Fiscal Year 2003 U.S. Government Financial Statements: Sustained Improvement in Federal Financial Management Is Crucial to Addressing Our Nation's Future Fiscal Challenges
Published: 2004-07-08T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GAO is required to annually audit the consolidated financial statements of the U.S. government. Proper accounting and reporting practices are essential in the public sector. The U.S. government is the largest, most diverse, most complex, and arguably the most important entity on earth today. Its services--homeland security, national defense, Social Security, mail delivery, and food inspection, to name a few--directly affect the well-being of almost every American. But sound decisions on the future direction of vital federal government programs and policies are made more difficult without timely, accurate, and useful financial and performance information. Until the problems discussed in GAO's audit report on the U.S. government's consolidated financial statements are adequately addressed, they will continue to (1) hamper the federal government's ability to accurately report a significant portion of its assets, liabilities, and costs; (2) affect the federal government's ability to accurately measure the full cost as well as the financial and nonfinancial performance of certain programs while effectively managing related operations; and (3) significantly impair the federal government's ability to adequately safeguard certain significant assets and properly record various transactions.
section_title: What GAO Found
paragraphs: As in the 6 previous fiscal years, certain material weaknesses in internal control and in selected accounting and reporting practices resulted in conditions that continued to prevent GAO from being able to provide the Congress and American citizens an opinion as to whether the consolidated financial statements of the U.S. government are fairly stated in conformity with U.S. generally accepted accounting principles. Three major impediments to an opinion on the consolidated financial statements continue to be (1) serious financial management problems at DOD, (2) the federal government's inability to fully account for and reconcile transactions between federal government entities, and (3) the federal government's ineffective process for preparing the consolidated financial statements. For fiscal year 2003, 20 of 23 Chief Financial Officers (CFO) Act agencies received unqualified opinions, the same number received by these agencies in fiscal year 2002, up from 6 for fiscal year 1996. However, only 3 of the CFO Act agencies had neither a material weakness in internal control, an issue involving compliance with applicable laws and regulations, nor an instance of lack of substantial compliance with Federal Financial Management Improvement Act requirements. The requirement for timely, accurate, and useful financial and performance management information is greater than ever as our nation faces major longterm fiscal challenges that will require tough choices in setting priorities and linking resources to results. Given the nation's large and growing long-term fiscal imbalance, which is driven largely by known demographic trends and health care costs, coupled with new homeland security and defense commitments, the status quo is unsustainable. Current financial reporting does not clearly and transparently show the wide range of responsibilities, programs, and activities that may either obligate the federal government to future spending or create an expectation for such spending and provides an unrealistic and even misleading picture of the federal government's overall performance and financial condition. In addition, too many significant federal government commitments and obligations, such as Social Security and Medicare, are not adequately addressed in the federal government's financial statements and budget process, and current federal financial reporting standards do not require such disclosure. A top-to-bottom review of government activities to ensure their relevance and fit for the 21st century and their relative priority is long overdue. The federal government needs a three-pronged approach to (1) restructure existing entitlement programs, (2) reexamine the base of discretionary and other spending, and (3) review and revise the federal government's tax policy and enforcement programs. New accounting and reporting approaches, budget control mechanisms, and metrics are needed for considering and measuring the impact of spending and tax policies and decisions over the long term.

section_title: Letter
paragraphs: I am pleased to be here today to discuss our report on the U.S.  government’s consolidated financial statements for fiscal years 2003 and  2002. Both the consolidated financial statements and our report are  included in the fiscal year 2003 Financial Report of the United States  Government, which was issued by the Department of the Treasury  (Treasury) on February 27, 2004, and is available through GAO’s Internet  site, at www.gao.gov, and Treasury’s Internet site, at  www.fms.treas.gov/fr/index.html.
As in the 6 previous fiscal years, certain material weaknesses in internal  control and in selected accounting and reporting practices resulted in  conditions that continued to prevent us from being able to provide the  Congress and American citizens an opinion as to whether the consolidated  financial statements of the U.S. government are fairly stated in conformity  with U.S. generally accepted accounting principles (GAAP). Until the  problems discussed in our report are adequately addressed, they will  continue to (1) hamper the federal government’s ability to accurately report  a significant portion of its assets, liabilities, and costs; (2) affect the federal  government’s ability to accurately measure the full cost as well as the  financial and nonfinancial performance of certain programs while  effectively managing related operations; and (3) significantly impair the  federal government’s ability to adequately safeguard certain significant  assets and properly record various transactions.
While the federal government has not yet been able to prepare auditable  financial statements, the requirement to do so at the consolidated level as  well as at the agency level has already yielded important results. We see  continuous movement toward the ultimate goals of annual accountability  and, more importantly, of development of the day-to-day financial  information that the federal government will need to best address today’s  budgetary challenges and the looming longer-term fiscal imbalance driven  by demographic trends, rising health care costs, and new homeland  security and defense commitments. Across government, financial  management improvement initiatives are under way that, if effectively  implemented, have the potential to appreciably improve the quality of the  federal government’s financial management and reporting. Federal  agencies continue to make progress in their efforts to modernize their  financial management systems and improve financial management  performance as called for in the President’s Management Agenda.
The Principals of the Joint Financial Management Improvement Program  (JFMIP) agreed with the Office of Management and Budget’s (OMB)  initiative to accelerate the agency financial statements reporting date to  November 15 for fiscal year 2004. For fiscal year 2003, OMB required the  Chief Financial Officers (CFO) Act agencies to deliver their Performance  and Accountability Reports, including their audited financial statements, to  OMB by January 30, 2004. However, to prepare for meeting the required  November 15 accelerated reporting date for fiscal year 2004, OMB  encouraged the CFO Act agencies to accelerate the issuance of their fiscal  year 2003 audited financial statements to November 15, 2003, or as close to  that date as possible. OMB reported that 8 CFO Act agencies—the  Department of Education, the Environmental Protection Agency, the  Department of Health and Human Services, the National Science  Foundation, the Social Security Administration, the Department of the  Treasury, the Agency for International Development, and the Department  of Veterans Affairs—were able to issue their fiscal year 2003 financial  statements with unqualified audit opinions by mid-November 2003.  Another 10 CFO Act agencies issued their financial statements by  December 31, 2003, and the remaining 5 CFO Act agencies issued by the  end of January 2004. A 24th major agency, the Department of Homeland  Security (DHS), issued its financial statements on February 13, 2004. DHS  faced a herculean challenge with respect to issuing audited financial  statements, since the department had been in operation only for the last 7  months of the fiscal year and involved a transfer of operations from a  number of diverse entities, some with known financial management  problems.
While these results represent a significant improvement over previous  years in the timeliness of CFO Act agencies’ issuance of audited financial  statements, they also demonstrate the significant challenges that the  federal government will face in meeting the November 15 accelerated  reporting date for fiscal year 2004. Auditors at several of the CFO Act  agencies reported that the agencies may not be able to produce auditable  financial statements within the accelerated time frame for fiscal year 2004  without making fundamental changes to improve a number of their  financial management practices. For example, certain federal agency  auditors reported that major improvements are needed in (1) management  controls to monitor established policies and procedures for conducting  financial analyses and reconciliations throughout the year, (2) fully  integrating financial management systems, and (3) providing adequate and  skilled staff to support efficient, effective preparation of federal agency  consolidated financial statements. Our experience as the auditor of the  financial statements of the Internal Revenue Service, which successfully  accelerated its reporting to November 15 beginning with its fiscal year 2002  financial statements, showed that significant changes had to be made to  improve routine financial management procedures in order to be able to  accelerate reporting.
For fiscal year 2003, as in fiscal year 2002, 20 of 23 CFO Act agencies were  able to attain unqualified audit opinions on their financial statements (see  table 1 and app. I), up from 6 agencies for fiscal year 1996. This is the same  number of unqualified opinions received by these CFO Act agencies for  fiscal year 2002. However, 2 agencies’ fiscal year 2003 opinions were  different from those they received for fiscal year 2002. The Agency for  International Development received an unqualified opinion on all of its  fiscal year 2003 financial statements for the first time, while the National  Aeronautics and Space Administration (NASA), which for fiscal year 2002  received an unqualified opinion on its financial statements, received a  disclaimer of opinion for fiscal year 2003. DHS, which as I mentioned  before prepared consolidated financial statements for fiscal year 2003  covering its first 7 months of operations, received a qualified opinion on  two of the six required financial statements.
In identifying improved financial performance as one of its five  governmentwide initiatives, the President’s Management Agenda  recognized that a clean (unqualified) financial audit opinion is a basic  prescription for any well-managed organization. At the same time, it  recognized that “most federal agencies that obtain clean audits only do so  after making extraordinary, labor-intensive assaults on financial records” at  or after year-end. The President’s Management Agenda further recognized  that without sound internal control and accurate and timely financial  information, it is not possible to accomplish the agenda and secure the best  performance and highest measure of accountability for the American  people. The JFMIP Principals have defined certain measures, in addition to  receiving an unqualified financial statement opinion, for achieving financial  management success. These additional measures include being able to  routinely provide timely, accurate, and useful financial and performance  information and having no material internal control weaknesses or material  noncompliance with laws and regulations and the requirements of the  Federal Financial Management Improvement Act of 1996 (FFMIA). As  shown in table 1, while the severity and magnitude of the problems  identified vary greatly, reports of inspectors general and their contract  auditors indicated that for fiscal year 2003 only 3 of the 23 CFO Act  agencies had neither a material weakness in internal control, an issue  involving compliance with applicable laws and regulations, nor an instance  of lack of substantial compliance with the requirements of FFMIA.
In this testimony, I will highlight the major issues relating to the  consolidated financial statements for fiscal years 2003 and 2002, discuss  systems problems that continue to hinder federal agency accountability,  and describe progress that has been made toward addressing major  impediments to an opinion on the consolidated financial statements. I will  also discuss why sound financial management today and in the future is  critical to meeting tomorrow’s fiscal needs and the need for “truth and  transparency” in connection with our nation’s financial condition and fiscal  outlook.
subsections: section_title: Highlights of Major Issues Related to the U.S. Government’s Consolidated Financial Statements for Fiscal Years 2003 and 2002
paragraphs: As I mentioned earlier, as has been the case for the previous 6 fiscal years,  the federal government continues to have a significant number of material  weaknesses related to financial systems, fundamental recordkeeping and  financial reporting, and incomplete documentation. Several of these  material weaknesses (referred to hereafter as material deficiencies)  resulted in conditions that continued to prevent us from forming and  expressing an opinion on the U.S. government’s consolidated financial  statements for the fiscal years ended September 30, 2003 and 2002. There  may also be additional issues that could affect the consolidated financial  statements that have not been identified.
Major challenges include the federal government’s inability to  properly account for and report property, plant, and equipment and  inventories and related property, primarily at the Department of Defense  (DOD);  reasonably estimate or adequately support amounts reported for certain  liabilities, such as environmental and disposal liabilities and related  costs at DOD, and ensure complete and proper reporting for  commitments and contingencies;  support major portions of the total net cost of government operations,  most notably related to DOD, and ensure that all disbursements are  properly recorded;  fully account for and reconcile intragovernmental activity and balances;  demonstrate how net outlay amounts reported in the consolidated  financial statements were related to net outlay amounts reported in the  underlying federal agencies’ financial statements; and  effectively prepare the federal government’s financial statements,  including ensuring that the consolidated financial statements are  consistent with the underlying audited agency financial statements,  balanced, and in conformity with GAAP.
In addition to these material deficiencies, we identified four other material  weaknesses in internal control related to loans receivable and loan  guarantee liabilities, improper payments, information security, and tax  collection activities.
The material weaknesses identified by our work are discussed in more  detail in appendix II, and their primary effects are described in appendix  III.
section_title: Recurring Systems Problems Hinder Accountability
paragraphs: The ability to produce the data needed to efficiently and effectively manage  the day-to-day operations of the federal government and provide  accountability to taxpayers and the Congress has been a long-standing  challenge at most federal agencies. The results of the fiscal year 2003  assessments performed by agency inspectors general or their contract  auditors under FFMIA show that these problems continue to plague the  financial management systems used by most of the CFO Act agencies.  While the problems are much more severe at some agencies than at others,  their nature and severity indicate that overall, management at most CFO  Act agencies lacks the full range of information needed for accountability,  performance reporting, and decision making. These problems include  nonintegrated financial systems, lack of accurate and timely recording of  data, inadequate reconciliation procedures, and noncompliance with  accounting standards and the U.S. Government Standard General Ledger  (SGL).
Agencies’ inability to meet the federal financial management systems  requirements continues to be the major barrier to achieving compliance  with FFMIA. Under FFMIA, CFO Act agency auditors are required to  report, as part of the agencies’ financial statement audits, whether  agencies’ financial management systems substantially comply with (1)  federal financial management systems requirements, (2) applicable federal  accounting standards, and (3) the SGL at the transaction level. As shown in  figure 1, auditors most frequently reported instances of noncompliance  with federal financial management systems requirements. These instances  of noncompliance involved not only core financial systems, but also  administrative and programmatic systems.
For fiscal year 2003, auditors for 17 of the 23 CFO Act agencies reported  that the agencies’ financial management systems did not comply  substantially with one or more of FFMIA’s three requirements. For the  remaining 6 CFO Act agencies, auditors provided negative assurance,  meaning that nothing came to their attention indicating that the agencies’  financial management systems did not substantially meet FFMIA  requirements. The auditors for these 6 agencies did not definitively state  whether the agencies’ systems substantially complied with FFMIA  requirements, as is required under the statute. DHS is not subject to the  requirements of the CFO Act and, consequently, is not required to comply  with FFMIA. Accordingly, DHS’s auditors did not report on DHS’s  compliance with FFMIA. However, the auditors identified and reported  deficiencies that related to the aforementioned three requirements of  FFMIA.
Federal agencies have recognized the seriousness of their financial systems  weaknesses and have efforts under way to implement or upgrade their  financial systems to alleviate long-standing problems, but some of these  efforts face significant challenges. For example, as we testified in May  2004, we have identified several issues related to NASA’s financial  management systems modernization effort: (1) NASA did not involve key  stakeholders in the design and implementation of the agency’s new  financial management system’s core financial module; (2) NASA did not  follow key best practices for acquiring and implementing this system; and  (3) the new system lacks key external reporting capabilities for property  and budgetary data. In addition, as I will discuss later in this testimony,  DOD faces major challenges in its efforts to develop a business enterprise  architecture. We recognize that it will take time, investment, and sustained  emphasis to improve agencies’ underlying financial management systems.
section_title: Addressing Major Impediments to an Opinion on Consolidated Financial Statements
paragraphs: As I mentioned earlier, for the past 7 fiscal years, the federal government  has been required to prepare, and have audited, consolidated financial  statements. Successfully meeting this requirement is tightly linked to the  requirements for the CFO Act agencies to also have audited financial  statements. This has stimulated extensive cooperative efforts and  considerable attention by agency chief financial officers, inspectors  general, Treasury and OMB officials, and GAO. With the benefit of the past  7 years’ experience by the federal government in having the required  financial statements subjected to audit, more intensified attention will be  needed on the most serious obstacles to achieving an opinion on the U.S.  government’s consolidated financial statements. Three major impediments  to an opinion on the consolidated financial statements are (1) serious  financial management problems at DOD, (2) the federal government’s  inability to fully account for and reconcile transactions between federal  government entities, and (3) the federal government’s ineffective process  for preparing the consolidated financial statements.
subsections: section_title: Financial Management at DOD
paragraphs: Essential to achieving an opinion on the consolidated financial statements  is resolution of the serious financial management problems at DOD, which we have designated as high risk since 1995. In accordance with section  1008 of the National Defense Authorization Act for Fiscal Year 2002, DOD  reported that for fiscal year 2003, it was not able to provide adequate  evidence supporting material amounts in its financial statements. DOD  stated that it is unable to comply with applicable financial reporting  requirements for (1) property, plant, and equipment (PP&E); (2) inventory  and operating materials and supplies; (3) environmental liabilities; (4)  intragovernmental eliminations and related accounting adjustments; (5)  disbursement activity; and (6) cost accounting by responsibility segment.  Although DOD represented that the military retirement health care liability  data had improved for fiscal year 2003, the cost of direct health care  provided by DOD-managed military treatment facilities was a significant  amount of DOD’s total recorded health care liability and was based on  estimates for which adequate support was not available.
DOD continues to confront pervasive decades-old financial management  and business problems related to its systems, processes (including internal  controls), and people (human capital). These problems preclude the  department from producing accurate, reliable, and timely information to  make sound decisions and to accurately report on its billions of dollars of  assets. DOD’s long-standing business management systems problems  adversely affect the economy, effectiveness, and efficiency of its operations  and have resulted in a lack of adequate accountability across all major  business areas. To date, none of the military services or major DOD  components has passed the test of an independent financial audit because  of pervasive weaknesses in financial management systems, operations, and  controls.
Additionally, the department’s stovepiped, duplicative, and nonintegrated  systems contribute to its vulnerability to fraud, waste, and abuse. In this regard, we have recently testified on problems related to military pay and  unused airline tickets. Vulnerability to fraud, waste, and abuse continues  despite substantial systems investment. For fiscal year 2004, DOD  requested approximately $19 billion to operate, maintain, and modernize its  reported 2,274 business systems. The duplicative and stovepiped nature of  DOD’s systems environment is illustrated by the numerous systems it has in  the same functional areas. For example, DOD reported that it has 565  systems to support logistics functions. These systems are not integrated  and thus have multiple points of data entry, which can result in significant  data integrity problems.
Further, DOD continues to lack effective management oversight and  control over business systems modernization investments. The actual  funding continues to be distributed among the military services and  defense agencies, thereby enabling the numerous DOD components to  continue to develop stovepiped, parochial solutions to the department’s  long-standing financial management and business operation challenges.  Lacking a departmentwide focus and effective management oversight and  control of business systems investment, DOD continues to invest billions of  dollars in systems that fail to provide integrated corporate solutions to its  long-standing business operations problems.
Over the past 14 years, DOD has initiated several broad-based reform  efforts intended to fundamentally reform its business operations and  improve the reliability of information used in the decision-making process.  While these initiatives produced some incremental improvements, they did  not result in the fundamental reform necessary to resolve the department’s  long-standing management challenges. Secretary Rumsfeld has made  business transformation a priority. For example, through its Business  Management Modernization Program, DOD is continuing its efforts to  develop and implement a business enterprise architecture and establish  effective management and control over its business system modernization  investments.
However, we recently reported that after about 3 years of effort and over  $203 million in obligations, we have not seen significant change in the  content of DOD’s architecture or in DOD’s approach to investing billions of  dollars annually in existing and new systems. Few actions have been taken  to address the recommendations we made in our previous reports, which  were aimed at improving DOD’s plans for developing the next version of  the architecture and implementing the institutional means for selecting and  controlling both planned and ongoing business systems investments. To  date, DOD has not addressed 22 of our 24 recommendations.
Currently, DOD has various initiatives under way to support its efforts to  obtain an unqualified audit opinion on its fiscal year 2007 financial  statements. Because there are not yet detailed plans guiding these  activities, however, it is unclear whether and how they support each other  and whether they support this goal. Therefore, the feasibility of meeting  this goal is as yet unknown.
The seriousness of DOD’s business management weaknesses underscores  the importance of no longer condoning “status quo” business operations at  DOD. Cultural resistance to change, military service parochialism, and  stovepiped operations have all contributed significantly to the failure of  previous attempts to implement broad-based management reforms at DOD.  The department has acknowledged that it confronts decades-old problems  deeply grounded in the bureaucratic history and operating practices of a  complex, multifaceted organization and that many of these practices were  developed piecemeal and evolved to accommodate different organizations,  each with its own policies and procedures.
To improve the likelihood that the department’s current business  transformation efforts will be successful, we have previously suggested  that a chief management official position be created. Previous failed  attempts to improve DOD’s business operations illustrate the need for  sustained involvement of DOD leadership in helping to assure that DOD’s  financial and overall business process transformation efforts remain a  priority. While the Secretary and other key DOD leaders have demonstrated  their commitment to the current business transformation efforts, the long- term nature of these efforts requires the development of an executive  position capable of providing strong and sustained executive leadership  over a number of years and various administrations.
This position would provide the sustained attention essential for  addressing key stewardship responsibilities such as strategic planning,  performance and financial management, and business systems  modernization in an integrated manner. This position could be filled by an  individual, appointed by the President and confirmed by the Senate, for a  set term of 7 years with the potential for reappointment. Such an individual  should have a proven track record as a business process change agent in  large, complex, and diverse organizations—experience necessary to  spearhead business process transformation across the department, and  potentially administrations, and serve as an integrator for the needed  business transformation efforts.
Further, in a recent report we also suggest that to improve management  oversight, accountability, and control of the department’s business systems  funding, Congress may wish to consider providing the funds to operate,  maintain, and modernize DOD’s business systems to the functional areas,  known as domains, rather than the military services and the defense  agencies. Currently, each military service and defense agency receives its  own funding and is largely autonomous in deciding how to spend these  funds, thereby hindering the development of broad-based, integrated  corporate system solutions to common DOD-wide problems. We believe it  is critical that funds for DOD business systems be appropriated to the  domain owners in order to provide for accountability and the ability to  prevent the continued parochial approach to systems investment that  exists today. The domains would establish a hierarchy of investment review  boards with DOD-wide representation, including the military services and  defense agencies. These boards would be responsible for reviewing and  approving investments to develop, operate, maintain, and modernize  business systems for the domain portfolio, including ensuring that  investments were consistent with DOD’s business enterprise architecture.
DOD still has a long way to go, and top leadership must continue to stress  the importance of achieving lasting improvement that truly transforms the  department’s business systems and operations. Only through major  transformation, which will take time and sustained leadership from top  management, will DOD be able to meet the mandate of the CFO Act and  achieve the President’s Management Agenda goal of improved financial  performance.
section_title: Intragovernmental Transactions
paragraphs: OMB and Treasury require the CFOs of 35 executive departments and  agencies, including the 23 CFO Act agencies, to reconcile selected  intragovernmental activity and balances with their “trading partners” and  to report to Treasury, the agency’s inspector general, and GAO on the  extent and results of intragovernmental activity and balances  reconciliation efforts. A substantial number of the agencies continue to be  unable to fully perform reconciliations of intragovernmental activity and  balances with their trading partners, citing reasons such as (1) trading  partners not providing needed data; (2) limitations and incompatibility of  agency and trading partner information systems; and (3) lack of human  resources. Amounts reported for federal agency trading partners for  certain intragovernmental accounts were significantly out of balance in the  aggregate for both fiscal years 2003 and 2002.
We reported in previous years that the heart of the intragovernmental  transactions issue was that the federal government lacked clearly  articulated business rules for these transactions so that they would be  handled consistently by agencies. In this regard, at the start of fiscal year  2003, OMB issued business rules to transform and standardize  intragovernmental ordering and billing. To address long-standing problems  with intragovernmental exchange transactions between federal agencies,  Treasury provided federal agencies with quarterly detailed trading partner  information during fiscal year 2003 to help them better perform their  trading partner reconciliations. In addition, the federal government began a  three-phase Intragovernmental Transactions e-gov project to define a  governmentwide data architecture and provide a single source of detailed  trading partner data. On April 20, 2004, however, OMB announced that it  was appropriate to pause and evaluate the results of the project to date.  OMB estimated that the evaluation will take 120 days and will be followed  by a phased deployment. Resolving the intragovernmental transactions  problem remains a difficult challenge and will require a commitment by the  CFO Act agencies and continued strong leadership by OMB.
section_title: Preparing the Consolidated Financial Statements
paragraphs: The federal government did not have adequate systems, controls, and  procedures to ensure that the consolidated financial statements are  consistent with the underlying audited agency financial statements,  balanced, and in conformity with GAAP. In this regard, Treasury is  developing a new system and procedures to prepare the consolidated  financial statements beginning with the statements for fiscal year 2004.  Treasury officials have stated that these actions are intended to, among  other things, directly link information from federal agencies’ audited  financial statements to amounts reported in the consolidated financial  statements and resolve many of the issues we identified in the process for  preparing the consolidated financial statements. As part of our fiscal year  2004 audit, we will evaluate the new system and procedures as they are  fully developed and implemented and determine the extent of linkage  accomplished for the fiscal year 2004 financial statements. Resolving issues  surrounding preparing the consolidated financial statements has been a  significant challenge and will require continued strong leadership by  Treasury management.
section_title: Truth and Transparency in the Fiscal Outlook
paragraphs: Our nation’s large and growing long-term fiscal imbalance, which is driven  largely by known demographic trends and rising health care costs—coupled  with new homeland security and defense commitments—serves to sharpen  the need to fundamentally review and re-examine basic federal  entitlements, as well as other mandatory and discretionary spending, and  tax policies. As we look ahead, our nation faces an unprecedented  demographic challenge with significant implications, among them  budgetary and economic. Between now and 2035, the number of people  who are 65 years old or over will double, driving federal spending on the  elderly to a larger and ultimately unsustainable share of the federal budget.  As a result, tough choices will be required to address the resulting  structural imbalance.
GAO prepares long-term budget simulations that seek to illustrate the likely  fiscal consequences of the coming demographics and rising health care  costs. Our latest long-term budget simulations reinforce the need for  change in the major cost drivers—Social Security and health care  programs. As shown in figure 2, by 2040, absent reform of these entitlement  programs, projected federal revenues may be adequate to pay little beyond  interest on the debt.
Current financial reporting does not clearly and transparently show the  wide range of responsibilities, programs, and activities that may either  obligate the federal government to future spending or create an  expectation for such spending and provides an unrealistic and even  misleading picture of the federal government’s overall performance and  financial condition. Few agencies adequately show the results they are  getting with the taxpayer dollars they spend. In addition, too many  significant federal government commitments and obligations, such as  Social Security and Medicare, are not fully and consistently disclosed in the  federal government’s consolidated financial statements and budget, and  current federal financial reporting standards do not require such  disclosure. Figure 3 shows some selected fiscal exposures. The spectrum  of these exposures ranges from covering only the explicit liabilities that are  shown on the consolidated financial statements to implicit promises  embedded in current policy or public expectations. These liabilities,  commitments, and promises have created a fiscal imbalance that will put  unprecedented strains on the nation’s spending and tax policies. Although  economic growth can help, the projected fiscal gap is now so large that the  federal government will not be able to simply grow its way out of the  problem. Tough choices are inevitable.
Particularly troubling are the many big-ticket items that taxpayers will  eventually have to deal with. The federal government has pledged its  support to a long list of programs and activities, including pension and  health care benefits for senior citizens, medical care for veterans, and  contingencies associated with various government-sponsored entities,  whose claims on future spending total trillions of dollars. Despite their  serious implications for future budgets, tax burdens, and spending  flexibilities, these unfunded commitments get short shrift in the federal  government’s current financial statements and in budgetary deliberations.
The federal government’s gross debt as of September 2003 was about $7  trillion, or about $24,000 for every man, woman, and child in this country  today. But that number excludes many big-ticket items, including the gap  between promised and funded Social Security and Medicare benefits,  veterans’ health care, and a range of other commitments and contingencies.  If these items are factored in, the total burden in current dollars is at least  $42 trillion. To put that number into perspective, $42 trillion is 18 times the  current federal budget, or 3.5 times our current annual gross domestic  product. One of the biggest contributors to this total bill will be the new  Medicare prescription drug benefit, whose estimated current-dollar cost  over the next 75 years is more than $8 trillion. Stated differently, the  current total burden for every American is more than $140,000—and every  day that burden is growing larger. GAO’s long-term budget simulations  show that by 2040, the federal government may have to cut federal  spending by 60 percent or raise taxes to about 2.5 times today’s level to pay  for the mounting cost of the federal government’s current unfunded  commitments. Either would be devastating.
Proper accounting and reporting practices are essential in the public  sector. After all, the U.S. government is the largest, most diverse, most  complex, and arguably the most important entity on earth today. Its  services—homeland security, national defense, Social Security, mail  delivery, and food inspection, to name a few—directly affect the well-being  of almost every American. But sound decisions on the future direction of  vital federal government programs and policies are made more difficult  without timely, accurate, and useful financial and performance  information.
Fortunately, we are starting to see efforts to address the shortcomings in  federal financial reporting. The President’s Management Agenda, which  closely reflects GAO’s list of high-risk government programs, is bringing  attention to troubled areas across the federal government and is taking  steps to better assess the results that programs are getting with the  resources they are given. The Federal Accounting Standards Advisory  Board is also making progress on many key financial reporting issues.
In addition to these efforts, we have published frameworks for analyzing  various Social Security reform proposals and for analyzing health care  reform proposals. We have also helped to create a consortium of “good  government” organizations to stimulate the development of a set of key  national indicators to assess the United States’ overall position and  progress over time and in comparison to those of other industrialized  nations.
Budget experts at the Congressional Budget Office (CBO) and GAO  continue to encourage reforms to the federal budget process to better  reflect the federal government’s commitments and signal emerging  problems. Among other things, we have recommended that the federal  government issue an annual report on major fiscal exposures. The  President’s fiscal year 2005 budget also proposes that future President’s  budgets report on any enacted legislation in the past year that worsens the  unfunded obligations of programs with long-term actuarial projections,  with CBO to make a similar report. Such reporting could be a good starting  point.
Although these are positive initial steps, much more must be done given the  magnitude of the federal government’s fiscal challenge. A top-to-bottom  review of government activities to ensure their relevance and fit for the  21st century and their relative priority is long overdue. As I have spoken  about in the past, the federal government needs a three-pronged approach  to (1) restructure existing entitlement programs, (2) reexamine the base of  discretionary and other spending, and (3) review and revise the federal  government’s tax policy, including major tax preferences, and enforcement  programs. New accounting and reporting approaches, budget control  mechanisms, and metrics are needed for considering and measuring the  impact of spending and tax policies and decisions over the long term.
section_title: Closing Comments
paragraphs: Our report on the U.S. government’s consolidated financial statements for  fiscal years 2003 and 2002 highlights the need to continue addressing the  federal government’s serious financial management weaknesses. With the  significantly accelerated financial reporting time frame for fiscal year 2004  and beyond, it is essential that the federal government move away from the  extraordinary efforts many federal agencies continue to make to prepare  financial statements and toward giving prominence to strengthening the  federal government’s financial systems, reporting, and controls. This is the  only way the federal government can meet the end goal of making timely,  accurate, and useful financial and performance information routinely  available to the Congress, other policymakers, and the American public.  The requirement for timely, accurate, and useful financial and performance  management information is greater than ever as our nation faces major  long-term fiscal challenges that will require tough choices in setting  priorities and linking resources to results.
The Congress and the President face the challenge of sorting out the many  claims on the federal budget without the budget enforcement mechanisms  or fiscal benchmarks that guided the federal government through the  previous years of deficit reduction into the brief period of surplus. While a  number of steps will be necessary to address this challenge, truth and  transparency in federal government reporting are essential elements of any  attempt to address the nation’s long-term fiscal challenges. The fiscal risks  I mentioned earlier can be managed only if they are properly accounted for  and publicly disclosed. A crucial first step will be to face facts and identify  the significant commitments facing the federal government. If citizens and  federal government officials come to understand various fiscal exposures  and their potential claims on future budgets, they are more likely to insist  on prudent policy choices today and sensible levels of fiscal risk in the  future. In addition, new budget control mechanisms will be required, along  with effective approaches to successfully engage in a fundamental review,  reassessment, and reprioritization of the base of federal government  programs and policies that I have recommended previously.
Public officials will have more incentive to make difficult but necessary  choices if the public has the facts and comes to support serious and  sustained action to address the nation’s fiscal challenges. Without  meaningful public debate, however, real and lasting change is unlikely.  Clearly, the sooner action is taken, the easier it will be to turn things  around.
I believe that nothing less than a national education campaign and outreach  effort is needed to help the public understand the nature and magnitude of  the long-term financial challenge facing this nation. An informed electorate  is essential for a healthy democracy. Members of Generations X and Y  especially need to become active in this discussion because they and their  children will bear the heaviest burden if policymakers fail to act in a timely  and responsible manner.
We at GAO are committed to doing our part, but others also need to step up  to the plate. By working together, I believe we can make a meaningful  difference for our nation, fellow citizens, and future generations of  Americans.
In closing, Mr. Chairman, I want to reiterate the value of sustained  congressional interest in these issues, as demonstrated by the Congress’s  annual hearings on the results of our audit of the consolidated financial  statements and of audits of certain federal agencies’ financial statements. It  will also be key that the appropriations, budget, authorizing, and oversight  committees hold agency top leadership accountable for resolving these  problems and that they support improvement efforts.
section_title: Contacts
paragraphs: For further information regarding this testimony, please contact Jeffrey C.  Steinhoff, Managing Director, or Gary T. Engel, Director, Financial  Management and Assurance, at (202) 512-2600.
section_title: Selected Major Federal Agencies: Fiscal Year 2003 Audit Results, Principal Auditors, and Number of Other Audit Contractors
paragraphs: R. Navarro & Associates, Inc.
R. Navarro & Associates, Inc.
section_title: Material Deficiencies
paragraphs: The federal government did not maintain adequate systems or have  sufficient, reliable evidence to support information reported in the  consolidated financial statements of the U.S. government, as described  below. These material deficiencies contributed to our disclaimer of opinion  on the consolidated financial statements and also constitute material  weaknesses in internal control.
subsections: section_title: Other Material Weaknesses
paragraphs: In addition to the material deficiencies noted above, we found four other  material weaknesses in internal control as of September 30, 2003: (1)  several federal agencies continue to have deficiencies in the processes and  procedures used to estimate the costs of their lending programs and value  their related loans receivable; (2) most federal agencies have not reported  the magnitude of improper payments in their programs and activities; (3)  federal agencies have not yet fully institutionalized comprehensive security  management programs; and (4) material internal control weaknesses and  systems deficiencies continue to affect the federal government’s ability to  effectively manage its tax collection activities.
subsections: section_title: Loans Receivable and Loan Guarantee Liabilities
paragraphs: In general, federal agencies continue to make progress in reducing the  number of material weaknesses and reportable conditions related to their  lending activities. However, significant deficiencies in the processes and  procedures used to estimate the costs of certain lending programs and  value the related loans receivable still remain. These deficiencies continue  to adversely affect the government’s ability to support annual budget  requests for these programs, make future budgetary decisions, manage  program costs, and measure the performance of lending activities. The  most notable deficiencies existed at the Small Business Administration  (SBA), which, while improved from last year, continues to have a material  weakness related to this area. For example, SBA did not adequately  document its estimation methodologies, lacked the management controls  necessary to ensure that appropriate estimates were prepared and reported  based on complete and accurate data, and could not fully support the  reasonableness of the costs of its lending programs and valuations of its  loan portfolio. We are currently assessing SBA’s actions to resolve certain  of these deficiencies related to accounting for previous loan sales and cost  estimates for disaster loans.
section_title: Improper Payments
paragraphs: Across the federal government, improper payments occur in a variety of  programs and activities, including those related to health care, contract  management, federal financial assistance, and tax refunds. While  complete information on the magnitude of improper payments is not yet  available, based on available data, OMB has estimated that improper  payments exceed $35 billion annually. Many improper payments occur in  federal programs that are administered by entities other than the federal  government, such as states. Improper payments often result from a lack of  or an inadequate system of internal controls. Although the President’s  Management Agenda includes an initiative to reduce improper payments,  most federal agencies have not reported the magnitude of improper  payments in their programs and activities.
The Improper Payments Information Act of 2002 provides for federal  agencies to estimate and report on their improper payments. It requires  federal agencies to (1) annually review programs and activities that they  administer to identify those that may be susceptible to significant improper  payments, (2) estimate improper payments in susceptible programs and  activities, and (3) provide reports to the Congress that discuss the causes  of improper payments identified and the status of actions to reduce them.  In accordance with the legislation, OMB issued guidance for federal  agencies’ use in implementing the act. Among other things, the guidance  requires federal agencies to report on their improper payment-related  activities in the Management Discussion and Analysis section of their  annual Performance and Accountability Reports (PAR). While the act does  not require such reporting by all federal agencies until fiscal year 2004,  OMB required 44 programs and 14 CFO Act agencies to report improper  payment information in their fiscal year 2003 PARs. Our preliminary review  of the PARs found that 12 of the 14 agencies reported improper payment  amounts for 27 of the 44 programs identified in the guidance. We also found  that, for the programs where improper payments were identified, the  reports often contained information on the causes of the payments but  little information that addressed the other reporting requirements cited in  the legislation.
section_title: Information Security
paragraphs: Although progress has been made, serious and widespread information  security weaknesses continue to place federal assets at risk of inadvertent  or deliberate misuse, financial information at risk of unauthorized  modification or destruction, sensitive information at risk of inappropriate  disclosure, and critical operations at risk of disruption. GAO has reported  information security as a high-risk area across government since February  1997. Such information security weaknesses could result in compromising  the reliability and availability of data that are recorded in or transmitted by  federal financial management systems. A primary reason for these  weaknesses is that federal agencies have not yet fully institutionalized  comprehensive security management programs, which are critical to  identifying information security weaknesses, resolving information  security problems, and managing information security risks on an ongoing  basis. The Congress has shown continuing interest in addressing these  risks, as evidenced by recent hearings on information security and  enactment of the Federal Information Security Management Act of 2002  and the Cyber Security Research and Development Act. In addition, the  administration has taken important actions to improve information  security, such as integrating information security into the Executive Branch  Management Scorecard.
section_title: Tax Collection Activities
paragraphs: Material internal control weaknesses and systems deficiencies continue to  affect the federal government’s ability to effectively manage its tax  collection activities. Due to errors and delays in recording activity in  taxpayer accounts, taxpayers were not always credited for payments made  on their taxes owed, which could result in undue taxpayer burden. In  addition, the federal government did not always follow up on potential  unreported or underreported taxes and did not always pursue collection  efforts against taxpayers owing taxes to the federal government.
section_title: Primary Effects of the Material Weaknesses Described in This Report
paragraphs: Primary Effects on the Fiscal Years 2003 and 2002 Consolidated Financial Statements and  the Management of Government Operations Without accurate asset information, the federal government does not fully know the assets it owns  and their location and condition and cannot effectively (1) safeguard assets from physical  deterioration, theft, or loss, (2) account for acquisitions and disposals of such assets, (3) ensure the  assets are available for use when needed, (4) prevent unnecessary storage and maintenance costs  or purchase of assets already on hand, and (5) determine the full costs of programs that use these  assets.
Problems in accounting for liabilities affect the determination of the full cost of the federal  government’s current operations and the extent of its liabilities. Also, improperly stated  environmental and disposal liabilities and weak internal control supporting the process for their  estimation affect the federal government’s ability to determine priorities for cleanup and disposal  activities and to allow for appropriate consideration of future budgetary resources needed to carry  out these activities. In addition, when disclosures of commitments and contingencies are  incomplete or incorrect, reliable information is not available about the extent of the federal  government’s obligations.
Inaccurate cost information affects the federal government’s ability to control and reduce costs,  assess performance, evaluate programs, and set fees to recover costs where required. Improperly  recorded disbursements could result in misstatements in the financial statements and in certain  data provided by federal agencies for inclusion in the President’s budget concerning obligations and  outlays.
Problems in accounting for and reconciling intragovernmental activity and balances impair the  government’s ability to account for billions of dollars of transactions between governmental entities.
Until the differences between the total net outlays reported in federal agencies’ Statements of  Budgetary Resources and the records used by the Department of the Treasury to prepare the  Statement of Changes in Cash Balance from Unified Budget and Other Activities are reconciled, the  effect that these differences may have on the U.S. government’s consolidated financial statements  will be unknown.
Because the federal government did not have adequate systems, controls, and procedures to  prepare its consolidated financial statements, the federal government’s ability to ensure that the  consolidated financial statements are consistent with the underlying audited agency financial  statements, balanced, and in conformity with U.S. generally accepted accounting principles was  impaired.
Without a systematic measurement of the extent of improper payments, federal agency  management cannot determine (1) if improper payment problems exist that require corrective  action, (2) mitigation strategies and the appropriate amount of investments to reduce them, and   (3) the success of efforts implemented to reduce improper payments.
Weaknesses in the processes and procedures for estimating credit program costs affect the  government’s ability to support annual budget requests for these programs, make future budgetary  decisions, manage program costs, and measure the performance of lending activities.
Information security weaknesses Information security weaknesses over computerized operations are placing enormous amounts of  federal assets at risk of inadvertent or deliberate misuse, financial information at risk of  unauthorized modification or destruction, sensitive information at risk of inappropriate disclosure,  and critical operations at risk of disruption.
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated Financial Statements and  the Management of Government Operations Weaknesses in controls over tax collection activities continue to affect the federal government’s  ability to efficiently and effectively account for and collect revenue. Additionally, weaknesses in  financial reporting affect the federal government’s ability to make informed decisions about  collection efforts. As a result, the federal government is vulnerable to loss of tax revenue and  exposed to potentially billions of dollars in losses due to inappropriate refund disbursements.
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