Financial Audit: Significant Internal Control Weaknesses Remain in Preparing the Consolidated Financial Statements of the U.S. Government
Published: 2006-04-21T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: For the past 9 years, since our first audit of the consolidated financial statements of the U.S. government (CFS), certain material weaknesses in internal control and in selected accounting and financial reporting practices have resulted in conditions that prevented GAO from expressing an opinion on the CFS. Specifically, GAO has reported that the U.S. government did not have adequate systems, controls, and procedures to properly prepare the CFS. Included with GAO's December 2005 disclaimer of opinion on the fiscal year 2005 CFS was its discussion of continuing weaknesses relating to the Department of the Treasury's (Treasury) preparation of the CFS. The purpose of this report is to (1) provide details of those additional weaknesses, (2) recommend improvements, and (3) describe the status of corrective actions on GAO's previous 154 recommendations.
section_title: What GAO Found
paragraphs: GAO identified weaknesses during its tests of Treasury's process for preparing the fiscal year 2005 CFS. Such weaknesses in the CFS preparation process impair the U.S. government's ability to ensure that the CFS is consistent with the underlying audited agency financial statements, properly balanced, and in conformity with U.S. generally accepted accounting principles. The weaknesses GAO identified during the fiscal year 2005 CFS audit involved the following areas: (1) directly linking audited federal agency financial statements to the CFS, (2) comparability of financial statements, (3) audit assurance over certain federal agencies' closing packages, (4) internal control monitoring, (5) consolidated reporting guidance to federal agencies, (6) reconciling of intragovernmental activity and balances, and (7) various other internal control weaknesses that were identified in previous years' audits but remained in fiscal year 2005. Of the 154 recommendations GAO reported in May 2005 regarding the process for preparing the CFS, 131 remained open as of December 2, 2005, when GAO completed its fieldwork for the audit of the fiscal year 2005 CFS. However, 76 of these 131 recommendations relate to specific disclosures required under U.S. generally accepted accounting principles. Treasury has submitted a proposal to the Federal Accounting Standards Advisory Board (FASAB) seeking to amend previously issued standards and eliminate or lessen the disclosure requirements for the consolidated financial statements so that U.S. generally accepted accounting principles would no longer require certain of the information Treasury has not been reporting. Comments on the exposure draft of a proposed FASAB standard, based on the Treasury proposal, were due March 1, 2006. GAO will continue to monitor the status of corrective actions to address open recommendations during its fiscal year 2006 audit of the CFS.

section_title: Letter
paragraphs: In our report dated December 2, 2005, we disclaimed an opinion on the  consolidated financial statements of the U.S. government (CFS) for the  fiscal years ended September 30, 2005, and 2004. For the past 9 years,  certain material weaknesses in internal control and in selected accounting  and financial reporting practices resulted in conditions that prevented us  from expressing an opinion on the CFS. Specifically, we have reported that  the federal government did not have adequate systems, controls, and  procedures to properly prepare its consolidated financial statements. Many  of these weaknesses in internal control that contributed to our continuing  disclaimers of opinion were identified by agency financial statement  auditors during their audits of federal agencies’ financial statements and  were reported in detail with recommendations to the agencies in separate  reports. However, some of the internal control weaknesses were identified  during our tests of the Department of the Treasury’s (Treasury) process for  preparing the CFS.
The purpose of this report is to (1) discuss the details of the additional  weaknesses we identified during our audit of the fiscal year 2005 CFS  regarding financial reporting procedures and internal control over the  process for preparing the CFS, (2) recommend improvements to address  those weaknesses, and (3) provide the status of corrective actions on the  recommendations detailed in our prior reports and listed in appendix I. We  have discussed each of the new weaknesses identified during our fiscal  year 2005 audit with your staff and have incorporated their comments as  appropriate. We also assessed Treasury’s ongoing effort to develop and  implement the Governmentwide Financial Report System (GFRS) and are providing the results of our assessment along with our recommendations in  a separate report.
subsections: section_title: Scope and Methodology
paragraphs: As part of our audit of the fiscal years 2005 and 2004 CFS, we evaluated  Treasury’s financial reporting procedures and related internal control, and  we followed up on the status of Treasury and OMB corrective actions to  address open recommendations regarding the process for preparing the  CFS that were in our prior years’ reports. In our disclaimer of opinion on  the fiscal year 2005 CFS, which is included in the fiscal year 2005 Financial  Report of the United States Government, we discussed material  deficiencies relating to Treasury’s preparation of the CFS. These material  deficiencies contributed to our disclaimer of opinion on the CFS and also  constitute a material weakness in internal control, which contributed to  our adverse opinion on internal control. We performed sufficient audit  procedures to provide the disclaimer of opinion in accordance with U.S.  generally accepted government auditing standards. This report provides  the details of the additional weaknesses we identified in performing our  fiscal year 2005 audit procedures related to the process for preparing the  CFS and our recommendations to correct those weaknesses, as well as the  status of corrective actions taken by Treasury and OMB to address  recommendations in our prior 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 discussed in the Agency Comments and Our  Evaluation section of this report. Treasury’s comments are reprinted in  appendix II and are also discussed in the Agency Comments and Our  Evaluation section.
section_title: Directly Linking Audited Federal Agency Financial Statements to the CFS
paragraphs: As discussed in our fiscal year 2005 audit report, fiscal year 2005 was the  second year that Treasury used GFRS to collect agency financial statement  information taken directly from federal agencies’ audited financial  statements. The goal of GFRS is to be able to directly link information from  federal agencies’ audited financial statements to amounts reported in the  consolidated financial statements and resolve many of the weaknesses we  previously identified in the process for preparing the consolidated financial  statements, a goal we strongly support. For both the fiscal year 2005 and  2004 reporting processes, GFRS was able to capture agency financial  information submitted to Treasury, but GFRS is still under development  and not at the stage that it could be used to fully compile the consolidated  financial statements from the information captured.
As we have reported in the past, Treasury’s process for compiling the CFS  does not yet fully ensure that financial information from federal agencies’  audited financial statements and other financial data directly link to  amounts reported in the CFS. In our fiscal year 2005 audit report, we noted  that Treasury made progress in demonstrating amounts in the Balance  Sheet and the Statement of Net Cost were consistent with federal agencies’  audited financial statements prior to eliminating intragovernmental activity  and balances. However, about 25 percent of the significant federal  agencies’ auditors reported internal control weaknesses related to the  processes the agencies perform to provide financial statement information  to Treasury for preparing the consolidated financial statements.
In our prior report, we recommended that as Treasury continues to design  and further implement its new process for compiling the CFS, the Secretary  of the Treasury should direct the Fiscal Assistant Secretary, in coordination  with the Controller of OMB, to modify Treasury’s closing package to   (1) require federal agencies to directly link their audited financial  statement notes to the CFS notes and (2) provide the necessary  information to demonstrate that all of the five principal consolidated  financial statements are consistent with the underlying information in  federal agencies’ audited financial statements and other financial data.
Progress was made during fiscal year 2005. Treasury has been continuing to  design and further implement its new process for compiling the CFS with  the development of GFRS. We continue, though, to be concerned that the  disciplined processes necessary to reduce risks to acceptable levels have  not yet been effectively implemented. For example, Treasury moved  forward with the project before ensuring that certain key elements, such as  a concept of operations, were developed or even defining and documenting  the financial reporting weaknesses that were expected to be addressed by  the system. Not effectively implementing such disciplined processes  creates an unnecessary risk that the system will cost more and take longer  than expected to deploy, while not providing all of the intended system  functionality. The implementation of any major system, such as GFRS, is  not without risk; however, organizations that follow and effectively  implement accepted best practices in systems development and  implementation have been shown to reduce these risks to acceptable  levels. A more detailed discussion of our assessment of Treasury’s ongoing  effort to develop and implement GFRS, along with recommendations to  reduce the risk noted above, can be found in a separate report.
section_title: Comparability of Financial Statements
paragraphs: The CFS includes 2 years of financial information. Because comparative  financial statements are intended to furnish useful data about the  differences in activity and balances between the 2 years shown,  consistency in how amounts are reported for the 2 years is a major factor in  creating comparability. We found that Treasury lacked a process to ensure  that consolidated financial statements and notes for fiscal years 2005 and  2004 were consistently reported and therefore comparable. During fiscal  year 2005, Treasury requested that agencies resubmit fiscal year 2004  financial information along with their fiscal year 2005 financial  information. Some agencies resubmitted fiscal year 2004 amounts in fiscal  year 2005 that differed from what Treasury published in fiscal year 2004.  Also, certain information reported for fiscal 2004 may have required  reclassification to be comparable to the fiscal year 2005 amounts. Treasury  did not analyze the fiscal year 2004 information submitted in fiscal year  2005 or reclassify amounts within various financial statement line items  and notes to achieve comparability and chose to continue to report what  was published for fiscal year 2004. For example, the Reconciliations of Net  Operating Cost and Unified Budget Deficit showed $47.8 billion and $.2  billion for property, plant, and equipment disposals and revaluations for  fiscal years 2005 and 2004, respectively. However, based on the audited  financial information provided by agencies to Treasury in GFRS in fiscal  year 2005, the fiscal year 2004 amount should be $25.4 billion, rather than  $.2 billion. The difference should have been reclassified from the Net  Amount of All Other Differences line item on the Reconciliations of Net  Operating Cost and Unified Budget Deficit.
subsections: section_title: Recommendation for Executive Action
paragraphs: We recommend that the Secretary of the Treasury direct the Fiscal  Assistant Secretary to develop a process to help ensure that, for each  reporting year, the 2 years of consolidated financial statements and note  information presented are consistently and comparably reported, in all  material respects.
section_title: Audit Assurance over Certain Federal Agencies’ Closing Packages
paragraphs: Treasury and OMB did not require closing packages from 4 of the 35  verifying agencies to be audited. Specifically, the Treasury Financial  Manual (TFM) states that the Inspector General or a contracted  independent public accountant for each federal verifying agency—except  those agencies whose fiscal year ends on a date other than September 30— must opine on the closing package data entered by the Chief Financial  Officer into GFRS. Because of these year-end differences, the TFM does not  require the Federal Deposit Insurance Corporation’s Funds, National Credit  Union Administration, and Farm Credit System Insurance Corporation—all  of which have a year end other than September 30—to have their closing  package data be audited. In addition, for fiscal years 2004 and 2005, OMB  waived the closing package audit requirement for the Tennessee Valley  Authority (TVA), which does have a September 30 fiscal year end. In these  four cases, Treasury and OMB did not develop any alternative solutions  that include the requirement for adequate audit procedures to be  performed over significant information included in the CFS. As a result,  unaudited September 30 information was included in the CFS for 4  agencies that Treasury and OMB consider to be significant. Treasury,  therefore, has less assurance that the information included in the CFS for  these agencies is fairly stated and directly links to the agencies’ audited  financial statements.
subsections: section_title: Recommendation for Executive Action
paragraphs: We recommend that the Director of OMB direct the Controller of the Office  of Federal Financial Management, in coordination with the Treasury Fiscal  Assistant Secretary, to develop an alternative solution for obtaining audit  assurance related to the Federal Deposit Insurance Corporation’s Funds,  National Credit Union Administration, and Farm Credit System Insurance  Corporation, which includes the requirement for adequate audit  procedures to be performed over significant information included in the  CFS for these agencies.
We also recommend that the Director of OMB direct the Controller of the  Office of Federal Financial Management to consider not waiving the  closing package audit requirement for any verifying agency in future years,  such as TVA.
section_title: Internal Control Monitoring
paragraphs: GAO’s Standards for Internal Control in the Federal Government states  that internal control is a major part of managing an organization and should  include monitoring. Monitoring of internal control should include  assessing the quality of performance over time and implementing policies  and procedures for the timely follow-up and resolution of findings of audits  and other reviews. The goal of these policies and procedures is to ensure  that managers (1) promptly evaluate findings from audits and other  reviews, including those showing deficiencies and recommendations  reported by auditors and others who evaluate agencies’ operations;   (2) determine proper actions in response to findings and recommendations  from audits and reviews; and (3) complete, within established time frames,  all actions that correct or otherwise resolve the matters brought to  management’s attention. However, Treasury, in coordination with OMB,  had not developed policies and procedures for monitoring internal control  or provided us with adequate documentation evidencing an executable  plan of action and milestones for short-term and long-range solutions for  certain internal control weaknesses we have previously reported regarding  the process for preparing the CFS. Without effective monitoring of internal  control, findings of audits may not be resolved timely and properly.
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   policies and procedures for monitoring internal control to help ensure  that (1) audit findings are promptly evaluated, (2) proper actions are  determined in response to audit findings and recommendations such as  a documented plan of action with milestones for short-term and long- range solutions, and (3) all actions that correct or otherwise resolve the  audit findings are completed within established time frames; and   an executable plan of action and milestones for short-term and long- range solutions for certain internal control weaknesses we have  previously reported regarding the process for preparing the CFS.
section_title: Consolidated Reporting Guidance to Federal Agencies
paragraphs: The TFM prescribes how federal agencies are to submit financial  information to Treasury to be used in compiling the CFS. While our planned  audit procedures were not to review the entire TFM to determine if its  guidance to agencies was clear, we found several areas where the TFM did  not give clear guidance to federal agencies about the information that they  were required to provide to Treasury, GAO, and OMB. Specifically, we  found that the TFM did not give clear guidance for (1) reporting note  disclosures for restricted cash, (2) reporting note disclosures for accounts  payable, (3) preparing summaries of unadjusted misstatements to be  included with federal agencies’ closing package management  representation letters, and (4) certain information to be reported by OPM  to Treasury that is used to allocate costs on the Statement of Net Cost. For  example, the TFM defines restricted cash as “amounts of cash that an  entity holds and does not have authority to spend” and cash that is not  restricted as “amounts of cash that an entity holds for which it has the  authority to spend.” Although these definitions are accurate at the agency  level, these definitions are not accurate at the CFS level. For example, an  agency may hold cash that it does not have the authority to spend because  of a certain law or regulation, but when this cash is consolidated at the  governmentwide level, the federal government as a whole may have the  authority to spend the cash. Therefore, this cash would appropriately be  restricted at the agency level, but not at the governmentwide level. As a  result of the unclear guidance, agencies reported certain financial  information inconsistently. This increases the risk of incomplete and  inaccurate summarization of data in the CFS.
subsections: section_title: Recommendations for Executive Action
paragraphs: We recommend that the Secretary of the Treasury direct the Fiscal  Assistant Secretary to ensure that the TFM and any other guidance to  federal agencies provide clear instructions for providing reliable data to  Treasury in the following specific areas:  summaries of unadjusted misstatements, and  certain information reported by OPM that is used to allocate costs on  the Statement of Net Cost.
section_title: Reconciling of Intragovernmental Activity and Balances
paragraphs: OMB and Treasury require federal agencies to reconcile selected  intragovernmental activity and balances with their “trading partners” and  report on the extent and results of the reconciliation efforts to Treasury. As  part of the reconciliation report, federal agencies were required to  categorize any material differences, as determined by Treasury, with their  trading partners at fiscal year end within five categories: (1) confirmed  reporting; (2) accounting methodology differences; (3) accounting or  reporting errors; (4) timing difference—current year, timing difference— prior year; and (5) unknown/unreconciled. According to Treasury,  confirmed reporting, the first category listed above, is intended to indicate  that the agency has verified that the amount it has reported is accurate. The  TFM requires a federal agency that selects the category “confirmed  reporting” to provide a detailed explanation to support its response.
However, we found that in many cases where a federal agency selected the  “confirmed reporting” category, the agency did not provide detailed  explanations. We also found cases where both trading partners selected  “confirmed reporting” for the same material difference and the agencies did  not provide detailed explanations for how both trading partners’ amounts  could be accurate when the material difference remained. When this  situation occurs, we found that Treasury and OMB do not have an effective  process to obtain clarification for inconsistent explanations provided and  that agencies may be unclear as to when to select this category. Incorrect  use of the confirmed reporting category and lack of detailed explanations  may hinder efforts to identify and correct problems that federal agencies  are experiencing in reconciling with their trading partners.
Further, Treasury received the closing packages that contained each  agency’s intragovernmental activity and balances amounts on November  18, 2005, and provided agencies with reconciliation reports that showed  material differences with their trading partners on November 21, 2005.  Treasury and OMB also require federal agencies’ IGs to annually perform  agreed-upon procedures on the intragovernmental activity and balances  reported in the closing package. For fiscal year 2005, Treasury required  agency IGs for the 35 verifying agencies to complete and report on these  agreed-upon procedures by December 2, 2005. The timing of these  procedures did not optimize their value because (1) this reporting date is  over 2 weeks after federal agencies’ audited financial statements were  required to be issued to OMB, and (2) did not allow Treasury sufficient time  to review the results and make any necessary adjustments to the CFS.
subsections: section_title: Recommendation for Executive Action
paragraphs: We recommend that the Secretary of the Treasury direct the Fiscal  Assistant Secretary, working in coordination with the Controller of OMB, to   provide clear guidance to federal agencies as to when the “confirmed  reporting” category in the intragovernmental reconciliation report  should be selected,  develop an effective process for obtaining clarification from federal  agencies for inconsistent or incomplete explanations provided in all  material difference categories, and   accelerate the due date for IGs to complete and report on the results of  agreed-upon procedures on the intragovernmental activity and balances  or develop an alternative solution that would allow Treasury sufficient  time to review the results and make any necessary adjustments to 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  agreed with the new findings and related recommendations in this report.  In addition, OMB provided some technical comments, which we have  incorporated as appropriate.
section_title: Treasury Comments
paragraphs: In written comments on a draft of this report, which are reprinted in  appendix II, Treasury stated that it agrees that the preparation process still  needs improvement and that it is addressing many of the recommendations  in our previous reports. Treasury also stated that it concurs with all of the  new recommendations in this report except for the recommendation to  accelerate the due date for IGs to complete the agreed-upon procedures on  the intragovernmental activity and balances. For fiscal year 2006, Treasury  does not plan to accelerate the due date for completing these  intragovernmental agreed-upon procedures. However, Treasury stated that  for fiscal year 2006, it plans to expand the audit coverage for  intragovernmental activity and balances by requiring the IGs to opine on  such information in their audit of the closing package, which is due to  Treasury by November 17, 2006. This is an appropriate alternative solution  to accelerating the due date for the IGs to complete the intragovernmental  agreed-upon procedures. We have modified our recommendation to also  include developing an alternative solution to address this finding.
This report contains recommendations to the Secretary of the Treasury and  the Director of OMB. 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 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 Chairmen and Ranking Minority  Members of the Senate Committee on Homeland Security and  Governmental Affairs; the Subcommittee on Federal Financial  Management, Government Information, and International Security, Senate  Committee on Homeland Security and Governmental Affairs; the House  Committee on Government Reform; and the Subcommittee on Government  Management, Finance, and Accountability, House Committee on  Government Reform. In addition, we are sending copies to the Fiscal  Assistant Secretary of the Treasury and the Deputy Director for  Management of OMB. Copies will be made available to others upon request.  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 Jeffrey C. Steinhoff,  Managing Director, Financial Management and Assurance, on   (202) 512-2600, or Gary T. Engel, Director, Financial Management and  Assurance, on (202) 512-3406. Staff contacts and other key contributors to  this report are listed in appendix II.
section_title: Status of Treasury’s and OMB’s Progress in Addressing GAO’s Prior Year Recommendations for Preparing the CFS
paragraphs: This appendix includes open recommendations from three of our prior  reports: 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); and 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).  Recommendations that were closed in prior reports are not included in this  appendix. This appendix includes the status of the 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.
Of the 154 recommendations regarding the process for preparing the CFS  that are listed in this appendix, 131 remained open as of December 2, 2005,  the end of GAO’s fieldwork for the audit of the fiscal year 2005 CFS. Of  these 131 recommendations, 76 relate to specific disclosures required  under U.S. generally accepted accounting principles (GAAP). Treasury has  submitted a proposal to the Federal Accounting Standards Advisory Board  (FASAB) seeking to amend previously issued standards and eliminate or  lessen the disclosure requirements for the consolidated financial  statements so that GAAP would no longer require certain of the  information Treasury has not been reporting. Comments on the exposure  draft of a proposed FASAB standard, based on the Treasury proposal, are  due March 1, 2006. Treasury stated that it is waiting for FASAB approval  and issuance of this proposed standard to determine the disclosures that  will be required in future consolidated financial statements.
section_title: Comments from the Department of the Treasury
subsections: section_title: GAO Comments
paragraphs: 1. See “Agency Comments and Our Evaluation” section.  2. We continue to believe that our recommendations relating to the  Statement of Changes in Cash Balance from Unified Budget and Other  Activities, Reconciliations of Net Operating Cost and Unified Budget  Deficit, and the adjustment process are sound. Our recommendations  are intended to allow flexibility in developing viable solutions to  address the issues. We will consider any alternative action that  Treasury may take to satisfactorily address the recommendations with  which it has disagreed. See appendix I for the status of related  recommendations.
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: In addition to the above contact, the following individuals made key  contributions to this report: Lynda Downing, Assistant Director; Keith  Kronin; Katherine Schirano; and Taya Tasse.