with selected provisions of the following laws and 

regulations: Anti-Deficiency Act, as amended (31 U.S.C. §1341 (a)(1)); 

Agreements for Payment of Tax Liability in Installments (26 U.S.C. 

§6159); Use of Appropriations (31 U.S.C. §1301); Release of Lien as 

Discharge of Property (26 U.S.C. §6325); Interest on Underpayment, 

Nonpayment, or Extension of Time for Payment of Tax (26 U.S.C. 

§6601); Interest on Overpayments (26 U.S.C. §6611); Determination of 

Rate of Interest (26 U.S.C. §6621); Failure to File Tax Return or to Pay 

Tax (26 U.S.C. §6651); Failure by Individual to Pay Estimated Income 

Tax (26 U.S.C. §6654); Failure by Corporation to Pay Estimated Income 

Tax (26 U.S.C. §6655); Civil Service Reform Act of 1978 (5 U.S.C. §§5332, 

5303, 5304); Fair Labor Standard Act of 1938, as amended (29 U.S.C. 

§206); Civil Service Retirement Act of 1930, as amended (5 U.S.C. 

§8334); Federal Employees’ Retirement System Act of 1986, as amended 

(5 U.S.C. §8423); Social Security Act, as amended (26 U.S.C. §§3101, 

3121 and 42 U.S.C. §430); Federal Employees Health Benefits Act of 

1959, as amended (5 U.S.C. §§8905, 8906, and 8909); and Federal 

Employees’ Group Life Insurance Act of 1980 (5 U.S.C. §§8701, 8702, 

8704, 8707, and 8708), and 

• tested whether IRS’ financial management systems substantially comply 

with FFMIA requirements, using the implementation guidance and OMB 

guidance.
Page 107 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements

Appendix III

Comments From the Internal Revenue ServiceApendxiI
Appendix III

Comments From the Internal Revenue 

Service

Page 108 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements
Appendix III

Comments From the Internal Revenue 

Service

Page 109 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements
Appendix III

Comments From the Internal Revenue 

Service

Page 110 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements
Appendix III

Comments From the Internal Revenue 

Service

Page 111 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements
Appendix III

Comments From the Internal Revenue 

Service

Page 112 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements
Appendix III

Comments From the Internal Revenue 

Service

(919500) Letr Page 113 GAO-01-394 IRS’ Fiscal Year 2000 Financial Statements
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