Fiscal Year 2004 U.S. Government Financial Statements: Sustained Improvement in Federal Financial Management Is Crucial to Addressing Our Nation's Future Fiscal Challenges
Published: 2005-02-09T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GAO is required by law to annually audit the consolidated financial statements of the U.S. government. Proper accounting and reporting practices are essential in the public sector. The U.S. government is the largest, most complex, and most diverse entity on earth today. Its services--homeland security, national defense, Social Security, health care, mail delivery, and food inspection, to name a few--directly affect the well-being of almost every American. Sound decisions on the current results and future direction of vital federal government programs and policies are made more difficult without timely, reliable, and useful financial and performance information. Until the problems discussed in GAO's audit report on the U.S. government's consolidated financial statements are adequately addressed, they will continue to (1) hamper the federal government's ability to reliably report a significant portion of its assets, liabilities, costs, and other information; (2) affect the federal government's ability to reliably measure the full cost as well as the financial and nonfinancial performance of certain programs; (3) impair the federal government's ability to adequately safeguard significant assets and properly record various transactions; and (4) prevent the federal government from having reliable financial information to operate in an economical, efficient, and effective manner.
section_title: What GAO Found
paragraphs: The federal government completed its consolidated financial statements on December 15, 2004. This is just 76 days after the end of the fiscal year--a record for timeliness. However, as in the previous 7 fiscal years, certain material weaknesses in internal control and in selected accounting and financial reporting practices resulted in conditions that continued to prevent GAO from being able to provide the Congress and American citizens an opinion as to whether the consolidated financial statements of the U.S. government are fairly stated in conformity with U.S. generally accepted accounting principles. Three major impediments to an opinion on the consolidated financial statements continue to be (1) serious financial management problems at the Department of Defense, (2) the federal government's ineffective process for preparing the consolidated financial statements, and (3) the federal government's inability to adequately account for and reconcile intragovernmental activity and balances between federal agencies. Further, in our opinion, the federal government did not maintain effective internal control over financial reporting and compliance due to numerous material weaknesses. While GAO was unable to express an opinion on the consolidated financial statements of the U.S. government, several key items deserve emphasis in order to put the information contained in the financial statements and Management's Discussion and Analysis in perspective. First, the federal government reported a $412.3 billion unified budget deficit and a $568 billion on-budget deficit in fiscal year 2004, representing approximately 3.6 percent and 4.9 percent of gross domestic product (GDP), respectively. Second, the U.S. government's reported liabilities, commitments, and other obligations grew by over $13 trillion in fiscal year 2004, primarily due to enactment of the new Medicare prescription drug benefit, and now surpass $43 trillion, representing close to four times current GDP. In addition, while the size of the nation's long-term fiscal imbalance grew significantly during the fiscal year, the retirement of the "baby boom" generation is closer to becoming a reality. Given these and other factors, it seems clear that the nation's current fiscal path is unsustainable and that tough choices by the President and the Congress will be necessary in order to address the nation's large and growing fiscal imbalance. An emerging issue during fiscal year 2004 that merits concern and close scrutiny was the growing number of Chief Financial Officers (CFO) Act agencies that restated certain of their financial statements for fiscal year 2003 to correct errors. Frequent restatements to correct errors can undermine public trust and confidence in both the entity and all responsible parties. The material internal control weaknesses discussed in this testimony serve to increase the risk that additional errors may occur and not be identified on a timely basis by management or the auditors, resulting in further restatements.

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 2004 and  2003. Both the consolidated financial statements and our report are  included in the fiscal year 2004 Financial Report of the United States  Government, which was issued by the Department of the Treasury  (Treasury) in mid-December, 2004, and is available through GAO’s Internet  site, at www.gao.gov, and Treasury’s Internet site, at  www.fms.treas.gov/fr/index.html.
I would like to thank you for continuing the annual tradition of oversight  hearings on this important subject. The involvement of your subcommittee  remains critical to ultimately assuring continued progress in the financial  management area while enhancing public confidence in the federal  government as a financial steward that is accountable for its finances.
The federal government completed its consolidated financial statements on  December 15, 2004.  This is just 76 days after the end of the fiscal year—a  record for timeliness.  However, as in the 7 previous fiscal years, certain  material weaknesses in internal control and in selected accounting and  financial reporting practices resulted in conditions that continued to  prevent us from being able to provide the Congress and American citizens  an opinion as to whether the consolidated financial statements of the U.S.  government were fairly stated in conformity with U.S. generally accepted  accounting principles (GAAP).  Until the problems discussed in our report  are adequately addressed, they will continue to (1) hamper the federal  government’s ability to reliably report a significant portion of its assets,  liabilities, costs, and other related information; (2) affect the federal  government’s ability to reliably measure the full cost as well as the financial  and nonfinancial performance of certain programs; (3) impair the federal  government’s ability to adequately safeguard significant assets and  properly record various transactions; and (4) prevent the federal  government from having reliable financial information to operate in an  economical, efficient, and effective manner. Sound decisions on the current  results and future direction of vital federal programs and policies are made  more difficult without timely, reliable, and useful financial and  performance information.
While the federal government has not yet been able to prepare auditable  financial statements, the requirement to do so at the consolidated level, as  well as at the agency level, has already yielded important results.  We see  continuous movement toward the ultimate goals of annual accountability  and, more importantly, of development of the day-to-day financial  information that the federal government will need to best address today’s  budgetary challenges and the looming longer-term fiscal imbalance driven  by, among other things, demographic trends, rising health care costs, and  new homeland security and defense commitments.  Across government,  financial management improvement initiatives are under way, and if  effectively implemented, have the potential to appreciably improve the  quality of the federal government’s financial management and reporting.  Individual federal agencies continue to make some progress in their efforts  to modernize their financial management systems and improve financial  management performance as called for in the President’s Management  Agenda.
The Office of Management and Budget (OMB) accelerated the fiscal year  2004 financial statements reporting date for agencies to November 15, 2004,  as compared with January 30, 2004, for fiscal year 2003. Twenty-two of 23  Chief Financial Officers (CFO) Act agencies were able to issue their fiscal  year 2004 financial statements by the accelerated reporting date and the  last one was issued during the first week of December.  These reporting  dates represent a significant improvement over fiscal year 2003 in the  timeliness of CFO Act agencies’ issuance of their financial statements.
As shown in appendix I, for fiscal year 2004, 18 of 23 CFO Act agencies  were able to attain unqualified audit opinions on their financial statements  from inspectors general and their contract auditors responsible for those  audits.  With accelerated reporting, which we support in concept, it is even  more imperative that federal agency management continue to work toward  fully resolving the pervasive and generally long-standing material  weaknesses that have been reported at the agency level for the past 9 fiscal  years. Otherwise, federal agencies may risk incurring additional costs while  at the same time sacrificing reliability to achieve accelerated reporting.
In identifying improved financial performance as one of its five  governmentwide initiatives, the President’s Management Agenda  recognized that a clean (unqualified) financial audit opinion is a basic  prescription for any well-managed organization. The Principals of the Joint  Financial Management Improvement Program (JFMIP) defined certain  measures, in addition to receiving an unqualified financial statement  opinion, for achieving financial management success. These additional  measures include being able to routinely provide timely, accurate, and  useful financial and performance information and having no material  internal control weaknesses or material noncompliance with laws and  regulations and the requirements of the Federal Financial Management  Improvement Act of 1996 (FFMIA).As shown in appendix II, while the  severity and magnitude of the problems identified vary greatly, our analysis  of audit reports of inspectors general and their contract auditors showed  that for fiscal year 2004 only 4 of the 23 CFO Act agencies had neither a  material weakness in internal control, an issue involving compliance with  applicable laws and regulations, nor an instance of lack of substantial  compliance with the requirements of FFMIA.
In this testimony, I will discuss why sound financial management today and  in the future is central to meeting our nation’s large and growing long-term  fiscal imbalance.  I will also discuss the growing number of CFO Act  agencies that restated certain of their financial statements for fiscal year  2003 to correct errors—an emerging issue that merits concern and close  scrutiny. I will then highlight the major issues relating to the consolidated  financial statements for fiscal years 2004 and 2003, discuss systems  problems that continue to hinder federal agency accountability, and  describe progress that has been made toward addressing major  impediments to an opinion on the consolidated financial statements.
subsections: section_title: The Nation’s Fiscal Imbalance
paragraphs: First, I would like to spend a few minutes discussing our nation’s  worsening financial condition and long-range fiscal outlook.  Last week, I  spoke on this issue at the National Press Club as part of the Outlook 2005  Conference, which was attended by government, corporate, and nonprofit  executives from around the country.  I have attached a copy of my remarks  at that conference to my testimony today as appendix III.
While we are unable to express an opinion on the U.S. government’s  consolidated financial statements, several key items deserve emphasis in  order to put the information contained in the financial statements and the  Management’s Discussion and Analysis section of the Financial Report of  the United States Government into context.
First, the federal government reported a $412.3 billion unified budget  deficit and a $568 billion on-budget deficit in fiscal year 2004, representing  approximately 3.6 percent and 4.9 percent of gross domestic product  (GDP), respectively. Second, the U.S. government’s reported liabilities,  commitments, and other obligations grew by over $13 trillion in fiscal year  2004, primarily due to the enactment of the new Medicare prescription drug  benefit, and now surpass $43 trillion, representing close to four times  current GDP.
In March 2004, the Trustees of the Social Security and Medicare trust funds  issued their respective 2004 annual reports on the current and projected  status of these two programs. Once again, the trustees’ reports confirmed  that both the Social Security and Medicare programs are unsustainable in  their present form. The trustees also noted that Medicare’s financial  difficulties are much more severe than those confronting Social Security.  Furthermore, the new prescription drug benefit has significantly increased  the federal government’s commitments associated with the Medicare  program. Specifically, in their 2004 report, the trustees estimated the  present value cost to the federal government of this new benefit over the  next 75 years to be $8.1 trillion as of January 1, 2004. The trustees  reiterated the message contained in their previous reports that action to  address the financial difficulties facing Social Security and Medicare  should be taken in a timely manner and that the sooner these financial  challenges are addressed, the more varied and less disruptive the solutions  can be.
The federal government’s gross debt as of September 2004 was about $7.4  trillion, or about $25,000 for every man, woman, and child in the country.  But that number excludes such items as the gap between promised and  funded Social Security and Medicare benefits, veterans’ health care, and a  range of other liabilities, commitments, and contingencies that the federal  government has pledged to support. If these items are factored in, the  current dollar burden for every American rises to about $145,000 per  person, or about $350,000 per full-time worker.
Current financial reporting does not clearly and transparently show the  wide range of responsibilities, programs, and activities that may either  obligate the federal government to future spending or create an  expectation for such spending.  Thus, it provides an unrealistic and even  misleading picture of the federal government’s overall performance,  financial condition, and future fiscal outlook.  Few federal agencies  adequately show the results they are getting with the taxpayer dollars they  spend.  In addition, too many significant federal government revenues—as  well as commitments and obligations such as those associated with Social  Security and Medicare—are not adequately and consistently disclosed in  the federal government’s consolidated financial statements and budget, and  current federal financial reporting standards do not require such  disclosure.  The Federal Accounting Standards Advisory Board recently  completed a project on accounting and reporting of earmarked funds,  which include the Social Security and Medicare trust funds, and has a  project underway to consider recognition, measurement, and display of  social insurance obligations.
Figure 1 shows some selected fiscal exposures.  The spectrum of these  exposures ranges from explicit liabilities shown on the consolidated  financial statements to implicit promises embedded in current policy or  public expectations. These liabilities, commitments, and promises have  created a fiscal imbalance that will put unprecedented strains on the  nation’s future spending and tax policies.  Although economic growth can  help, the projected fiscal gap is now so large that the federal government  will not be able to simply grow its way out of the problem.  Tough choices  by the President and the Congress are inevitable.
GAO’s fiscal policy simulations illustrate that the fiscal policies in place  today—absent substantive entitlement reform or unprecedented changes  in tax and/or spending policies—will result in large, escalating, and  persistent deficits that are economically unsustainable over the long term.  Assuming that discretionary spending grows with inflation and all existing  tax cuts are allowed to expire when scheduled under current law, spending  for Social Security and health care programs would grow to consume over  three-quarters of federal revenue by 2040.  Moreover, if all expiring tax  provisions are extended and discretionary spending keeps pace with the  economy, by 2040 total federal revenues may be adequate to pay little more  than interest on the federal debt.  Without reform, known demographic  trends, rising health care costs, and projected growth in federal spending  for Social Security, Medicare, and Medicaid will result in massive fiscal  pressures that, if not effectively addressed, could cripple the economy,  threaten our national security, and adversely affect the quality of life of  Americans in the future.
The President and the Congress face the challenge of sorting out the many  claims on the federal budget without the budget enforcement mechanisms  or fiscal benchmarks that guided the federal government through the years  of deficit reduction into a brief period of federal surpluses. While a number  of steps will be necessary to address this challenge, as outlined in my  February 2, 2005, remarks at the Press Club, truth and transparency in  federal government financial reporting and budgeting are essential  elements of any attempt to address the nation’s long-term fiscal challenges.  Further, Congress needs to have access to the long-term cost of selected  spending and tax proposals before they enact related laws.  The fiscal risks  just mentioned can be managed only if they are properly accounted for and  publicly disclosed, including the many existing commitments facing the  federal government. In addition, new budget control mechanisms will be  required, along with effective approaches to successfully engage in a  fundamental review, reassessment, and reprioritization of the base of  federal government programs and policies. In this regard, we should not  assume that all defense and homeland security expenditures are both  necessary and prudent. Furthermore, the use of across-the-board  adjustments to address the spending imbalance serves to avoid making the  necessary difficult choices, is inequitable, and simply will not get the job  done.
section_title: Potential Impact of Restatements on Agencies’ Financial Statements
paragraphs: An emerging issue during fiscal year 2004 that merits concern and close  scrutiny was the growing number of CFO Act agencies that restated certain  of their financial statements for fiscal year 2003 to correct errors.  As  shown in appendix II, at least 11 of the 23 CFO Act agencies fell into this  category as compared with at least 5 CFO Act agencies that had  restatements covering their fiscal year 2002 financial statements in fiscal  year 2003.  At least 3 CFO Act agencies had restatements in both years. For  example, in fiscal year 2003, one agency misstated certain of its fiscal year  2002 financial statements by about $1 billion.  The following year, this same  agency restated certain of its fiscal year 2003 financial statements by over  $5 billion.  Nonetheless, for both years, the agency received unqualified  audit opinions on its financial statements.
Nine of the 11 agencies having restatements for fiscal year 2003 had  received unqualified opinions on their originally issued fiscal year 2003  financial statements.  Seven of the nine auditors issued unqualified  opinions on the restated financial statements, which in substance replace  the auditors’ opinions on their respective agencies’ original fiscal year 2003  financial statements.  For two of these nine, the auditors not only withdrew  their unqualified opinion on the fiscal year 2003 financial statements but  also issued other than unqualified opinions on their respective agencies’  restated fiscal year 2003 financial statements because they could not  determine whether there were any additional misstatements and the effect  that such could have on the restated fiscal year 2003 financial statements.
The material internal control weaknesses discussed in this testimony  increase the risk that additional misstatements may occur and not be  identified on a timely basis by management or the auditors, resulting in  further restatements.  Frequent restatements to correct errors can  undermine public trust and confidence in both the entity and all  responsible parties.  According to Statement of Federal Financial  Accounting Standards (SFFAS) No. 21, Reporting Corrections of Errors  and Changes in Accounting Principles, prior period financial statements  presented should only be restated for corrections of errors that caused  such statements to be materially misstated.  Errors in financial statements  result from mathematical mistakes, mistakes in the application of  accounting principles, or oversight or misuse of facts that existed at the  time the financial statements were prepared.  The restatements to CFO Act  agencies’ fiscal year 2003 financial statements ranged from correcting two  line items on one agency’s balance sheet to numerous line items on several  of another agency’s financial statements.  The amounts of the agencies’  restatements ranged from several million dollars to over $91 billion.
As part of our fiscal year 2004 audit, we reviewed certain federal agencies’  fiscal year 2003 Statement of Budgetary Resources (SBR) for consistency  of (1) certain information reported in the SBR with related information  reported in the agencies’ other financial statements and notes and (2) the  offsetting receipts and net outlays reported in the SBR with published  governmentwide reports.  We found significant inconsistencies in these  areas, which we brought to the attention of these agencies and their  auditors prior to completion of their fiscal year fiscal year 2004 audits.  For  example, we notified a federal agency that the net outlays reported in its  fiscal year 2003 SBR were overstated by about $91 billion due to certain  offsetting receipts that were not reported in the SBR as offsets to outlays,  as required by OMB guidance.  In fiscal year 2004, this agency’s fiscal year  2003 SBR was restated, reducing its previously reported net outlays from  $596 billion to $505 billion.  At least four of the nine agencies that received  unqualified opinions on their fiscal year 2003 financial statements restated  certain of these financial statements in fiscal year 2004 to address some of  the significant inconsistencies we identified in the SBR.
The transparency of the restatements in the agency auditors’ reports and  the agencies’ financial statements is also a concern of ours. We believe  that the auditor’s report should clearly inform the reader about the  correction of a material misstatement.  In our view, the reader of the  financial statements and auditor’s report should be able to readily  understand that the financial statements originally issued by management  in the previous year and the opinion thereon should no longer be relied on  and instead the restated financial statements and the related auditor’s  opinion should be used. The reader should also be able to gain at least a  basic understanding as to why the agency needed to restate its prior year  financial statements and the impact of the restatement on the financial  statements.
In our preliminary review of the fiscal year 2003 restatements, several  issues regarding the inadequate transparency in connection with the  reporting on the restatements were readily apparent.  First, two of the nine  agency auditors that had issued unqualified opinions the previous year on  their respective agencies’ originally issued fiscal year 2003 financial  statements did not include a reference to management’s restatement  footnote in their audit reports.  Second, while our analysis of restatements  is just underway, the information included in the auditors’ reports along  with the agency’s financial statements were in some instances not  sufficient in our view for a reader of the financial statements to clearly  understand the error that occurred and the effects it had on the financial  statements.  Third, while U.S. generally accepted accounting principles do  not expressly require financial statements to be labeled as restated, 9 of the  11 agencies having fiscal year 2003 restatements did so, which we support.  However, 2 of the 11 did not label their prior year restated financial  statements as restated, which we believe also demonstrates a lack of  transparency.  As I highlighted earlier, in keeping with full transparency and  accountability, when restatements occur, all readers should be able to  understand the ramifications of what happened and that the financial  statements originally issued by management, along with the related  auditor’s opinion, should no longer be relied on.  Furthermore, agencies  that have to restate their prior year financial statements for material errors  should not refer to their prior year opinions as having been unqualified  since, by definition, the restatement means they should not have received  an unqualified opinion on their prior year’s statement(s).
We plan to perform a more detailed review of the nature and causes of the  restatements during our audit of the fiscal year 2005 consolidated financial  statements, and later this year will report separately on the results of this  work.
section_title: Highlights of Major Issues Related to the U.S. Government’s Consolidated Financial Statements for Fiscal Years 2004 and 2003
paragraphs: As I mentioned earlier, as has been the case for the previous 7 fiscal years,  the federal government continues to have a significant number of material  weaknesses related to financial systems, fundamental recordkeeping and  financial reporting, and incomplete documentation.  Several of these  material weaknesses, which generally have existed for years, contributed  to our disclaimer of opinion on the U.S. government’s consolidated  financial statements for the fiscal years ended September 30, 2004, and  2003. Appendix IV describes these material deficiencies in more detail  and highlights their primary effects on the consolidated financial  statements and on the management of federal government operations.  There may also be additional issues that could affect the consolidated  financial statements that have not been identified.  The material  deficiencies we identified were the federal government’s inability to satisfactorily determine that property, plant, and equipment and  inventories and related property, primarily held by the Department of  Defense (DOD), were properly reported in the consolidated financial  statements; reasonably estimate or adequately support amounts reported for certain  liabilities, such as environmental and disposal liabilities, or determine  whether commitments and contingencies were complete and properly  reported; support significant portions of the total net cost of operations, most  notably related to DOD, and adequately reconcile disbursement activity  at certain agencies; ensure that the federal government’s consolidated financial statements  were consistent with the underlying audited agency financial  statements, balanced, and in conformity with GAAP; adequately account for and reconcile intragovernmental activity and  balances between federal agencies; and resolve material differences that exist between the total net outlays  reported in federal agencies’ SBRs and the records used by Treasury to  prepare the Statements of Changes in Cash Balance.
In addition to these material deficiencies, we found four other material  weaknesses in internal control as of September 30, 2004. These weaknesses  are discussed in more detail in appendix V, including their primary effects  on the consolidated financial statements and on the management of federal  government operations. These material weaknesses were the federal  government’s inability to  implement effective processes and procedures for properly estimating  the cost of certain lending programs, related loan guarantee liabilities,  and value of direct loans; determine the extent to which improper payments exist;  identify and resolve information security control weaknesses and  manage information security risks on an ongoing basis; and effectively manage its tax collection activities.
section_title: Continuing Systems Problems Hinder Accountability
paragraphs: The ability to produce the data needed for efficient and effective  management of day-to-day operations in the federal government and  provide the necessary accountability to taxpayers and the Congress has  been a long-standing challenge at most federal agencies. The results of the  fiscal year 2004 assessments performed by agency inspectors general or  their contract auditors under FFMIA show that these problems continue to  affect financial management systems at most of the 23 CFO Act agencies.  While the problems are much more severe at some agencies than at others,  the nature and severity of the problems indicate that overall, management  at most CFO Act agencies lacks the complete range of information needed  for accountability, performance reporting, and decision making. These  problems include nonintegrated financial systems, lack of accurate and  timely recording of data, inadequate reconciliation procedures, and  noncompliance with accounting standards and the U.S. Government  Standard General Ledger (SGL).
The inability of agencies to meet federal financial management systems  requirements continues to be the major barrier to achieving compliance  with FFMIA. Under FFMIA, CFO Act agency auditors are required to report  whether agencies’ financial management systems substantially comply  with (1) federal financial management systems requirements, (2)  applicable federal accounting standards, and (3) the SGL at the transaction  level as part of the agencies’ financial statement audits.  These factors are  critical for improving accountability over government operations and  routinely producing sound cost and operating performance information.  As shown in figure 3, instances of noncompliance with federal financial  management systems requirements were the compliance issue most  frequently reported by auditors. These instances of noncompliance  involved not only core financial systems, but also administrative and  programmatic systems.
For fiscal year 2004, auditors for 16 of the 23 CFO Act agencies reported  that the agencies’ financial management systems did not comply  substantially with one or more of FFMIA’s three requirements. For 6 of the  remaining 7 CFO Act agencies, auditors provided negative assurance,  meaning that nothing came to their attention indicating that the agencies’  financial management systems did not substantially meet FFMIA  requirements. The auditors for these 6 agencies did not definitively state  whether the agencies’ systems substantially complied with FFMIA  requirements, as is required under the statute. In contrast, auditors for the  Department of Labor provided positive assurance by stating that, in their  opinion, the department’s financial management systems substantially  complied with the requirements of FFMIA.  The Department of Homeland  Security (DHS) was not subject to the requirements of the CFO Act in fiscal  year 2004 and, consequently, was not required to comply with FFMIA.  Accordingly, DHS’s auditors did not report on DHS’s compliance with  FFMIA. However, the auditors identified and reported deficiencies that  related to the aforementioned three requirements of FFMIA.  With the  recent passage of the Department of Homeland Security Financial  Accountability Act, DHS has been designated as a CFO agency.  With this  designation, DHS is now required to implement and maintain financial  management systems that comply with FFMIA, and its auditors will be  required to report on the department’s financial management systems’  compliance beginning with fiscal year 2005.
In an effort to address problems such as nonintegrated systems, inadequate  reconciliations, and lack of compliance with the SGL, a number of agencies  have efforts underway to implement new financial management systems or  to upgrade existing systems.  Agencies expect that the new systems will  provide reliable, useful, and timely data to support managerial decision  making and assist taxpayer and congressional oversight.  Whether in  government or the private sector, implementing and upgrading systems is a  difficult job and brings a degree of new risk.  Organizations that follow and  effectively implement accepted best practices in systems development and  implementation (commonly referred to as disciplined processes) can  manage and reduce these risks to acceptable levels.  However, our work at  DOD, the Department of  Health and Human Services (HHS), and the  National Aeronautics and Space Administrationhas shown that these  agencies, which all have experienced significant problems in implementing  new financial management systems, are not following the necessary  disciplined processes for efficient and effective development and  implementation of such systems.  Further, the Department of Veterans  Affairs recently halted pilot implementation of its new core financial  system, in which it had invested a reported $249 million.  The problems  cited by the Department of Veterans Affairs Office of Inspector General  were similar to those we noted at DOD, HHS, and the National Aeronautics  and Space Administration.  As the federal government moves forward with  ambitious modernization efforts to identify opportunities to eliminate  redundant systems and enhance information reliability and availability,  adherence to disciplined processes will be a crucial element to reduce risks  to acceptable levels.  Given the nature and magnitude of the problems  facing federal agencies, we recognize that it will take time, investment, and  sustained emphasis to successfully modernize agencies' underlying  financial management systems.
section_title: Addressing Major Impediments to an Opinion on Consolidated Financial Statements
paragraphs: For the past 8 fiscal years, the federal government has been required to  prepare, and have its consolidated financial statements audited.  Successfully meeting this requirement is closely linked to the requirements  for the CFO Act agencies (and now all covered executive agencies) to also  have audited financial statements.  This has resulted in extensive  cooperative efforts and considerable attention by agency chief financial  officers, inspectors general, Treasury and OMB officials, and GAO.  With  the benefit of the past 8 years’ experience in having the required financial  statements subjected to audit, more intensified attention will be needed on  the most serious obstacles to achieving an opinion on the U.S.  government’s consolidated financial statements.  There are three primary  ongoing reasons why the consolidated financial statements remained  unauditable for fiscal year 2004: (1) serious financial management  problems at DOD, (2) the federal government’s ineffective process for  preparing the consolidated financial statements, and (3) the federal  government’s inability to adequately account for and reconcile  intragovernmental activity and balances between federal agencies.
subsections: section_title: Financial Management at DOD
paragraphs: Essential to achieving an opinion on the consolidated financial statements  is resolution of the serious financial management problems at DOD, which  we have designated as high risk since 1995. Overhauling DOD’s financial  management operations represents a challenge that goes far beyond  financial accounting to the very fiber of DOD’s range of business  operations, management information systems, and culture. DOD’s financial  management problems 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.  The seriousness of the weaknesses in DOD’s business operations  underscores the importance of no longer condoning the status quo at DOD.  Although the Secretary of Defense and several key agency officials have  shown commitment to transformation, as evidenced by key initiatives such  as the Business Management Modernization Program and the Financial  Improvement Initiative, little tangible evidence of significant broad-based  and sustainable improvements has been seen in DOD’s business operations  to date. For example, the department’s former comptroller started the  Financial Improvement Initiative with the goal of obtaining an unqualified  opinion for fiscal year 2007 on DOD’s departmentwide financial statements;  however, the initiative still lacks a clearly defined, well-documented, and  realistic plan to make the stated goal a reality. In particular, the initiative  lacks several of the key elements critical to success, including (1) a  comprehensive, integrated plan; (2) results-oriented goals and performance  measures; and (3) effective oversight and monitoring. For DOD to  successfully transform its business operations, it will need a  comprehensive and integrated business transformation plan; people with  the skills, responsibility, and authority to implement the plan; an effective  process and related tools, such as a business enterprise architecture; and  results-oriented performance measures that link institutional, unit, and  individual personnel goals and expectations to promote accountability for  results.
section_title: Preparing the Consolidated Financial Statements
paragraphs: The federal government continued to have inadequate systems, controls,  and procedures to ensure that the consolidated financial statements are  consistent with the underlying audited agency financial statements,  balanced, and in conformity with GAAP.  During fiscal year 2004, Treasury  made progress in laying the foundation to address certain long-standing  material deficiencies in preparing the consolidated financial statements.  Foremost is the ongoing development of a new system, the  Governmentwide Financial Reporting System (GFRS), to collect agency  financial statement information directly from federal agencies’ audited  financial statements rather than using federal agencies’ SGL data as  Treasury had done in previous years to compile the consolidated financial  statements. The goal of the new system is to be able to directly link  information from federal agencies’ audited financial statements to amounts  reported in the consolidated financial statements, a concept that we  strongly support. For the fiscal year 2004 reporting process, Treasury’s  GFRS was able to capture certain agency financial information from  agencies’ audited financial statements, which is an important first step. The  automated system, though, was not yet at the stage of development that it  could be used to compile the consolidated financial statements from the  information that was captured.
section_title: Intragovernmental Activity and Balances
paragraphs: Federal agencies are unable to adequately account for and reconcile  intragovernmental activity and balances.  OMB and Treasury require the  CFOs of 35 executive departments and agencies to reconcile, on a quarterly  basis, selected intragovernmental activity and balances with their trading  partners. In addition, these agencies are required to report to Treasury,  the agency’s inspector general, and GAO on the extent and results of  intragovernmental activity and balances reconciliation efforts as of the end  of the fiscal year.
A substantial number of the agencies did not fully perform the required  reconciliations for fiscal years 2004 and 2003. For fiscal year 2004, based on  trading partner information provided in GFRS, Treasury produced a  “Material Difference Report” for each agency showing amounts for certain  intragovernmental activity and balances that significantly differed from  those of its corresponding trading partners. After analysis of the material  differences, a significant number of CFOs cited differing accounting  methodologies, accounting errors, and timing differences for their material  differences with their trading partners. Many CFOs simply indicated that  they were unable to explain the differences with their trading partners. For  both fiscal years 2004 and 2003, amounts reported by federal agency  trading partners for certain intragovernmental accounts were significantly  out of balance. As a result, the federal government’s ability to determine the  impact of these differences on the amounts reported in the consolidated  financial statements is impaired. Resolving the intragovernmental  transactions problem remains a difficult challenge and will require a  commitment by federal agencies and strong leadership and oversight by  OMB.
section_title: Closing Comments
paragraphs: The U.S. government is the largest, most complex and most diverse entity  on earth today.  Its services and programs—homeland security, national  defense, Social Security, health care, mail delivery, and food inspection, to  name just a few—directly affect the well-being of almost every American.  Our nation’s large and growing long-term fiscal imbalance, which is driven  largely by known demographic trends and rising health care costs—  coupled with new homeland security and defense commitments and the  recent downward trend in revenue as a share of GDP—continues to  sharpen the need to fundamentally review and reexamine basic federal  entitlements, as well as other mandatory and discretionary spending and  tax policies.  Clearly, tough choices will be required to address the resulting  structural imbalance.
Sound decisions on the current results and future direction of vital federal  programs and policies are made more difficult without timely, reliable, and  useful financial and performance information.  Proper accounting and  financial reporting practices are essential in the public sector.  Until the  problems discussed in our audit report are adequately addressed, they will  continue to present a number of adverse implications for the federal  government and the taxpayers, which are outlined in our report.  At the  same time, the need for timely, reliable, and useful financial and  performance information is greater than ever.
There will need to be ongoing and sustained top management attention to  business systems transformation at DOD to address what are some of the  most difficult financial management challenges in the federal government.  As noted in our recent high-risk report, we also believe that the  implementation of a new Chief Management Officer position at DOD will  be needed in order for the department to succeed in its overall business  transformation plan.  Further, continued leadership from OMB and  Treasury will be important to resolve the issues that have prevented us  from expressing an opinion on the consolidated financial statements.
In closing, Mr. Chairman, I want to reiterate the value of sustained  congressional interest in these issues, as demonstrated by your  subcommittee’s hearings. It will also be key that the appropriations,  budget, authorizing, and oversight committees hold agency top leadership  accountable for resolving these problems and that they support  improvement efforts.
subsections: section_title: Contacts
paragraphs: For further information regarding this testimony, please contact Jeffrey C.  Steinhoff, Managing Director, and Gary T. Engel, Director, Financial  Management and Assurance, at (202) 512-2600.
section_title: Fiscal Year 2004 Audit Results
paragraphs: R. Navarro & Associates, Inc.
R. Navarro & Associates, Inc.
section_title: Fiscal year 2004 and 2003 Agency Results
paragraphs: unqualified opinions with  no material weaknesses  The auditors for the Department of Justice withdrew the unqualified opinion that had been previously  rendered on the department's fiscal year 2003 financial statements and issued a disclaimer of opinion  on these restated financial statements.
The auditors for the Nuclear Regulatory Commission withdrew the unqualified opinion that had been  previously rendered on the commission's fiscal year 2003 financial statements and issued a qualified  opinion on these restated financial statements.
section_title: Outlook 2005 Conference The National Press Club February 2, 2005
paragraphs: Saving our Nation’s Future: An Intergovernmental Challenge  Keynote Address By the Honorable David M. Walker Comptroller General  of the United States  Thank you for that kind introduction and for the opportunity to speak to  you today.
As a federal official speaking at this state and local conference, it is  important to note at the outset that in today’s world governments,  institutions, and individuals are increasingly interconnected and  interdependent.  This trend is occurring both internationally and  domestically and among different economic and social sectors.  From a  federal, state, and local government perspective, this interconnection and  interdependence involves a range of issues, including tax policy, education,  the environment, health care, homeland security, social welfare, and  transportation.
I could talk about any number of intergovernmental challenges, but today I  plan to brighten the lights and turn up the heat on an overarching problem  that too many people seem content to put on the back burner.  That  problem is our nation’s worsening financial condition and long-range fiscal  outlook.
I’m sad to say that since I last spoke on this issue here at the National Press  Club back in September of 2003, our nation’s long-range fiscal imbalance  has deteriorated significantly.  Furthermore, as you all know, most state  and local governments also have their own fiscal challenges and are having  to make increasingly difficult choices.
We now confront three large and interrelated national deficits.  The first is  a large federal budget deficit.  The second is a growing balance-of­ payments deficit.  And the third is an alarming personal savings deficit.
Frankly, it’s easy to dismiss government deficits and debt as someone else’s  problem. But in my view, every American has both a personal reason and a  civic responsibility to become more informed and involved in the coming  debate over our collective fiscal future.
The American people need to realize that the fiscal choices being made in  Washington today have profound consequences for the future of our  country, and our children.  In a nutshell, these fiscal choices will directly  affect our future national security, economic vitality, and quality of life.
In the past, Americans have shrugged off warnings about the impending  deficit and debt crises.  Many Americans are too focused on today and  aren’t thinking enough about tomorrow.  As Walter Shapiro pointed out in a  recent column in USA Today, low interest rates and modest inflation give  many Americans a false sense of security.  These false perceptions are  reinforced by the government’s financial statements, which currently do  not provide a full and fair view of our nation’s current financial condition  and long-term outlook.  The simple truth is that our nation’s financial  condition is much worse than advertised.  In addition, due largely to the  looming retirement of the baby boomers, surging health care costs, and  relatively low federal revenues as a percentage of the economy, we now  face decades of red ink.
One aspect of government financial reporting in which I’m directly involved  as Comptroller General of the United States is the audit of the federal  government’s consolidated financial statements.  Every year, the federal  government is required to issue a comprehensive report on its finances and  operations.  My agency, the U.S. Government Accountability Office (GAO),  has a statutory responsibility to audit these financial statements.  As the  person who has to sign GAO’s audit report, and a CPA, I have an official as  well a professional and personal interest in ensuring that the federal  government is accountable to the taxpayers.  The federal government’s  fiscal 2004 report was issued in record time.  Unfortunately, for the eighth  year in a row, GAO was unable to vouch for the accuracy and completeness  of the information in the financial statements.
Recent accountability failures in the private sector underscore the  importance of accurate and timely financial reporting.  The scandals at  Enron, Worldcom, and other corporations have led to restatements of  financial statements and bankruptcies that have harmed countless  shareholders, employees, pensioners, and other stakeholders, including  entire communities.  Here in Washington, the recently announced  restatements at Fannie Mae and Freddie Mac hit uncomfortably close to  home.  We at GAO are committed to doing our best to ensure that such  accountability failures are not repeated in the federal government.
Beyond the financial statement numbers, what does the federal  government’s annual report say about the results that are being achieved  with the taxpayer dollars being spent?  The answer is not much!  It’s bad  enough that too few agencies adequately show the results they are getting  with the taxpayer dollars they spend, but policymakers also frequently do  not focus on the long-term impact of new spending and tax proposals  before taking action on related legislation.  Particularly troubling are the  enormous commitments that we face in connection with Social Security,  Medicare, Medicaid, and veteran’s health care.  Down the line, we could  also be facing potential federal bailouts of several entities like the Pension  Benefit Guaranty Corporation.
Over the years, our federal fiscal debates have gone from millions to  billions to trillions.  Unless you’re an economist, a statistician, an actuary,  or a CPA, these numbers are mind-boggling.  What’s a million dollars?  When it comes to the federal government, a million dollars is practically  pocket change.  Last year, the federal government experienced a deficit  that averaged more than $1 billion each and every day.  That is more than  $750,000 a minute.
If you’re honest about keeping score and include promised but unfunded  Social Security and Medicare benefits along with explicit benefit and other  commitments, the federal government’s obligations, current liabilities and  unfunded fiscal commitments are over $43 trillion and rising. In the last  year alone, this amount has risen by more than $13 trillion, largely due to  the new Medicare prescription drug benefit.  Yes, that’s trillions with 12  zeros rather than billions with 9 zeros.  To put that number into  perspective, even with the recent run up in housing prices, the estimated  total net worth of every American, including Bill Gates and other  billionaires, is only about $47 trillion.  That means that every American  would have to fork over more than 90 percent of their net worth to cover  the government’s current promises.  Stated differently, the current burden  for every American works out to more than $145,000.  The numbers are  even worse for full-time workers, whose share now exceeds $350,000.  That  amount is growing every day and it isn’t even tax deductible!  Keep in mind  that the average family income in this country is around $42,000 a year.
As bad as these numbers are, it’s the real-life consequences of unchecked  deficits that are truly frightening.  For example, if we continue as we have,  higher interest rates are inevitable.  It’s only a matter of when and how  high.  As government borrows more and more money to finance its debt,  less money will be available for companies to invest to stay competitive in  today’s global economy.  Without meaningful changes, long-term economic  growth will suffer, and along with it American jobs and purchasing power.  And don’t forget that high budget deficits can lead to slower growth, higher  interest rates and higher inflation, which in many respects is the cruelest  tax of all.
By continuing to run huge budget deficits, America is partially ceding  control over its own destiny to others.  Why?  Because America’s personal  savings rate has reached historic lows.  So guess who’s been financing  much of our spending spree in recent years?  The answer is foreign  investors.  Since 1993 the share of publicly held debt owned by  international investors has more than doubled, from 19% to over 40%.  Last  year, foreign investors purchased nearly $399 billion in Treasury  securities—just $13 billion less than the size of the 2004 deficit! If these  foreign investors lose confidence in U.S. securities as a safe haven and start  to move their money elsewhere, our economy could take a serious and  sudden hit.  The recent decline in the value of the dollar may be a warning  shot in this regard.
Mounting deficits and debt will also eventually imperil many government  programs and services that Americans have come to take for granted.  The  reality is that government functions like national defense, homeland  security, education, transportation, and our judicial system fall under the  category of “discretionary spending.”  These programs are facing  increasing budget pressures, and our ability to respond to new and  emerging needs is also being constrained.  If we don’t get serious soon,  many important programs at the state and local level will also feel the  crunch.  Right now, state and local governments play a key role in a range  of important functions, such as educating our children, housing the poor,  delivering health care, and building roads and bridges.  But in the future,  state and local governments may not be able to count on as much federal  help.  Furthermore, states may also face additional unfunded federal  mandates.
In the past, particularly in the decades since World War II, America was the  world’s engine of economic growth.  We still are, but our long-term fiscal  gap is so great today that there’s no way we’ll be able to grow our way out  of the problem.  Using plausible assumptions, closing our fiscal gap would  require average real growth in double-digits for the next 75 years.  By any  measure, that’s unrealistic.  In fact, even during the boom years of the  1990s, the economy grew at an average annual real rate of only 3.2 percent.
If we continue on our present path, we’ll see pressure for deep spending  cuts or dramatic tax increases.  GAO’s long-term budget simulations paint a  chilling picture.  If we do nothing, by 2040 we may have to cut federal  spending by more than half or raise federal taxes by more than two and half  times to balance the budget.  Clearly, the status quo is both unsustainable  and difficult choices are unavoidable.  And the longer we wait, the more  onerous our options will become and the less transition time we will have.
So how do we start to turn things around?  At the federal level, a crucial  first step is to insist on truth and transparency in government operations,  including federal financial reporting.  The federal government must provide  a fuller and fairer picture of existing budget deficits, the so-called “trust  funds,” and the growing financial burdens facing every American.
On the budget side, the current 10-year cash-flow projections are an  improvement over past practices.  But given known demographic trends,  even these projections fail to capture the long-term consequences of  today’s spending and tax policy choices.  In my view, elected  representatives should have more explicit information on the present value  dollar costs of major spending and tax bills—before they vote on them.  This was not the case when Congress passed the Medicare prescription  drug bill with its $8.1 trillion price tag.  The time has also come to reinstate  budget controls, such as reasonable spending caps and responsible “pay­ go” rules which would require any new spending increases or tax cuts to be  paid for by equivalent tax increases and/or spending cuts.
Further reforms to the substance and timing of the current appropriations  and authorization processes may also be needed.  When considering these  reforms, we should look to the states.  In some ways, the states are way  ahead of the federal government in dealing with fiscal imbalances. They  have made hard choices in the past— partly driven by their state  constitutions, partly by their inability to print money and partly by their  sensitivity to their bond ratings!
From a more strategic and results based perspective, we also need to  develop a set of key national performance and outcome-based indicators to  measure America’s position and progress on a range of economic, security,  environmental, and social issues.  Key indicators can help to inform  strategic planning, enhance performance and accountability reporting, and  improve key decision-making.  Several countries, states, and localities have  already adopted key indicator systems, but I’m sorry to say the United  States still lacks such a system at the national level.  This has meant that at  times our policymakers have been flying blind, not unlike an airplane pilot  at night without an instrument panel.  Importantly, we are currently looking  at how states use performance information to reprioritize their budgets in  tight fiscal times.  We are also working with the National Academies and  the OECD to help make key indicators become a reality in the U.S. and  elsewhere.
Think about it.  Each year, the federal government spends more than $2  trillion on a wide range of programs and operations, provides hundreds of  billions of dollars in tax preferences, and issues thousands of pages of  regulations.  And it does all this without having enough knowledge about  whether federal policies, programs, and activities are making a real  difference.  Based on where we are headed, we need to engage in a base­ line review of the entire federal government that encompasses three key  dimensions.
First, we need to undertake a top-to-bottom review of government  programs, policies, functions, and activities to ensure their relevance for  the 21st century.  This includes both discretionary and mandatory spending.
Today, many if not most government policies and programs are based on  conditions that existed when Harry Truman or Dwight Eisenhower were  President.  We cannot afford to spend increasingly limited taxpayer dollars  on government policies and programs that were designed to deal with the  problems of the past or can’t show they’re that making a meaningful  difference today.  Congress and the President need to decide which  programs and policies remain priorities, which should be overhauled, and  which have outlived their usefulness.  Importantly, increases in targeted  earmark spending combined with across-the-board cuts are not substitutes  for making tough and informed choices about the base of government.  These trends can result in adding fat and protecting ineffective programs  while cutting muscle from high-priority and high-performing programs.
Second, we need to revisit existing tax policy and enforcement efforts.  Every year, our government forgoes hundreds of billions of revenue  because of existing tax preferences, significant uncollected back taxes, and  tax evasion.  In fact, in some years, the cost of tax preferences exceeds  total discretionary spending. Our complex tax system distorts decisions to  work, save, and invest—and that dampens economic growth.  Complexity  also creates opportunities for tax evasion through vehicles such as tax  shelters.  All of this raises questions about fairness with taxpayers  wondering whether their friends, neighbors and business competitors are  paying their fair share.  Clearly, comprehensive tax reform is needed.  Reform could also better position the United States to compete in today’s  global economy—one that is increasingly knowledge-based and subject to  fast-paced technological change.  It’s important to recognize that the ripple  effects of comprehensive tax reform will be felt at all levels of government.
Third, entitlement reform is essential.  We need to put Social Security and  Medicare on a sound footing and make them solvent, sustainable, and  secure for both current and future generations.  Actually, the problems with  Social Security are not that difficult to solve.  In fact, we now have a  window of opportunity to exceed the expectations of all Americans—  whether they’ll be retiring 30 days or 30 years from now.  I’d be happy to tell  you more about how we can do this during the question and answer period.
On the other hand, it seems clear that the biggest single domestic challenge  is health care, of which Medicare and Medicaid are a big part.  Mounting  health care costs are a problem for governments, employers, and  individuals.  Despite repeated efforts to rein in health care spending, costs  continue to climb. Between 1990 and 2000, U.S. health care spending rose  from $696 billion to $1.3 trillion.  Spending on health care is projected to  more than double again by the end of this decade.  Clearly, such growth is  unsustainable, and it’s one of the main reasons why both the Medicare and  Medicaid programs are on GAO’s high-risk list.  It’s also one of the reasons  that Medicaid costs represent the fastest growing and one of the largest  budget items—second only to education—for states.
The problems affecting Medicare and Medicaid will be much more difficult  to solve than Social Security.  More broadly, we need to reconsider how we  define, deliver, and finance health care in this country—both in the public  and the private sectors.  We need to weigh unlimited individual wants  against specific societal needs and decide how responsibility for health  care should be divided among employers, individuals, and governments.
Despite the huge amounts of money we’re spending on medical care, broad  access to basic coverage remains an elusive goal.  The rising cost of  government health care programs increases budget pressures at both the  federal and state levels.  Rising health care costs are also discouraging  additional pension coverage, constraining wage increases, and reducing the  tax base because an increasing percentage of employee compensation is  coming in the form of nontaxable benefits like health insurance. Some  reports suggest that rising health care premiums are also causing  companies to move jobs offshore, cut overall employment levels, and hire  part-time rather than full-time workers.
As you may have heard about in news stories, GAO recently released its  new high-risk report, which deals primarily with the here and now.  GAO’s  high-risk report lists current government programs and functions that need  special focus and immediate attention.  In addition, yesterday we issued a  report on the results of a GAO forum on our long-range fiscal challenges.
In the next couple of weeks, GAO will be issuing its 21st Century Challenges  Report, which will discuss where we are and where we’re headed as a  nation.  This report will include a number of illustrative questions that  policymakers should consider in examining the base of government.  Frankly, it’s going to take many years to get us back on a prudent and  sustainable long-term fiscal track but the time to start is now.
There’s clearly a real payoff for prompt action.  By acting now, both  America and Americans can minimize the need for drastic measures and  give all of us more time to adjust to any changes.  By acting now, we can  help to ensure that the miracle of compounding eventually works for us  rather than against us—as it is today.  By acting now, we can also avoid a  dangerous upward spiral of deficits and debt that will ultimately harm  America and every American family.  By acting now, we can enhance our  credibility with investors and improve public confidence in the  government’s ability to deal with large, complex and controversial fiscal  issues before a crisis is upon us.  Finally, by acting now, we can reduce the  burdens that will otherwise be imposed on our children and grandchildren  and give them more freedom of choice over what role they would like for  government to play in the future.
As a member of the Sons of the American Revolution, I sometimes wonder  what the Founding Fathers would think if they came back today.  George  Washington, Thomas Jefferson, Benjamin Franklin, Alexander Hamilton,  and the other founders can seem larger than life, but most of them earned a  living as farmers and businessmen.  They understood first hand both the  value of thrift and the perils of personal and public debt.  Theirs was, after  all, a world with debtors’ prisons.  With good reason, Ben Franklin said, “He  who goes a borrowing goes a sorrowing.”
At the same time, our first Secretary of the Treasury, Alexander Hamilton,  was a realist who recognized that adding debt in times of war or economic  recession may be a temporary necessity.  It seems clear, however, that our  Founding Fathers did not believe that adding debt in the normal course of  events was either prudent or appropriate.
No less than the father of our country, George Washington felt that the  most important personal value was courage and the most important  institutional value was fiscal responsibility.  His views are particularly  timely at this point in our nation’s history.
Somehow, in the last 200 years we seem to have forgotten the sound advice  from Washington, Hamilton and Franklin.  If the Founding Fathers were to  return today, I have no doubt they’d be justifiably proud of many things our  nation has accomplished, as we are.  But I suspect many of them would be  shocked and saddened by our willingness to forgo fiscal discipline and pile  on both personal and public debt.  It’s likely that our Founding Fathers  would see our mounting debt as a violation of our stewardship  responsibility to future generations of Americans.
This is at the heart of my message.  For the debate about our fiscal future is,  ultimately, not about numbers but about values.  The debate we are really  having is about the kind of world we’re prepared to pass on to our children  and grandchildren.  The time has come for responsible public officials to  heed George Washington’s words by demonstrating more individual  courage and recommitting to institutional fiscal responsibility.
It’s very important to emphasize here that the nation’s fiscal imbalance is  not a partisan issue.  There are many players we could blame for our  current financial situation.  After all, it’s been many years in the making.  The point is that while we can’t change the past, we can and must do  something about our future.
Overcoming our fiscal challenges will take the combined efforts of both  sides of the aisle in Washington and in every state capital.  Right now, what  we need are leaders who will acknowledge that we have a problem and are  willing do something about it.  In this regard, actions speak louder than  words.
In my judgment, the worst thing that could happen is to continue on our  present path and do nothing.  Because once a crisis is upon us, we face  terrible choices.  And while it’s true that other nations also have long-range  fiscal challenges, who wants to be the best looking horse in the glue  factory?
Although my message is sobering and I want you to take our situation  seriously, I don’t want you to go away thinking that things are hopeless or  that I am pessimistic.  That’s far from true and those who know me will  attest to the fact that I am a results oriented optimistic by nature.  After all,  America has overcome much more serious challenges in the past.  Furthermore, in America, anything is possible with leadership, vision,  commitment, and persistence.  But we need to get serious and we need to  act soon.  Keep in mind, the passengers on the Titanic had a smooth ride  and a great time until the very moment the ship hit the iceberg.
Today, every American needs to be part of the solution.  In my view, our  best hope for change is for people who live on Main Street to recognize the  magnitude of our challenge and appreciate the risks posed by these deficits  to them, their children and their grandchildren.
If the folks who live on Main Street remain silent, significant and  sustainable change is unlikely.  After all, why should any elected official  stick his or her neck out on a complex and controversial issue if no one  cares?  Younger Americans especially need to become active in this  discussion because they and their children will bear the heaviest burden if  today’s leaders fail to act.
State and local governments need to play a strong role in our fiscal  challenge debate, because in the end, every government entity and public  servant, myself included, is in the same boat.  After all, bad news eventually  flows down hill.  This means we’ve got to start paddling together, or we’ll  surely sink separately.
My hope is that when you leave here today, you will spread the word among  your friends and colleagues at the state and local level.  We have to start  doing something about America’s triple deficits.  Everyone from governors  and mayors to rank-and-file state and local employees have a stake in this  cause, and they need to become more informed and involved in demanding  change and suggesting constructive and realistic solutions.
In closing, one of my favorite Presidents is Theodore Roosevelt.  As a  person of strong character who was trustbuster, environmentalist,  internationalist and a winner of both the Medal of Honor and the Nobel  Peace Prize, he showed that if you put your mind to something, anything is  possible.  TR said, “Fighting for the right  is the noblest sport the  world affords.”  When it comes to our current fiscal challenges, I hope  you’ll join me in working together as modern-day patriots to insist on the  facts, speak the truth, and help save our nation’s future.
Thank you for your time and attention.  I’d be happy to answer any  questions that you may have.
section_title: Material Deficiencies
paragraphs: The federal government did not maintain adequate systems or have  sufficient, reliable evidence to support information reported in the  consolidated financial statements, as described below.  These material  deficiencies contributed to our disclaimer of opinion on the federal  government’s consolidated financial statements and also constitute  material weaknesses in internal control.
subsections: section_title: Property, Plant, and Equipment and Inventories and Related Property
paragraphs: The federal government could not satisfactorily determine that property,  plant, and equipment (PP&E) and inventories and related property were  properly reported in the consolidated financial statements. Most of the  PP&E and inventories and related property are the responsibility of the  Department of Defense (DOD). As in past years, DOD did not maintain  adequate systems or have sufficient records to provide reliable information  on these assets. Other agencies, most notably the National Aeronautics and  Space Administration, reported continued weaknesses in internal control  procedures and processes related to PP&E.
Without reliable asset information, the federal government does not fully  know the assets it owns and their location and condition and cannot  effectively (1) safeguard assets from physical deterioration, theft, or loss;  (2) account for acquisitions and disposals of such assets; (3) ensure that  the assets are available for use when needed; (4) prevent unnecessary  storage and maintenance costs or purchase of assets already on hand; and  (5) determine the full costs of programs that use these assets.
section_title: Liabilities and Commitments and Contingencies
paragraphs: The federal government could not reasonably estimate or adequately  support amounts reported for certain liabilities. For example, DOD was not  able to estimate with assurance key components of its environmental and  disposal liabilities. In addition, DOD could not support a significant amount  of its estimated military postretirement health benefits liabilities included  in federal employee and veteran benefits payable. These unsupported  amounts related to the cost of direct health care provided by DOD­ managed military treatment facilities. Further, the federal government  could not determine whether commitments and contingencies, including  those related to treaties and other international agreements entered into to  further the U.S. government’s interests, were complete and properly  reported.
Problems in accounting for liabilities affect the determination of the full  cost of the federal government’s current operations and the extent of its  liabilities. Also, improperly stated environmental and disposal liabilities  and weak internal control supporting the process for their estimation affect  the federal government’s ability to determine priorities for cleanup and  disposal activities and to appropriately consider future budgetary  resources needed to carry out these activities. In addition, when  disclosures of commitments and contingencies are incomplete or  incorrect, reliable information is not available about the extent of the  federal government’s obligations.
section_title: Cost of Government Operations and Disbursement Activity
paragraphs: The previously discussed material deficiencies in reporting assets and  liabilities, material deficiencies in financial statement preparation, as  discussed below, and the lack of adequate disbursement reconciliations at  certain federal agencies affect reported net costs. As a result, the federal  government was unable to support significant portions of the total net cost  of operations, most notably related to DOD.
With respect to disbursements, DOD and certain other federal agencies  reported continued weaknesses in reconciling disbursement activity. For  fiscal years 2004 and 2003, there was unreconciled disbursement activity,  including unreconciled differences between federal agencies’ and the  Department of the Treasury’s (Treasury) records of disbursements and  unsupported federal agency adjustments, totaling billions of dollars, which  could also affect the balance sheet.
Unreliable cost information affects the federal government’s ability to  control and reduce costs, assess performance, evaluate programs, and set  fees to recover costs where required. Improperly recorded disbursements  could result in misstatements in the financial statements and in certain data  provided by federal agencies for inclusion in the President’s budget  concerning obligations and outlays.
section_title: Preparation of Consolidated Financial Statements
paragraphs: During fiscal year 2004, Treasury made progress in laying the foundation to  address certain long-standing material deficiencies in preparing the consolidated financial statements. Foremost is the ongoing development of  a new system, the Governmentwide Financial Reporting System (GFRS), to  collect agency financial statement information directly from federal  agencies’ audited financial statements rather than using federal agencies’  Standard General Ledger data as Treasury had done in previous years to  compile the consolidated financial statements. The goal of the new system  is to be able to directly link information from federal agencies’ audited  financial statements to amounts reported in the consolidated financial  statements, a concept that we strongly support. Once Treasury is able to  achieve this, it would eliminate a major impediment to our being able to  audit the consolidated financial statements.
For the fiscal year 2004 reporting process, Treasury’s GFRS was able to  capture certain agency financial information from agencies’ audited  financial statements, which is an important first step. The automated  system, though, was not yet at the stage of development that it could be  used to compile the consolidated financial statements from the information  that was captured. Therefore, for fiscal year 2004, Treasury had to rely  primarily on Excel spreadsheets and extensive manual procedures to  prepare the consolidated financial statements. As discussed in our scope  limitation section of our audit report, the federal government could not  produce the fiscal year 2004 consolidated financial statements in time for  us to complete all of our planned auditing procedures. In addition, for fiscal  year 2004, the federal government continued to have inadequate systems,  controls, and procedures to ensure that the consolidated financial  statements are consistent with the underlying audited agency financial  statements, balanced, and in conformity with U.S. generally accepted  accounting principles (GAAP). Specifically, during our fiscal year 2004  audit, we found the following:
Treasury’s process for compiling the consolidated financial statements  did not ensure that the information in these statements was fully  consistent with the underlying information in federal agencies’ audited  financial statements and other financial data.
Treasury’s ability to timely prepare a complete set of consolidated  financial statements was greatly impaired because in some cases the  financial information provided by federal agencies to Treasury did not  agree to the agencies’ audited financial statements, causing Treasury to  have to resort to last-minute, alternative methods to gather the needed  information. These problems were compounded by Treasury’s reliance  on internal controls that were dependent on procedures that would  attempt to identify any errors after they were made by an agency  (detective controls) rather than implementation of internal controls that  may have prevented or minimized the errors from occurring (preventive  controls).
Other internal control weaknesses existed in Treasury’s process for  preparing the consolidated financial statements, involving a lack of (1)  segregation of duties, (2) appropriate documentation of certain policies  and procedures for preparing the consolidated financial statements, (3)  adequate support for adjustments made to the consolidated financial  statements, and (4) required management reviews.
Information system weaknesses existed within the segments of GFRS  that were used during the fiscal year 2004 reporting process. We found  that inappropriate access to GFRS was granted to certain Treasury  personnel and that the GFRS database was not configured to prevent  the alteration of data submitted by federal agencies and was used for  both production and testing during the fiscal year 2004 reporting  process.
Treasury did not have the infrastructure to address the magnitude of the  fiscal year 2004 financial reporting challenges it was faced with, such as  an incomplete financial reporting system, compressed time frames for  compiling the financial information, and inaccurate and incomplete  information provided by certain federal agencies. We found that  personnel at Treasury’s Financial Management Service had excessive  workloads that required an extraordinary amount of effort and  dedication to compile the consolidated financial statements; however,  there were not enough personnel with specialized financial reporting  experience to ensure accurate and reliable financial reporting by the  accelerated reporting date. Nevertheless, a foundation for the future  was put into place and a number of lessons were learned.
To make the fiscal years 2004 and 2003 consolidated financial  statements balance, Treasury recorded a net $3.4 billion increase and a  net $24.5 billion decrease, respectively, to net operating cost on the  Statements of Operations and Changes in Net Position, which it labeled  “Unreconciled Transactions Affecting the Change in Net Position.” An  additional net $1.2 billion and $11.3 billion of unreconciled transactions  were recorded in the Statement of Net Cost for fiscal years 2004 and  2003, respectively. Treasury is unable to fully identify and quantify all  components of these unreconciled activities.
Treasury eliminated many intragovernmental activity and balances  through accounting entries for fiscal year 2004 rather than “dropping” or  “offsetting” the amounts as it has done in the past, which is a positive  step. However, as discussed below, amounts reported for federal agency  trading partnersfor certain intragovernmental accounts were  significantly out of balance, resulting in the need for unsupported  intragovernmental elimination entries in order to force the Statement of  Operations and Changes in Net Position into balance. Treasury’s ability  to eliminate certain intragovernmental activity and balances continues  to be impaired by the federal agencies’ problems in handling their  intragovernmental transactions, which are noted below. In addition,  significant differences in other intragovernmental accounts, primarily  related to appropriations, have not been reconciled and still remain  unresolved. Therefore, the federal government continues to be unable to  determine the impact of unreconciled intragovernmental activity and  balances to the consolidated financial statements.
The federal government did not have an adequate process to identify  and report items needed to reconcile the operating results, which for  fiscal year 2004 showed a net operating cost of $615.6 billion, to the  budget results, which for the same period showed a unified budget  deficit of $412.3 billion. In addition, a net $23.2 billion “net amount of all  other differences” was needed to force this statement into balance.
The consolidated financial statements include certain financial  information for the executive, legislative, and judicial branches, to the  extent that federal agencies within those branches have provided  Treasury such information. However, there are undetermined amounts  of assets, liabilities, costs, and revenues that are not included, and the  federal government did not provide evidence or disclose in the  consolidated financial statements that such excluded financial  information was immaterial.
Treasury did not have an adequate process to ensure that the financial  statements, related notes, Stewardship Information, and Supplemental  Information are presented in conformity with GAAP. For example, we  found that certain financial information required by GAAP was not  disclosed in the consolidated financial statements. Treasury did not  provide us with documentation of its rationale for excluding this  information. As a result of this and certain of the material deficiencies  noted above, we were unable to determine if the missing information  was material to the consolidated financial statements. In an effort to  begin addressing this issue, we found that Treasury collected certain  additional financial information required by GAAP in its new process for  fiscal year 2004. However, due to the compressed time frames to  compile the consolidated financial statements and because GFRS is still  being developed, Treasury plans to analyze this information in fiscal  year 2005 and determine how or whether to disclose this information in  future years’ consolidated financial statements.
section_title: Accounting for and Reconciliation of Intragovernmental Activity and Balances
paragraphs: Federal agencies are unable to adequately account for and reconcile  intragovernmental activity and balances. The Office of Management and  Budget (OMB) and Treasury require the chief financial officers (CFO) of 35  executive departments and agencies to reconcile, on a quarterly basis,  selected intragovernmental activity and balances with their trading  partners. In addition, these agencies are required to report to Treasury, the  agency’s inspector general, and GAO on the extent and results of  intragovernmental activity and balances reconciliation efforts as of the end  of the fiscal year.
A substantial number of the agencies did not fully perform the required  reconciliations for fiscal years 2004 and 2003. For fiscal year 2004, based on  trading partner information provided in GFRS, Treasury produced a  “Material Difference Report” for each agency showing amounts for certain  intragovernmental activity and balances that significantly differed from  those of its corresponding trading partners. After analysis of the material  differences, a significant number of CFOs cited differing accounting  methodologies, accounting errors, and timing differences for their material  differences with their trading partners. Many CFOs simply indicated that  they were unable to explain the differences with their trading partners. For  both fiscal years 2004 and 2003, amounts reported by federal agency  trading partners for certain intragovernmental accounts were significantly  out of balance. As a result, the federal government’s ability to determine the  impact of these differences on the amounts reported in the consolidated  financial statements is impaired. Resolving the intragovernmental  transactions problem remains a difficult challenge and will require a  commitment by federal agencies and strong leadership and oversight by  OMB.
section_title: Net Outlays—A Component of the Budget Deficit
paragraphs: OMB Bulletin No. 01-09, Form and Content of Agency Financial  Statements, states that outlays in federal agencies’ Statement of Budgetary  Resources (SBR) should agree with the net outlays reported in the budget  of the U.S. government. In addition, Statement of Federal Financial  Accounting Standards No. 7, Accounting for Revenue and Other  Financing Sources and Concepts for Reconciling Budgetary and  Financial Accounting, requires explanation of any material differences  between the information required to be disclosed (including net outlays) in  the financial statements and the amounts described as “actual” in the  budget of the U.S. government.
The federal government reported in the Statement of Changes in Cash  Balance from Unified Budget and Other Activities (Statement of Changes in  Cash Balance) a budget deficit for fiscal year 2004 of $412.3 billion. The  budget deficit is calculated by subtracting actual budget outlays from  actual budget receipts.In previous years, the Statement of Changes in  Cash Balance reported actual budget outlays and actual budget receipts;  however, for fiscal year 2004, the federal government chose not to disclose  budget outlays and budget receipts in this financial statement and only  included the budget deficit. As we reported for fiscal year 2003, we found  $140 billion in differences between the total net outlays reported in  selected federal agencies’ audited SBRs and Treasury’s central accounting  records, which it uses to prepare the Statement of Changes in Cash  Balance. Treasury again chose for fiscal year 2004 to use its central  accounting records to prepare the Statement of Changes in Cash Balance  without a process for identifying and resolving the differences between its  central accounting records and net outlay amounts reported in the  agencies’ audited SBRs. For fiscal year 2004, while Treasury no longer  disclosed this information in the Statement of Changes in Cash Balance, we  again found material differences between the total net outlays reported in  certain federal agencies’ audited SBRs and the records Treasury used to  prepare the Statement of Changes in Cash Balance totaling about $69  billion. In addition, we also noted reported internal control weaknesses  regarding certain agencies’ SBRs.
OMB’s efforts in working with the agencies resulted in some notable  improvements in reducing the approximately $140 billion of differences  that we reported in fiscal year 2003 between the total net outlays reported  in the federal agencies’ SBRs and the Statement of Changes in Cash  Balance. As we reported, two agencies, Treasury and HHS, accounted for  about 83 percent of these differences. We found that the major cause of the  differences for the two agencies for fiscal year 2003 was the treatment of  offsetting receipts.Some offsetting receipts for these two agencies had not  been included in the agencies’ SBRs, which would have reduced the  agencies’ net outlays and made the amounts more consistent with  Treasury’s records used to prepare the Statement of Changes in Cash  Balance. In fiscal year 2004, a major component of HHS restated its fiscal  year 2003 net outlays in its SBR, and Treasury obtained a waiver from OMB  exempting it from reporting certain offsetting receipts in its SBR totaling  about $16.9 billion until further research is performed. However, about $75  billion of differences we found for fiscal year 2003 still remained  unreconciled as of September 30, 2004.
Until the material differences between the total net outlays reported in the  federal agencies’ SBRs and the records used to prepare the Statement of  Changes in Cash Balance are timely reconciled, the effect of these  differences on the U.S. government’s consolidated financial statements will  be unknown.
section_title: Other Material Weaknesses
paragraphs: The federal government did not maintain effective internal control over  financial reporting (including safeguarding assets) and compliance with  laws and regulations as of September 30, 2004. In addition to the material  deficiencies discussed in appendix IV, we found the following four other  material weaknesses in internal control.
subsections: section_title: Loans Receivable and Loan Guarantee Liabilities
paragraphs: Federal agencies continue to have material weaknesses and reportable  conditions related to their lending activities. In fiscal year 2004, significant  deficiencies in the processes and procedures used to estimate the costs of  certain lending programs and value of loans receivable increased. While the  Small Business Administration (SBA) made noteworthy progress to  improve its cost estimation processes, additional improvements are still  needed at SBA to fully resolve the deficiencies in the area so that  reasonable estimates can be produced and audited in a timely manner.  Further, this year at the Department of Housing and Urban Development  (HUD), a new material weakness was reported. HUD lacked adequate  management reviews of underlying data and cost estimation methodologies  that resulted in material errors being undetected, and significant  adjustments were needed. These material weaknesses at SBA and HUD,  plus deficiencies at the Department of Agriculture and the Department of  Education relating to the processes and procedures for estimating credit  program costs, continue to adversely affect the federal government’s ability  to support annual budget requests for these programs, make future  budgetary decisions, manage program costs, and measure the performance  of lending activities. Further, these weaknesses and the complexities  associated with estimating the costs of lending activities greatly increase  the risk that significant errors in agency and governmentwide financial  statements could occur and go undetected.
section_title: Improper Payments
paragraphs: Across the federal government, improper payments occur in a variety of  programs and activities, including those related to health care, contract  management, federal financial assistance, and tax refunds. Many improper  payments occur in federal programs that are administered by entities other  than the federal government, such as states and municipalities. Generally,  improper payments result from a lack of or an inadequate system of  internal control, but some result from program design issues. Federal  agencies’ estimates of improper payments based on available information  for fiscal year 2004 exceeded $45 billion. This estimate could increase  significantly over the next several years as agencies become more effective  at estimating and reporting improper payment amounts for programs and  activities that are susceptible to significant improper payments.
Fiscal year 2004 represents the first full year that federal agencies were  required to include the reports required by the Improper Payments  Information Act of 2002 (IPIA) in their Performance and Accountability  Reports (PAR). IPIA raised improper payments to a new level of  importance by requiring federal agencies to annually review all programs  and activities and identify those that may be susceptible to significant  improper payments. Federal agencies are to then estimate the annual  amount of improper payments for those programs and activities identified  as susceptible to significant improper payments. The law further requires  federal agencies to report to the Congress the improper payment estimates  and information on the actions the agency is taking to reduce the improper  payments. The Office of Management and Budget (OMB) implementation  guidance required that estimates and, if applicable, the corrective action  report, be included in federal agencies’ PARs beginning with fiscal year  2004.
The OMB guidance also required 44 programs of 14 CFO Act agencies to  report improper payment information in their fiscal year 2003 PARs. Last  year, we reported that those 14 CFO Act agencies reported the required  improper payment amounts for 29 of the 44 programs, suggesting that  despite the enhanced emphasis on improper payments and legislative  reporting requirements, those agencies appeared to be struggling with  estimating improper payment amounts for about one-third of their  programs.
Our preliminary reviews of 29 federal agencies’ fiscal year 2004 PARs  further suggest that a number of agencies were not well positioned to meet  the reporting requirements of IPIA. For example, while most agencies  acknowledged the IPIA reporting requirements in their PARs, 8 of the 44  programs with previous reporting requirements as noted above indicated  that they would be able to estimate and report on improper payments  sometime within the next 4 years but could not do so now. Another 5  programs in 2 agencies with previous reporting requirements determined  that improper payment amounts were insignificant for their programs.  Further, 4 additional programs in 4 agencies with prior reporting  requirements did not estimate improper payment amounts for their  programs and were silent as to whether they would report estimates in  future reports. Therefore, 32 of the 44 programs with previous reporting  requirements reported estimates or reported that their improper payment  amounts were insignificant in their fiscal year 2004 PARs.
Until all agencies develop and implement a systematic measurement of the  extent of improper payments, the federal government cannot determine (1)  the extent to which improper payments exist, (2) mitigation strategies and  the appropriate amount of investments to reduce them, and (3) the success  of efforts implemented to reduce improper payments.
section_title: Information Security
paragraphs: Although progress has been made, serious and widespread information  security control weaknesses continue to place federal assets at risk of  inadvertent or deliberate misuse, financial information at risk of  unauthorized modification or destruction, sensitive information at risk of  inappropriate disclosure, and critical operations at risk of disruption. GAO  has reported information security as a high-risk area across government  since February 1997. Such information security control weaknesses could  result in compromising the reliability and availability of data that are  recorded in or transmitted by federal financial management systems. A  primary reason for these weaknesses is that federal agencies have not yet  fully institutionalized comprehensive security management programs,  which are critical to identifying information security control weaknesses,  resolving information security problems, and managing information  security risks on an ongoing basis. The Congress has shown continuing  interest in addressing these risks, as evidenced by hearings on information  security and enactment of the Federal Information Security Management  Act of 2002 and the Cyber Security Research and Development Act. In  addition, the administration has taken important actions to improve  information security, such as integrating information security into the  Executive Branch Management Scorecard.
section_title: Tax Collection Activities
paragraphs: Material internal control weaknesses and systems deficiencies continue to  affect the federal government’s ability to effectively manage its tax  collection activities, an issue that has been reported in our financial  statement audit reports for the past 7 years. Due to errors and delays in  recording activity in taxpayer accounts, taxpayers were not always  credited for payments made on their taxes owed, which could result in  undue taxpayer burden. In addition, the federal government did not always  follow up on potential unreported or underreported taxes and did not  always pursue collection efforts against taxpayers owing taxes to the  federal government.
Weaknesses in controls over tax collection activities continue to affect the  federal government’s ability to efficiently and effectively account for and  collect revenue. Additionally, weaknesses in financial reporting of revenues  affect the federal government’s ability to make informed decisions about  collection efforts. As a result, the federal government is vulnerable to loss  of tax revenue and exposed to potentially billions of dollars in losses due to  inappropriate refund disbursements.
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