Internal Revenue Service: Progress Made, but Further Actions Needed to Improve Financial Management
Published: 2001-10-19T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: This is a follow-on to GAO's report on its audit of the Internal Revenue Service's (IRS) fiscal year 2000 financial statements. Many of the issues raised in this report have persisted for years. IRS believes that the solution to many of these issues may lie in systems modernization. IRS plans to implement a new financial system that includes a cost accounting module as well as integrated administrative and custodial general ledgers that are supported by subsidiary ledgers containing the transactional details for key accounts, such as taxes receivable and property and equipment. IRS continues to make progress in addressing its financial management challenges. The strong commitment by IRS senior management to financial management reform has played a crucial role in the agency's progress so far and is critical for future improvements. IRS has developed many workaround processes that allowed it to produce reliable financial statements for fiscal year 2000. However, these processes take considerable time, effort, and expense and do not fix many of the fundamental financial management issues that continue to plague IRS.

section_title: Letter
paragraphs: This report is a follow-on to our report on the results of our audit of the  Internal Revenue Service’s (IRS) fiscal year 2000 financial statements. In  fiscal year 2000, IRS was able to produce for the first time combined  financial statements that were fairly stated in all material respects. This  achievement was the result of the dedication and months of efforts of IRS’  management and staff working around serious systems deficiencies and  internal control weaknesses, many of which have plagued IRS since we  first began auditing its financial statements in 1992. Although this effort  produced reliable financial statement balances, they were reliable only for  a single point in time and fell short of addressing the fundamental  weaknesses in IRS’ systems and internal controls. As a result, we gave an  unqualified opinion on IRS’ fiscal year 2000 financial statements but also  concluded that IRS did not maintain effective internal controls. We also  found two instances of noncompliance with laws and regulations relating  to IRS’ structuring of installment agreements and the timing of the release  of tax liens.
During our fiscal year 2000 audit, we noted that IRS had made many  improvements to address some of the financial management issues we  have raised in previous reports. For example, IRS had significantly  improved its controls over reconciling its appropriated fund balance with  Treasury accounts and in minimizing the number and dollar amount of  transactions held in suspense accounts. Additionally, IRS had significantly  improved the quality of its documentation of unpaid tax assessments. IRS  had also made important improvements in its handling of taxpayer receipts  and data, and had made progress in addressing both long-standing  weaknesses in controls over its property and equipment and weaknesses in  budgetary controls. IRS’ progress is attributable to the extraordinary  efforts of IRS senior management and staff and the continued strong  commitment by senior management to address the agency’s financial  management issues.
Despite this progress, a continued high level of effort by IRS is necessary to  implement long-lasting solutions to serious systems deficiencies and  internal control weaknesses. Because of the seriousness of these issues, we  continue to designate IRS financial management as high risk.  Furthermore, until these problems are addressed, IRS cannot achieve the  overriding objective of the Chief Financial Officers (CFO) Act and other  reform legislation enacted during the last decade—to produce reliable,  useful, and timely financial and performance information for day-to-day  decision-making. Addressing these issues will also provide IRS with the  added benefit of improving its customer service and its operational  effectiveness as the nation’s tax collector.
The matters addressed in this report relate to IRS’ activities associated with  its fiscal year 2000 appropriation of $8.3 billion and issues relating to IRS’  collection of federal tax revenue, improper refunds, and unpaid tax  assessments. This report discusses (1) the status of previously reported  internal control and compliance issues and related recommendations  associated with our annual financial statement audits and related financial  management reviews of IRS and (2) new issues identified during our fiscal  year 2000 financial audit, along with recommendations to address these  issues.
subsections: section_title: Background
paragraphs: IRS’ mission is to provide taxpayers with top-quality service by helping  them to understand and meet their tax responsibilities and by applying the  tax law with integrity and fairness. In fiscal year 2000, IRS collected over  $2 trillion in tax revenue, issued about $194 billion in tax refunds, and had  net taxes receivable at year-end of $22 billion. Although most of the  revenue was collected by intermediaries such as financial depository  institutions and transferred directly to the Department of the Treasury’s  general fund, IRS offices and lockbox banks collected $435 billion in fiscal  year 2000. IRS has 10 campuses nationwide that have collection, refund,  and enforcement responsibilities. IRS also has other field offices to assist  taxpayers and perform collection and enforcement activities. Ten  commercial lockbox banks also receive and process taxpayer receipts,  then forward the data to IRS for input and processing. In response to  congressional concerns as embodied in the Internal Revenue Service  Restructuring and Reform Act of 1998, IRS instituted a reorganization that  has significantly affected the roles and responsibilities of its offices.
Fiscal year 2000 marked the first time IRS was able to produce combined  financial statements covering its tax custodial and administrative activities  that were fairly stated in all material aspects. This achievement required  extraordinary human effort and extensive reliance on compensating  processes to work around IRS’ serious system and control weaknesses to  derive reliable year-end balances for its financial statements. However, this  approach does not fix its fundamental weaknesses nor produce the  reliable, useful, and timely financial and performance information IRS  needs for ongoing decision-making consistent with the CFO Act of 1990.
section_title: Objectives, Scope, and Methodology
paragraphs: The objectives of this report are to (1) provide a status of previously  reported internal control and compliance issues and related  recommendations and (2) present new issues identified during our audit of  IRS’ fiscal year 2000 financial statements along with new  recommendations. Appendix I provides further details on our scope and  methodology. We performed our work from April 2000 through February  2001 in accordance with U.S. generally accepted government auditing  standards.
section_title: Weaknesses Hinder Management of Unpaid Assessments
paragraphs: During fiscal year 2000, IRS continued to have serious internal control  deficiencies that affected its reporting and management of unpaid  assessments. IRS’ lack of an appropriate general ledger system prevented  it from properly and routinely classifying unpaid assessments without  substantial use of specialized computer programs and manual intervention.  Additionally, significant delays and errors in recording taxpayer payments  and other information adversely affected the accuracy of taxpayer  accounts and thus IRS’ ability to ensure taxpayers were not unduly harmed  or burdened. Also, the lack of valid and timely cost-benefit data hindered  IRS’ ability to make or justify resource allocation decisions that directly  affect the management of unpaid assessments and, thus, the collection of  federal revenue. Collectively, these issues are indications of serious  internal control deficiencies and constitute a material weakness in unpaid  assessments. Additionally, the continued existence of these issues could  result in lost revenue to the government, erode taxpayer confidence in the  equity of the tax system, and adversely affect future compliance.
Table 1 summarizes the issues we identified related to unpaid assessments,  their effects, and IRS’ actions to address these issues. These issues were  also identified in prior years’ audits, for which recommendations have  already been made. Consequently, we are not making any new  recommendations related to unpaid assessments. Appendix II lists these  previous recommendations and IRS’ actions to address them.
subsections: section_title: Reporting Reliable Balances
paragraphs: In an integrated financial management system, the general ledger is  supported by subsidiary ledgers, which contain detailed records of  transactions and automatically update the appropriate general ledger  account balances as transactions occur. Throughout the year, detailed  records in the subsidiary ledger would then support key account balances  in the general ledger. However, throughout fiscal year 2000, IRS continued  to lack an effective subsidiary ledger system that could accumulate and  track the status of unpaid assessments on an ongoing basis. This deficiency  continued to necessitate the use of an extensive workaround process in  order for IRS to derive the balances in the three categories of unpaid  assessments as defined by federal accounting standards—taxes receivable,  compliance assessments, and write-offs—for year-end financial reporting.
This workaround process is costly, labor-intensive, and time-consuming. It  involves the use of a specialized computer program to extract all unpaid  assessment data from IRS’ master files—its only detailed database of  taxpayer information—and classify them for financial reporting. However,  the master files do not contain all the details necessary to properly and  fully classify unpaid assessment accounts. Therefore, the workaround  process also includes the need to select statistical samples of IRS’ unpaid  assessments and manually review the sampled accounts to (1) determine  their proper classification and (2) estimate collectibility for those  assessments properly classified as taxes receivable. As in past years, this  statistical sampling has resulted in the need to materially adjust the  amounts generated by the computer extraction program—by tens of  billions of dollars—to produce reliable amounts for taxes receivable and  other unpaid assessments. In fiscal year 2000, of a total of 474 unpaid  assessment sample items selected for detail testing that IRS’ computer  extraction program originally classified as taxes receivable, 158 items were  misclassified and were actually write-offs or partial write-offs,  compliance assessments, or were deemed not to be unpaid assessments.  Based on our work, we estimate that 12.6 percent of unpaid assessments  originally classified by IRS’ computer extraction program as taxes  receivable were misclassified.
Figure 1 below illustrates the problem by showing the level of adjustments  needed to the amounts generated by the computer extraction program in  fiscal year 2000 to arrive at reliable amounts for each category of unpaid  assessments.
Although the workaround processes allowed IRS to report reliable year-end  information for unpaid assessments in its financial statements, these  balances are reliable only for a single point in time and are not available  until several months after the end of the fiscal year. Additionally, the  magnitude of the adjustments needed demonstrate that the data provided  by IRS’ automated system for unpaid assessments but not supplemented by  these workaround procedures and adjustments are unreliable for financial  reporting. They cannot be used to track the overall status of IRS’ unpaid  assessments and cannot be relied upon by IRS management and Congress  to make policy and budgetary decisions.
section_title: Maintaining Accurate Taxpayer Accounts
paragraphs: Maintaining accurate taxpayer accounts is important for properly  managing activity and ensuring the fair and equitable treatment of  taxpayers, and it is necessary for reliable financial reporting. However,  significant delays and errors in updating taxpayers’ accounts further  exacerbated problems related to the reliability of unpaid assessment  balances in general and the reliability and management of individual  taxpayer accounts in particular throughout the fiscal year. Errors and  delays in recording activity also continued to lead to instances in which tax  liens were not promptly released or not released at all during the period  covered by our audit. These conditions continued to result in instances of  taxpayer burden and lost opportunities to collect outstanding taxes owed.
As in previous years, we found delays and errors in recording payments for  unpaid payroll taxes where separate accounts are established and  assessments recorded for a related tax liability. IRS' systems cannot  automatically link to each other the multiple assessments made for the one  tax liability. Consequently, IRS’ systems are unable to automatically reduce  the balance in the related account (or accounts) if the business or an  officer pays some or all of the outstanding taxes. To compensate, IRS  established procedures to manually link the related accounts. However, we  still found many instances in which payments were not posted to accounts  that had been linked. The statistical sample of 474 unpaid tax assessment  cases reviewed included 68 unpaid payroll cases involving multiple  assessments. Of these 68, we found that   29 cases contained payments that IRS either had not recorded, or had  failed to record in a timely manner, to all related accounts. Some of  these amounts were paid by taxpayers in the late 1980s. Based on the  results of our work, we estimate that 42 percent of the population of  unpaid payroll tax accounts involving multiple assessments as of  September 30, 2000, had this characteristic; and  of these 29 cases, 28 (96 percent) had a manual code cross-referencing  them to related accounts, yet the payments were still not recorded in all  of the related accounts.
We also found other delays and errors. For example, we found that IRS’  failure to enter or reverse status or freeze codes into the taxpayers’  accounts resulted in improper refunds being issued—in two cases, more  than $4,000 each—to taxpayers who had other outstanding liabilities. In  another case, IRS recorded an estate payment of $68 million to the wrong  taxpayer account. Though the taxpayer’s estate was owed a refund of  almost $7 million, this error was not corrected until almost 2 years later,  and thus the refund was not issued for nearly 2 years after it was owed.
Delays and errors in recording activity in taxpayer accounts complicate  IRS’ efforts to derive a reliable balance for taxes receivable and other  unpaid assessments in its financial statements. The accuracy of taxpayer  accounts affects the determination of both the appropriate classification of  these accounts under federal accounting standards and the basis for  estimating collectibility for those accounts determined to represent taxes  receivable. For example, to determine whether an unpaid payroll tax  liability related to a defunct business should be classified as a write-off, IRS  must first determine that no outstanding penalty assessments against  officers of the business exist or have any future collection potential. If the  accounts representing penalty assessments against officers continue to  show outstanding balances solely because payments have not been  appropriately recorded in these accounts, IRS could erroneously conclude  that the unpaid tax owed by the business still has some collection potential  from the officers and thus erroneously classify the account as a tax  receivable.
Delays in updating taxpayer accounts and taking appropriate actions also  led to instances in which IRS did not release federal tax liens applied  against the property of taxpayers within 30 days after the taxpayers had  satisfactorily discharged their tax liabilities as required by Section 6325 of  the Internal Revenue Code. In fiscal year 2000, we found that IRS continued  to experience significant delays in releasing some tax liens. Specifically, in  3 of the 38 tax lien cases we reviewed in fiscal year 2000, we found that it  took IRS more than 100 days, and in one case 583 days, to release the liens  against the taxpayers’ properties after the taxpayers had satisfied their  outstanding tax liabilities. Based on our work, we estimate that during  fiscal year 2000, for 11 percent of resolved unpaid assessment cases that  had tax liens, IRS did not release the liens within the 30-day requirement.  The failure to promptly release liens could cause undue hardship and  burden to taxpayers who may want to sell property or apply for  commercial credit.
section_title: Pursuing Collections of Unpaid Taxes
paragraphs: As with any large agency, IRS is confronted by the ongoing management  challenge of allocating its limited resources among competing priorities.  However, IRS does not have the management data necessary to prepare  reliable cost-benefit analyses to make more informed decisions about  how best to allocate its resources. Consequently, IRS is hindered in its  ability to determine whether it is devoting the appropriate level of  resources to identifying and pursuing collection of unpaid taxes relative to  the costs and potential benefits involved.
During fiscal year 2000, we continued to find that IRS was closing  delinquent tax cases without working them—that is, without making  collection contact with taxpayers through either telephone calls or field  visits. This type of case closure is referred to as “shelving.” The process of  shelving cases began in mid 1999 in response to an increasing inventory  workload and IRS’ assessment that resource constraints and decisions  regarding where to deploy these resources would not permit it to actively  pursue the cases. According to IRS records, as of September 30, 2000,  1.8 million cases totaling $8.6 billion—compared to 648,000 cases totaling  $2.4 billion at September 30, 1999—were shelved because IRS judged that  resource constraints would not allow it to actively pursue collection on  these cases.
We also continued to find unpaid assessment cases that had collection  potential but were not being actively worked by IRS. We found at least six  cases in our testing of unpaid assessments constituting taxes receivable for  which information in the case files indicated some collection potential, but  for which IRS had taken no collection action. In two of these cases, IRS  was not actively pursuing collection of taxpayers who owed $23,000 and  $88,000, respectively, in outstanding taxes and who each had annual  incomes in subsequent years of at least $110,000.
How IRS derives its balance for taxes receivable in its financial statements  is affected by actions taken by IRS to collect outstanding taxes. In  estimating collectibility for those accounts in its statistical samples that are  appropriately classified as taxes receivable, IRS reviews case file  information and considers whether the agency is pursuing collection  through such means as levies, seizures, offers-in-compromise, or  installment agreements. To the extent these files contain no evidence of  such efforts, IRS must assess collectibility for the account at zero. This  ultimately affects the balance of both net taxes receivable and the related  allowance for doubtful accounts reported in its financial statements.
IRS’ failure to pursue delinquent taxpayers with at least some ability to pay  is part of a broader and continued decline in IRS’ enforcement activities  and disposition of delinquent tax cases. For example, according to IRS  records, between fiscal years 1998 and 2000, enforcement activities such as  levy notifications experienced a substantial decline, from more than 9  percent to less than 1 percent of these unpaid assessment accounts. During  the same period, the dispositions of delinquent accounts and  investigations as a percentage of total outstanding cases decreased from  6.1 to 3.5 percent, a reduction of more than 43 percent. According to IRS  records, collections on delinquent taxpayer accounts also decreased by  28 percent during this period, from $5.3 billion in fiscal year 1998 to  $3.8 billion in fiscal year 2000.
While there is a point at which it ceases to be cost effective to pursue  collection, we believe that these decisions should be based on reliable cost- benefit data. Without valid cost-benefit analyses, IRS is hindered in its  ability to make sound comparisons among competing priorities and to most  effectively allocate resources among these priorities. One element that is  critical to such a cost-benefit analysis is a measure of taxpayers’ voluntary  compliance with the nation’s tax laws. However, as we have previously  reported, IRS lacks such a measure. Consequently, it does not know the  impact of the recent declines in enforcement activities and delinquency  collections on taxpayer compliance. Congress and tax practitioners have  expressed concerns that declines in pursuing potential unpaid taxes and in  enforcing and collecting on delinquent accounts may increase incentives  for taxpayers either to not report or to underreport their tax obligations.  The lack of reliable cost-benefit information with which to make informed  decisions could result in billions of dollars in outstanding amounts going  uncollected and could lead to further erosion in taxpayers’ confidence in  the equity of the tax system and adversely affect future compliance.
section_title: Weaknesses in Controls Over Refunds and Earned Income Tax Credits
paragraphs: During fiscal year 2000, IRS disbursed over 101 million tax refunds totaling  about $194 billion. However, because of long-standing weaknesses in IRS’  controls over refund disbursements and other management challenges, the  federal government continued to be exposed to material losses through the  issuance of improper refunds, particularly with respect to EITC claims.  Time constraints, high volume, reliance on information supplied by  taxpayers, and the timing of filing of information returns by third parties  create inherent limitations in IRS’ options for addressing the problem of  improper refunds. Consequently, in fiscal year 2000 IRS continued to  (1) issue improper refunds associated with invalid EITC claims and (2) rely  extensively on post-refund (detective) controls that were not fully effective  in identifying and limiting the losses associated with improper refunds.  This, in turn, continued to expose the government to financial losses,  possibly in the billions of dollars, through the disbursement of improper  refunds.
Table 2 summarizes issues we found relating to refund processing controls,  their effects, and IRS’ actions to address these issues. These issues were  also identified in prior years’ audits, for which recommendations have  already been made. Consequently, we are not making any new  recommendations related to refund processing controls. Appendix II lists  the previous recommendations and IRS’ actions to address them.
subsections: section_title: Preventive Controls
paragraphs: The options available to IRS in its efforts to ensure that only valid refunds  are disbursed are currently limited. For example, while it processes  hundreds of millions of tax returns each filing season, IRS must also issue  refunds within certain time constraints or be subject to interest charges. At  the same time, IRS must contend with the fact that third-party information,  such as form 1099s, are not required to be filed prior to the start of the tax  filing season. Comparison of such information with tax return data is  problematic because IRS does not have time to prepare the third-party data  for matching prior to the receipt of individual tax returns. Nonetheless, IRS  does have some preventive controls which, if effectively implemented,  could help to reduce the level of risk associated with issuing improper  refunds related to EITC claims. For example, IRS’ Examination Branch is  responsible for performing examinations on tax returns with potentially  invalid EITC refund claims to determine the validity of the claim.  However, it has not performed a cost-benefit analysis to determine whether  it is focusing the appropriate level of resources on this effort. Without this,  IRS is unable to determine the extent to which refunds associated with  invalid EITC claims could be prevented or minimized had IRS devoted  more resources to its examination efforts.
The Electronic Fraud Detection System (EFDS) is an automated  screening tool IRS’ Criminal Investigation Division (CI) uses to identify  EITC refund claims with the highest potential to be fraudulent or invalid. CI  uses EFDS to score each EITC claim, using a set of screening criteria. CI  retains those cases that indicate a high potential for fraud for follow-up and  forwards all other cases that score above a certain level to the Examination  Branch. For each of its 10 campuses, the Examination Branch determines a  set number of cases that it perceives as the workload each campus’s  resources can handle. It then refers cases to each campus for examination  up to that campus’s established workload amount.
During fiscal year 2000, the Examination Branch reduced the number of  cases referred by CI for examination by choosing a higher minimum score  level for each case and reviewing other factors such as how recently the  taxpayer was last examined. Additionally, it discontinued referring cases  associated with a particular campus once it reached the determined  workload level it established for that campus. Consequently, the number of  EITC refund claims subject to examination by IRS was predetermined by  the available resources rather than based on an analysis of what the  optimum score level should be for selecting cases to examine based on the  expected yield at each level and the associated resource cost.
The government could be losing billions of dollars through improper  refunds associated with invalid EITC claims. For example, in a study of tax  year 1997 returns, IRS estimated that of approximately $30.3 billion EITC  claims received, about $9.3 billion (30.6 percent) were invalid claims. IRS  did not know the exact amount of the related improper refunds, but based  on IRS’ fiscal year 1998 refund rate of about 78 percent of EITC claims, we  estimate the amount of improper EITC refunds to be about $7.3 billion. In  the same study, IRS estimated that it would not be able to recover 84  percent of the total invalid EITC claims. Applying this rate to the refunds  portion only, we estimate that $6.1 billion of the improper refunds could be  unrecoverable. With such a potential for invalid refunds, IRS must better  ensure that it is devoting the appropriate level of resources to examining  these claims.
section_title: Detective Controls
paragraphs: IRS’ primary detective controls are its automated matching programs to  match tax returns against third-party data. Identified discrepancies may  indicate underreported tax liabilities and possible improper refunds, to the  extent that the underreporting resulted in refunds being disbursed. IRS has  separate automated matching programs for individual and employer tax  returns which are performed several months after the returns are filed.  However, IRS did not perform follow-up examinations on millions of  identified tax returns estimated to have billions of dollars of underreported  tax liabilities. As a result, to the extent these taxpayers had received  improper refunds by underreporting their taxes, IRS did not pursue  recovery of these refunds. Table 3 presents IRS’ workload for the matching  program for individual returns referred to as the Automated Underreporter  Program (AUR).
As shown in this table, in tax years 1996 through 1998, IRS did not  investigate over 30 million AUR cases with about $30 billion in estimated  underreported taxes which may have also resulted in the issuance of  improper refunds. Because IRS did not investigate these cases, the exact  amount of underreported taxes due and any resulting improper refunds  disbursed are unknown.
section_title: Allocating Resources for Refund Controls
paragraphs: IRS’ decision to forgo follow-up examinations and collection efforts on  potentially underreported tax liabilities, improper refunds, and invalid  EITC claims was based on perceived resource constraints.  However, as  discussed later in this report, IRS’ financial management systems do not  currently provide reliable information for cost-benefit analyses.  Consequently, IRS management cannot determine whether the cost  associated with the level of resources it expends on various refund control  projects is commensurate with the benefits that could be realized from  such efforts. Additionally, IRS cannot determine whether it is effectively  directing its resources to the areas with the most potential benefit. As a  result, billions of dollars of improper refunds could be disbursed as a result  of invalid EITC claims and underreported tax liabilities and could remain  uncollected. This in turn could erode taxpayer confidence in the equity of  the tax system and reduce compliance with the tax laws.
section_title: Weaknesses Over Safeguarding of Manual Tax Receipts and Taxpayer Data Continue
paragraphs: IRS’ controls over cash, checks, and related hard-copy taxpayer data it  receives from taxpayers continue to be inadequate. While IRS has made  some improvements, further action and policy changes are needed to  further mitigate risks. Without adequate controls, IRS cannot ensure proper  safeguarding of assets and taxpayer data. Table 4 summarizes the issues we  identified in this area, their effects, and IRS’ actions to address these  issues. Most of these issues were also identified in prior years’ audits, for  which recommendations have already been made. Appendix II lists these  previous recommendations and IRS’ actions to address them.
subsections: section_title: Hiring Practices for IRS Employees
paragraphs: As part of its procedures to determine suitability of an applicant for  employment, IRS requires permanent and temporary applicants to undergo  a fingerprint prescreening check. During a fingerprint check, an applicant’s  fingerprints are processed through the FBI’s national database to identify  those with arrest records. However, further review of the disposition of the  case is necessary to determine if the applicant was convicted of the crime.   We previously reported on several weaknesses related to this fingerprinting  process. Although IRS significantly improved the turnaround time for  obtaining the fingerprint results, other weaknesses persisted. IRS issued  new policies to address these weaknesses. However, we found that the new  policies were not consistently applied throughout IRS during fiscal year  2000. Additionally, Treasury Inspector General for Tax Administration  (TIGTA) auditors found that the IRS’ current fingerprinting process was  ineffective in screening out juvenile applicants with questionable  backgrounds.
In response to a recommendation we had made previously, IRS issued, on  April 3, 2000, a policy that prohibited the hiring and placement of an  applicant at any IRS location until the applicant’s fingerprint checks had  been received and case disposition evaluated. This policy applied to  permanent and temporary employees. However, we found that IRS offices  did not consistently comply with this new hiring policy. Out of the  approximately 19,600 employees hired during fiscal year 2000, about 4,900  (25 percent) were hired and began working prior to IRS’ receipt and  evaluation of their fingerprint checks. As IRS did most of its hiring from  October through April in preparation for the peak tax-filing period, the new  policy was not in place in time to affect many of these new hires.   Nonetheless, there were about 2,700 persons hired after the April 2000  policy was issued, of which 145 (5 percent) were hired and began working  with taxpayer receipts and sensitive taxpayer data without IRS first  receiving the results of their fingerprint checks. The following table shows,  on a monthly basis, the number of persons who were hired and reported for  duty without IRS having first received the results of their fingerprint checks  out of the total number hired after the issuance of the April 3, 2000, hiring  policy. Although the table shows a downward trend in the number of  violations after the April 2000 policy, we cannot determine to what extent  this is due to compliance with the new policy or due to IRS’ not hiring as  many staff in May through September.
To compound this problem, IRS staff also did not comply with its April and  June 1999 policies which require the fingerprinting of all filing season  applicants at the earliest possible time in the job application process.  According to IRS’ personnel database, about 2,200 employees out of  approximately 19,600 (11 percent) hired during fiscal year 2000 were not  fingerprinted until they first reported for duty or several days—and in some  instances months—later. The delays in initiating the fingerprinting process  delayed IRS management’s receipt of the fingerprint results. This,  combined with the pressing need for more resources to meet the increased  workload during the tax-filing period, was a contributing cause for new  employees entering on duty before the results of fingerprints were  received. Consequently, as a result of noncompliance with IRS’ hiring  policies, IRS managers could have unknowingly allowed employees with  unsuitable backgrounds to handle cash, checks, and sensitive taxpayer  information, thus increasing their risk of theft and misuse. In fact, from  April through September, of the 145 persons who entered on duty before  IRS received their fingerprint checks, 22 (15 percent) were subsequently  found to have had potentially unsuitable backgrounds, such as drug use  and assault.
Additionally, a TIGTA audit completed in May 2000 found that IRS’  fingerprint prescreening procedures were ineffective for juvenile  applicants, i.e., those under 18 years of age, due to mitigating  circumstances involving the release of juvenile records. IRS campuses  often hire high school students to fill short-term positions to process  income taxes. IRS’ policy to complete fingerprint prescreening checks  applies to all new hires, even short-term temporary employees.
As of April 2000, TIGTA found that at the two campuses it reviewed, 192  juveniles were hired to work in the receipts processing areas and all of  them had fingerprint checks completed. However, 18 U.S.C. 5038 states  that information about a juvenile’s record may not be released when the  request for information is related to an application for employment. It  further states that responses to such inquiries shall not be different from  responses made about persons who have never been arrested. Therefore,  the case disposition from any juvenile arrest could not be released or  otherwise known. According to TIGTA, because juveniles’ records are  sealed, it was not certain whether local authorities, which provide  information for the FBI’s national database, forward juvenile arrest records  to the FBI. Even if the fingerprint check identified a juvenile arrest record,  current laws prevent investigators from determining whether the juvenile  was convicted or acquitted. TIGTA recommended that IRS develop a  process to more effectively screen out juvenile applicants with  questionable backgrounds for receipt processing positions. IRS agreed to  look into this matter.
IRS’ lack of a process to screen out juvenile applicants with questionable  backgrounds could result in IRS’ unknowingly hiring persons with  unsuitable backgrounds to process receipts and sensitive taxpayer data,  thus increasing the risk of theft. In fact, TIGTA special agents have already  investigated juvenile employees for theft of receipts. Given these risks, we  agree with TIGTA’s recommendation for IRS to develop procedures to more  effectively screen out juvenile employees with questionable backgrounds.
section_title: Hiring Practices for Lockbox Employees
paragraphs: We found that the scope of background checks required of lockbox bank  employees was inconsistent with IRS’ hiring policy and was less than that  required of IRS employees. The Treasury’s Financial Management Service  (FMS) contracts with 10 commercial banks to process taxpayers’ payments  and tax data for IRS. Lockbox banks are staffed with both permanent bank  employees and temporary employees.
As previously discussed, the new IRS hiring policy prohibits the hiring and  placement of an IRS applicant, for permanent or temporary position, at any  IRS location until the applicant’s fingerprint checks have been received and  evaluated. Despite the fact that lockbox employees also handle taxpayer  receipts and data, IRS’ new hiring policy does not apply to them. At two  lockbox banks we visited, we found that 63 permanent employees were  hired and began working in fiscal year 2000 prior to the banks’ receipt of  their fingerprint checks. We also found that fingerprint checks were not  required at all for temporary lockbox employees. Neither the IRS  guidelines for lockbox operations nor the FMS contracts with lockbox  banks required fingerprint checks for temporary employees of the  lockbox. The lockbox guidelines required only a police check for all  temporary employees. However, a police check, which is a records check  for arrests and legal proceedings, is limited to the jurisdictions that the  employee states he or she resided in within the past 7 years. In contrast, the  FBI fingerprint checks required of IRS applicants do not depend on the  individual to accurately state where he or she lives because the FBI obtains  information for its national database from law enforcement agencies.
We also found that the length of time it took for the lockbox banks to get  the results of fingerprint checks varied widely. For example, officials at one  of the lockbox banks we visited informed us they received the results of the  fingerprint checks in 8 business days while the officials at a second  lockbox bank stated they received the results in 3 to 6 months. As a result  of the above weaknesses in lockbox hiring practices, taxpayers and the  government were unnecessarily exposed to potential financial losses and  fraud that could have occurred if lockbox employees with unsuitable  backgrounds were unknowingly hired to process sensitive taxpayer  information and receipts.
section_title: IRS Courier Practices
paragraphs: We previously reported on various security weaknesses related to courier  services. IRS uses couriers to transport deposits of taxpayer receipts to  financial institutions. On March 14, 2000, IRS issued a revision to its  minimum courier service requirements for IRS campuses to address the  security weaknesses we previously reported. As a result of this new  policy, we noted additional improvements over courier security that helped  reduce the vulnerability of taxpayer receipts and taxpayer data recorded on  checks from theft, loss, or misuse. For example, the revised courier  standards limit courier access on campus premises and require campus  personnel to deliver the deposits to a designated point of transfer. At two  campuses we visited, we observed that the campus personnel complied  with this policy.
However, some weaknesses still remain. For example, the courier  standards require two courier service employees to pick up and deliver  deposits in order to increase security and help ensure that such deposits  are never left unattended while in the courier service’s custody. At one of  the campuses we visited, only one courier showed up to pick up the  deposits. According to IRS campus officials, this was because IRS did not  directly contract with the courier service. Instead, the contract was  between the depository institution and the courier service. Therefore, IRS  had less control over the security requirements included in the courier  contract. Regardless of who contracts directly with the courier service, IRS  has a fiduciary responsibility to the taxpayers and the government to  safeguard taxpayer receipts with which it was entrusted. An IRS official  stated that IRS plans to issue new guidance that will require all IRS campus  courier service contracts to include IRS’ minimum courier security  standards, regardless of who contracts for the courier services.
Recognizing its responsibility to protect taxpayer information and receipts,  IRS has clearly made a concerted effort to address courier security  weaknesses by adopting a more stringent requirement on courier security  standards. However, unless IRS consistently implements this policy,  taxpayers and the government will still be unnecessarily exposed to  financial losses.
section_title: Lockbox Bank Courier Practices
paragraphs: We also found that lockbox banks were not required to have the same level  of courier security as IRS campuses. The lockbox courier service  requirements are listed in the Lockbox Processing Guidelines. Based on  our comparison of the January 2000 lockbox processing guidelines to IRS’  courier requirements in effect during our review, significant requirements  from IRS’ courier guidelines were absent from the lockbox processing  guidelines. For example, the lockbox guidelines did not require use of two  insured couriers nor did they require all courier service employees to pass  a limited background investigation. During our site visits at two lockbox  banks, we noted that a single courier was used at both locations.
IRS officials stated that the fiscal year 2002 lockbox contracts would  contain courier standards for lockbox banks consistent with requirements  at IRS campuses. However, until these standards are required and  implemented, taxpayer receipts and data are unnecessarily exposed to  theft and fraud, such as identity theft schemes, while in the custody of the  lockbox courier services.
section_title: Other Taxpayer Receipts and Taxpayer Data Control Weaknesses
paragraphs: Despite some improvements, we continued to find other internal control  weaknesses over the safeguarding and accounting of manual payments and  taxpayer data. Appendix II lists the improvements IRS made in this area  during fiscal year 2000. However, during our fiscal year 2000 visits to  various IRS locations and lockbox banks, we found that other previously  reported weaknesses, such as the issues outlined in table 4, persisted.
For example, we continued to find weaknesses regarding access to receipt  processing areas. IRS security guidelines designate the receipts processing  area as a restricted area to be accessed only by authorized personnel. As  such, this area should be physically secured from the rest of the processing  units of the IRS campus. Nonauthorized persons entering the receipt  processing area must sign in with a door monitor, wear a special badge, and  be escorted. Cleaning personnel are only to be allowed access to this area  during operating hours when they can be observed. However, at one  campus, a GAO auditor was allowed access through the rear entrance of  the receipt processing area by an employee who did not know the auditor,  and the auditor had unescorted access once inside. At four field offices, we  found similar access problems where entrances to walk-in payment  processing areas were left open or were inadequate to prevent  nonemployees from entering. In the same TIGTA review discussed earlier,  TIGTA found that physical barriers for receipt processing areas at two  other campuses were not adequate for various reasons, such as (1) receipt  processing areas with walls or partitions that were inadequate to secure the  areas and not supplemented by intrusion detecting devices, (2) doors that  were left open after hours, and (3) door locks that did not meet minimum  security standards. At the same campuses, they also found that cleaning  personnel were allowed unescorted access to receipt processing areas  during nonoperating hours. At one of these campuses, the security guards  did not respond to motion sensor alarms set off by a TIGTA auditor before  regular duty hours because, according to the guards, they assumed that the  alarms were set off by the janitor who was generally in that area at that  time.
We have previously reported, and continued to find, receipts in receipt  processing areas vulnerable to theft or loss because accountability for  them was not always established as soon as they were received and  because the receipts were stored in easily accessible containers. As such,  physical access controls to these areas are particularly important to reduce  the risk of theft of taxpayer receipts and data. The weaknesses cited above  unnecessarily expose taxpayer receipts and accompanying data to theft by  unauthorized persons.
section_title: Weaknesses in Management and Accounting for Property and Equipment
paragraphs: During fiscal year 2000, IRS made progress in improving the reliability of its  property and equipment (P&E) inventory records. IRS began implementing  a new process for managing and maintaining records for its automated data  processing (ADP) P&E, assigned a senior-level official responsibility for  management and control of ADP P&E, and conducted an officewide  inventory of all P&E. IRS also continued to develop and implement interim  procedures to compensate for fundamental deficiencies in its financial  accounting system. Specifically, it developed manual procedures to extract  the costs of P&E acquisitions from its accounting records.
Although these efforts allowed IRS to report in its fiscal year 2000 financial  statements a P&E balance that was fairly stated, these compensating  procedures were labor intensive and required extensive contractor support  to arrive at a reliable P&E balance months after fiscal year-end.  Additionally, these procedures did not address long-standing, fundamental  weaknesses in IRS’ property and financial systems. As a result, we  continued to find problems with (1) the accuracy and reliability of IRS’  P&E inventory records and (2) IRS’ ability to record P&E transactions in its  financial system as transactions occur. Until these problems are addressed,  IRS will continue to rely on costly and labor-intensive compensating  procedures to arrive at a P&E balance that is only reliable for its year-end  financial statements. More importantly, the procedures IRS employed  during fiscal year 2000 did not provide management with reliable, useful,  and timely P&E information throughout the year for day-to-day decision- making, thus hindering IRS’ ability to properly manage $1.3 billion in  assets.  Table 6 summarizes the issues relating to P&E, along with their  effects and IRS’ actions to address these issues.
subsections: section_title: Tracking of P&E in Inventory Systems
paragraphs: For many years, IRS’ P&E records were not adequate for maintaining  accountability over its property. IRS has acknowledged the deficiencies in  its property management controls since 1983. In the long-term, IRS plans  to acquire and implement a new P&E inventory management system to  address the deficiencies in its current P&E inventory systems. In the  interim, IRS has taken steps to improve the reliability of its P&E inventory  records during fiscal year 2000. However, these interim measures have not  been fully implemented, and we continued to find errors in IRS’ P&E  inventory records during our fiscal year 2000 financial audit.
IRS maintains two P&E inventory systems, one to manage ADP P&E and  another to track non-ADP P&E. These systems provide data, such as a  description of the item, its location, and current status (e.g., disposed  versus in service) that assist property managers and officials in managing  property. In an effort to address its long-standing inability to maintain  complete and accurate records in the ADP inventory system, IRS issued  interim Single Point Inventory Function (SPIF) operating guidelines and  procedures in June 2000. SPIF centralized responsibility for managing ADP  property and maintaining ADP inventory records into a single dedicated  unit at each IRS location, thus establishing clear accountability for the  receipt, management, and disposal of ADP assets.
Although this was a significant step, we found during our visits to IRS  campuses and field offices in September 2000 that SPIF teams had not been  fully staffed and SPIF procedures had not been fully implemented at all IRS  facilities. Thus, as in prior years, we found that IRS’ procedures for  recording P&E acquisitions, disposals, and transfers still did not ensure  that transactions were promptly recorded. Specifically, we found that 35 of  220 P&E items we selected from IRS records at 22 sites could not be  located at the time of our review. These items were eventually accounted  for when IRS later reported that 23 of the items had been disposed of  months earlier (including one disposed of in 1998) but IRS had failed to  update the records, 8 items were subsequently located, and 4 items were  erroneous records of software. Nonetheless, based on our work, we  estimate that 16 percent of the items in IRS’ P&E inventory records at  September 30, 2000, were erroneously included as IRS assets.
The GAO Standards for Internal Control in the Federal Government  requires that qualified and continuous supervision be provided to ensure  that internal control objectives are achieved. It is particularly important for  IRS to have strong management oversight to help compensate for the  limitations of its current P&E systems. IRS partially addressed the issue of  management oversight in November 1999 by providing its Chief  Information Officer (CIO) the authority over and overall responsibility for  ownership, management, and control of all ADP property. In addition,  SPIF procedures assigned ADP property managers responsibility for  reviewing the accuracy and completeness of P&E information. Specifically,  the IRS policy states that ADP property managers are responsible for  maintaining a management and quality review program to ensure the  timeliness, completeness, and accuracy of the inventory records and to  conduct annual property management evaluations at selected sites. These  types of managerial review serve as a key internal control in ensuring the  accuracy, completeness, and timely recording of inventory data that will  subsequently be used to prepare reports for management decision-making.  However, based on the errors we found during our testing of the P&E  inventory records, these managerial reviews did not appear to be effective.  Consequently, the information in IRS’ P&E inventory tracking systems was  unreliable and fell short of meeting management reporting needs.
section_title: Recording P&E in the Accounting System
paragraphs: As in prior years, IRS was unable to record P&E assets and corresponding  liabilities in its accounting system as the transactions occurred due to  inadequate accounting procedures and systems design flaws.  Consequently, IRS hired a contractor who implemented extensive and time- consuming manual procedures to derive a reliable P&E balance for IRS’  financial statements.
IRS did not have policies and procedures in accordance with federal  accounting standards to identify and record in its general ledger accounts  its P&E assets and corresponding liabilities as the transactions occurred.  For example, federal accounting standards require agencies to record a  capital lease asset and its corresponding liability at the inception of the  lease agreement.However, neither IRS’ inventory system nor its  accounting system was designed to capture key information on capital  leases to enable it to report the asset or the corresponding capital lease  liability as the transactions occurred. IRS expensed all property purchases  during the year, including major acquisitions such as capital leases,  leasehold improvements, and major systems. A contractor then analyzed  and extracted from IRS’ automated expense records purchases of P&E,  leasehold improvements, major systems, and capital leases based on codes  within IRS’ accounting system to derive the fiscal year-end amounts that  should have been capitalized as P&E. IRS then recorded adjusting entries  to transfer these P&E acquisitions to the appropriate general ledger  account. This process was time-consuming and did not always result in  accurate information as we found during our review of fiscal year 2000  nonpayroll expenses and P&E transactions. For example:  Of 156 statistically sampled nonpayroll expenses we reviewed, 3  transactions totaling $1.7 million that should have been recorded as  P&E had not been properly extracted by the contractors from the  population of fiscal year 2000 expenses and transferred to the P&E  general ledger account. Based on our work, we estimate that the most  likely understatement of the P&E balance as a result of P&E  transactions being incorrectly recorded as expenses was $50 million,  with an upper error limit of $127 million.
Of 60 statistically sampled P&E transactions we reviewed, 8  transactions totaling $879,000 were inappropriately identified by the  contractors as fiscal year 2000 P&E acquisitions. Two of the 8  transactions were fiscal year 1999 transactions, and the remaining 6  items were non-P&E items that should have remained as expenses.  Based on our work, we estimate that the most likely overstatement of  the P&E balance as a result of transactions incorrectly recorded as  fiscal year 2000 P&E was $61 million, with an upper error limit of  $106 million.
Additionally, IRS uses financial accounting codes that classify expenses by  type to extract P&E, leasehold improvements, major systems, and capital  leases from its automated records of expenses. These Sub-Object Class  (SOC) codes appear on all basic accounting documents and provide  detailed cost data on the types of expenses that are significant to IRS’  operations. However, IRS recorded both capitalizable and noncapitalizable  P&E transactions under the same SOC codes. This complicated the process  of extracting capitalizable P&E transactions based on SOC codes because  additional analysis was required to determine whether the transactions  represented an expense or a capitalizable P&E purchase. For example, in  fiscal year 2000, the contractor determined that more than $43 million in  software license fees, which should have been expensed, were charged to  an SOC code defined as capitalized software.
section_title: Lack of an Integrated Inventory and Accounting System
paragraphs: IRS’ costly, time-consuming process for determining a year-end P&E  balance was necessary because IRS’ procurement system, inventory  tracking systems, and the general ledger are not integrated. In an integrated  financial management system, the general ledger is supported by  subsidiary ledgers, which contain detailed records of transactions and  automatically update the appropriate general ledger balances as  transactions occur. Therefore, on an on-going basis, detailed records in the  subsidiary ledgers should support the P&E balances in the general ledger.
However, during fiscal year 2000 IRS did not have subsidiary ledgers for its  P&E. Instead, the two inventory tracking systems served as subsidiary  records for P&E. However, property acquisitions and dispositions recorded  in the inventory tracking systems did not automatically update appropriate  P&E balances in the general ledger system because the two systems were  not integrated. Additionally, unlike true subsidiary ledgers, the inventory  tracking systems did not record the cost of assets that tie to the general  ledger balances at a summary level. Consequently, P&E balances recorded  in general ledger P&E accounts could not be easily reconciled to IRS’  subsidiary records to verify that such balances were supported by actual  assets recorded in the inventory tracking systems.
IRS plans to install an integrated financial system by late 2004 to address  the design flaws of its current systems. In the meantime, due to the systems  and control weaknesses discussed above, IRS management continues to  rely on a contractor and a labor-intensive procedure to derive a reliable  P&E balance for its financial statements. Because this procedure only  provides a reliable balance for the fiscal year-end date, IRS does not have  reliable P&E data on an ongoing basis to make operational decisions  related to the purchase, disposition, and use of its P&E. Moreover, errors in  IRS’ inventory tracking systems continue to compromise IRS  management’s ability to safeguard $1.3 billion of government assets.
section_title: Recommendations
paragraphs: To address weaknesses in the timely recording of P&E transactions while  an integrated P&E financial system is being developed, we recommend that  IRS implement policies and procedures to record capitalizable acquisition  costs for property and equipment, capital leases, leasehold improvements,  and major systems in the appropriate P&E general ledger accounts as  transactions occur.
To ensure that SOC codes facilitate compilation of capitalizable P&E  transactions in the proper general ledger asset accounts and, if applicable,  lease liability accounts, we recommend that IRS revise the definitions of  SOC codes pertaining to P&E or establish new codes so that individual SOC  codes cannot be used for both capitalizable purchases (assets) and  noncapitalizable purchases (expenses). For example, the SOC code used to  record capitalizable software costs should not be used to record  noncapitalizable software license fees.
section_title: Weak Controls Over Appropriated Funds Continue
paragraphs: In fiscal year 2000, IRS made substantial progress in addressing previously  identified budgetary control weaknesses. IRS (1) reduced the number of  employees with authority to override automated spending controls;  (2) decreased the number, dollar amount, and duration of items held in  suspense; and (3) implemented procedures to deobligate funds no longer  required for a specific purpose.
Despite this progress, IRS’ internal controls were inadequate for providing  reasonable assurance that the $8.3 billion in fiscal year 2000 budgetary  authority was routinely accounted for, reported, and controlled.  Specifically, we found that IRS (1) incurred costs prior to establishing an  obligation, (2) inappropriately recorded unrelated activities as adjustments  to obligations, and (3) failed to reduce undelivered orders when goods  and services were received. As a result, IRS was unable to ensure the  reliability of key budgetary information it needs on an ongoing basis to  effectively manage its operations and ensure that its resources do not  exceed budgetary authority. While these conditions in isolation may not  rise to the level of material weakness, collectively they are indications of  serious deficiencies in internal controls over appropriated funds. Table 7  summarizes the issues we identified related to obligations and undelivered  orders, along with their effects and IRS’ actions to address these issues.
subsections: section_title: Recording Obligations
paragraphs: In the federal budgeting process, agencies’ operations are funded by  appropriations. Appropriations typically provide agencies with budgetary  authority, i.e., the legal right to obligate—and ultimately to spend—funds  for specific purposes, within a specific period of time, up to a specific  amount. An obligation is a definite commitment by an agency of the  government, which creates a legal liability to another party. To prevent  obligations in excess of available funding, OMB Circular A-34 gives  instructions to federal agencies as to when an obligation of funds should be  recorded in the agency’s financial system. For example, an obligation for  reimbursable travel expenses incident to employee relocation should be  recorded when a travel order is approved; an obligation for a contract  should be recorded in the month that the contract is let; and an obligation  for an order for goods or services is to be recorded at the time the order is  placed. In addition, GAO’s Standards for Internal Control in the Federal  Government requires that transactions be promptly recorded to maintain  their relevance and value to management in controlling operations and  making decisions. However, during our fiscal year 2000 audit, we found  that IRS did not always record obligations in its accounting system prior to  incurring costs. For example:  IRS received software maintenance services for the period May 1, 2000,  through April 31, 2001, totaling $415,000. However, IRS did not generate  a purchase order to record the obligation of funds until July 28, 2000— almost 3 months after the services were received.
An IRS site accepted delivery of services for which funds were not  available at that site. In this instance, a contracting officer at an IRS site  ordered services totaling more than $15,000 for transporting and  installing systems furniture in June 1999. However, the obligation was  not recorded before the cost was incurred. When the voucher was  submitted in November 1999, IRS discovered that the amount exceeded  what was available to the site at the time the order was placed. Although  IRS was able to make up for the deficiency by transferring fiscal year  1999 funds from another site, had there not been funds available at that  time IRS may have run the risk of spending more than it was authorized  to spend.
As a result of not recording obligations in a timely manner, IRS cannot  routinely rely on its financial records to provide reliable information on the  status of its budgetary resources for day-to-day decision-making. Until the  obligation of funds is recorded, the balance in obligations incurred would  be understated. This could lead IRS management to believe that the agency  has more funding than is actually available. Consequently, IRS management  and personnel might enter into additional obligations in excess of the  budgetary authority made available by Congress.
section_title: Adjusting Obligations
paragraphs: During fiscal year 2000, IRS recorded certain activities as adjustments to  prior years’ obligations that were not valid adjustments to those  obligations. In fiscal year 2000, $167 million of the $277 million (over 60  percent) that were recorded in IRS’ accounting system as adjustments to  prior years’ obligations were not valid upward or downward adjustments.  IRS subsequently adjusted its records to correct these erroneous  transactions. However, these errors adversely affected IRS’ ability to  routinely report accurate and reliable information on total budgetary  resources and obligations.
GAO’s Standards for Internal Control in the Federal Government requires  that transactions and other significant events be properly classified to  maintain their relevance and value to management in controlling  operations and making decisions. Furthermore, transactions and events are  to be completely and accurately recorded and classified in the summary  records from which reports and financial statements are prepared.  Adjustments to prior years’ obligations are recorded when the obligation  amount that was previously recorded is affected by a subsequent event,  such as a change in the price or quantity of goods or services. For example,  if an undelivered order for a good was established for $1,000, but the good  was delivered in a later year at $1,250, then an upward adjustment of $250  to obligations would be recorded. An upward adjustment would increase  obligations incurred and reduce the unobligated balance. Similarly, if an  undelivered order was established for $1,000 but the good was delivered in  a later year for $750, then a downward adjustment to prior years’  obligations of $250 would be recorded.
However, we found that IRS overstated both the upward and downward  adjustment accounts during fiscal year 2000. Many activities that were  recorded as adjustments to the prior years’ obligations were not actual  upward or downward adjustments but were related to changes in  accounting codes, travel, and adjustments for doubtful accounts. Of the  $277 million in adjustments IRS recorded in its accounting system in fiscal  year 2000, $82 million in upward adjustments and $85 million in downward  adjustments were not valid adjustments to the prior years’ obligated  balance. These errors were attributed to IRS’ accounting system, which,  according to IRS personnel, recorded all adjustments that affect a prior  year’s appropriation, including those that did not affect the obligated  amount, as upward or downward adjustments to prior years’ obligations.
Through adjusting entries totaling $167 million, IRS was able to correct  these errors in time to prevent the financial statements from being  misstated. However, upward adjustments to prior years’ obligations are  also reported on the SF133 Report on Budget Execution and Budgetary  Resources that federal agencies submit to OMB quarterly as “obligations  incurred,” while downward adjustments to prior years’ obligations are  reported on the SF133 as “recoveries to prior year obligations.” Because  the upward and downward adjustment accounts were misstated during the  year, data IRS reported to OMB on its budgetary activities may not be  reliable. Specifically, the September 2000 SF133 IRS submitted to OMB  misstated both the obligations incurred and recoveries to prior years’  obligations line items.
section_title: Recording Receipt of Undelivered Orders
paragraphs: IRS records an undelivered order when it orders a good or service for use  in its operations. It then reduces the undelivered order balance and records  an expense when the good or service is received. However, we found  instances in which IRS did not reduce the balance in undelivered orders  when the goods and services were received. As a result, the balance of  undelivered orders and accrued expenses were misstated.
We tested statistical samples of 83 and 78 transactions from fiscal year 2000  beginning and ending balances of undelivered orders, respectively. For  both samples, we found instances in which IRS received goods and  services during one fiscal year but did not reduce the undelivered orders  balance reflected in its accounting system until the following fiscal year.  This was caused, in part, by IRS personnel’s incorrectly recording into its  accounting system the dates that the goods and services were received.   This resulted in IRS’ overstating the beginning and the ending fiscal year  2000 undelivered order balances and understating accrued expenses. For  example:  In fiscal year 2000, IRS recorded an obligation and a corresponding  undelivered order for computer equipment totaling $7.9 million. As of  September 30, 2000, IRS had received equipment totaling $3.4 million.  However, its records as of September 30, 2000, still showed that the  entire undelivered order amount was still outstanding, i.e., $3.4 million  was not yet removed from the undelivered order balance.
Telephone support services for the month of September 1999 were  entered into the receipt and acceptance system as being received on  October 5, 1999. Consequently, the beginning fiscal year 2000 balance in  undelivered orders was overstated.
IRS failed to remove more than $4.1 million from the ending undelivered  order balance for lockbox services received from July through  September 2000. Consequently, the fiscal year 2000 ending undelivered  order balance was overstated.
The errors in the beginning undelivered orders balance totaled $2.9 million,  while errors in the ending undelivered orders balance totaled $12.4 million.  Based on our work, we estimate (1) the most likely overstatement of the  fiscal year 2000 beginning undelivered orders balance as a result of these  errors was $65 million, with an upper error limit of $111 million and (2) the  most likely overstatement of the ending undelivered orders balance and  corresponding understatement of accrued expenses was $47 million, with  an upper error limit of $87 million.
Because of the deficiencies in controls over the accurate recording of  undelivered orders, IRS’ balances in undelivered orders and accrued  expenses were misstated during fiscal year 2000. These deficiencies  continued to affect IRS’ ability to report reliable, timely, and routine  information critical for making sound day-to-day decisions and effectively  managing its operations.
section_title: Recommendations
paragraphs: To ensure effective management of available funding and accurate  reporting of obligations, we recommend that IRS perform periodic reviews  to monitor and ensure that obligations are promptly established in the  accounting system. Such reviews would assist IRS in maintaining accurate  and complete records of its obligations, and in reducing the risk of  obligations exceeding available funding.
To ensure that reported budget data are reliable on a routine basis, we  recommend that IRS incorporate into its systems modernization blueprint  the capability to differentiate prior-year adjustments between activities that  are valid upward and downward adjustments to obligations and activities  that are not valid adjustments to obligations. Such actions would help  ensure that activities that are not valid adjustments to obligations are not  recorded as adjustments to obligations.
section_title: Deficiencies in the Collection and Reporting of Financial Data
paragraphs: In fiscal year 2000, IRS revised the format of its statement of net cost and  significantly expanded and enhanced the related disclosures in its financial  statements to address an issue we had raised in our prior audit regarding  the commingling of certain program costs in its financial statements. The  resulting presentation appropriately classified the cost of IRS’ programs.   However, in fiscal year 2000, as in prior years, IRS was unable to generate  reliable financial information on a day-to-day basis to support decision- making. IRS lacked a financial management system that complies with the  requirements of the Federal Financial Management Improvement Act of  1996 (FFMIA). In addition, IRS did not record transactions in a timely  manner and perform routine reconciliations necessary to ensure the  reliability of general ledger data. Finally, IRS lacked an effective system  that can report on the full costs of its activities and on cost-based  performance measures consistent with the Government Performance and  Results Act (GPRA) of 1993. These weaknesses affected IRS’ ability to  (1) routinely prepare reliable periodic financial reports, (2) generate  routine and reliable cost-based information, (3) accurately determine the  amount of revenue collected for specific tax types, and (4) certify excise  taxes distributed to trust funds. Collectively, these issues are indications of  serious internal control deficiencies and constitute a material weakness in  controls over financial reporting.
As noted earlier, in fiscal year 2000, due to monumental efforts and  extensive workaround processes, IRS was able to produce for the first time  combined financial statements that were fairly stated in all material  respects. However, the information reported in the financial statements  was reliable only for a single point in time. Financial data not subjected to  these compensating procedures may not be reliable and cannot be used to  effectively manage IRS’ day-to-day operations. Ultimately, Congress, IRS  management, and the public do not routinely have timely and accurate  information to evaluate IRS’ performance and make informed management  and policy decisions. Table 8 summarizes the issues we identified in this  area, together with their effects and IRS’ actions to address these issues.
subsections: section_title: Reporting Year-End Balances
paragraphs: As the table above indicates, IRS does not have an adequate financial  management system. As a result, IRS is hindered in its ability to produce  reliable financial statements and to generate timely and accurate  information needed to make management and operational decisions.
An adequate financial management system is one that can provide  complete, reliable, consistent, timely, and useful financial management  information. Such a system comprises, among other elements, an  integrated general ledger system using common data elements and  transaction processing that is supported by transactional details and a  system of internal controls to ensure that reliable data are obtained,  maintained, and disclosed in reports. Such a system is also capable of  capturing and reporting reliable performance information. However, IRS’  financial management system is made up of two independent general  ledgers—custodial and administrative—that are not integrated with each  other nor with their supporting records for material balances. Specifically,  IRS’ custodial general ledger does not have adequate audit trails for federal  taxes receivable, federal tax revenue, or federal tax refunds, while its  administrative general ledger lacks audit trails for P&E and program costs.
For example, as discussed earlier in this report, the lack of clear  traceability between the general ledger and underlying financial  transactions required IRS to use extensive ad hoc procedures and  statistical methods to derive reliable balances for taxes receivable and  other unpaid assessments. In addition, as discussed further below, because  of weaknesses in internal controls, IRS could not demonstrate that  reported performance indicators were reliable. Consequently, neither of  IRS’ two general ledgers complies with the requirements of the U.S.  Government Standard General Ledger (SGL) at the transaction level and  cannot be used to support the preparation of financial statements without  material financial reporting adjustments, nor do they comply with the  requirements of FFMIA.
One important requirement of an effective financial management system is  that it can be relied upon to support the timely production of auditable  financial statements. At IRS, this is not the case. Although IRS was able to  produce financial statements that were fairly stated in all material respects  for fiscal year 2000, these statements required monumental human efforts  that extended well after the September 30, 2000, fiscal year-end. In  addition, information produced by IRS’ financial management system  required billions of dollars in adjustments to derive reliable financial  statement balances. As mentioned earlier, substantial adjustments totaling  billions of dollars had to be made to reliably report the balance for taxes  receivable. These adjustments, as well as the balance in net taxes  receivable, were not available until well after the fiscal year had ended.  Similarly, fiscal year 2000 administrative activities totaling over $3.7 billion  were either recorded in the wrong general ledger accounts or were not yet  recorded in IRS’ general ledger as of September 30, 2000. For example, as  of fiscal year-end, accrued payroll and depreciation expenses totaling  $480 million had yet to be recorded in IRS’ general ledger, while P&E  acquisitions that should have been capitalized were recorded as expenses.  These activities had to be analyzed and recorded or reclassified, a time- consuming process that took several months to complete.
Though IRS achieved an important milestone in receiving an unqualified  opinion on its fiscal year 2000 financial statements, the approach used to  achieve this goal did not address the underlying purpose of sound financial  management as envisioned by the CFO Act—to produce reliable, useful,  and timely financial and performance information on a routine basis for  day-to-day decision-making. Furthermore, until lasting improvements are  achieved, IRS will have to continue to rely on extensive efforts to produce  reliable financial statements.
section_title: Maintaining Accurate and Timely Financial Data
paragraphs: During fiscal year 2000, IRS did not timely record transactions and perform  the necessary reconciliations to ensure that the data contained in its  general ledger systems were up-to-date and accurate. Consequently, IRS  did not have reliable, timely, and routine financial information to effectively  manage its operations.
GAO’s Standards for Internal Control in the Federal Government requires  that transactions and events be recorded accurately and timely and that  ongoing monitoring occur in the course of normal operations to provide  reasonable assurance that financial reporting is reliable. These internal  control processes and procedures are crucial to ensuring that an agency’s  financial management systems produce information that is reliable, timely,  and useful. Without these processes and procedures, a modern and  integrated financial management system by itself does not guarantee that  an agency will be able to prepare financial statements that are fairly stated  and generate financial data that can be relied upon for day-to-day decision- making.
During fiscal year 2000, IRS’ internal controls over financial reporting were  not consistent with these standards. Specifically, IRS did not record  material transactions in the general ledger until months after they  occurred. For example:   Depreciation expenses totaling more than $350 million were not  recorded throughout the year, but only at year-end. As a result, the  balance in depreciation was inaccurate at interim periods during the  year.
Imputed financing costs totaling nearly $400 million were not recorded  in the general ledger throughout the year but rather as a lump sum  amount several months after the fiscal year-end. While IRS made the  necessary adjustments to produce reliable year-end financial  statements, the balance for imputed financing costs was incorrect  throughout fiscal year 2000.
In addition, IRS lacked adequate policies and procedures for ensuring that  financial data would be adequately reviewed on an ongoing basis.  Specifically, IRS management informed us that it did not have policies and  procedures requiring systematic reviews and analyses of account balances  at interim periods. Consequently, errors and omissions were allowed to  arise without prompt detection and correction, and adjusting entries that  should have been made throughout the year were allowed to build up until  they became material and time-consuming to correct. IRS also did not have  policies and procedures requiring reconciliation between its proprietary  and budgetary accounts during fiscal year 2000. IRS had to make  adjustments totaling more than $160 million several months after the fiscal  year-end to bring the net cost of operations derived from the budgetary  accounts and the net cost of operations derived from the proprietary  accounts into agreement. The failure to maintain accurate and up-to-date  financial data impeded IRS management in its ability to use the general  ledger as a reliable source of financial data at interim periods to make  managerial and operational decisions.
section_title: Reporting on and Managing Performance
paragraphs: IRS did not track the cost accounting information needed to prepare cost- based performance information consistent with GPRA. Deficiencies in IRS’  systems and internal controls discussed above mean that IRS cannot  routinely generate reliable financial and performance data for cost-benefit  analyses. This could adversely affect IRS management’s and Congress’  ability to make informed management decisions related to resource  allocation and other aspects of IRS’ operations throughout the year.
The Joint Financial Management Improvement Program’s (JFMIP) System  Requirements for Managerial Cost Accounting requires that, at a  minimum, agencies have cost accounting information to support the  aggregation of financial information related to programs and projects, each  of which could have several levels, such as subprograms. In order for IRS  to aggregate cost information by program and project to conform to this  standard, it must first capture costs at the detail level as they are incurred.  However, IRS did not have a systematic process in place to capture costs at  the project level during fiscal year 2000. Though IRS had a Project Cost  Accounting Subsystem (PCAS) coding structure that can capture personnel  costs at the detailed project and subproject level, IRS did not require that  all of its employees use PCAS to itemize the time spent on specific projects  on their time cards. Consequently, during fiscal year 2000, IRS staff did  not use PCAS codes for time charged to either of IRS’ two largest  appropriations, which collectively accounted for 74 percent of IRS’  budgetary resources.
Similarly, except for information technology projects, PCAS did not collect  nonpersonnel costs such as equipment depreciation, rent, and utilities by  projects and subprojects. At year-end, IRS extracted data from its  accounting system, imported the data into a database, and used a  spreadsheet to allocate these nonpersonnel costs to the different projects  and subprojects in an effort to derive reliable net operating cost data for  the Statement of Net Cost. However, these data were not available until  months after the fiscal year-end, were only reliable for a single point in  time, and thus were not available on an ongoing basis for management  purposes. The failure to fully and accurately capture cost at the project  level affected IRS’ ability to produce reliable cost data. Specifically, IRS  was unable to report on the costs associated with each of the 15 key  performance indicators it reported in the “Management Discussion and  Analysis” that accompanied its fiscal year 2000 financial statements. As a  result, IRS cannot be consistent with GPRA in reporting cost-based  performance measures related to its various programs.
In addition, IRS was unable to provide evidence that supervisory review  was performed to ensure that the performance indicators, and data used to  derive these indicators, were complete, accurate, and reliable. For  example, IRS did not have documentation demonstrating that a responsible  official had reviewed the data to ensure that all data that should be  collected for a specific performance indicator was collected, and that only  pertinent data was included. This increases the risk that any errors or  omissions affecting IRS’ key performance indicators will not be detected  and corrected in a timely manner.
Finally, IRS faces an additional challenge in the fact that its custodial and  administrative general ledgers are independent of each other and are not  integrated. Since cost data are primarily contained in the administrative  general ledger while critical performance data comes from the custodial  general ledger, IRS needs to be able to link these two general ledgers before  it can calculate reliable, cost-based performance measures. IRS plans to  implement a major portion of an integrated financial and taxpayer account  management system by fiscal year 2005. Consequently, this link between  the custodial and administrative general ledgers will not occur before then.
section_title: Reporting Tax Revenues
paragraphs: IRS continues to be unable to determine the specific amount of revenue it  actually collects for Social Security, Hospital Insurance, individual income  taxes, and excise tax trust funds. These conditions exist primarily because  (1) at the time of payment, taxpayers are not required to provide  information on the specific taxes that they are paying and (2) IRS’ systems  are not capable of capturing such information. Although the tax returns,  which the taxpayers file months after the deposits are made, do contain a  breakdown on the type of tax, this information pertains only to the amount  of the tax liability and not to the amount of taxes paid to IRS. This  condition restricts IRS’ ability to report actual collections of significant  taxes, such as Social Security, that would be of interest to many parties,  including Congress. IRS is developing a system to capture detailed  collection information by type of tax and plans to initiate a study, in 3 to 4  years, to gauge taxpayers’ readiness to provide such detailed information.
section_title: Trust Fund Certification
paragraphs: Because data are not available for the allocation of excise taxes to the  appropriate trust funds when deposits are made, IRS uses a certification  process that is complex, cumbersome, and prone to error in order to  distribute excise tax receipts to the respective trust funds. In response to  our previous reports, IRS implemented procedures to improve controls  over the certification process. However, we continued to find weaknesses  in the excise tax certification process. For example, due to delays in  recording tax return information in its systems, the amount IRS certified to  the Highway Trust Fund for the quarter ended September 30, 1999,  included nearly $346 million in collections from previous quarters. These  delays resulted in delays in transferring these amounts to the trust funds,  thus reducing the amount of interest income the trust funds earn on these  receipts. This reduction in interest income could adversely affect  distributions of trust fund receipts to the states because the amounts  distributed would be based on inaccurate data.
section_title: Recommendations
paragraphs: To reduce the magnitude of year-end adjustments and assist IRS in  improving the reliability of its financial data on a routine basis, we  recommend that IRS develop, document, and implement policies and  procedures to require   monthly reconciliations between proprietary and budgetary accounts so  that differences can be identified promptly and, if necessary, adjusted;  routine reviews and analyses of general ledger account balances to  promptly identify errors and omissions; and   recording corrections and adjusting entries throughout the year to  reduce the magnitude of year-end adjustments and improve the  reliability of interim financial data.
To improve IRS’ ability to collect and report on the full costs of its  activities, we recommend that IRS implement policies and procedures to   require that all employees itemize the time spent on specific projects on   allocate nonpersonnel costs to programs and activities routinely  throughout the year.
To provide assurance on the reliability of performance data, we  recommend that IRS document reviews performed to validate that  performance data are complete, accurate, and reliable.
section_title: Conclusions
paragraphs: Many of the issues presented throughout this report have existed for  several years, and IRS has noted that the ultimate solution to many of these  issues is modernization of its systems. As part of this modernization  initiative, IRS plans to implement a new financial system that includes a  cost accounting module as well as integrated administrative and custodial  general ledgers that are supported by subsidiary ledgers containing the  transactional details for key accounts such as taxes receivable and  property and equipment. The modernized environment is expected to  provide IRS with, among other things, the ability to (1) track and report on  the status of each unpaid assessment category, amount, and taxpayer,  (2) record P&E transactions in its general ledger accounts as they occur,  and (3) prepare cost-benefit analyses and cost-based performance  measures. However, these systems will take years to implement.
IRS continues to make progress in addressing its financial management  challenges. The strong commitment and dedication to financial  management reform by IRS senior management has played a crucial role in  the progress the agency has made to date and is critical for future  improvements.
IRS has developed many workaround processes that resulted in its ability  to produce reliable financial statements for fiscal year 2000. However,  these processes take considerable time, effort, and expense and do not fix  many of the fundamental financial management issues that continue to  plague the agency. Until these issues are addressed, IRS cannot achieve the  overriding objective of the CFO Act and other reform legislation enacted  during the last decade—to produce reliable, useful, and timely financial  and performance information for day-to-day decision-making.
section_title: Agency Comments and Our Evaluation
paragraphs: In commenting on a draft of this report, IRS agreed that, in order to  improve financial management, it must sustain a high level of effort to  implement solutions that will address systems deficiencies and internal  control weaknesses. IRS also provided information regarding past and  current initiatives to address GAO’s audit recommendations. For example,  during fiscal year 2000, IRS (1) routinely reconciled its fund balance,  (2) reviewed and managed suspense items, (3) eliminated unneeded  obligations, (4) installed and used live-scan fingerprint equipment, and  (5) implemented procedures and processes to improve the reliability of  P&E records. IRS also noted that it has undertaken additional initiatives to  address remaining internal control deficiencies. For example, it noted that  it implemented a new inventory system for its P&E and enforced standards  to improve inventory practices, developed a standard checklist and  conducted monthly security reviews in fiscal year 2001, and hired  additional staff to support the master file extract process. We will follow up  during our fiscal year 2001 audit to assess the effectiveness of these  initiatives.
While agreeing with the overall thrust of our report, IRS disagreed with  some of the specific report findings and recommendations. Specifically, in  the area of P&E, IRS disagreed that in the short term, property acquisitions  should be recorded as capital assets as the transactions occur. IRS noted  that, until an integrated property management system is acquired, it should  continue the current practice of recording property acquisitions as  expenses and then transferring these expenses to capital assets in the  general ledger after a review process. We disagree. As our report states,  IRS’ process for deriving a reliable P&E balance for its annual financial  statements involves the use of extensive manual procedures by a  contractor to extract and analyze IRS’ data on expenses to identify items  that should be classified as assets. This process is time-consuming, occurs  months after the acquisition of the assets, and only provides a reliable  balance for P&E for a single point in time. This process does not provide  IRS with reliable P&E data on an ongoing basis for use in operational  decision-making.
IRS also disagreed with our conclusions regarding the timeliness of IRS’  recording of obligations. IRS believed that the 2 instances we cited of IRS’  failure to timely record obligations were isolated and thus did not  constitute a material weakness in controls over appropriated funds. The 2  instances cited in our report were illustrative examples of IRS’ failure to  record obligations before goods and services were received, and did not  represent the total number of errors found in our testing. In fact, we found  10 instances in which IRS failed to record obligations before goods and  services were received. These exceptions were brought to the attention of  IRS staff and management, in writing, throughout the audit. These 10  instances together represent more than isolated instances of IRS’ not  recording obligations before goods and services are received. It is also  important to note that we did not characterize in our report the issue of IRS  not timely recording obligations in and of itself as a material weakness.  However, taken collectively, this, plus other issues in the area of  appropriated funds management, constitute a material weakness in IRS’  internal controls over its appropriated funds that preclude IRS from  providing reasonable assurance that material misstatements would be  prevented or detected on a timely basis.
In addition, IRS disagreed that we should include its failure to properly  record adjustments to obligations as a material weakness. IRS also  requested that we reconsider our recommendation that it include in its  systems modernization blueprint the capability to differentiate between  valid and invalid adjustments to prior-year obligations. IRS stated that the  issue stemmed from our and its different interpretations of the definition of  upward and downward adjustments. IRS believed that it had successfully  resolved this issue because it made audit adjustments we proposed prior to  issuing its final fiscal year 2000 financial statements and stated that it  would continue to make these adjustments in the future.
While we agree that IRS made the audit adjustments we proposed to its  financial statements, we disagree that this issue has been resolved and  should be excluded from our report. As discussed above, our report does  not characterize this issue in and of itself as a material weakness. As stated  in our report, we requested that IRS make adjustments in instances  involving changes in accounting codes and travel entries that do not meet  the definition of upward and downward adjustments. IRS made these  adjustments to its fiscal year 2000 financial statements. These adjustments  eliminated the type of known errors found during our testing and reduced  the dollar amounts of these accounts to levels not considered material for  purposes of fairly presenting the financial statements as a whole. These  adjustments do not, however, correct the underlying problems that gave  rise to the errors in these accounts that required adjusting. Also, while IRS  took exception to our recommendation, it noted that the CFO has included  this issue in the functional requirements for IRS’ new financial  management system, and that, in the short term, it will continue to make  these adjustments manually. These corrective actions, if effectively  implemented, should address our recommendation regarding this issue. We  will evaluate the effectiveness of these actions during the fiscal year 2001  audit.
IRS also contested our including an example in the report to illustrate its  failure to record the liability for goods and services when received. IRS  stated that it had entered into an agreement with us to exclude invoices  received after November 30, 2000, from fiscal year 2000 audit procedures.  As the invoice for this particular transaction was received on December 6,  2000, IRS believed that this transaction fell outside the agreed-to cutoff  date and should thus not be cited.
We disagree with IRS’ characterization of what was agreed to. The  agreement between IRS and us related to our testing of subsequent  disbursements. In previous years, we tested disbursements made within  the 3 months following fiscal year-end to identify transactions that should  have been, but were not, recorded as a transaction in the year under audit.  In fiscal year 2000, we agreed to reduce the test period to 2 months  following the fiscal year-end, that is, we would test only subsequent  disbursements made from October 1 through November 30 after the fiscal  year-end. However, the particular example in our report that IRS is taking  issue with was identified during our testing of IRS’ ending undelivered  orders balance—this was separate and apart from the testing of subsequent  disbursements. Further, lockbox services are recurring transactions  covered by 5-year contracts. Consequently, IRS had the capability to accrue  for these services without waiting for the invoice. As our report states, the  most likely misstatement of the ending undelivered orders balance  resulting from the failure to timely record receipt of undelivered orders  was $47 million, with an upper error limit of $87 million. The magnitude of  these errors reinforces the need for IRS to act to ensure that goods and  services are recorded when received.
With respect to financial reporting, IRS took issue with our findings that  material inaccuracies were found in the fiscal year 2000 financial  statements and that these inaccuracies were not effectively detected in IRS’  review of these financial statements. IRS disagreed that these findings  should be cited as a material reporting weakness. IRS further stated that it  was aware of only two material adjustments we proposed that fell within  the purview of financial reporting.
Again, we disagree. Each of the internal control deficiencies over financial  reporting cited in our report do not individually constitute a material  weakness—it is the combination of these deficiencies that constitutes a  material weakness. Further, as our report states, IRS’ draft financial  statements contained material inaccuracies and the review procedures  instituted by IRS were not effective in identifying and addressing errors and  omissions material to the financial statements. For example, the first two  draft financial statements prepared in January and early February 2001  omitted a material footnote comparing IRS’ Statement of Budgetary  Resources with the President’s Budget as required by U.S. generally  accepted accounting principles and OMB 97-01, despite the fact that we  had indicated to IRS in October 2000 that the footnote was necessary. An  effective review procedure would have identified this material omission.  Further, we proposed not 2, but 14 audit adjustments, which IRS accepted  and recorded. The aggregate absolute value impact of these adjustments  was (1) $160 million to assets and liabilities, (2) $140 million to net cost,  and (3) $227 million to the statements of financing and budgetary  resources.
In the area of refunds, IRS disagreed with our finding that IRS does not  screen all EITC claims through EFDS. IRS stated that all EITC claims are  run through the EFDS program, which prioritizes returns according to  criteria that were based on the 1997 EITC Compliance study. We agree that  all cases with EITC refund claims are run through the EFDS program by  IRS’ Criminal Investigation Division and assigned a score to assist in  prioritizing which cases to work. CI, in turn, refers cases above a certain  score to the Examination Branch for examination. However, the  Examination Branch only examines a subset of those cases referred for  examination based upon its perceived level of available resources without  collecting the data necessary to determine whether it is focusing the  appropriate level of resources on this effort. Without such data, IRS is  unable to determine the extent to which refunds associated with invalid  EITC claims could be prevented or minimized had IRS devoted more  resources to its examination efforts. We have modified our report to  provide a more detailed explanation of the EITC examination selection  process.
IRS also disagreed with our recommendation that it implement policies and  procedures requiring all employees to itemize their time on their time  cards. IRS stated that it currently tracks itemized information for most  employees through its functional tracking systems. We will follow up  during our fiscal year 2001 audit to assess the adequacy of this approach.
Again, we recognize that IRS achieved an important milestone in producing  for the first time combined financial statements in fiscal year 2000 that  were fairly stated in all material respects. However, as we state in our  report, the tremendous efforts undertaken by IRS staff and management to  produce reliable financial statements do not result in reliable, useful, and  timely financial and performance information IRS needs for decision- making on an ongoing basis. 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. As we have reported for several years, long-term and systematic  improvements in IRS’ processes and systems are needed to address the  management challenges we have identified.
During fiscal year 2000, IRS demonstrated a strong commitment to address  the operational and financial management issues raised by us in previous  financial statement audits. It successfully implemented a number of  initiatives to address outstanding financial-related recommendations and  laid the groundwork for continued sustainable improvements in financial  management. We will continue to work closely with IRS to build on the  improvements made in fiscal year 2000 and to achieve sustained progress  in these areas.
The complete text of the IRS’ Deputy Commissioner for Operations’  response to this report is reprinted in appendix III.
This report contains new recommendations to you. 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 send your statement  to the Senate Committee on Governmental Affairs and the House  Committee on Government Reform within 60 days after the date of this  report. A written statement also must be sent to the House and Senate  Committees on Appropriations with the agency’s first request for  appropriations made over 60 days after the date of this report.
We are sending copies of this report to the Chairmen and Ranking Minority  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; 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 Secretary of the  Treasury, 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- 2600.
section_title: Scope and Methodology
paragraphs: As part of our audit of IRS’ fiscal year 2000 financial statements, we  evaluated IRS’ internal controls and its compliance with selected  provisions of laws and regulations, and we followed up on the status of  open recommendations from prior financial audits and related financial  management reports. We designed our audit procedures to test relevant  controls and included tests for proper authorization, execution,  accounting, and reporting of transactions. Specifically, we   Tested selected statistical samples of unpaid assessment, revenue,  refund, accounts payable, accrued expense, payroll, nonpayroll and  undelivered order transactions. These statistical samples were selected  primarily to substantiate, and in some cases derive, balances and  activities 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. In testing  these samples, certain attributes were identified that indicated  significant deficiencies in the design or operation of internal control.  These attributes can be and have been statistically projected to the  appropriate populations.
Conducted analytical testing procedures where appropriate.  Evaluated relevant internal controls over financial reporting and  reviewed the overall form and content of the financial statements.
Reviewed the IRS contractor’s methodology and procedures for  compiling the fiscal year 2000 P&E additions.
Tested detailed purchasing transactions of P&E, major systems, capital  leases, and leasehold improvements and a statistical sample of P&E  items at several IRS locations.
Compared EITC amounts from IRS and Treasury reports, and reviewed  EITC audit cases.
Tested transactions that represent the underlying basis of amounts  distributed to various trust funds, primarily the Highway Trust Fund and  Airport and Airway Trust Fund.
Reviewed the IRS certifications of excise tax revenue distributed to the  Highway Trust Fund and Airport and Airway Trust Fund.
Reviewed IRS’ reconciliations and specific controls over refund  processing and financial reporting.
Observed physical safeguards over cash and checks received and  processed at campuses, field offices, and lockbox banks.
Interviewed and observed management and personnel at campuses,  field offices, and lockbox banks.
Reviewed relevant audit reports from the Office of the Treasury  Inspector General for Tax Administration.
Reviewed IRS’ fiscal year 2000 Federal Managers’ Financial Integrity Act  Annual Assurance Statement, IRS’ January 2001 letter to Congress  responding to Recommendations to Improve Financial and  Operational Management (GAO-01-42), and IRS’ April 2001  Remediation Plan.
We performed our work from April 2000 through February 2001 in  accordance with U.S. generally accepted government auditing standards.   We have also issued a management letter addressing additional matters  that we identified during our fiscal year 2000 audit regarding accounting  procedures and internal controls that could be improved, and we have  issued separate reports on computer security issues.
section_title: Status of GAO Recommendations From Prior IRS Financial Audits and Related Financial Management Reports
paragraphs: Appendix II consists of two tables. Table 9 lists our recommendations from  prior financial statement audits and related financial management reports.  Table 10 lists new recommendations resulting from our fiscal year 2000  audit. From our previous reports on IRS’ financial activities, 85  recommendations remained open as of the date of this report (1 through 85  in table 9). We are closing 24 of these recommendations primarily because  IRS has addressed them or because they are being superseded by updated  or more detailed recommendations. Thus, 61 of these prior  recommendations remain open. The column “GAO status of  recommendations” in table 9 lists the current status of these  recommendations and indicates whether we believe that each open  recommendation could be addressed in the short term (such as enforcing  policies that are not being consistently followed) or whether each would  require long-term changes for fundamentally deficient financial systems or  other more extensive changes.  We are also making 10 new  recommendations in this report, numbered 86 through 95 in table 10, with  short- or long-term changes also indicated. Consequently, 71  recommendations are open as of the date of this report. We have  highlighted in bold the 9 recommendations we consider of highest priority  for IRS to address. These are recommendations 6, 8, 17, 47, 48, 49, 53, 54,  and 55. We will continue to monitor IRS’ progress toward addressing each  of the recommendations in this appendix during our fiscal year 2001 audit.
section_title: Comments From the Internal Revenue Service
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to those named above, Tuyet-Quan Thai, Delores Lee, Richard  Harada, George Jones, and William Cordrey made key contributions to this  report.
section_title: GAO’s Mission
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section_title: Public Affairs
subsections: section_title: United States General Accounting Office Washington, D.C. 20548-0001