U.S. Government Financial Statements: FY 2001 Results Highlight the Continuing Need to Accelerate Federal Financial Management Reform
Published: 2002-04-09T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: As in the past four years, GAO was unable to express an opinion on the federal government's consolidated financial statements for fiscal years 2000 and 2001 because of material weaknesses in internal control and accounting and reporting issues. These conditions prevented GAO from providing Congress and American citizens with an opinion as to whether the consolidated financial statements are fairly stated in conformity with U.S. generally accepted accounting principles. Until these problems are adequately addressed, the government will continue to have difficulty (1) reporting its assets, liabilities, and costs; (2) adequately measuring the full cost and financial performance of programs and effectively manage related operations; and (3) adequately safeguarding significant assets and and properly recording transactions.

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 2001 and  2000.  Both the consolidated financial statements and our report are  included in the fiscal year 2001 Financial Report of the United States  Government, which was issued by the Department of the Treasury  (Treasury) on March 29, 2002, and is available through GAO’s Internet site,  at www.gao.gov.  Your work and that of this subcommittee have been a  catalyst to facilitate government management reform over the past 5 years  and will be critical to ultimately restoring the confidence of citizens in the  federal government as a financial steward that is accountable for its  finances.
As in the 4 previous fiscal years, we were unable to express an opinion on  the consolidated financial statements because of certain material  weaknesses in internal control and accounting and reporting issues.  These  conditions prevented us from being able to provide the Congress and  American citizens an opinion as to whether the consolidated financial  statements are fairly stated in conformity with U.S. generally accepted  accounting principles.
Until the problems discussed in our report are adequately addressed, they  will continue to (1) hamper the government’s ability to accurately report a  significant portion of its assets, liabilities, and costs, (2) affect the  government’s ability to accurately measure the full cost and financial  performance of certain programs and effectively manage related  operations, and (3) significantly impair the government’s ability to  adequately safeguard certain significant assets and properly record various  transactions.
Progress is being made in addressing impediments to an unqualified  opinion on the U.S. government’s consolidated financial statements.  For  example, in fiscal year 2001, the Department of Agriculture (USDA) and  certain other key agencies made significant improvements in estimating the  cost of the government’s lending programs and the net loan amounts  expected to be collected, which had contributed to our disclaimer of  opinion in prior years.  However, many of the pervasive and generally long- standing material weaknesses we have reported for the past 4 years have  not been fully resolved.  The underlying causes of these issues are  significant financial management systems weaknesses, problems with  fundamental recordkeeping and financial reporting, incomplete  documentation, and weak internal control.
Across government, there are a range of financial management  improvement initiatives underway that, if effectively implemented, will  improve the quality of the government’s financial management and  reporting.  For fiscal year 2001, 18 of the 24 Chief Financial Officers (CFO)  Act agencies were able to attain unqualified audit opinions on their  financial statements, which is the same number of agencies as last year and  up from 6 agencies for fiscal year 1996.  Also, the Office of Management and  Budget (OMB) reported that, for the second consecutive year, all 24 CFO  Act agencies met the statutory reporting deadline.  Further, two agencies  that did not receive unqualified opinions from their auditor last year were  able to do so this year, including the Department of Justice, which received  an unqualified opinion for the first time.  However, two other agencies were  unable to sustain the unqualified opinions received from their auditor last  year.  Additionally, for fiscal years 2001 and 2000, reports of inspectors  general and their contract auditors indicated that only 3 of the 24 CFO Act  agencies had neither a material control weakness, an issue involving  compliance with applicable laws and regulations, nor an instance of lack of  substantial compliance with requirements of the Federal Financial  Management Improvement Act (FFMIA) of 1996.
The largest impediment to an unqualified opinion on the consolidated  financial statements continues to be the Department of Defense’s (DOD)  serious financial management problems, which we have designated as high  risk since 1995.  DOD faces financial management problems that are  pervasive, complex, long-standing, and deeply rooted in virtually all  business operations throughout the department.  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.  Overhauling financial  management represents a major management challenge that goes far  beyond financial accounting to the very fiber of the department’s business  operations and management culture.  Cultural resistance to change and  military service parochialism have played a significant role in impeding  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.  In September 2001, Secretary of  Defense Rumsfeld announced a DOD-wide initiative intended to transform  the full range of the department’s business processes, including decades- old financial systems that are not well interconnected.  For the first time,  the Quadrennial Defense Review prepared by DOD includes business  process transformation as a key element. The Secretary has also taken  action to set aside $100 million for financial modernization and to establish  a number of top-level committees, councils, and boards, including the  Business Initiative Council and the Defense Business Practices  Implementation Board, to help develop and implement an integrated DOD- wide strategy for fundamentally transforming business practices.
Two other major impediments that must be overcome are the government’s  inability to account for billions of dollars of transactions between federal  government entities and to properly prepare the consolidated financial  statements.  The heart of the intragovernmental transactions issue is that  the government lacks clearly articulated business rules for these  transactions so that they are handled consistently by agencies.   Compounding this problem, agencies have not reconciled  intragovernmental balances with their trading partners.  As a result,  information reported to Treasury is not reliable.  OMB and Treasury have  several initiatives underway to address this issue.  With respect to properly  preparing the consolidated financial statements, Treasury plans to develop  a new system and procedures to prepare the financial statements.  The  continued leadership of both OMB and Treasury will be important to  resolving both of these issues.
Many agencies have been able to obtain unqualified audit opinions only by  expending significant resources on extensive ad hoc procedures and  making billions of dollars in adjustments to derive financial statements  months after the end of a fiscal year.  As I previously testified before this  subcommittee, if agencies continue year after year to rely on significant  costly and time-intensive manual efforts to achieve or maintain unqualified  opinions without improving underlying financial management systems, it  can serve to mislead the public as to the true status of the agency’s financial  management capabilities.  An unqualified opinion achieved on this basis  will become an accomplishment without much substance.
Irrespective of the unqualified opinions on their financial statements, many  agencies do not have timely, accurate, and useful financial information,  including cost data, and do not have sound controls with which to make  informed decisions and ensure accountability on an ongoing basis.  For  example, for fiscal year 2001, auditors for 17 of the 24 CFO Act agencies  reported at least one material control weakness, compared to 15 such  agencies for fiscal year 2000.  In addition, for fiscal year 2001, reports of  inspectors general and their contract auditors indicated that 20 of the 24  CFO Act agencies’ financial management systems were not in substantial  compliance with at least one of FFMIA’s three federal financial  management systems requirements, compared to 19 such agencies for  fiscal year 2000.  For the remaining four CFO Act agencies (the  Departments of Energy and Labor, the General Services Administration  (GSA), and the Social Security Administration (SSA)), auditors provided  negative assurance, meaning that nothing came to their attention indicating  these agencies’ financial management systems do not meet FFMIA  requirements.  The auditors for these four agencies did not definitively  state whether these agencies’ systems substantially complied with FFMIA’s  requirements, which we believe is required under the statute.  Ultimately, to  fully meet the goals of financial management reform legislation, agencies  will need to be able to generate timely, accurate, and useful financial and  management information, including reporting performance results, to  make decisions and monitor government performance every day.  Agencies  will also need to have effective internal controls in place and must ensure  compliance with applicable laws and regulations.
The President’s Management Agenda Fiscal Year 2002 includes improved  financial management performance as one of his five top governmentwide  management goals.  Other governmentwide initiatives include strategic  management of human capital, competitive sourcing, expanded electronic  government, and budget and performance integration.  These initiatives  cannot be addressed in an isolated or piecemeal fashion, but must be  addressed in an integrated way to ensure that they drive a broader  transformation of the cultures of federal agencies.  The administration  plans to use the Executive Branch Management Scorecard, which includes  broad standards, to highlight agencies’ progress in achieving management  and performance improvements embodied in The President’s Management  Agenda Fiscal Year 2002.  This is a step in the right direction to improving  management and performance, but the value of the scorecards is not in the  scoring, but in the degree to which scores lead to sustained focus and  demonstrable improvements.  It will be important that there be continuous  rigor in the scoring process in order for this approach to be credible and  effective.
In August 2001, the Principals of the Joint Financial Management  Improvement Program (JFMIP)—Secretary of the Treasury O’Neill, Office  of Management and Budget Director Daniels, Office of Personnel  Management (OPM) Director James, and I, as Comptroller General of the  United States and chair for the group—began a series of periodic meetings  that have resulted in unprecedented substantive deliberations and  agreements focused on key financial management reform issues such as  better defining measures for financial management success.  These  measures include being able to routinely provide timely, accurate, and  useful financial information and having no material internal control  weaknesses or material noncompliance with laws and regulations and  FFMIA requirements, which are essential to meeting the CFO Act’s  expectations, The President’s Management Agenda Fiscal Year 2002, and  Secretary of Defense Rumsfeld’s business process transformation  initiative.  In addition, the JFMIP Principals have agreed to significantly  accelerate financial statement reporting so that the government’s financial  statements are more timely and to discourage costly efforts designed to  obtain unqualified opinions on financial statements without addressing  underlying systems challenges.  For fiscal year 2004, audited agency  financial statements are to be issued no later than November 15, with the  U.S. government’s audited consolidated financial statements becoming due  by December 15.
Federal agencies have started to make progress in their efforts to  modernize their financial management systems.  However, the need for  timely, accurate, and useful financial and performance management  information is greater than ever given the increasing demands on the  federal budget.  Indeed, the challenges of combating terrorism and  ensuring our homeland security have come to the fore as urgent claims on  our attention and on the federal budget.  At the same time, the known fiscal  pressures created by the retirement of the baby boom generation and rising  health care costs remain.  Correspondingly, the ultimate task of addressing  today’s needs without unduly exacerbating the long-range fiscal challenge  has become much more difficult.
As we look ahead we face an unprecedented demographic challenge.  A  nation that has prided itself on its youth will become older.  In fact, in  2008—only 6 years from now—the first wave of baby boomers become  eligible to claim their Social Security benefits.  As the share of the  population over 65 climbs to more than 20 percent in 2035, federal  spending on the elderly will absorb larger and ultimately unsustainable  shares of the federal budget.  Federal health and retirement spending are  expected to surge as people live longer and spend more time in retirement.   In addition, advances in medical technology are likely to keep pushing up  the cost of providing health care.  Absent substantive reform of these  entitlement programs, a rapid escalation of federal spending for Social  Security, Medicare, and Medicaid is virtually certain to overwhelm the rest  of the federal budget.
On March 26, 2002, the Trustees of the Social Security and Medicare trust  funds reported on the current and projected status of these programs over  the next 75 years.  The Trustees’ reports highlight the need to address the  long-term fiscal challenges facing the nation.  The Trustees state that, while  the near-term financial conditions have improved slightly since last year’s  reports, the programs continue to face substantial financial challenges in  the not-too-distant future that need to be addressed soon.  Once again, the  Trustees underscored the fact that the most significant implication of these  findings is that both Social Security and Medicare need to be reformed and  strengthened at the earliest opportunity.  The Trustees also stated that  Medicare faces financial difficulties that in many ways are more severe  than those confronting Social Security.
These long-term demographic and fiscal pressures and the new  commitments undertaken after September 11 sharpen the need to look at  competing claims and new priorities.  While reforming health and  retirement entitlement programs is essential to preserving fiscal flexibility  in the long term, a fundamental review of all programs and operations can  create much-needed fiscal flexibility to address emerging needs and  unexpected requirements.  Given our long-range budget simulation work  and various key trends, there is a clear and compelling need to consider  what the proper role of the federal government should be in the 21st  century and how the government should do business in the future.
Timely, accurate, and useful financial and performance information can  form the basis for reconsidering the relevance or “fit” of any federal  program or activity in today’s world and for the future.  Such a review  might identify programs that have proven to be outdated or persistently  ineffective, or alternatively could prompt the government to update and  modernize activities through such actions as improving program targeting  and efficiency, consolidation, or reengineering processes and operations.   The budget and performance integration initiative under The President's  Management Agenda Fiscal Year 2002 should help provide information  for use in conducting such a review.  In addition, any review should not be  limited to only spending programs but should include the full range of more  indirect tools of governance that the federal government uses to address  national objectives.  These tools include loans and loan guarantees, tax  expenditures, and regulations.  Ultimately, we should strive to hand to the  next generation the legacy of a government that is effective, respected,  responsive, and relevant to a changing society—a government that is as  free as possible from outmoded commitments and operations that can  inappropriately encumber the future.
The Congress and President Bush face the challenge of sorting out these  many claims on the federal budget without the fiscal benchmarks that  guided us through the years of deficit reduction into surplus.  Going  forward, new rules and goals will be important both to ensure fiscal  discipline and to prompt a focus on the longer term implications of  decisions.  It is still the case that the federal government needs a decision- making framework that permits it to evaluate choices against both today’s  needs and the longer term fiscal future that will be handed to future  generations.  As stewards of our nation’s future, we must begin to prepare  for tomorrow.  In this regard, we must determine how best to address these  structural challenges in a reasonably timely manner in order to identify  specific actions that need to be taken.
I would now like to highlight the major issues relating to the U.S.  government’s consolidated financial statements for fiscal years 2001 and  2000.  I will then discuss the urgency of providing sustained leadership and  oversight to accelerate financial management reform, provide my  perspectives on the importance of agencies’ building upon their unqualified  audit opinions by significantly improving underlying financial management  systems, and underscore the need to address major impediments to an  unqualified opinion on the consolidated financial statements.  Also, I will  present my observations on selected audit matters that are essential to  protect the public interest and conclude with a few thoughts on several key  challenges in preparing to meet tomorrow’s fiscal needs.
subsections: section_title: Highlights of Major Issues Relating to the U.S. Government’s Consolidated Financial Statements for Fiscal Years 2001 and 2000
paragraphs: As I mentioned earlier, as has been the case for the past 4 fiscal years, a  significant number of material weaknesses related to financial systems,  fundamental recordkeeping and financial reporting, and incomplete  documentation continued to (1) hamper the government’s ability to  accurately report a significant portion of its assets, liabilities, and costs,  (2) affect the government’s ability to accurately measure the full cost and  financial performance of certain programs and effectively manage related  operations, and (3) significantly impair the government’s ability to  adequately safeguard significant assets and properly record various  transactions.  Several of these material weaknesses (referred to hereafter  as material deficiencies) resulted in conditions that continued to prevent us  from expressing an opinion on the U.S. government’s consolidated financial  statements for the fiscal years ended September 30, 2001 and 2000.  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 DOD;  use effective processes and procedures to estimate the cost of certain  major federal credit programs and the related loans receivable and loan  guarantee liabilities;  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 contingences;  support major portions of the total net cost of government operations,  most notably related to DOD and USDA, and ensure that all  disbursements are properly recorded;  fully account for and reconcile intragovernmental activity and balances;   properly prepare the federal government’s financial statements,  including balancing the statements, eliminating substantial amounts of  transactions between governmental entities, fully ensuring that the  information in the consolidated financial statements is consistent with  the underlying agency financial statements, and adequately reconciling  the results of operations to budget results.
In addition, we identified material weaknesses in internal control related to  improper payments, tax collection activities, and computer security.   Further, the financial management systems of most CFO Act agencies were  again reported by their auditors not to be in substantial compliance with  certain FFMIA requirements.
For the fiscal year 2001 Financial Report of the United States  Government, the government has for the first time presented: (1)  comparative financial statements; (2) two new financial statements,  namely, the Reconciliations of Net Operating Revenue/(Cost) to the Budget  Surplus (Unaudited), and the Dispositions of the Budget Surplus  (Unaudited); and (3) a Statement of Net Cost that arrays information  classified by agency rather than by function, as was shown in prior years.
I would now like to discuss in more detail the material deficiencies  identified by our work.
subsections: section_title: Ineffective Internal Control
paragraphs: In addition to the material deficiencies noted above, we found that (1) most  agencies have not estimated the magnitude of improper payments in their  programs, (2) material internal control weaknesses and systems  deficiencies continue to affect the government’s ability to effectively  manage its tax collection activities, and (3) widespread and serious  computer control weaknesses affect virtually all federal agencies.
subsections: section_title: Improper Payments
paragraphs: Across 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, and include payments made  for unauthorized purposes and for excessive amounts, such as  overpayments to program recipients or contractors and vendors.  The  reasons for improper payments range from program design issues, to  inadvertent errors, to fraud and abuse.  While reported estimates of  improper payments totaled approximately $19 billion for both fiscal years  2001 and 2000, the government did not estimate the full extent of improper  payments.
The Department of Health and Human Services (HHS) has been reporting a  national estimate of improper Medicare Fee-for-Service payments as part of  its annual financial statements since fiscal year 1996.  In fiscal year 2001,  HHS reported estimated improper Medicare Fee-for-Service payments of  $12.1 billion, or about 6.3 percent of such benefits—up from $11.9 billion,  or 7 percent, a year earlier and down from $23.2 billion, or 14 percent, for  fiscal year 1996.  HHS’s reporting and analysis of improper Medicare  payments has helped lead to the implementation of several initiatives to  identify and reduce such payments.  Annual estimates of improper  payments in future audited financial statements will provide information  on the progress of these initiatives.
However, most agencies have not estimated the magnitude of improper  payments in their programs and comprehensively addressed this issue in  their annual performance plans under the Government Performance and  Results Act (GPRA) of 1993.  For example, the Internal Revenue Service  (IRS) follows up on only a portion of the suspicious Earned Income Tax  Credit (EITC) claims it identifies, although the EITC has historically been  vulnerable to high rates of invalid claims.  During fiscal year 2000, IRS  released the results of its study of EITC compliance for tax year 1997.  In  this study, which is not performed annually, IRS estimated that taxpayers  filed returns claiming about $9.3 billion in invalid EITCs, of which  $1.5 billion (16 percent) either was recovered or was expected to be  recovered through compliance efforts.  Although the full extent of refunds  resulting from invalid EITCs is unknown, the IRS has not routinely  estimated the potential magnitude of invalid refunds and has not disclosed  an annual estimate of improper payments in its financial reports.  As a  result, the amount of improper payments included in the almost $26 billion  IRS disbursed for EITC in fiscal year 2001 is unknown.
Without a systematic measurement of the extent of improper payments,  agency management cannot determine (1) if the problem is significant  enough to require corrective action, (2) how much to invest in preventative  internal control, (3) the success of efforts implemented to reduce improper  payments, or (4) the magnitude or trends of improper payments, which  limits the ability to pinpoint or target mitigation strategies.  To help in  making such determinations, OMB now requires agencies to provide  information on erroneous payment rates for benefit and assistance  programs expending over $2 billion annually.
section_title: Tax Collection Activities
paragraphs: Material internal control weaknesses and systems deficiencies continue to  affect the government’s ability to effectively manage its tax collection  activities.  This situation continues to result in the need for extensive,  costly, and time-consuming ad hoc programming and analyses, as well as  material audit adjustments, to prepare basic financial information.  As  further discussed later in this testimony, this approach cannot be used to  prepare such information on a timely, routine basis to assist in ongoing  decision-making.  Additionally, the severity of the system deficiencies that  give rise to the need to resort to such procedures for financial reporting  purposes, as well as deficient physical safeguards, result in burden on  taxpayers and lost revenue.
The lack of appropriate subsidiary systems to track the status of taxpayer  accounts and material weaknesses in financial reporting affect the  government’s ability to make informed decisions about collection efforts.   Due to errors and delays in recording activity in taxpayer accounts,  taxpayers were not always being credited for payments made on their tax  liabilities.  In addition, the 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.   This could result in billions of dollars not being collected and adversely  affect future compliance.
The federal government continues to be vulnerable to lost tax revenue due  to weaknesses in controls intended to maximize the government’s ability to  collect what is owed and to minimize the risk of payment of improper  refunds. The government identifies billions of dollars of potentially  underreported taxes and improper refunds each year.  However, due in  large part to perceived resource constraints, the federal government  selects only a portion of the questionable cases it identifies for follow-up  investigation and action.  In addition, the federal government often does  not initiate follow-up on the cases it selects until months after the related  tax returns have been filed and any related refunds disbursed, affecting its  chances of collecting amounts due on these cases.  Consequently, the  federal government is exposed to potentially significant losses from  reduced revenue and disbursements of improper refunds.  Finally,  continued weaknesses in physical controls over cash, checks, and sensitive  data received from taxpayers increase both the government’s and the  taxpayers’ exposure to losses and increases the risk of taxpayers becoming  victims of crimes committed through identity fraud.
IRS senior management continues to be committed to addressing many of  these operational and financial management issues and has made a number  of improvements to address some of these weaknesses.  Successful  implementation of long-term efforts to resolve these serious problems will  require the continued commitment of IRS management as well as  substantial resources and expertise.
section_title: Computer Security Weaknesses
paragraphs: GAO has reported computer security as a governmentwide high-risk area  since February 1997.  Computer security weaknesses are placing  enormous amounts of government 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.  The government is  not in a position to estimate the full magnitude of actual damage and loss  resulting from federal computer security weaknesses because it is likely  that many such incidents are either not detected or not reported.  Agencies  have not yet established comprehensive security management programs  that would provide the government with a framework for resolving  computer security problems and managing computer security risk on an  ongoing basis.
The computer security weaknesses continue to cover the full range of  computer security controls.  For example, access controls were not  effective in limiting or detecting inappropriate access to computer  resources, such as ensuring that only authorized individuals can read, alter,  or delete data.  In addition, software change controls were ineffective in  ensuring that only properly authorized and tested software programs were  implemented.  Further, duties were not appropriately segregated to reduce  the risk that one individual could conduct unauthorized transactions  without being detected.  Finally, sensitive operating system software was  not controlled, and adequate steps had not been taken to ensure continuity  of operations.
As we recently testified, the initial implementation of government  information security reform provisions contained in the National Defense  Authorization Act for fiscal year 2001 is a significant step in improving  federal agencies’ information security programs and addressing their  serious, pervasive information security weaknesses.  In its first report on  the reform provisions, OMB commended agencies’ improvement efforts  but noted that many agencies have significant deficiencies in every  important area of security.  Agencies have noted benefits of this first-year  implementation, including increased management attention to and  accountability for information security.  In addition, the administration has  taken important actions to address information security, such as (1)  development of plans to integrate information security into the Executive  Branch Management Scorecard, which is discussed later in this testimony,  (2) appointment of a Special Advisor for Cyberspace Security to coordinate  interagency efforts to secure information systems, and (3) creation of the  President’s Critical Infrastructure Protection Board to recommend policies  and coordinate programs, including government and industry’s working  closely together to address increasing interconnections and shared risks.
section_title: Compliance with Applicable Laws and Regulations and FFMIA Requirements
paragraphs: Our work to determine compliance with selected provisions of applicable  laws and regulations related to financial reporting was limited by the  material weaknesses discussed above.  Instances of noncompliance, some  of which the agency auditors reported were material to individual agency  financial statements, are included in individual agency audit reports.   However, none of these instances were material to the U.S. government’s  consolidated financial statements.  Additionally, as further discussed later  in this testimony, for most CFO Act agencies, the auditors reported that  agencies’ financial management systems did not substantially comply with  certain FFMIA requirements.
section_title: Providing Sustained Leadership and Oversight to Accelerate Financial Management Reform
paragraphs: A year ago, in testimony before this subcommittee on the U.S.  government’s consolidated financial statements, I said that Treasury  Secretary O’Neill, OMB Director Daniels, and I (who, as I mentioned earlier,  along with OPM Director James, are the JFMIP Principals) had agreed on  the need for aggressive action to accelerate progress in financial  management reform.  This has sparked our personal commitment to  provide the leadership necessary to address pressing governmentwide  financial management issues.  Also since that time, President Bush has  launched a promising new initiative, The President’s Management Agenda  Fiscal Year 2002, to provide direction to, and to closely monitor,  management reform across government, which will encompass improved  financial performance.  Actions such as these are important elements of  ensuring the government’s full and effective implementation of the federal  financial management reforms enacted by the Congress.
subsections: section_title: The JFMIP Principals’ Initiative
paragraphs: Over the past year, the JFMIP Principals have established an excellent  working relationship, a basis for action, and a new sense of urgency  through which significant and meaningful progress can be achieved.  In  August 2001, the JFMIP Principals began a series of periodic meetings that  marked the first time all four of the Principals had gathered together in  over 10 years.  To date, these sessions have resulted in substantive  deliberations and agreements focused on key issues such as   Defining success measures for financial management performance that  go far beyond an unqualified audit opinion on financial statements and  include measures such as financial management systems that routinely  provide timely, reliable, and useful financial information and no material  internal control weaknesses or material noncompliance with laws and  regulations and FFMIA requirements;  Restructuring the Federal Accounting Standards Advisory Board’s  (FASAB) composition to enhance the independence of the Board and  increase public involvement in setting standards for federal financial  accounting and reporting;  Significantly accelerating financial statement reporting so that the  government financial statements are timely and to discourage costly  efforts designed to obtain unqualified opinions on financial statements  without addressing underlying systems challenges;  Establishing audit committees for the major federal agencies;  Addressing the impediments to an audit opinion on the U.S.  government's consolidated financial statements; and  Reporting social insurance financial information in the U.S.  government’s consolidated financial statements that includes  information from the most recent reports issued by the Social Security  and Medicare Trustees.
Various aspects of the matters outlined above are further discussed in  applicable sections later in this testimony.  Future meetings, with the next  meeting planned for May 2002, will enable the JFMIP Principals to reach  agreements and monitor progress on strategies critical to the full and  successful implementation of federal financial management reform and to  provide greater transparency and accountability in managing federal  programs and financial resources.
section_title: The President’s Management Agenda
paragraphs: President Bush has established an agenda for improving the management  and performance of the federal government that targets the most apparent  deficiencies where the opportunity to improve performance is the greatest.   It is no accident that the President’s Management Agenda has a strong  correlation to GAO’s high-risk list.  This is just one example of how GAO  and OMB have worked constructively to identify key issues deserving  increased attention throughout government.  As stated in the President’s  Management Agenda—and we wholeheartedly agree—there are few items  more urgent than ensuring that the federal government is well run and  results-oriented.
The President’s Management Agenda, which is a starting point for  management reform, includes improved financial management  performance as one of his five governmentwide management goals.  Other  governmentwide initiatives include strategic management of human  capital, competitive sourcing, expanded electronic government, and budget  and performance integration.
The results of our audits of the U.S. government’s consolidated financial  statements helped to lay the foundation for the President’s Management  Agenda financial management performance initiative.  The President’s  Management Agenda frames the problem this way:  “A clean financial audit  is a basic prescription for any well-managed organization, yet the federal  government has failed all four  audits since 1997.  Moreover, most  federal agencies that obtain clean audits only do so after making  extraordinary labor-intensive assaults on financial records.  Without  accurate and timely financial information, it is not possible to accomplish  the president’s agenda to secure the best performance and high measure of  accountability for the American people.”
In particular, the improved financial performance initiative is aimed at  ensuring that federal financial systems produce accurate and timely  information to support operating, budget, and policy decisions.  Also, this  initiative focuses special attention on addressing erroneous payments,  which as discussed earlier, is another problem our audit identified.
Under this governmentwide initiative, OMB will work with agencies to  improve the timeliness, enhance the usefulness, and ensure the reliability  of financial information.  The expected result is financial management  systems that routinely produce information that is (1) timely, to measure  and effect performance immediately, (2) useful, to make more informed  operational and investing decisions, and (3) reliable, to ensure consistent  and comparable trend analysis over time and to facilitate better  performance measurement and decisionmaking.  This result is a key to  successfully achieving the goals set out by the Congress in the CFO Act and  other federal financial management reform legislation.
section_title: The Executive Branch Management Scorecard
paragraphs: As we recently testified before this subcommittee, the administration  plans to use the Executive Branch Management Scorecard to highlight  agencies’ progress in achieving management and performance  improvements embodied in the President’s Management Agenda.  The  Executive Branch Management Scorecard grades agencies’ performance  regarding the five governmentwide initiatives by using broad standards and  a red-yellow-green coding system to indicate the level at which agencies  are meeting the standards.
In the financial management area, while recognizing the importance of  achieving a clean opinion from auditors on financial statements, the  scorecard focuses on the fundamental and systemic issues that must be  addressed in order to generate timely, accurate, and useful financial  information, sound internal structures, and effective compliance systems.   The first scorecard’s results show dramatically the extent of work  remaining across government to improve financial and other management  areas.  For financial management, most agencies were scored in the red  category.  This is not surprising, considering the well-recognized need to  transform financial management and other business processes at agencies  such as DOD, the results of our analyses under FFMIA, and the various  financial management operations we have designated as high risk.
Also, central to effectively addressing the federal government’s  management problems is recognition that the five governmentwide  initiatives cannot be addressed in an isolated or piecemeal fashion.  As  stated in the President’s Management Agenda, they are mutually  reinforcing.  More generally, the initiatives must be addressed in an  integrated way to ensure that they drive a broader transformation of the  cultures of federal agencies.
Improved financial management, for example, is also a key to successfully  achieving other governmentwide initiatives set out in the President’s  Management Agenda:  Strategic management of human capital:  Financial management reform  will require having the right people in CFO leadership positions and  enough people with the right skills and knowledge to perform important  financial operations.
Competitive sourcing:  For example, accurately knowing the cost for  providing goods and services in-house for comparison with private  sector performance will be important in making sound sourcing  decisions.
Expanded electronic government:  Many e-government applications will  likely be financial in nature, interact with financial systems and  reporting, and greatly change the internal control environment.
Budget and performance integration:  It is critical to focus on integrating  accounting, budget, and performance information, which the CFO Act  requires; reporting the cost of performance, which is essential to  successfully implementing GPRA; and providing useful information for  setting priorities and making informed budget decisions.
The focus that the administration’s scorecard approach brings to improving  management and performance, including financial performance, is  certainly a step in the right direction.  The value of the scorecards is not in  the scoring, but in the degree to which scores lead to sustained focus and  demonstrable improvement over time.  This will depend on continued  efforts to assess progress and maintain accountability to ensure that  agencies are able to, in fact, improve their performance.  It will be  important that there be continuous rigor in the scoring process in order for  this approach to be credible and effective.  Also, it is important to recognize  that many of the challenges the federal government faces, such as  improving financial management, are long-standing and complex, and will  require sustained attention.
section_title: Looking Beyond Unqualified Audit Opinions
paragraphs: Across government, there are financial management improvement  initiatives that could ultimately lead to an unqualified opinion on the U.S.  government’s consolidated financial statements.  However, accelerating the  pace of completing ongoing and planned efforts to implement financial  management reform is essential, as shown by reports of inspectors general  and their contract auditors indicating that only 3 of the 24 CFO Act  agencies had neither a material control weakness, an issue involving  compliance with applicable laws and regulations, nor an instance of lack of  substantial compliance with FFMIA requirements.  While many of the  pervasive and generally long-standing material weaknesses we have  reported for the past 4 years remain to be fully resolved, some progress  continues to be made in addressing the underlying causes of these  problems—significant financial systems weaknesses, problems with  fundamental recordkeeping and financial reporting, incomplete  documentation, and weak internal control.
For fiscal year 2001, 18 of the 24 CFO Act agencies were able to attain  unqualified audit opinions on their financial statements, which is the same  number of agencies as last year and up from 6 agencies for fiscal year 1996.   Also, OMB reported that, for the second consecutive year, all 24 CFO Act  agencies met the statutory reporting deadline.  Further, two agencies that  did not receive unqualified opinions from their auditor last year were able  to do so this year, including the Department of Transportation (DOT) and  the Department of Justice, which received an unqualified opinion for the  first time.  However, two other agencies, the National Aeronautics and  Space Administration (NASA) and the Federal Emergency Management  Agency, were unable to sustain the unqualified opinions received from their  auditor last year.
In the case of NASA, as we recently testified before this subcommittee,  after 5 years of receiving unqualified opinions on financial statements from  its previous independent auditor, the new independent auditor disclaimed  an opinion on the agency’s fiscal year 2001 financial statements.  The fiscal  year 2001 audit report also identified a number of significant internal  control weaknesses related to accounting for space station material and  equipment and to computer security.  Finally, the auditor concluded that  NASA’s financial management systems do not substantially comply with  federal financial management systems requirements and applicable federal  accounting standards, as required by FFMIA.  NASA’s financial  management difficulties are not new.  The weaknesses discussed in the  auditor’s report are consistent with the findings discussed in our previous  reports.  Since 1990, we have designated NASA’s contract management  problems as a high-risk area, due in part to financial management systems  problems that make it difficult for NASA to assure contracts are being  efficiently and effectively implemented.  We have also reported on NASA’s  misstatement of its Statement of Budgetary Resources, lack of detailed  support for amounts reported against certain cost limits, and lack of  historical cost data for accurately projecting future cost.
Irrespective of the unqualified opinions on their financial statements, many  agencies do not have timely, accurate, and useful financial information and  sound controls with which to make informed decisions and to ensure  accountability on an ongoing basis.  While agencies are making some  progress in obtaining unqualified audit opinions on annual financial  statements, many of these opinions were obtained by expending significant  resources on extensive ad hoc procedures and making billions of dollars in  adjustments to derive financial statements months after the end of a fiscal  year.  Several examples follow.  The need for such time-consuming  procedures primarily results from inadequate financial management  systems.
Our unqualified opinions on IRS’s fiscal years 2001 and 2000 financial  statements were made possible by the extraordinary efforts of IRS  senior management and staff to develop processes to compensate for  serious internal control and systems deficiencies.  IRS was again  compelled to rely extensively on costly, time-consuming processes;  statistical projections; external contractors; substantial adjustments;  and monumental human efforts that extended nearly four months after  the September 30, 2001, fiscal year-end to derive reliable year-end  balances for its financial statements. For example, IRS does not have a  detailed record, or subsidiary ledger, for taxes receivable to allow it to  track and manage amounts due from taxpayers.  To enable it to report a  reliable taxes receivable balance in the absence of a subsidiary ledger,  IRS has, for the last five years, relied on a complex statistical sampling  approach that requires substantial human and financial resources to  conduct, takes months to complete, and yields tens of billions of dollars  of adjustments.  Similarly, IRS does not have an integrated property  management system that appropriately records property and equipment  additions and disposals as they occur and links costs on the accounting  records to the property records.  During fiscal year 2001, IRS expensed  property additions during the year and then capitalized them at year-end  based on analysis of expense records conducted by a contractor.
DOT’s major agencies use the Departmental Accounting and Financial  Information System (DAFIS), which cannot produce financial  statements based on the information included within the system.  As a  result, DOT made about 850 adjustments, totaling about $41 billion,  outside DAFIS to prepare the financial statements.  These adjustments  were recorded in a financial statement module, a tool used to process  the adjustments.  However, all DOT agencies did not use the financial  statement module to prepare the financial statements, and the  adjustments were not recorded in DAFIS.  The DOT inspector general  reported that DOT plans to have a new accounting system fully  operational and compliant with accounting standards by January 2003.
Again, in fiscal year 2001, HHS attained an unqualified opinion on its  financial statements.  However, system and internal control weaknesses,  such as lack of an integrated financial management system, continued to  make it difficult for certain HHS components to prepare timely and  reliable financial statements.  For example, the National Institutes of  Health used a manual year-end process to create and post correct  Standard General Ledger accounts, generating about 19,000  nonstandard accounting entries with an absolute value of approximately  $348 billion.  Also, the Centers for Medicare and Medicaid Services,  continued to contract with independent public accounting firms, as it  has since FY 1999, to validate contractor receivables.   Further, the  Administration for Children and Families and the Centers for Disease  Control, produced their financial statements using a manually intensive  process that required adjusting entries to their general ledgers with an  absolute value of approximately $51 billion and $2 billion, respectively.
The Department of Education’s auditor expressed a qualified opinion on  the department’s fiscal year 2001 financial statements, primarily because  of weaknesses in the department’s financial reporting process.   Consistent with prior years, Education relied on work-around  procedures to prepare its financial statements, including significant  manual adjustments, due to deficiencies in the current general ledger  system and the lack of a fully integrated financial management system.   Because of errors that existed in prior years, the department performed  extensive analysis of certain general ledger account balances during  fiscal year 2001, which resulted in manual adjustments to correct certain  general ledger balances. However, the auditor noted that there were  errors in certain manual adjustments that had been processed and  approved by the department, resulting in additional manual adjustments  being posted to the financial statements.
The Department of Veterans Affairs (VA) received unqualified audit  opinions on its financial statements for fiscal years 2000 and 2001, but  producing them required significant efforts to assemble, compile, and  review the necessary financial information.  In many cases, significant  manual work-around procedures and “cuff” or out-of-date feeder  systems are used, as VA has not yet completed its transition to a fully  integrated financial management system.  According to VA’s auditors,  timely account reconciliations were not consistently prepared at the  department’s medical centers and assets were not timely capitalized.   Also, a significant number of manual adjustments were made during the  year-end closing process.
Situations such as these demonstrate the tremendous efforts, lasting 5  months or more, that many agencies use to produce annual financial  statements.  These agencies undertake far more work to prepare financial  statements, beginning at the close of a fiscal year, than would be necessary  if they had financial systems in place to routinely provide the data.   Information to compile agency financial statements should flow from their  financial management systems.  (The need for agencies to improve  financial management systems is further discussed later in this testimony.)
At the same time and as agreed to by the JFMIP Principals, there is a need  to accelerate the timeliness of providing audited financial statements.   March 1 is the current statutory deadline for the 24 CFO Act agencies to  submit audited financial statements, 5 months after the close of the fiscal  year.  For fiscal year 2001 reporting, OMB pushed this time frame ahead to  February 27.  Beginning with fiscal year 2004, OMB will require these  agencies to issue audited financial statements by November 15, 6 weeks  after the fiscal year end.  While this is important for timely financial  reporting, it will be difficult for some agencies to sustain unqualified audit  opinions and still meet the accelerated time frame for submitting audited  financial statements.
IRS is a case in point.  With the extraordinary efforts described above, IRS  found it extremely difficult to meet the February 27 reporting timeline  required by OMB for fiscal year 2001.  If IRS is to meet the November 15  deadline and sustain an unqualified opinion on its financial statements, the  tremendous amount of hard work and commitment that IRS has  demonstrated in recent years will no longer be sufficient to achieve this  goal unless accompanied by systemic changes in how IRS processes  transactions, maintains its financial records, and reports its financial  results.
It will be difficult for agencies to continue to rely on significant costly and  time-intensive manual efforts to achieve or maintain unqualified opinions  until automated, integrated processes and systems are implemented that  readily produce the necessary information. As a result, many agencies must  accelerate their efforts to improve underlying financial management  systems and controls, which is consistent with reaching the financial  management success measures envisioned by the JFMIP Principals and  called for by the President’s Management Agenda.  If agencies continue  year after year to rely on significant costly and time-intensive manual  efforts to achieve or maintain unqualified opinions without such  improvements, this practice can serve to mislead the public as to the true  status of the agency’s financial management capabilities.  An unqualified  opinion will become an accomplishment without much substance.
section_title: Addressing Major Impediments to Unqualified Opinion on Consolidated Financial Statements
paragraphs: As I mentioned earlier, for the past 5 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  requirement for the 24 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 the General Accounting Office.   With the benefit of several years’ experience by the government in having  the required financial statements subjected to audit, the time has come to  focus even more intensified attention on the most serious obstacles to  achieving an unqualified opinion on the U.S. government’s consolidated  financial statements.  In this regard, the JFMIP Principals have discussed  plans and strategies for addressing impediments to an unqualified opinion  on the U.S. government’s consolidated financial statements.
subsections: section_title: Reforming Financial Management at DOD
paragraphs: This year, upon early implementation of certain provisions of the National  Defense Authorization Act for fiscal year 2002, DOD reported that the  department’s financial management systems are not able to provide  adequate evidence supporting material amounts in its financial statements.   DOD asserted that it is unable to comply with applicable financial reporting  requirements for (1) property, plant, and equipment, (2) inventory and  operating materials and supplies, (3) military retirement health care  actuarial liability, (4) environmental liabilities, (5) intragovernmental  eliminations and related accounting adjustments, and (6) cost accounting  by suborganization/responsibility segment and major program. Based  largely on DOD’s assertion, the DOD inspector general disclaimed an  opinion on DOD’s financial statements for fiscal year 2001 as it had for the  previous 5 fiscal years.  DOD’s financial management deficiencies and  reporting weaknesses substantially impair our ability to determine the  reliability of the financial information reported in the government’s overall  financial reports.  Until DOD corrects these material weaknesses, our  ability to express an unqualified opinion on the U.S. government’s  consolidated financial statements will be impeded.
As I previously stated, 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 DOD’s financial management systems,  operations, and internal control, including an inability to compile financial  statements that comply with U.S. generally accepted accounting principles.   The department has made progress in a number of areas, but is far from  solving a range of serious financial management problems.  Their  resolution, however, is key to having auditable consolidated financial  statements because DOD had budget authority of $352 billion for fiscal year  2001, or about 18 percent of the entire federal budget, and is accountable  for a vast amount of government assets worldwide.
Despite progress, ineffective asset accountability and lack of effective  internal controls continue to adversely affect visibility over DOD’s  estimated $1 trillion investment in weapon systems and inventories.  These  weaknesses can affect the department’s ability to ensure that materials are  on hand when needed and its ability to prevent the purchase of assets  already on hand.  Further, unreliable cost and budget information related to  a reported over $1.4 trillion of reported liabilities and about $735 billion of  net costs negatively affects DOD’s ability to effectively measure  performance, reduce costs, and maintain adequate fund control.
As part of our constructive engagement approach with DOD, I met with  Secretary Rumsfeld last summer to provide our perspectives on the  underlying causes of the problems that have impeded past reform efforts at  the department and to discuss options for addressing these challenges.   The underlying causes discussed were  a lack of sustained top-level leadership and management accountability   deeply embedded cultural resistance to change, including military  service parochialism and stovepiped operations;  a lack of results-oriented goals and performance measures and   inadequate incentives for seeking change.
In this regard, I also attended the initial March 15, 2002, meeting of DOD’s  Business Practices Implementation Board, which is composed of outside  experts to advise the department on its effort to address these underlying  causes.
As we testified before this subcommittee last month and in May 2001, our  experience has shown there are several key elements that collectively  would enable the department to effectively address the underlying causes  of its inability to resolve its long-standing financial management problems.   These elements, which are key to any successful approach to financial  management reform, include  addressing the department’s financial management challenges as part of  a comprehensive, integrated, DOD-wide business process reform;  providing for sustained leadership by the Secretary of Defense and  resource control to implement needed financial management reforms;  establishing clear lines of responsibility, authority, and accountability  for such reform tied to the Secretary;  incorporating results-oriented performance measures and monitoring  tied to financial management reforms;  providing appropriate incentives or consequences for action or inaction;  establishing an enterprisewide system architecture to guide and direct  financial management modernization investments; and  ensuring effective oversight and monitoring.
The department has acknowledged the need for fundamental reform of its  business practices.  Specifically, the department’s September 30, 2001,  Quadrennial Defense Review reported that:  “While America’s businesses  have streamlined and adopted new business models to react to fast-moving  changes in markets and technologies, the Defense Department has lagged  behind without an overarching strategy to improve its business practices.”
Action on many of the key areas central to successfully achieving desired  financial management and related business process transformation goals— particularly those that rely on longer term systems improvements—will  take a number of years to fully implement.  Secretary Rumsfeld has  estimated that his envisioned transformation may take 8 or more years to  complete.  Consequently, both long-term actions focused on the Secretary’s  envisioned business transformation and short-term actions focused on  improvements within existing systems and processes will be critical going  forward.  Short-term actions in particular will be critical if the department  is to achieve the greatest possible accountability over existing resources  and more reliable data for day-to-day decisionmaking while longer-term  systems and business process reengineering efforts are under way.
Beginning with the Secretary’s recognition of the need for a fundamental  transformation of the department’s business processes, and building on  some of the work begun under past administrations, DOD has taken a  number of positive steps in many of these key areas.  For example, DOD  has taken action to set aside $100 million for financial modernization and,  as discussed previously, established a number of top-level committees,  councils and boards to help guide its financial transformation efforts.  At  the same time, the challenges remaining in each of these key areas are  daunting.  The JFMIP Principals have invited DOD Comptroller Zakheim to  their planned May 2002 meeting to discuss the department’s transformation  effort and to begin a constructive engagement with DOD on this important  initiative.
section_title: Focusing on Intragovernmental Transactions
paragraphs: For several years, OMB and Treasury have required the CFO Act agencies  to reconcile selected intragovernmental activity and balances with their  trading partners.  However, numerous agencies did not fully perform such  reconciliations for fiscal year 2000.  Beginning with fiscal year 2001, OMB  and Treasury required agency chief financial officers to report on the  extent and results of intragovernmental activity and balances  reconciliation efforts.  The inspectors general reviewed these reports and  communicated the results of their reviews to OMB, Treasury, and GAO.  A  substantial number of the CFO Act agencies did not fully perform the  required reconciliations for fiscal year 2001, citing reasons such as (1)  trading partners’ not providing needed data, (2) limitations and  incompatibility of agency and trading partner systems, and (3) human  resource issues.  For fiscal years 2001 and 2000, amounts reported for  agency trading partners for certain intragovernmental accounts were  significantly out of balance.  In addition, solutions will be required to  resolve significant differences reported in other intragovernmental  accounts, primarily related to appropriations.
To help address certain issues that contributed to the out-of-balance  condition for intragovernmental activity and balances, OMB has stated that  it is implementing the recommendations included in a study conducted for  the JFMIP in fiscal year 2001.  OMB is also pursuing other changes to  address core problems in this area, such as enhancing governmentwide  business rules for transactions among trading partners, requiring quarterly  reconciliations of intragovernmental activity and balances, and modifying  certain standard general ledger accounts required to be used by federal  agencies.  Resolving this problem remains a difficult challenge and will  require commitment by the CFO Act agencies and continued strong  leadership by OMB.
section_title: Preparing the Consolidated Financial Statements
paragraphs: The government did not have adequate systems, controls, and procedures  to properly prepare its consolidated financial statements.  Also, disclosure  of certain financial information was not presented in the consolidated  financial statements in conformity with U.S. generally accepted accounting  principles.
subsections: section_title: Elimination of Intragovernmental Activity and Balances
paragraphs: Consolidated financial statements are intended to present the results of  operations and financial position of the components that comprise a  reporting entity as if the entity were a single enterprise. When preparing the  consolidated financial statements, the preparer must eliminate  intragovernmental activity and balances between the agencies.  Because of  agencies’ problems in handling their intragovernmental transactions,  Treasury’s ability to eliminate these transactions is impaired.  Significant  differences reported in intragovernmental accounts as noted above have  been identified.  Intragovernmental activity and balances are “dropped” or  “offset” in the preparation of the consolidated financial statements rather  than eliminated through balanced accounting entries.  This contributes to  the government’s inability to determine the impact of these differences on  amounts reported in the consolidated financial statements.
section_title: Reconciling Operating Results with Budget Results
paragraphs: The government did not have a process to effectively identify and report  items needed to reconcile adequately the operating results, which for fiscal  year 2001 showed a net operating cost of $514.8 billion, to the budget  results, which for the same period showed a unified surplus of $127 billion.
section_title: Consolidated Financial Statement Compilation
paragraphs: The government could not adequately ensure that the information for each  agency that was included in the consolidated financial statements was  consistent with the underlying agency financial statements.  This problem  is compounded by the need for broad changes in the structure of the  government’s Standard General Ledger (SGL) accounts and the process for  maintaining the SGL.  For example, changes are needed that will result in  direct alignment by SGL account from agencies’ financial statement line  items to like items reported in the consolidated financial statements.
To make the fiscal year 2001 consolidated financial statements balance,  Treasury recorded a net $17.3 billion decrease to net operating cost on the  Statement of Operations and Changes in Net Position, which it labeled  unreconciled transactions.  For the prior fiscal year, a net $4.8 billion in  unreconciled transactions was recorded as a decrease to net operating  revenue in the accompanying consolidated financial statements.  An  additional net $3.9 billion and $.2 billion of unreconciled transactions were  improperly recorded in net cost for fiscal years 2001 and 2000, respectively.   Treasury attributes these net unreconciled transaction amounts primarily  to the government’s inability to properly identify and eliminate transactions  between governmental entities, agency adjustments that affected net  position, and other errors. However, Treasury was unable to adequately  identify and explain the gross components of such amounts.  Unreconciled  transactions also may exist because the government does not have  effective controls over reconciling net position.
The net position reported in the consolidated financial statements is  derived by subtracting liabilities from assets, rather than through balanced  accounting entries. Further, the process used to prepare the consolidated  financial statements requires significant human and financial resources and  does not adequately leverage the existing work and work products  resulting from federal agencies’ audited financial statements.
Treasury plans to develop a new system and procedures to prepare the  consolidated financial statements.  These actions are intended to, among  other things, directly link information from agencies’ financial statements  to amounts reported in the consolidated financial statements and facilitate  the reconciliation of net position.
section_title: Improving Financial Management Systems
paragraphs: The inability 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  weakness at most federal agencies.  The President’s Management Agenda  recognizes that the central challenge to producing reliable, useful, and  timely data throughout the year and at year-end is overhauling the  government’s financial management information systems.  The CFO Act  calls for the modernization of financial management systems, including the  systematic measurement of performance, the development of cost  information, and the integration of program, budget, and financial  information.
FFMIA builds on the CFO Act by emphasizing the need for agencies to have  systems that can generate timely, accurate, and useful information with  which to make informed decisions and to ensure accountability on an  ongoing basis.  FFMIA requires the 24 departments and agencies covered  by the CFO Act to implement and maintain financial management systems  that comply substantially with (1) federal financial management systems  requirements, (2) applicable federal accounting standards, and (3) the U.S.  Standard General Ledger (SGL) at the transaction level.  These  requirements are at the center of the financial management success  measures expressed by the JFMIP Principals and are key elements for  scoring agencies’ financial management performance using the Executive  Branch Management Scorecard.
For fiscal year 2001, auditors for 20 of the 24 CFO Act agencies reported  that agencies’ financial management systems did not substantially comply  with one or more of FFMIA’s three requirements.  For the remaining four  CFO Act agencies (the Departments of Energy and Labor, GSA, and SSA),  auditors provided negative assurance, meaning that nothing came to their  attention indicating these agencies’ financial management systems do not  meet FFMIA requirements.  The auditors for these four agencies did not  definitively state whether these agencies’ systems substantially complied  with FFMIA’s requirements.
In this regard, OMB Bulletin 01-02, Audit Requirements for Federal  Financial Statements, does not require auditors to make an affirmative  statement regarding an agency’s financial management system’s substantial  compliance with FFMIA, but rather permits auditors to report negative  assurance, meaning that their report can be based on limited audit testing  that disclosed no substantial instances of FFMIA noncompliance.  If  readers of the audit report do not understand this distinction, which is  important in terms of how much audit testing is required, they may have a  false impression that the auditor is stating that they found the systems to be  substantially compliant.  To provide positive assurance, or an opinion,  which is what we believe the law requires, auditors need to perform  sufficient testing to determine whether the system is in substantial  compliance.
Noncompliance with FFMIA is indicative of the overall continuing poor  condition of many financial management systems across government.  We  have consistently reported over the past few years that the reasons for  systems noncompliance included nonintegrated financial management  systems, inadequate reconciliation procedures, untimely recording of  financial information, noncompliance with the SGL, lack of adherence to  the accounting standards, and weak security controls over information  systems.  We have also reported that agency remediation plans, required by  FFMIA, may not adequately address the system deficiencies.
While agencies continue to make some progress in addressing their  financial management systems weaknesses, the serious shortcomings  reported for these systems result in the lack of reliable financial  information needed for managing day-to-day operations effectively,  efficiently, and economically; measuring program performance; executing  the budget; maintaining accountability; and preparing financial statements.   Having such financial information is the goal of FFMIA and the CFO Act,  necessary for implementing GPRA, and critical to the transition to a more  results-oriented federal government as envisioned in the President’s  Management Agenda.
For example, agency financial management systems are required to  produce information on the full cost of programs and projects.  This is not a  new expectation—the requirement for managerial cost information has  been in place for more than a decade, since 1990, under the CFO Act, and  since 1998 stemming from applicable accounting standards.  Yet, some  agencies are only able to provide cost accounting information at the end of  the fiscal year through periodic cost surveys.  The lack of timely  information on the full cost of operations precludes meaningful data that is  needed to make resource allocation choices, reach contracting-out  decisions, determine program efficiencies, assess user fees, and report  performance.
To remedy these deficiencies and carry out the President’s Management  Agenda for improving financial management, OMB and the CFO Act  agencies will need to aggressively and rigorously collaborate.  This will be  critical, since overhauling agency financial management systems is a  difficult challenge.  Our work to identify financial management best  practices in world-class organizations has identified key factors for  successfully modernizing financial systems, including (1) reengineering  business processes in conjunction with implementing new technology, (2)  developing systems that support the partnership between finance and  operations, and (3) translating financial data into meaningful data.  We  identified other financial management best practices as well, such as (1)  providing clear strong executive leadership, (2) making financial  management an entitywide priority, and (3) building a culture of control  and accountability.
The size and complexity of many federal agencies and the discipline  needed to overhaul or replace their financial management systems present  a significant challenge—not simply a challenge to overcome a technical  glitch, but a demanding management challenge that requires attention from  the highest levels of government along with sufficient human capital  resources to effect lasting change.  We recognize that it will take time,  investment, and sustained emphasis on correcting deficiencies to improve  federal financial management systems to the level required by FFMIA.  The  JFMIP Principals’ leadership, commitment, and oversight will be important  to provide the needed impetus to meet this challenge.
section_title: Protecting The Public Interest
paragraphs: Two audit matters have recently come to the fore and are key to protecting  the public interest.  One matter involves auditors’ responsibility for  reporting on internal control, and the other concerns auditor  independence.
subsections: section_title: Auditors’ Responsibility for Reporting on Internal Control
paragraphs: We have long believed that auditors have an important responsibility to  provide an opinion on the effectiveness of internal control over financial  reporting and compliance with applicable laws and regulations.  Currently,  this is not required by American Institute of Certified Public Accountants  (AICPA) auditing standards or by OMB in its guidance to auditors  conducting federal agency financial statement audits.
For financial statements audits that we conduct—which include the U.S.  government’s consolidated financial statements, the financial statements of  the IRS, the Schedules of Federal Debt managed by the Bureau of Public  Debt, and the financial statements of the Federal Deposit Insurance  Corporation and numerous small entities’ operations and funds—we issue  a separate opinion on the effectiveness of internal control over financial  reporting and compliance with applicable laws and regulations.
For years we have provided opinions on internal control effectiveness  because of the importance of internal control to protecting the public’s  interest.  Our reports have engendered major improvements in internal  control.  As you might expect, as part of the annual audit of our own  financial statements, we practice what we recommend to others and  contract with a CPA firm for both an opinion on our financial statements  and an opinion on the effectiveness of our internal control over financial  reporting and compliance with applicable laws and regulations.
Recently, GAO and the President’s Council on Integrity and Efficiency  jointly issued the Financial Audit Manual to provide guidance to auditors  conducting federal agency financial statement audits.  This manual calls for  these auditors to test internal control over financial reporting and  compliance with applicable laws and regulations, and thus provides a  foundation for issuing a separate opinion on the effectiveness of internal  control.  Although OMB requires testing of these internal controls, auditors  are not required to provide an opinion on internal control effectiveness.   However, we found that 3 of the 24 CFO Act agency auditors (those for  GSA, SSA, and the Nuclear Regulatory Commission) provided an opinion  on the effectiveness of internal control as of September 30, 2001.
Also, the JFMIP Principals have agreed that a measure of financial  management success is for an agency to have no material control  weaknesses.  By giving assurance about internal control, auditors of federal  financial statements can better serve their clients and other financial  statements users and protect the public interest by having a greater role in  providing assurances of the effectiveness of internal control in deterring  fraudulent financial reporting, protecting assets, and providing an early  warning of internal control weaknesses.
section_title: Auditor Independence
paragraphs: The independence of auditors—both in fact and appearance—is critical to  the credibility of financial reporting.  Auditors have the capability of  performing a range of valuable services for their clients, and providing  certain nonaudit services can ultimately be beneficial to federal entities.   However, in some circumstances, it is not appropriate for auditors to  perform both audit and certain nonaudit services for the same client.  In  these circumstances, the auditor, the client, or both will have to make a  choice as to which of these services the auditor will provide.
These concepts, which I strongly believe are in the public interest, are  reflected in the revisions to auditor independence requirements for  government audits, which GAO recently issued as part of Government  Auditing Standards.  The new independence standard has gone through  an extensive deliberative process over several years, including extensive  public comments and input from my Advisory Council on Government  Auditing Standards.  The standard, among other things, toughens the rules  associated with providing nonaudit services and includes a principle-based  approach to addressing this issue, supplemented with certain safeguards.   The two overarching principles in the standard for nonaudit services are  that   auditors should not perform management functions or make   auditors should not audit their own work or provide nonaudit services  in situations where the amounts or services involved are significant or  material to the subject matter of the audit.
Both of these principles should be applied using a substance-over-form  determination.  Under the revised standard, auditors are allowed to  perform certain nonaudit services provided the services do not violate  these principles; however, in most circumstances certain additional  safeguards would have to be met.  For example:  (1) personnel who  perform allowable nonaudit services would be precluded from performing  any related audit work, (2) the auditor’s work could not be reduced beyond  the level that would be appropriate if the nonaudit work were performed by  another unrelated party, and (3) certain documentation and quality  assurance requirements must be met.  The new standard includes an  express prohibition regarding auditors’ providing certain bookkeeping or  record keeping services and limits payroll processing and certain other  services, all of which are presently permitted under current independence  rules of the AICPA.
The focus of these changes to the government auditing standards is to  better serve the public interest and to maintain a high degree of integrity,  objectivity, and independence for audits of government entities and entities  that receive federal funding.  However, these standards apply only to audits  of federal entities and those organizations receiving federal funds, and not  to auditors of public companies.  In the transmittal letter issuing the new  independence standard, we expressed our hope that the AICPA will raise  its independence standards to those contained in the new standard in order  to eliminate any inconsistency between this standard and their current  standards.
The new independence standard is the first of several steps GAO has  planned in connection with nonaudit services covered by government  auditing standards.  In May 2002, we plan to issue a question and answer  document concerning our independence standard, and I will ask my  Advisory Council on Government Auditing Standards to review and  monitor this area to determine what, if any, additional steps may be  appropriate.  In addition, the JFMIP Principals have agreed that the 24  major federal departments and agencies covered by the CFO Act should  have audit committees.  The scope, structure, and timing of this new  requirement will be determined over the next several months.  This will  include determining what role these audit committees might play in  connection with nonaudit services.
section_title: Preparing to Meet Tomorrow’s Fiscal Needs
paragraphs: Several of the matters I previously discussed related to preparing to meet  tomorrow’s fiscal needs warrant repeating.  The requirement for timely,  accurate, and useful financial and performance management information is  greater than ever.  Both the long-term fiscal pressures created by the  retirement of the baby boom generation and the new commitments  undertaken in the aftermath of September 11 sharpen the need to look at  competing claims on federal budgetary resources and new priorities.  In  previous testimony, I noted that it should be the norm to reconsider the  relevance or “fit” of any federal program or activity in today’s world and for  the future.   Such a fundamental review is necessary both to increase  fiscal flexibility and to make government fit the modern world.  Stated  differently, there is a need to consider what the proper role of the federal  government should be in the 21st century and how the government should  do business in the future.
As we look ahead we face an unprecedented demographic challenge.  A  nation that has prided itself on its youth will become older.  Between now  and 2035, the number of people who are 65 or over will double.  As the  share of the population over 65 climbs, federal spending on the elderly will  absorb larger and ultimately unsustainable shares of the federal budget.   Federal health and retirement spending are expected to surge as people  live longer and spend more time in retirement.  In addition, advances in  medical technology are likely to keep pushing up the cost of providing  health care.  Moreover, the baby boomers will have left behind fewer  workers to support them in retirement, prompting a slower rate of  economic growth from which to finance these higher costs.  Absent  substantive change in related entitlement programs, large deficits will  return, requiring a combination of unprecedented spending cuts in other  areas, and/or unprecedented tax increases, and/or substantially increased  borrowing from the public (or correspondingly less debt reduction than  would otherwise have been the case).  These trends have widespread  implications for our society, our economy, and the federal budget.
On March 26, 2002, the Trustees of the Social Security and Medicare trust  funds reported on the current and projected status of these programs over  the next 75 years.  The Trustees’ reports highlight the need to address the  long-term fiscal challenges facing the nation.  The Trustees state that, while  the near-term financial conditions have improved slightly since last year’s  reports, the programs continue to face substantial financial challenges in  the not-too-distant future that need to be addressed soon.  Once again, the  Trustees underscored the fact that the most significant implication of these  findings is that both Social Security and Medicare need to be reformed and  strengthened at the earliest opportunity.  The Trustees also stated that  Medicare faces financial difficulties that in many ways are more severe  than those confronting Social Security.
Early action to change these programs would yield the highest fiscal  dividends for the federal budget and would provide a longer period for  prospective beneficiaries to make adjustments in their own planning.   Waiting to take action entails risks.  First, we lose an important window  where today’s relatively large workforce can increase saving and enhance  productivity, two elements critical to growing the future economy.  Second,  we lose the opportunity to reduce the burden of interest in the federal  budget, thereby creating a legacy of higher debt as well as elderly  entitlement spending for the relatively smaller workforce of the future.   Third, and most critically, we risk losing the opportunity to phase in  changes gradually so that all can make the adjustments needed in private  and public plans to accommodate this historic shift.
In a closely related matter, I have previously testified before this  subcommittee on the need to synchronize the timing of the Trustees’  reports with agency and consolidated financial statements.  Once again, the  U.S. government’s consolidated financial statements reported an update of  key indicators of the financial status of the Social Security and Medicare  trust funds from the Trustees’ reports.  The Trustees issued their reports  the same week as the consolidated financial statements.  Without this  update, the government would have provided two different reports on the  sustainability of these important programs, which could cause confusion  and reduce confidence in the credibility of the U.S. government’s  consolidated financial statements.  This updated information will not be  available when the U.S. government’s consolidated financial statements are  issued on an accelerated basis, beginning with fiscal year 2004.  The JFMIP  Principals are considering ways to ensure that reports issued by the Social  Security and Medicare Trustees, agency financial statements, and the U.S.  government’s consolidated financial statements present social insurance  financial information that is consistent and more timely.  In our view, the  Congress may need to enact legislation that will require earlier reporting  and issuance of the Trustees’ reports in order to allow for timely social  insurance information to be included in agencies’ and the U.S.  government’s consolidated financial statements.
While addressing the challenges of Social Security and Medicare is key to  ensuring future fiscal flexibility, a fundamental review of all programs and  operations can create much-needed fiscal flexibility to address emerging  needs.  As I have stated previously, it is healthy for the nation periodically  to review and update its programs, activities, and priorities.  Many  programs were designed years ago to respond to earlier challenges.   Ultimately, we should strive to hand to the next generations the legacy of a  government that is effective and relevant to a changing society—a  government as free as possible of outmoded commitments and operations  that can inappropriately encumber the future.
A reexamination of existing programs and activities could help weed out  programs that have proven to be outdated or persistently ineffective or  alternatively could prompt us to update and modernize activities through  such actions as improving program targeting and efficiency, consolidation,  or reengineering of processes and operations.  Such a review should not be  limited to only spending programs but should include the full range of tools  of governance that the federal government uses to address national  objectives such as loans, guarantees, tax expenditures, and regulations.
In the last decade the Congress put in place a series of laws designed to  improve information about cost and performance.  This framework and the  information it provides can help structure and inform the debate about  what the federal government should do.  In addition, GAO has identified a  number of areas warranting reconsideration based on program  performance, targeting, and costs.  Every year, we issue a report identifying  specific options, many scored by the Congressional Budget Office, for  congressional consideration stemming from our audit and evaluation  work. This report provides opportunities for (1) reassessing objectives of  specific federal programs, (2) improved targeting of benefits, and (3) improving the efficiency and management of federal initiatives.
Today the Congress and President Bush face the challenge of sorting out  these many claims on the federal budget without the fiscal benchmarks  that guided us through the years of deficit reduction into surplus.  However,  it is still the case that the federal government needs a decision-making  framework that permits it to evaluate choices against both today’s needs  and the longer-term fiscal future that will be handed to future generations.   As a way to frame the debate, targets can remind us that today’s decisions  are not only about current needs but also about how fiscal policy affects  the choices over the longer-term.  Other nations have found it useful to  embrace broader targets such as debt-to-GDP ratios, or surpluses equal to a  percent of GDP over the business cycle.  To work over time targets should  not be rigid—it is in the nature of things that they will sometimes be  missed.  Reaching a target is not a straight line but an iterative process.   The other nations we have studied have found that targets prompted them  to take advantage of windows of opportunity to save for the future and that  decisionmakers must have flexibility each year to weigh pressing short- term needs and adjust the fiscal path without abandoning the longer-term  framework.
The events of the past year have served to highlight the benefits of fiscal  flexibility.  Addressing the long-term drivers in the budget is essential to  preserving any flexibility in the long term.  In the nearer term a  fundamental review of existing programs and operations can also create  much-needed fiscal flexibility.  In this regard, we must determine how best  to address the necessary structural challenges in a reasonably timely  manner in order to identify specific actions that need to be taken.  As  stewards of our nation’s future, we must begin to prepare for tomorrow.
section_title: Closing Comments
paragraphs: Our report on the U.S. government’s consolidated financial statements for  fiscal years 2001 and 2000 highlights the need to continue addressing the  government’s serious financial management weaknesses.  Looking beyond  current progress by agencies in attaining unqualified opinions on financial  statements, it will be essential for the government to begin moving away  from the extraordinary efforts many agencies now use to prepare financial  statements and toward giving prominence to strengthening the  government’s financial systems, reporting, and controls.  This approach  becomes even more critical as the government progresses to an  accelerated financial statement reporting time frame, and it is the only way  the government can meet the end goal of making timely, accurate, and  useful financial 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 the Congress and the  administration prepare to meet tomorrow’s fiscal challenges.  This type of  financial information is central to managing the government’s operations  more efficiently, effectively, and economically and in supporting GPRA.   Moreover, meaningful financial and performance information can form the  basis for reconsidering the relevance or “fit” of any federal program or  activity in today’s world and for the future.
In closing Mr. Chairman, I want to underscore the importance of the  additional impetus provided by President Bush through his President’s  Management Agenda and the Executive Branch Management Scorecard for  coming to grips with federal financial management problems, indeed  management problems across the board. Regarding DOD in particular,  Secretary of Defense Rumsfeld’s vision and approach for transforming the  department’s full range of business processes is serious and encouraging.   These efforts will be key to fulfilling the President’s Management Agenda  and addressing the largest obstacle to an unqualified opinion on the U.S.  government’s consolidated financial statements.  The cooperative efforts  spearheaded by the JFMIP Principals have been most encouraging in  developing the short- and long-term strategies and plans necessary to  address many of the problems I have discussed this morning.  In addition,  GAO has probably never had a better working relationship with OMB and  cabinet level and other key officials on a range of “good government issues”