Financial Audit: Material Weaknesses in Internal Control Continue to Impact Preparation of the Consolidated Financial Statements of the U.S. Government
Published: 2009-04-21T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Since GAO's first audit of the fiscal year 1997 consolidated financial statements of the U.S. government (CFS), material weaknesses in internal control and other limitations on the scope of our work have prevented GAO from expressing an opinion on the accrual basis CFS. Certain of those material weaknesses relate to inadequate systems, controls, and procedures to properly prepare the CFS. The purpose of this report is to (1) provide details of the continuing material weaknesses related to the preparation of the CFS, (2) recommend improvements, and (3) provide the status of corrective actions taken to address the 56 open recommendations GAO reported for this area in June 2008.
section_title: What GAO Found
paragraphs: During its audit of the fiscal year 2008 CFS, GAO identified continuing and new control deficiencies in the federal government's processes used to prepare the CFS. These control deficiencies contribute to material weaknesses in internal control over the federal government's ability to (1) adequately account for and reconcile intragovernmental activity and balances between federal agencies; (2) ensure that the CFS was consistent with the underlying audited agency financial statements, properly balanced, and in conformity with U.S. generally accepted accounting principles; and (3) identify and either resolve or explain material differences between components of the budget deficit reported in the Department of the Treasury's records, used to prepare the Reconciliation of Net Operating Cost and Unified Budget Deficit and Statement of Changes in Cash Balance from Unified Budget and Other Activities, and related amounts reported in federal agencies' financial statements and underlying financial information and records. The control deficiencies GAO identified involved: (1) establishing and documenting policies and procedures for identifying and eliminating federal agencies' intragovernmental payroll tax amounts when compiling the CFS, (2) establishing and documenting policies and procedures for preparing and reviewing information included in key sections of the Financial Report of the U.S. Government, (3) establishing criteria for identifying federal entities' significance to the CFS and annually assessing which entities meet such criteria, (4) enhancing procedures for analyzing and reviewing data used when compiling the Statements of Net Cost, and (5) various other control deficiencies identified in previous years' audits. Of the 56 open recommendations GAO reported in June 2008, 16 were closed and 40 remained open as of December 9, 2008, the date of GAO's report on its audit of the fiscal year 2008 CFS. GAO will continue to monitor the status of corrective actions taken to address the 4 new recommendations as well as the 40 open recommendations from prior years.

section_title: Letter
paragraphs: In our report dated December 9, 2008, we disclaimed an opinion on the  consolidated financial statements of the U.S. government (CFS) for the  fiscal years ended September 30, 2008 and 2007, except for the 2008 and  2007 Statements of Social Insurance, which received unqualified opinions.  Since GAO’s first audit of the fiscal year 1997 CFS, material weaknesses in  financial reporting and other limitations on the scope of our work have  prevented us from expressing an opinion on the federal government’s  accrual basis consolidated financial statements. We have reported that  the federal government did not have adequate systems, controls, and  procedures for preparing the CFS to ensure that the consolidated financial  statements are consistent with the underlying audited agency financial  statements, properly balanced, and in conformity with U.S. generally  accepted accounting principles (GAAP).
On behalf of the federal government, the Department of the Treasury  (Treasury), in coordination with the Office of Management and Budget  (OMB), prepares the CFS. Many of the material weaknesses in internal  control that have contributed to our continuing disclaimers of opinion  were identified by other auditors during their audits of individual federal  agencies’ financial statements and were reported in detail with  recommendations to the agencies in separate reports. This report presents  the additional material weaknesses that we identified during our tests of  the federal government’s processes used to prepare the CFS.
The purpose of this report is to (1) provide more detailed information on  the material weaknesses that we identified during our audit of the fiscal  year 2008 CFS that relate to internal control over the processes used to  prepare the CFS, (2) recommend improvements to address these  weaknesses, and (3) provide the status of corrective actions by Treasury  and OMB to address the 56 recommendations detailed in our previous  reports that remained open at the end of the fiscal year 2007 audit (see  app. I). We have discussed each of the new control deficiencies identified  during our fiscal year 2008 audit with your staff and have incorporated  their comments as appropriate.
subsections: section_title: Scope and Methodology
paragraphs: As part of our audit of the fiscal years 2008 and 2007 CFS, we evaluated  the federal government’s financial reporting procedures and related  internal control. Also, we determined the status of corrective actions by  Treasury and OMB to address open recommendations relating to the  processes used to prepare the CFS detailed in our previous reports. In our  audit report on the fiscal year 2008 CFS, which is included in the fiscal  year 2008 Financial Report of the United States Government (Financial  Report), we discussed the material weaknesses related to the federal  government’s processes used to prepare the CFS. These material  weaknesses contributed to our disclaimer of opinion on the accrual basis  consolidated financial statements and also contributed to our adverse  opinion on internal control. We performed sufficient audit procedures to  provide the disclaimer of opinion on the accrual basis consolidated  financial statements in accordance with U.S. generally accepted  government auditing standards. This report provides the details of the  material weaknesses identified during the fiscal year 2008 audit that relate  to the processes used to prepare the CFS and our recommendations to  correct these weaknesses, as well as the status of corrective actions by  Treasury and OMB to address recommendations from previous reports.
We requested comments on a draft of this report from the Director of OMB  and the Secretary of the Treasury or their designees. OMB provided oral  comments, which are summarized in the Agency Comments and Our  Evaluation section of this report. Treasury’s comments are reprinted in  appendix II and are also summarized in the Agency Comments section.
section_title: Treatment of Intragovernmental Payroll Tax Amounts in Compiling the CFS
paragraphs: Treasury did not establish policies and procedures to provide assurance  that federal agencies’ intragovernmental payroll tax amounts are identified  and eliminated at the governmentwide level when compiling the CFS.  Consolidated financial statements are intended to present the results of  operations and financial position of all of the components that make up  the reporting entity as if the entity were a single enterprise. Therefore,  when preparing the CFS, Treasury should ensure that intragovernmental  activity and balances between federal agencies are eliminated. Federal  agencies, as well as other employers, are required to pay, among other  taxes, a matching amount of Social Security and Medicare taxes for their  employees (payroll taxes). Federal agencies’ payments of payroll taxes to  the Internal Revenue Service represent intragovernmental transactions. If  these amounts are not eliminated at the governmentwide level when  compiling the CFS, revenues and expenses become overstated in the CFS.  However, in disclosing the types of revenues included in the Statement of  Operations and Changes in Net Position in the draft CFS, Treasury’s  description stated that “individual income tax and tax withholdings  include….payroll taxes collected from other agencies.” We inquired of  Treasury as to why these amounts would be included in the CFS and not  eliminated during the preparation process. Treasury subsequently deleted  the language regarding the inclusion of federal agency payroll taxes from  the CFS. However, Treasury was unable to provide any documentation  demonstrating that these amounts were appropriately classified as  intragovernmental transactions and eliminated from the CFS. Without  adequate policies and procedures to accurately identify and eliminate  intragovernmental payroll tax amounts in the process used to prepare the  CFS, the federal government’s ability to determine the impact of these  amounts on the CFS is impaired and, consequently, the CFS may be  misstated.
subsections: section_title: Recommendation for Executive Action
paragraphs: We recommend that the Secretary of the Treasury direct the Fiscal  Assistant Secretary to design, document, and implement policies and  procedures to identify and eliminate intragovernmental payroll tax  amounts at the governmentwide level when compiling the CFS.
section_title: Consistency and Accuracy of Key Sections of the Financial Report
paragraphs: Treasury, in coordination with OMB, did not take the steps necessary to  help assure that certain key information related to significant financial  events and conditions were consistent and accurately presented  throughout the fiscal year 2008 Financial Report. Specifically, Treasury, in  coordination with OMB, has not fully established an effective process for  preparing and reviewing information included in the Management’s  Discussion and Analysis (MD&A), and “The Federal Government’s  Financial Health: A Citizen’s Guide to the Financial Report of the United  States Government” (Citizen’s Guide) sections of the Financial Report.  According to Statement of Federal Financial Accounting Standards No. 15,  Management’s Discussion and Analysis, the MD&A should highlight key  information and increase the understanding and usefulness of the  Financial Report. Similarly, the Citizen’s Guide is intended to provide  readers with a brief, high-level summary of key financial information from  the Financial Report on our nation’s current fiscal condition and the long- term sustainability. Further, data presented in both the MD&A and  Citizen’s Guide must be consistent with related data in the CFS.
Treasury, in coordination with OMB, performed certain procedures to  prepare and review the MD&A and Citizen’s Guide. However, these  procedures were not effective in helping assure that (1) information was  consistently reported in the CFS and these related sections of the  Financial Report and (2) information reported in the MD&A and Citizen’s  Guide was consistent, complete, and accurate. During our comparison of  information reported in draft versions of the MD&A and Citizen’s Guide  with information reported in the fiscal year 2008 draft CFS, we identified  (1) several inconsistencies and (2) numerous instances in which  information was omitted from, or incorrectly reported in, these draft  sections of the Financial Report that were not detected by Treasury’s  review process. For example, information in the draft MD&A and Citizen’s  Guide regarding certain federal actions for addressing the financial crisis  was incomplete or incorrectly reported. In addition, the $339 billion  change in veterans benefit liability in fiscal year 2008 reported in the draft  CFS was incorrectly reported as $365 billion in the draft versions of the  MD&A and Citizen’s Guide. We communicated our findings to Treasury  officials who corrected the data presented in the MD&A and Citizen’s  Guide sections of the final Financial Report. Without effective procedures  for preparing and reviewing the MD&A and Citizen’s Guide to ensure that  the information is complete, accurate, and consistent with the information  reported in the CFS, Treasury is at risk that information provided in these  key sections of the Financial Report will not be reliable.
A contributing factor to the reporting errors and inconsistencies we  detected is that Treasury does not have documented procedures for  preparing and reviewing the MD&A and Citizen’s Guide sections of the  Financial Report in comparison with data presented in the CFS. As  preparer of the Financial Report, Treasury management, in coordination  with OMB, is responsible for developing and documenting detailed  policies, procedures, and practices and for ensuring that internal control is  built into and is an integral part of operations to ensure that information is  consistent and accurate throughout the Financial Report. GAO’s Standards  for Internal Control in the Federal Government calls for clear  documentation of policies and procedures. Although, Treasury has  documented policies and procedures used to compile the CFS in its  Standard Operating Procedures (SOP) entitled “Preparing the Financial  Report of the U.S. Government,” the SOP does not provide procedures for  preparing and reviewing the MD&A and Citizen’s Guide—two key report  sections providing information to the Congress and the public regarding  the fiscal condition of the U.S. government—to help assure they are  consistent and accurate in comparison with related information presented  elsewhere in the Financial Report.
subsections: section_title: Recommendation for Executive Action
paragraphs: We recommend that the Secretary of the Treasury direct the Fiscal  Assistant Secretary, in coordination with the Controller of OMB, to  develop, document, and implement processes and procedures for  preparing and reviewing the MD&A and Citizen’s Guide sections of the  Financial Report to help assure that information reported in these sections  is complete, accurate, and consistent with related information reported  elsewhere in the Financial Report.
section_title: Identifying Federal Entities Significant to the CFS
paragraphs: Treasury, in coordination with OMB, has not established and documented  criteria for identifying which federal entities are significant to the CFS for  purposes of verifying and validating the information submitted by federal  entities for inclusion in the CFS. Treasury, through the Treasury Financial  Manual (TFM), identified 35 significant federal agencies and entities,  referred to as “verifying agencies.” Those agencies are required to  perform a number of procedures to provide audit assurance over the  information submitted to Treasury for the CFS. However, Treasury and  OMB have not (1) established and documented criteria for designating  federal entities as “verifying agencies” significant to the CFS, and (2)  established policies and procedures for assessing and documenting, on an  annual basis, which entities meet the criteria.
Treasury, in coordination with OMB, is required to prepare the CFS.  According to the Federal Accounting Standards Advisory Board’s  Statement of Federal Financial Accounting Concepts No. 4, Intended  Audience and Qualitative Characteristics for the Consolidated Financial  Report of the United States Government, the consolidated financial report  should be a general purpose report that is aggregated from federal  agencies’ and other federal entities’ financial reports. The TFM provides  policies and procedures on how federal agencies are to provide their  financial data to Treasury for consolidation.
In accordance with the TFM, verifying agencies are required to submit  their financial data to Treasury using a Closing Package. The verifying  agency’s Chief Financial Officer must certify the accuracy of the data in  the Closing Package and have the Closing Package audited by the agency’s  Inspector General. In addition, the Closing Package process requires  verifying agencies to reclassify their audited financial statements to the  Closing Package “special purpose financial statements.” Verifying agencies  must also identify trading partners and enter certain financial statement  notes. The special purpose financial statements are audited to obtain  reasonable assurance about whether the financial statements are (1) free  of material misstatements, (2) in conformity with accounting principles  generally accepted in the United States, and (3) presented pursuant to the  requirements of the TFM. Because the Closing Package process requires  verifying agencies to verify and validate the information in the special  purpose financial statements with their audited information and receive an  audit opinion, Treasury is provided a level of assurance that it is compiling  the CFS with audited financial information. All other federal entities that  contribute financial information to the CFS are classified by Treasury as  “nonverifying agencies.” Over 100 nonverifying federal agencies and  entities submitted data for fiscal year 2008. Currently these entities are  only required to submit adjusted trial balance data to Treasury instead of  an audited Closing Package. Because of a lack of criteria for determining  an entity’s significance to the CFS, it is unclear whether any of these  “nonverifying agencies” should be classified as “verifying agencies.”
One of Treasury’s and OMB’s goals for preparing the CFS is to link the  agencies’ audited financial statements to the CFS. To accomplish this goal,  Treasury needs an appropriate level of assurance that it compiles the CFS  using audited Closing Packages from the federal entities contributing the  most significant amounts of financial information. However, without  establishing the criteria for identifying federal entities as significant to the  CFS and establishing related policies and procedures to assess, on an  annual basis, which entities meet such criteria, Treasury and OMB cannot  obtain this level of assurance.
subsections: section_title: Recommendations for Executive Action
paragraphs: We recommend that the Secretary of the Treasury direct the Fiscal  Assistant Secretary, in coordination with the Controller of OMB, to   (1) establish and document criteria to be used in identifying federal  entities as significant to the CFS for purposes of obtaining assurance over  the information being submitted by those entities for the CFS and   (2) develop and implement policies and procedures for assessing and  documenting, on an annual basis, which entities met such criteria. These  actions will help provide Treasury and OMB with assurance that the  information being used to prepare the CFS is consistent with the audited  financial statements of the federal agencies, in all material respects.
section_title: Procedures for Reviewing the Statements of Net Cost
paragraphs: During fiscal year 2008, Treasury enhanced its SOP entitled “Preparing the  Financial Report of the U.S. Government” to require an overall analysis of  the consolidated numbers in the financial statements to include a review  for reasonableness of changes from the prior year to the current year.  However, because of a lack of details on the objectives of the analysis and  the procedures to be performed, the overall analysis did not detect  significant errors in amounts used to prepare the Statements of Net Cost  (SNC).
Internal control should provide, among other things, reasonable assurance  that financial reporting is reliable. GAO’s Standards for Internal Control in  the Federal Government defines the minimum level of quality acceptable  for internal control in the federal government and provides the standards  against which internal control is to be evaluated. These standards state  that internal controls should include, among other items, reviews by  management at the functional or activity level.
Treasury categorizes and allocates costs in the SNC by agency. For  example, most of the costs associated with pension and health benefits  that are reported by the Office of Personnel Management (OPM) in its  financial statements are allocated to the costs of OPM’s federal user  agencies for governmentwide federal reporting purposes. Treasury uses  head count figures reported by OPM in its Closing Package to perform the  allocation of pension and health benefit costs across all user federal  agencies. However, we found that Treasury did not detect a significant  variance in head count between certain federal entities from 2007 to 2008,  which resulted in significant errors in the draft SNC. Specifically, we found  that, in fiscal year 2007, the head count used for the Department of  Defense (DOD) was 497,724, and the head count used for “all other  entities” was 92,566. In fiscal year 2008, we found that the head counts  were erroneously reversed. The head count used for DOD was 95,157,  while the head count used for “all other entities” was 495,673. Treasury’s  review process and overall analysis did not detect this error. As a result,  Treasury’s draft SNC understated DOD’s reported costs on the fiscal year  2008 SNC by approximately $10 billion and costs for the “all other entities”  line item was equally overstated. Without sufficiently detailed procedures  including guidance for performing the analysis and review of data used in  the allocation process for compiling the SNC, significant errors could  occur in the SNC and not be detected.
subsections: section_title: Recommendation for Executive Action
paragraphs: We reaffirm our recommendation that the Secretary of the Treasury direct  the Fiscal Assistant Secretary to further enhance the SOP entitled  “Standard Operating Procedures for Preparing the Financial Report of the  U.S. Government” to better ensure that CFS compilation practices are  proper, complete, and can be consistently applied, including detailed  procedures for conducting reviews and documenting reasonableness of  data used in the process for compiling the CFS.
section_title: Agency Comments and Our Evaluation
subsections: section_title: OMB Comments
paragraphs: In oral comments on a draft of this report, OMB stated that it generally  concurred with the new findings and related recommendations in this  report. In addition, OMB provided technical comments, which we have  incorporated as appropriate.
section_title: Treasury Comments
paragraphs: In its April 15, 2009, written comments on a draft of this report, which are  reprinted in appendix II, Treasury stated that it concurs with the new  recommendations and expects to implement them by the end of fiscal year  2009. We will evaluate the actions taken to address our recommendations  as part of our fiscal year 2009 CFS audit.
This report contains recommendations to the Secretary of the Treasury.  The head of a federal agency is required by 31 U.S.C. § 720 to submit a  written statement on actions taken on these recommendations. You should  submit your statement to the Senate Committee on Homeland Security and  Governmental Affairs and the House Committee on Oversight and  Government Reform within 60 days of the date of this report. A written  statement must also be sent to the House and Senate Committees on  Appropriations with the agency’s first request for appropriations made  more than 60 days after the date of the report.
We are sending copies of this report to the Chairman and Ranking Member  of the Senate Committee on Homeland Security and Governmental Affairs  and its Subcommittee on Federal Financial Management, Government  Information, Federal Services, and International Security and the  Chairman and Ranking Member of the House Committee on Oversight and  Government Reform and its Subcommittee on Government Management,  Organization, and Procurement. In addition, we are sending copies to the  Fiscal Assistant Secretary of the Treasury, the Director of OMB, the  Deputy Director for Management of OMB, and the Acting Controller of  OMB’s Office of Federal Financial Management. This report is also  available at no charge on GAO’s Web site at http://www.gao.gov.
We acknowledge and appreciate the cooperation and assistance provided  by Treasury and OMB during our audit. If you or your staff have any  questions or wish to discuss this report, please contact me    (202) 512-3406 or engelg@gao.gov. Key contributors to this report are  listed in appendix III.
section_title: Appendix I: Status of Treasury’s and OMB’s Progress in Addressing GAO’s Prior Year Recommendations for Preparing the CFS
paragraphs: This appendix includes the status of recommendations from the following  six reports that were open at the beginning of our fiscal year 2008 audit:  Financial Audit: Process for Preparing the Consolidated Financial  Statements of the U.S. Government Needs Improvement, GAO-04-45  (Washington, D.C.: Oct. 30, 2003);  Financial Audit: Process for Preparing the Consolidated Financial  Statements of the U.S. Government Needs Further Improvement,  GAO-04-866 (Washington, D.C.: Sept. 10, 2004);  Financial Audit: Process for Preparing the Consolidated Financial  Statements of the U.S. Government Continues to Need Improvement,  GAO-05-407 (Washington, D.C.: May 4, 2005);  Financial Audit: Significant Internal Control Weaknesses Remain in  Preparing the Consolidated Financial Statements of the U.S.  Government, GAO-06-415 (Washington, D.C.: Apr. 21, 2006);  Financial Audit: Significant Internal Control Weaknesses Remain in the  Preparation of the Consolidated Financial Statements of the U.S.  Government, GAO-07-805 (Washington, D.C.: July 23, 2007); and  Financial Audit: Material Weaknesses in Internal Control over the  Processes Used to Prepare the Consolidated Financial Statements of the  U.S. Government, GAO-08-748 (Washington, D.C.: June 17, 2008).
Recommendations from these reports that were closed in prior years are  not included in this appendix. This appendix includes the status of the   56 remaining open recommendations, according to the Department of the  Treasury (Treasury) and the Office of Management and Budget (OMB), as  well as our own assessments. Explanations are included in the status of  recommendations per GAO when Treasury and OMB disagreed with our  recommendation or our assessment of the status of a recommendation.  We will continue to monitor Treasury’s and OMB’s progress in addressing  GAO’s recommendations.
Of the 56 recommendations relating to the processes used to prepare the  consolidated financial statements of the U.S. government (CFS) that are  listed in this appendix, 16 were closed and 40 remained open as of  December 9, 2008, the date of our report on the audit of the fiscal year  2008 CFS.
section_title: Appendix II: Comments from the Department of the Treasury
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: In addition to the above contact, the following individuals made key  contributions to this report: Louise DiBenedetto, Assistant Director; Lynda  Downing, Assistant Director; Cole Haase; Dragan Matic; Maria Morton;  Thanomsri Piyapongroj; and Taya Tasse.