Fiscal Year 2007 U.S. Government Financial Statements: Sustained Improvement in Financial Management Is Crucial to Improving Accountability and Addressing the Long-Term Fiscal Challenge
Published: 2008-06-26T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Congress and the President need to have reliable, useful and timely financial and performance information to make sound decisions on the current and future direction of vital federal government programs and policies. Unfortunately, except for the 2007 Statement of Social Insurance, GAO was again unable to provide assurance on the reliability of the consolidated financial statements of the U.S. government (CFS) due primarily to certain material weaknesses in the federal government's internal control. GAO has reported that unless these weaknesses are adequately addressed, they will, among other things, (1) hamper the federal government's ability to reliably report a significant portion of its assets, liabilities, costs, and other related information; and (2) affect the federal government's ability to reliably measure the full cost as well as the financial and nonfinancial performance of certain programs and activities. This testimony presents the results of GAO's audit of the CFS for fiscal year 2007 and discusses the federal government's long-term fiscal outlook.
section_title: What GAO Found
paragraphs: For the 11th consecutive year, three major impediments prevented GAO from rendering an opinion on the federal government's accrual basis consolidated financial statements: (1) serious financial management problems at the Department of Defense, (2) the federal government's inability to adequately account for and reconcile intragovernmental activity and balances between federal agencies, and (3) the federal government's ineffective process for preparing the consolidated financial statements. In addition, financial management system problems continue to hinder federal agency accountability. Although the federal government still has a long way to go, significant progress has been made in improving federal financial management. For example, audit results for many federal agencies have improved and federal financial system requirements have been developed. In addition, GAO was able to render an unqualified opinion on the 2007 Statement of Social Insurance. Further, for the first time, the federal government issued a summary financial report which is intended to make the information in the Financial Report of the U.S. Government (Financial Report) more accessible and understandable to a broader audience. It is important that this progress be sustained by the current administration as well as the new administration that will be taking office next year and that the Congress continues its oversight to bring about needed improvements to federal financial management. Given the federal government's current financial condition and the nation's long-term fiscal challenge, the need for the Congress and federal policymakers and management to have reliable, useful, and timely financial and performance information is greater than ever. Information included in the Financial Report, such as the Statement of Social Insurance along with long-term fiscal simulations and fiscal sustainability reporting, can help increase understanding of the nation's long-term fiscal outlook. The nation's long-term fiscal challenge is a matter of utmost concern. The federal government faces large and growing structural deficits due primarily to rising health care costs and known demographic trends. Simply put, the federal government is on an imprudent and unsustainable long-term fiscal path. Addressing this challenge will require a multipronged approach. Moreover, the longer that action is delayed, the greater the risk that the eventual changes will be disruptive and destabilizing. Finally, the federal government should consider the need for further revisions to the current federal financial reporting model to recognize the unique needs of the federal government. A broad reconsideration of issues, such as the kind of information that may be relevant and useful for a sovereign nation, could lead to reporting enhancements that might help provide the Congress and the President with more useful financial information to deliberate strategies to address the nation's long-term fiscal challenge.

section_title: Letter
paragraphs: I am most pleased to be here today to discuss our report on the U.S.  government’s consolidated financial statements for fiscal years 2007 and  2006. I would like to thank you for holding an oversight hearing on this  important subject. Your subcommittee’s active involvement is critical to  ultimately assuring the continued progress in improving federal financial  management while enhancing public confidence in the government as a  steward that is accountable for its finances. Such hearings play a vital role  in ensuring that the federal government is held accountable to the  American people.
In this testimony, I will discuss (1) the major issues relating to the  consolidated financial statements for fiscal years 2007 and 2006, including  progress that has been made toward addressing major impediments to an  opinion on the consolidated financial statements; (2) financial  management systems problems that continue to hinder federal agency  accountability; (3) the challenges posed by the federal government’s long- term fiscal condition and GAO’s views on a possible way forward; and   (4) the need for an improved federal financial reporting model. Until these  issues are adequately addressed, they will continue to have adverse  implications for the federal government and the taxpayers.
Both the consolidated financial statements and our related audit report are  included in the fiscal year 2007 Financial Report of the United States  Government (Financial Report). The Financial Report was issued by the  Department of the Treasury (Treasury) on December 17, 2007. In addition,  for the first time, Treasury and the Office of Management and Budget  (OMB) in coordination with GAO issued on February 14, 2008, a summary  financial report entitled, The Federal Government’s Financial Health: A  Citizens Guide to the 2007 Financial Report of the United States  Government. This guide is intended to make the information in the  Financial Report more understandable and more accessible to a broader  audience. The Director of OMB, the Secretary of the Treasury, and I  believe that the information discussed in this guide is important to all  Americans. This is a good first step, and I am confident that the guide will  evolve over time. Both of these reports are available through GAO’s  Internet site, at http://www.gao.gov/financial/fy2007financialreport.html  and Treasury’s Internet site, at http://www.fms.treas.gov/fr/index.html.
subsections: section_title: Highlights of Major Issues Related to the U.S. Government’s Consolidated Financial Statements for Fiscal Years 2007 and 2006
paragraphs: As has been the case for the previous 10 fiscal years, the federal  government did not maintain adequate systems or have sufficient and  reliable evidence to support certain material information reported in the  U.S. government’s accrual basis consolidated financial statements. The  underlying material weaknesses in internal control, which generally have  existed for years, contributed to our disclaimer of opinion on the U.S.  government’s accrual basis consolidated financial statements for the fiscal  years ended 2007 and 2006. Appendix I describes the material weaknesses  that contributed to our disclaimer of opinion in more detail and highlights  the primary effects of these material weaknesses on the accrual basis  consolidated financial statements and on the management of federal  government operations.
The material weaknesses that contributed to our disclaimer of opinion  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;  implement effective credit reform estimation and related financial  reporting processes at certain federal credit agencies;  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;    adequately account for and reconcile intragovernmental activity and  balances between federal agencies;    ensure that the federal government’s consolidated financial statements  were (1) consistent with the underlying audited agency financial  statements, (2) properly balanced, and (3) in conformity with Generally  Accepted Accounting Principles; and,  identify and either resolve or explain material differences that exist  between certain components of the budget deficit reported in Treasury’s  records, used to prepare the Reconciliation of Net Operating Cost and  Unified Budget Deficit and Statement of Changes in Cash Balance from  Unified Budget and Other Activities, and related amounts reported in  federal agencies’ financial statements and underlying financial information  and records.
Due to the material weaknesses and the additional limitations on the  scope of our work, as discussed in our audit report, there may also be  additional issues that could affect the accrual basis consolidated financial  statements that have not been identified.
In addition to the material weaknesses that contributed to our disclaimer  of opinion, which were discussed above, we found three other material  weaknesses in internal control as of September 30, 2007. These  weaknesses are discussed in more detail in appendix II, including the  primary effects of the material weaknesses on the accrual basis  consolidated financial statements and on the management of federal  government operations. These other material weaknesses were the federal  government’s inability to    determine the full extent to which improper payments occur,  identify and resolve information security control weaknesses and manage  information security risks on an ongoing basis, and    effectively manage its tax collection activities.
Further, our audit report discusses certain significant deficiencies in  internal control at the governmentwide level. These significant  deficiencies involve the following areas:    preparing the Statement of Social Insurance for certain programs, and    monitoring and oversight regarding certain federal grants and entities that  offer Medicare health plan options.
Individual federal agency financial statement audit reports identify  additional control deficiencies which were reported by agency auditors as  material weaknesses or significant deficiencies at the individual agency  level. We do not deem these additional control deficiencies to be material  weaknesses at the governmentwide level.
Regarding agencies’ internal controls, in December 2004, OMB revised  OMB Circular No. A-123, Management’s Responsibility for Internal  Control, which became effective for fiscal year 2006. In fiscal year 2006,  agencies began to implement the more rigorous requirements of the  revised OMB Circular No. A-123, which include management  identification, assessment, testing, correction, and documentation of  internal controls over financial reporting for each account or group of  accounts, as well as an annual assurance statement from the agency head  as to whether internal control over financial reporting is effective.
OMB recognized that due to the complexity of some agencies,  implementation of these new requirements may span more than 1 year.  Accordingly, certain agencies have adopted multiyear implementation  plans. According to OMB’s Federal Financial Management Report for  2007, 16 of the 24 CFO Act agencies have performed assessments required  by OMB Circular No. A-123 for all key processes, while the remaining 8  CFO Act agencies are phasing in implementation of the requirements by  testing a portion of the key processes and providing plans for testing the  remaining processes within 3 years. Also, according to that report, to  achieve its strategic goal of improving effectiveness of internal control  over financial reporting, OMB has developed priority actions that include  updating guidance, as necessary, based on lessons learned from agencies’  implementation of the circular. It will be important that OMB continue to  monitor and oversee federal agencies’ implementation of these new  requirements.
subsections: section_title: Addressing Major Impediments to an Opinion on the Accrual Basis Consolidated Financial Statements
paragraphs: Three major impediments to our ability to render an opinion on the U.S.  government’s accrual basis consolidated financial statements continued to  be: (1) serious financial management problems at DOD, (2) the federal  government’s inability to adequately account for and reconcile  intragovernmental activity and balances between federal agencies, and   (3) the federal government’s ineffective process for preparing the  consolidated financial statements. Extensive efforts by DOD officials and  cooperative efforts between agency chief financial officers, Treasury  officials, and OMB officials will be needed to resolve these serious  obstacles to achieving an opinion on the U.S. government’s accrual basis  consolidated financial statements.
subsections: section_title: Financial Management at DOD
paragraphs: Essential to further improving financial management governmentwide and  ultimately to achieving an opinion on the U.S. government’s consolidated  financial statements is the resolution of serious weaknesses in DOD’s  business operations. DOD is one of the largest and most complex  organizations in the world. Since the first financial statement audit of a  major DOD component was attempted almost 20 years ago, we have  reported that weaknesses in DOD’s business operations, including  financial management, not only adversely affect the reliability of reported  financial data, but also the economy, efficiency, and effectiveness of its  operations.
DOD continues to dominate GAO’s list of high-risk programs designated as  vulnerable to waste, fraud, abuse, and mismanagement, bearing  responsibility, in whole or in part, for 15 of 27 high-risk areas. Eight of  these areas are specific to DOD and include DOD’s overall approach to  business transformation, as well as business systems modernization and  financial management. Collectively, these high-risk areas relate to DOD’s  major business operations, including financial management, which directly  support the warfighters, including their pay, the benefits provided to their  families, and the availability and condition of equipment and supplies they  use both on and off the battlefield.
Successful transformation of DOD’s financial management operations will  require a multifaceted, cross-organizational approach that addresses the  contribution and alignment of key elements, including sustained  leadership, strategic plans, people, processes, and technology. Congress  clearly recognized, in the National Defense Authorization Act for Fiscal  Year 2008, the need for executive-level attention in ensuring that DOD  was on a sustainable path toward achieving business transformation. This  legislation codifies Chief Management Officer (CMO) responsibilities at a  high level in the department—assigning them to the Deputy Secretary of  Defense—and establishing a full-time Deputy CMO and designating CMO  responsibilities within the military services. However, in less than a year,  our government will undergo a change in administrations, which raises  questions about the continuity of effort and the sustainability of the  progress that DOD has made to date. As such, we believe the CMO  position should be codified as a separate position from the Deputy  Secretary of Defense in order to provide full-time attention to business  transformation over the long term, subject to an extended term  appointment. Because business transformation is a long-term and complex  process, we have recommended a term of at least 5 to 7 years to provide  sustained leadership and accountability.
Importantly, DOD has taken steps toward developing and implementing a  framework for addressing the department’s long-standing financial  management weaknesses and improving its capability to provide timely,  reliable, and relevant financial information for analysis, decision making,  and reporting, a key defense transformation priority. Specifically, this  framework, which is discussed in both the department’s Enterprise  Transition Plan (ETP) and the Financial Improvement and Audit  Readiness (FIAR) Plan, includes the department’s Standard Financial  Information Structure (SFIS) and Business Enterprise Information System  (BEIS). DOD intends this framework to define and put into practice a  standard DOD-wide financial management data structure as well as  enterprise-level capabilities to facilitate reporting and comparison of  financial data across the department.
DOD’s efforts to develop and implement SFIS and BEIS should help to  improve the consistency and comparability of the department’s financial  information and reporting; however, a great deal of work remains before  the financial management capabilities of DOD and its components’  transformation efforts achieve financial visibility. Examples of work  remaining include data cleansing; improvements to current policies,  processes, procedures, and controls; and implementation of fully  integrated systems.
In 2007, DOD introduced refinements to its approach for achieving  financial statement auditability. These refinements include the following:    Requesting audits of entire financial statements rather than attempting to  build upon audits of individual financial statement line items.
Focusing on improvements in end-to-end business processes, or  segments that underlie the amounts reported on the financial statements.
Using audit readiness validations and annual verification reviews of  segment improvements to help ensure sustainability of corrective actions  and improvements.
Forming a working group to begin auditability risk assessments of  financial systems at key decision points in their development and  deployment life cycle to help ensure that the processes and internal  controls support repeatable production of auditable financial statements.
We are encouraged by DOD’s efforts and emphasize the necessity for  consistent management oversight toward achieving financial management  capabilities and reporting of meaningful and measurable transformation  effort benchmarks and accomplishments. We will continue to monitor  DOD’s efforts to transform its business operations and address its  financial management challenges as part of our continuing DOD business  enterprise architecture and financial audit readiness oversight.
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  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 each fiscal year.
A substantial number of the agencies did not adequately perform the  required reconciliations for fiscal years 2007 and 2006. For these fiscal  years, based on trading partner information provided to Treasury via  agencies’ closing packages, 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 as of the end of the fiscal year. Based on  our analysis of the “Material Difference Reports” for fiscal year 2007, we  noted that a significant number of CFOs were unable to adequately explain  the differences with their trading partners or did not provide adequate  documentation to support responses. For both fiscal years 2007 and 2006,  amounts reported by federal agency trading partners for certain  intragovernmental accounts were not in agreement by significant amounts.  In addition, a significant number of CFOs cited differing accounting  methodologies, accounting errors, and timing differences for their material  differences with their trading partners. Some CFOs simply indicated that  they were unable to explain the differences with their trading partners  with no indication when the differences will be resolved. As a result of the  above, the federal government’s ability to determine the impact of these  differences on the amounts reported in the accrual basis consolidated  financial statements is significantly impaired.
In 2006, OMB issued Memorandum No. M-07-03, Business Rules for  Intragovernmental Transactions (Nov. 13, 2006), and Treasury issued the  Treasury Financial Manual Bulletin No. 2007-03, Intragovernmental  Business Rules (Nov. 15, 2006). This guidance added criteria for resolving  intragovernmental disputes and major differences between trading  partners for certain intragovernmental transactions and called for the  establishment of an Intragovernmental Dispute Resolution Committee.
OMB is currently working with the Chief Financial Officers Council to  create the Intragovernmental Dispute Resolution Committee. Treasury is  also taking steps to help resolve material differences in intragovernmental  activity and balances. For example, Treasury is requiring federal agencies  to provide a plan of action on how the agency is addressing certain of its  unresolved material differences. Resolving the intragovernmental  transactions problem remains a difficult challenge and will require a  strong commitment by federal agencies to fully implement the recently  issued business rules and continued strong leadership by OMB and  Treasury.
section_title: Preparing the Consolidated Financial Statements
paragraphs: Although further progress was demonstrated in fiscal year 2007, 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,  properly balanced, and in conformity with U.S. generally accepted  accounting principles (GAAP). Treasury has showed progress by  demonstrating that amounts in the Statement of Social Insurance were  consistent with the underlying federal agencies’ audited financial  statements and that the Balance Sheet and the Statement of Net Cost were  consistent with federal agencies’ financial statements prior to eliminating  intragovernmental activity and balances. However, Treasury’s process for  compiling the consolidated financial statements did not ensure that the  information in the remaining three principal financial statements and  notes were fully consistent with the underlying information in federal  agencies’ audited financial statements and other financial data. During  fiscal year 2007, Treasury, in coordination with OMB, continued to develop  and implement corrective action plans and milestones for short-term and  long-range solutions for certain internal control weaknesses we have  reported regarding the process for preparing the consolidated financial  statements. Resolving some of these internal control weaknesses will be a  difficult challenge and will require a strong commitment from Treasury  and OMB as they execute and implement their corrective action plans.
section_title: Federal Agencies’ Financial Management Systems
paragraphs: Under the Federal Financial Management Improvement Act of 1996  (FFMIA), as a part of the CFO Act agencies’ financial statement audits,  auditors are required to report whether agencies’ financial management  systems comply substantially with (1) federal financial management  systems requirements, (2) applicable federal accounting standards, and   (3) the U.S. Government Standard General Ledger (SGL) at the  transaction level. These factors, if implemented successfully, help provide  a solid foundation for improving accountability over government  operations and routinely producing sound cost and operating performance  information.
As shown in figure 1, 19 out of the 24 CFO Act agencies received an  unqualified opinion on their financial statements in fiscal year 2007;  however, 8 of these 19 agencies’ systems did not substantially comply with  one or more of the three FFMIA requirements. This shows that  irrespective of these unqualified “clean” opinions on the financial  statements, many agencies still do not have reliable, useful and timely  financial information with which to make informed decisions and ensure  accountability on an ongoing basis.
The modernization of federal financial management systems has been a  long-standing challenge at many federal agencies. As shown in figure 1,  auditors reported that 13 of the 24 CFO Act agencies’ systems did not  substantially comply with one or more of the three FFMIA requirements  for fiscal year 2007. This compares with 17 agencies for fiscal year 2006.  Although the number of agencies reported as not substantially compliant  has declined, the federal government’s capacity to manage with timely and  useful data remains limited, thereby hampering its ability to effectively  administer and oversee its major programs.
For fiscal year 2007, noncompliance with federal financial management  systems requirements was the most frequently cited deficiency of the three  FFMIA requirements. One of the federal financial management systems  requirements is for agencies to have integrated financial management  systems. Based on our review of the fiscal year 2007 audit reports, we  identified the lack of integrated financial management systems to be one  of the six problem areas for the 13 agency systems that are reported as not  being substantially compliant with FFMIA. Figure 2 summarizes these six  areas and the number of agencies with problems reported in each area.
The lack of integrated financial management systems typically results in  agencies expending major time, effort, and resources, including in some  cases, hiring external consultants to develop information that their  systems should be able to provide on a daily or recurring basis. In  addition, nonintegrated systems are more prone to error which could  result in information that is not reliable, useful, or timely. Figure 2 also  shows that auditors for 11 CFO Act agencies had reported the lack of  accurate and timely recording of financial information as a problem in  fiscal year 2007. Accurate and timely recording of financial information is  essential for effective financial management. Furthermore, the majority of  participants at a recent Comptroller General’s forum on improving  financial management systems agreed that financial management systems  are not able to provide, or provide little, information that is reliable,  useful, and timely to assist management in their day-to-day decision  making, which is the ultimate goal of FFMIA.
Participants at the forum also discussed current financial management  initiatives and the strategies for transformation of federal financial  management. To reduce the cost and improve the outcome of federal  financial management systems implementations, OMB continues to move  forward on a key initiative—the financial management line of business  (line of business), by leveraging common standards and shared solutions.  OMB anticipates that the line of business initiative will help achieve the  goals of improving the cost, quality, and performance of financial  management operations. OMB and the Financial Systems Integration  Office have demonstrated continued progress toward implementation of  the line of business initiative by issuing a common governmentwide  accounting classification structure, financial services assessment guide,  and exposure drafts of certain standard business processes. However, as  we previously recommended, OMB needs to continue defining standard  business processes. A critical factor for success will be ensuring that  agencies cannot continue developing and implementing their own  stovepiped systems. Failure to do so may require additional work, increase  costs to adopt these standard business processes, and further delay the  transformation of federal financial management systems.
In a January 2008 memo, OMB recognized the risks associated with  nonstandardized processes and updated its guidance on the line of  business. Current plans are for the Financial Systems Integration Office to  continue developing business standards and incorporate them into  software requirements and permit agencies and shared service providers  to utilize only the certified products as configured. Along with these  changes, continued high-priority and sustained top-level commitment by  OMB and leaders throughout the federal government will be necessary to  fully and effectively achieve the common goals of the line of business and  FFMIA.
section_title: The Nation’s Long- Term Fiscal Challenge
paragraphs: The nation’s long-term fiscal challenge is a matter of utmost concern. The  federal government faces large and growing structural deficits due  primarily to rising health care costs and known demographic trends. There  is a need to engage in a fundamental review of what the federal  government does, how it does it, and how it is financed. Understanding  and addressing the federal government’s financial condition and the  nation’s long-term fiscal challenge are critical to maintain fiscal flexibility  so that policymakers can respond to current and emerging social,  economic, and security challenges.
While some progress has been made in recent years in addressing the  federal government’s short-term fiscal condition, the nation has not made  progress on its long-term fiscal challenge. However, even this short-term  deficit is understated: It masks the fact that the federal government has  been using the Social Security surplus to offset spending in the rest of  government for many years. If the Social Security surplus is excluded, the  on-budget deficit in fiscal year 2007 was more than double the size of the  unified deficit. For example, Treasury reported a unified deficit of $163  billion and an on-budget deficit of $344 billion in fiscal year 2007.
While the federal government’s unified budget deficit has declined in  recent years, its liabilities, contingencies and commitments, and social  insurance responsibilities have increased. As of September 30, 2007, the  U.S. government reported in the 2007 Financial Report that it owed (i.e.,  liabilities) more than it owned (i.e., assets) by more than $9 trillion.  Further, the Statement of Social Insurance in the Financial Report  disclosed $41 trillion in social insurance responsibilities, including  Medicare and Social Security, up more than $2 trillion from September 30,  2006.
Information included in the Financial Report, such as the Statement of  Social Insurance along with long-term fiscal simulations and fiscal  sustainability reporting can help increase understanding of the federal  government’s long-term fiscal outlook. Over the next few decades, the  nation’s fiscal challenge will be shaped largely by rising health care costs  and known demographic trends. As the baby boom generation retires,  federal spending on retirement and health care programs—Social Security  and Medicare, and Medicaid—will grow dramatically.
The future costs of Social Security and Medicare commitments are  reported in the Statement of Social Insurance in the Financial Report. We  were able to render an unqualified opinion on the 2007 Statement of Social  Insurance—a significant accomplishment for the federal government. The  statement displays the present value of projected revenues and  expenditures for scheduled benefits of social insurance programs. For  Social Security and Medicare alone, projected expenditures for scheduled  benefits exceed earmarked revenues (i.e., dedicated payroll taxes and  premiums) by approximately $41 trillion over the next 75 years in present  value terms. Stated differently, one would need approximately $41 trillion  invested today to deliver on the currently promised benefits not covered  by earmarked revenues for the next 75 years.
Table 1 shows a simplified version of the Statement of Social Insurance by  its primary components.
Although these social insurance commitments dominate the long-term  outlook, they are not the only federal programs or activities that bind the  future. GAO developed the concept of “fiscal exposures” to provide a  framework for considering the wide range of responsibilities, programs,  and activities that may explicitly or implicitly expose the federal  government to future spending. In addition to the social insurance  commitments, the federal government’s fiscal exposures include about $11  trillion in liabilities reported on the Balance Sheet, $1 trillion of other  commitments and contingencies, as well as other potential exposures that  cannot be quantified. So beyond dealing with Medicare and Social  Security, policymakers need to look at other policies that limit the federal  government’s flexibility—not necessarily to eliminate all of them but to at  least be aware of them and make a conscious decision to reform them in a  manner that will be responsible, equitable, and sustainable.
Long-term fiscal simulations of future revenues and costs for all federal  programs offer a comprehensive assessment of the federal government’s  long-term fiscal outlook. Since 1992, GAO has published long-term fiscal  simulations of what might happen to federal deficits and debt levels under  varying policy assumptions. GAO’s simulations—which are neither  forecasts nor predictions—continue to show ever-increasing long-term  deficits resulting in a federal debt level that ultimately spirals out of  control. The timing of deficits and the resulting debt buildup varies  depending on the assumptions used. For example, figure 3 shows GAO’s  simulation of the deficit path based on recent trends and policy  preferences. In this simulation, we start with the Congressional Budget  Office’s (CBO) baseline and then assume that (1) all expiring tax  provisions are extended through 2018—and then revenues are brought to  their historical level as a share of gross domestic product (GDP) plus  expected revenue from deferred taxes—(2) discretionary spending grows  with the economy, and (3) no structural changes are made to Social  Security, Medicare, or Medicaid.
Over the long term, the nation’s fiscal challenge stems primarily from  rising health care costs and, to a lesser extent, the aging of the population.  Absent significant changes on the spending or revenue sides of the budget  or both, these long-term deficits will encumber a growing share of federal  resources and test the capacity of current and future generations to afford  both today’s and tomorrow’s commitments.
Figure 4 looks behind the deficit path to the composition of federal  spending. It shows that the estimated growth in the major entitlement  programs leads to an unsustainable fiscal future. In this figure, the  category “all other spending” includes much of what many think of as  “government”—discretionary spending on such activities as national  defense, homeland security, veterans health benefits, national parks,  highways and mass transit, and foreign aid, plus mandatory spending on  the smaller entitlement programs such as Supplemental Security Income,  Temporary Assistance for Needy Families, and farm price supports. The  growth in Social Security, Medicare, Medicaid, and interest on debt held  by the public dwarfs the growth in all other types of spending. A  government that in one generation does nothing more than pay interest on  its debt and mail checks to retirees and some of their health providers is  unacceptable.
The federal government’s increased spending and rising deficits will drive  a rising debt burden. At the end of fiscal year 2007, debt held by the public  exceeded $5 trillion. Figure 5 shows that this growth in the federal  government’s debt cannot continue unabated without causing serious  harm to the economy.  In the last 200 years, only during and after World  War II has debt held by the public exceeded 50 percent of GDP.
But this is only part of the story. The federal government for years has  been borrowing the surpluses in the Social Security trust funds and other  similar funds and using them to finance federal government costs. When  such borrowings occur, Treasury issues federal securities to these  government funds that are backed by the full faith and credit of the U.S.  government. Although borrowing by one part of the federal government  from another may not have the same economic and financial implications  as borrowing from the public, it represents a claim on future resources  and hence a burden on future taxpayers and the future economy. If federal  securities held by those funds are included, the federal government’s total  debt is much higher—about $9 trillion as of the end of fiscal year 2007.
As shown in figure 6, total federal debt increased over each of the last four  fiscal years.
On September 29, 2007, the statutory debt limit had to be raised for the  third time in 4 years in order to avoid being breached; between the end of  fiscal year 2003 and the end of fiscal year 2007, the debt limit had to be  increased by about one-third. It is anticipated that actions will need to be  taken in fiscal year 2009 to avoid breaching the current statutory debt limit  of $9,815 billion.
A quantitative measure of the long-term fiscal challenge measure is called  “the fiscal gap.” The fiscal gap is the amount of spending reduction or tax  increases that would be needed today to keep debt as a share of GDP at or  below today’s ratio. The fiscal gap is an estimate of the action needed to  achieve fiscal balance over a certain time period such as 75 years. Another  way to say this is that the fiscal gap is the amount of change needed to  prevent the kind of debt explosion implicit in figure 5. The fiscal gap can  be expressed as a share of the economy or in present value dollars.
Under GAO’s alternative simulation, closing the fiscal gap would require  spending cuts or tax increases equal to 6.7 percent of the entire economy  over the next 75 years, or about $54 trillion in present value terms. To put  this in perspective, closing the gap would require an increase in today’s  federal tax revenues of about 36 percent or an equivalent reduction in  today’s federal program spending (i.e., in all spending except for interest  on the debt held by the public, which cannot be directly controlled) to be  maintained over the entire period.
Policymakers could phase in the policy changes so that the tax increases  or spending cuts would grow over time and allow people to adjust. The  size of these annual tax increases and spending cuts would be more than  five times the fiscal year 2007 deficit of 1.2 percent of GDP. Delaying  action would make future adjustments even larger. Under our alternative  simulation, waiting even 10 years would require a revenue increase of  about 45 percent or noninterest spending cuts of about 40 percent. This  gap is too large for the federal government to grow its way out of the  problem. To be sure, additional economic growth would certainly help the  federal government’s financial condition and ability to address this fiscal  gap, but it will not eliminate the need for action.
Understanding and addressing the federal government’s financial  condition and the nation’s long-term fiscal challenge are critical to the  nation’s future. As we reported in December 2007, several countries have  begun preparing fiscal sustainability reports to help assess the  implications of their public pension and health care programs and other  challenges in the context of overall sustainability of government finances.  European Union members also annually report on longer-term fiscal  sustainability. The goal of these reports is to increase public awareness  and understanding of the long-term fiscal outlook in light of escalating  health care cost growth and population aging, to stimulate public and  policy debates, and to help policymakers make more informed decisions.  These countries used a variety of measures, including projections of future  revenue and spending and summary measures of fiscal imbalance and  fiscal gaps, to assess fiscal sustainability. Last year, we recommended that  the United States should prepare and publish a long-range fiscal  sustainability report. I am pleased to note that the Federal Accounting  Standards Advisory Board (FASAB) will soon issue a draft of a proposed  standard on fiscal sustainability reporting.
Here in the first half of 2008, the long-term fiscal challenge is not in the  distant future. In fact, the oldest members of the baby boom generation  are now eligible for Social Security retirement benefits and will be eligible  for Medicare benefits in less than 3 years. The budget and economic  implications of the baby boom generation’s retirement have already  become a factor in CBO’s 10-year budget projections and that impact will  only intensify as the baby boomers age.
The financial markets also are noticing. Earlier this year, Moody’s  Investors Service issued its annual report on the United States. In that  report, it noted that absent Medicare and Social Security reforms, the long- term fiscal health of the United States and the federal government’s  current Aaa sovereign credit rating were at risk. Likewise, Standard and  Poor’s noted in a recent report that Medicare and Social Security reform is  necessary to prevent a much worse long-term fiscal deterioration. These  comments serve to note the significant longer-term interest rate risk that  the federal government faces absent meaningful action to address these  long-range challenges. Higher longer-term interest costs would only serve  to complicate the nation’s fiscal, economic, and other challenges in future  years.
At some point, action will need to be taken to change the nation’s fiscal  course. The sooner appropriate actions are taken, the sooner the miracle  of compounding will begin to work for the federal budget rather than  against it. Conversely, the longer that action to deal with the nation’s long- term fiscal outlook is delayed, the greater the risk that the eventual  changes will be disruptive and destabilizing and future generations will  have to bear a greater burden of the cost. Simply put, the federal  government is on an imprudent and unsustainable long-term fiscal path  that is getting worse with the passage of time.
subsections: section_title: A Possible Way Forward
paragraphs: Meeting this long-term fiscal challenge overarches everything. It is the  nation’s largest sustainability challenge, but it is not the only one. Aligning  the federal government to meet the challenges and capitalize on the  opportunities of the 21st century will require a fundamental review of  what the federal government does, how it does it, and how it is financed.
In addressing the growing costs of the major entitlement programs and  reexamining other major programs, policies, and activities, attention  should be paid to both the spending and the revenue sides of the budget.  Programs that run through the tax code—sometimes referred to as tax  expenditures—must be reexamined along with those that run through the  spending side. Moving forward, the federal government needs to start  making tough choices in setting priorities and linking resources and  activities to results.
Meeting the nation’s long-term fiscal challenge will require a multipronged  approach bringing people together to tackle health care, Social Security,  and the tax system as well as    strengthening oversight of programs and activities, including creating  approaches to better facilitate the discussion of integrated solutions to  crosscutting issues; and  reengineering and reprioritizing the federal government’s existing  programs, policies, and activities to address 21st century challenges and  capitalize on related opportunities.
Regarding the tax system, although tax reform may need to play a role in  meeting our challenges, any system will need to include design features  and reasonable service and enforcement efforts to maximize compliance.   Under the current system, the tax gap—the difference between the tax  amounts taxpayers pay voluntarily on time and what they should pay  under the laws—contributes to the nation’s long-term fiscal challenges and  can undermine compliance if those who comply see their friends,  neighbors, and business competitors avoiding their tax obligations.   According to the latest Internal Revenue Service (IRS) estimates for tax  year 2001, the federal government falls $345 billion short of collecting all  of the taxes owed before voluntary late payments and IRS enforcement  actions and $290 billion afterwards.  Although the extent to which we can  reduce the tax gap is unknown, meaningful reductions can contribute  resources to dealing with our long-term challenges.
There are also some process changes that might help the discussion by  increasing the transparency and relevancy of key financial, performance,  and budget reporting and estimates that highlight the fiscal challenge.  Stronger budget controls for both spending and tax policies to deal with  both near-term and longer-term deficits may also be helpful.
In summary, to effectively address the nation’s long-term fiscal challenge,  tackling health care cost growth and other existing entitlement programs  will be essential. However, this entitlement reform alone will not get the  job done. The federal government also needs to reprioritize and constrain  other spending and consider whether revenues at the historical average of  18.3 percent of GDP will be sufficient—that may involve discussion of the  tax system. I am pleased that GAO has been able to offer you specific  analysis and tools to assist you in this important work. However, only  elected officials can and should decide which issues to address as well as  how and when to address them. Addressing these problems will require  tough choices, and the fiscal clock is ticking.
section_title: The Federal Financial Reporting Model
paragraphs: The Financial Report provides useful information on the government’s  financial position at the end of the fiscal year and changes that have  occurred over the course of the year. However, in evaluating the nation’s  fiscal condition, it is critical to look beyond the short-term results and  consider the overall long-term financial condition and long-term fiscal  challenge of the government—that is, the sustainability of the federal  government’s programs, commitments, and responsibilities in relation to  the resources expected to be available.
The current federal financial reporting model does not clearly,  comprehensively 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 does not provide the best possible picture of the federal  government’s overall performance, financial condition, and future fiscal  outlook.
Accounting and financial reporting standards have continued to evolve to  provide adequate transparency and accountability over the federal  government’s operations, financial condition and fiscal outlook. However,  after 11 years of reporting at the governmentwide level, it is appropriate to  consider the need for further revisions to the current federal financial  reporting model, which could affect both consolidated and agency  reporting. While the current reporting model recognizes some of the  unique needs of the federal government, a broad reconsideration of the  federal financial reporting model could address the following types of  questions:    What kind of information is most relevant and useful for a sovereign  nation?
Do traditional financial statements convey information in a transparent  manner?
What is the role of the balance sheet in the federal government reporting  model?
How should items that are unique to the federal government, such as  social insurance commitments and the power to tax, be reported?
In addition, further enhancements to accounting and financial reporting  standards are needed to effectively convey the long-term financial  condition of the U.S. government and annual changes therein. For  example, the federal government’s financial reporting should be expanded  to disclose the reasons for significant changes during the year in  scheduled social insurance benefits and funding. It should also include   (1) a Statement of Fiscal Sustainability that provides a long-term look at  the sustainability of social insurance programs in the context of all federal  programs, and (2) other sustainability information, including  intergenerational equity. The Federal Accounting Standards Advisory  Board is currently considering possible changes to social insurance  reporting and has initiated a project on fiscal sustainability reporting.
Engaging in a reevaluation of the federal financial reporting model could  stimulate discussion that would bring about a new way of thinking about  the federal government’s financial and performance reporting needs. To  understand various perceptions and needs of the stakeholders for federal  financial reporting, a wide variety of stakeholders from the public and  private sector should be consulted. Ultimately, the goal of such a  reevaluation would be reporting enhancements that can help the Congress  deliberate on strategies to address the federal government’s challenges,  including its long-term fiscal challenge.
section_title: Closing Comments
paragraphs: In closing, it is important that the progress that has been made in  improving federal financial management activities and practices be  sustained by the current administration as well as the new administration  that will be taking office next year. Across government, financial  management improvement initiatives are underway, and if effectively  implemented, they have the potential to greatly improve the quality of  financial management information as well as the efficiency and  effectiveness of agency operations. However, the federal government still  has a long way to go before realizing strong federal financial management.  For DOD, the challenges are many. We are encouraged by DOD’s efforts  toward addressing its long-standing financial management weaknesses,  but consistent and diligent management oversight toward achieving  financial management capabilities, including audit readiness is needed.  Federal agencies need to improve the government’s financial management  systems. The civilian CFO Act agencies must continue to strive toward  routinely producing not only annual financial statements that can pass the  scrutiny of a financial audit, but also quarterly financial statements and  other meaningful financial and performance data to help guide decision  makers on a day-to-day basis.
Addressing the nation’s long-term fiscal challenge constitutes a major  transformational challenge that may take a generation or more to resolve.  GAO is committed to sustained attention to this fiscal challenge to help  ensure that this is not the first generation to leave its children and  grandchildren a legacy of failed fiscal stewardship and the hardships that  would bring. Given the size of the projected deficit, the leadership and  efforts of many people will be needed to put the nation on a more prudent  and sustainable longer-term fiscal path.
Given the federal government’s current financial condition and the  nation’s long-term fiscal challenge, the need for the Congress and federal  policymakers and management to have reliable, useful, and timely  financial and performance information is greater than ever. Sound  decisions on the current and future direction of vital federal government  programs and policies are more difficult without such information. We will  continue to stress the need for development of more meaningful financial  and performance reporting on the federal government. Until the problems  discussed in this testimony are effectively addressed, they will continue to  have adverse implications for the federal government and the taxpayers.
Finally, I want to emphasize the value of sustained congressional interest  in these issues. It will be key that, going forward, the appropriations,  budget, authorizing, and oversight committees hold agency top leadership  accountable for resolving the remaining problems and that they support  improvement efforts.
Mr. Chairman, this concludes my prepared statement. I would be pleased  to respond to any questions that you or other members of the  subcommittee may have at this time.
section_title: GAO Contacts and Acknowledgments
paragraphs: For further information regarding this testimony, please contact McCoy  Williams, Managing Director; and Gary Engel, Director; Financial  Management and Assurance at (202) 512-2600, as well as Susan Irving,  Director; Federal Budget Analysis, Strategic Issues at (202) 512-9142. Key  contributions to this testimony were also made by staff on the  Consolidated Financial Statement audit team.
section_title: Appendix I: Material Weaknesses Contributing to Our Disclaimer of Opinion on the Accrual Basis Consolidated Financial Statements
paragraphs: The continuing material weaknesses discussed below contributed to our  disclaimer of opinion on the federal government’s accrual basis  consolidated financial statements. The federal government did not  maintain adequate systems or have sufficient reliable evidence to support  information reported in the accrual basis consolidated financial  statements, as described below.
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: Loans Receivable and Loan Guarantee Liabilities
paragraphs: Federal agencies that account for the majority of the reported balances for  direct loans and loan guarantee liabilities continue to have internal control  weaknesses related to their credit reform estimation and related financial  reporting processes. While progress in addressing these long-standing  weaknesses was reported by certain federal credit agencies, certain  deficiencies in the Department of Agriculture’s credit reform processes  contributed to its auditor being unable to obtain sufficient, appropriate  evidence to support related accounts. As such, for fiscal year 2007, we  have added this area to the list of material weaknesses contributing to our  disclaimer of opinion on the accrual basis consolidated financial  statements.
These issues and the complexities associated with estimating the costs of  lending activities significantly increase the risk that material  misstatements in agency and governmentwide financial statements could  occur and go undetected. Moreover, these weaknesses continue to  adversely affect the federal government’s ability to support annual budget  requests for federal lending programs, make future budgetary decisions,  manage program costs, and measure the performance of lending activities.
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 the past, 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. This year, the auditor’s report  on the financial statements that include the estimated military  postretirement health benefits liabilities had not been issued as of the date  of our audit report. 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, weaknesses in internal control supporting the process for  estimating environmental and disposal liabilities could result in  improperly stated liabilities as well as 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, if 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 weaknesses in reporting assets and  liabilities, material weaknesses 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 2007 and 2006, there was unreconciled disbursement activity,  including unreconciled differences between federal agencies’ and  Treasury’s 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. If disbursements are improperly  recorded, this could result in misstatements in the financial statements  and in certain data provided by federal agencies for inclusion in The  Budget of the United States Government (hereafter referred to as “the  President’s Budget”) concerning obligations and outlays.
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. 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 adequately perform the  required reconciliations for fiscal years 2007 and 2006. For these fiscal  years, based on trading partner information provided to Treasury via  agencies’ closing packages, 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 as of the end of the fiscal year. Based on  our analysis of the “Material Difference Reports” for fiscal year 2007, we  noted that a significant number of CFOs were unable to adequately explain  the differences with their trading partners or did not provide adequate  documentation to support responses. For both fiscal years 2007 and 2006,  amounts reported by federal agency trading partners for certain  intragovernmental accounts were not in agreement by significant amounts.  In addition, a significant number of CFOs cited differing accounting  methodologies, accounting errors, and timing differences for their material  differences with their trading partners. Some CFOs simply indicated that  they were unable to explain the differences with their trading partners  with no indication when the differences will be resolved. As a result of the  above, the federal government’s ability to determine the impact of these  differences on the amounts reported in the accrual basis consolidated  financial statements is significantly impaired.
section_title: Preparation of Consolidated Financial Statements
paragraphs: While further progress was demonstrated in fiscal year 2007, 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,  properly balanced, and in conformity with U.S. generally accepted  accounting principles (GAAP). In addition, as discussed in our scope  limitation section of our audit report, Treasury could not provide the final  fiscal year 2007 accrual basis consolidated financial statements and  adequate supporting documentation in time for us to complete all of our  planned auditing procedures. During our fiscal year 2007 audit, we found  the following:    Treasury has showed progress by demonstrating that amounts in the  Statement of Social Insurance were consistent with the underlying federal  agencies’ audited financial statements and that the Balance Sheet and the  Statement of Net Cost were consistent with federal agencies’ financial  statements prior to eliminating intragovernmental activity and balances.  However, Treasury’s process for compiling the consolidated financial  statements did not ensure that the information in the remaining three  principal financial statements and notes were fully consistent with the  underlying information in federal agencies’ audited financial statements  and other financial data.
At the federal agency level, for fiscal year 2007, auditors for many of the  CFO Act agencies reported material weaknesses or other significant  deficiencies regarding agencies’ financial reporting processes which, in  turn, could affect the preparation of the consolidated financial statements.  For example, auditors for several agencies reported that a significant  number of adjustments were required to prepare the agencies’ financial  statements. These and other auditors are also required to separately audit  financial information sent by the federal agencies to Treasury via a closing  package. In connection with preparing the consolidated financial  statements, Treasury had to create adjustments to correct significant  errors found in agencies’ audited closing package information.
To make the fiscal years 2007 and 2006 consolidated financial statements  balance, Treasury recorded net decreases of $6.7 billion and $11 billion,  respectively, to net operating cost on the Statement of Operations and  Changes in Net Position, which it labeled “Other – Unmatched  transactions and balances.” An additional net $2.5 billion and $10.4 billion  of unmatched transactions were recorded in the Statement of Net Cost for  fiscal years 2007 and 2006, respectively. Treasury is unable to fully identify  and quantify all components of these unreconciled activities.
The federal government could not demonstrate that it had fully identified  and reported all items needed to reconcile the operating results, which for  fiscal year 2007 showed a net operating cost of $275.5 billion, to the budget  results, which for the same period showed a unified budget deficit of  $162.8 billion.
Treasury’s elimination of certain intragovernmental activity and balances  continues to be impaired by the federal agencies’ problems in handling  their intragovernmental transactions. As previously discussed, amounts  reported for federal agency trading partners for certain intragovernmental  accounts were not in agreement by significant amounts. This resulted in  the need for intragovernmental elimination entries by Treasury that  recorded the net differences between trading partners as “Other –  Unmatched transactions and balances,” in order to force the Statements of  Operations and Changes in Net Position into balance. In addition,  differences in other intragovernmental accounts, primarily related to  transactions with the General Fund, have not been reconciled, still remain  unresolved, and total hundreds of billions of dollars. Therefore, the federal  government continues to be unable to determine the impact of  unreconciled intragovernmental activity and balances on the accrual basis  consolidated financial statements.
We have consistently reported that certain financial information required  by GAAP was not disclosed in the consolidated financial statements. In  2006, the Federal Accounting Standards Advisory Board issued a new  standard that eliminated or lessened the disclosure requirements for the  consolidated financial statements related to certain information that  Treasury had not been reporting. While Treasury made progress in  addressing some of the remaining omitted information, there continue to  be disclosures required by GAAP that are excluded from the consolidated  financial statements. Also, certain material weaknesses noted in this  report, for example, commitments and contingencies related to treaties  and other international agreements, preclude Treasury from determining if  a disclosure is required by GAAP in the consolidated financial statements  and us from determining if the omitted information is material. Further,  Treasury’s ability to report information in accordance with GAAP will also  remain impaired until federal agencies, such as DOD, can provide Treasury  with complete and reliable information required to be reported in the  consolidated financial statements.
Other internal control weaknesses existed in Treasury’s process for  preparing the consolidated financial statements, involving inadequate or  ineffective (1) documentation of certain policies and procedures;   (2) management reviews of adjustments and key iterations of the financial  statements, notes, and management discussion and analysis provided to  GAO for audit; (3) supporting documentation for certain adjustments  made to the consolidated financial statements; (4) processes for  monitoring the preparation of the consolidated financial statements; and  (5) spreadsheet controls.
The consolidated financial statements include financial information for the  executive, legislative, and judicial branches, to the extent that federal  agencies within those branches have provided Treasury such information.  However, as we have reported in past years, there continue to be  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 the excluded  financial information was immaterial.
As in previous years, Treasury did not have adequate systems and  personnel to address the magnitude of the fiscal year 2007 financial  reporting challenges it faced, such as weaknesses in Treasury’s process for  preparing the consolidated financial statements noted above. 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 help  ensure reliable financial reporting by the reporting date. In addition, the  federal government does not perform quarterly compilations at the  governmentwide level, which leads to almost all of the compilation effort  being performed during a condensed time period at the end of the year.
section_title: Components of the Budget Deficit
paragraphs: Both the Reconciliation of Net Operating Cost and Unified Budget Deficit  and Statement of Changes in Cash Balance from Unified Budget and Other  Activities report a budget deficit for fiscal years 2007 and 2006 of $162.8  billion and $247.7 billion, respectively. The budget deficit is calculated by  subtracting actual budget outlays (outlays) from actual budget receipts  (receipts).
For several years, we have been reporting material unreconciled  differences between the total net outlays reported in selected federal  agencies’ Statement of Budgetary Resources (SBR) and Treasury’s central  accounting records used to compute the budget deficit reported in the  consolidated financial statements. OMB and Treasury have continued to  work with federal agencies to reduce these material unreconciled  differences. However, billions of dollars of differences still exist in this  and other components of the deficit because the federal government does  not have effective processes and procedures for identifying, resolving, and  explaining material differences in the components of the deficit between  Treasury’s central accounting records and information reported in agency  financial statements and underlying agency financial information and  records. Until these differences are timely reconciled by the federal  government, their effect on the U.S. government’s consolidated financial  statements will be unknown.
In fiscal year 2007, we again noted that several agencies’ auditors reported  internal control weaknesses (1) affecting the agencies’ SBRs, and   (2) relating to monitoring, accounting, and reporting of budgetary  transactions. These weaknesses could affect the reporting and calculation  of the net outlay amounts in the agencies’ SBRs. In addition, such  weaknesses also affect the agencies’ ability to report reliable budgetary  information to Treasury and OMB and may affect the unified budget  outlays reported by Treasury in its Combined Statement of Receipts,  Outlays, and Balances, and certain amounts reported in the President’s  Budget.
section_title: Appendix II: Other Material Weaknesses
paragraphs: The federal government did not maintain effective internal control over  financial reporting (including safeguarding assets) and compliance with  significant laws and regulations as of September 30, 2007. In addition to  the material weaknesses discussed in appendix I that contributed to our  disclaimer of opinion on the accrual basis consolidated financial  statements, we found the following three other material weaknesses in  internal control.
subsections: section_title: Improper Payments
paragraphs: Although showing progress under OMB’s continuing leadership, agencies’  fiscal year 2007 reporting under the Improper Payments Information Act of  2002 (IPIA) does not reflect the full scope of improper payments. For  fiscal year 2007, federal agencies’ estimates of improper payments, based  on available information, totaled about $55 billion. The increase from the  prior year estimate of $41 billion was primarily attributable to a  component of the Medicaid program reporting improper payments for the  first time totaling about $13 billion for fiscal year 2007, which we view as a  positive step to improve transparency over the full magnitude of improper  payments.
Major challenges remain in meeting the goals of the act and ultimately  better ensuring the integrity of payments. For fiscal year 2007, four agency  auditors reported noncompliance issues with IPIA related to agencies’ risk  assessments, sampling methodologies, implementing corrective action  plans, and recovering improper payments. We also identified issues with  agencies’ risk assessments such as not completing risk assessments of all  programs and activities or not conducting annual reviews of any programs  and activities. OMB’s current guidance allows for annual risk assessments  to be conducted less often than annually (generally every 3 years) for  programs where baselines are already established, are in the process of  being measured, or are scheduled to be measured by an established date.  For fiscal year 2007, we noted that 4 agencies were implementing a 3-year  cycle for conducting risk assessments. Furthermore, select agencies have  not reported improper payment estimates for 14 risk-susceptible federal  programs with total program outlays of about $170 billion for fiscal year  2007. Lastly, we found that major management challenges and internal  control weaknesses continue to plague agency operations and programs  susceptible to significant improper payments. For example, in the  Department of Education’s fiscal year 2007 Performance and  Accountability Report, the Office of Inspector General reported that its  recent investigations continue to uncover problems, including inadequate  attention to improper payments and failure to identify and take corrective  action to detect and prevent fraudulent activities by grantees.
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. During fiscal year 2007, federal agencies did not  consistently implement effective controls to prevent, limit, or detect  unauthorized access to computing resources. Specifically, agencies did not  always (1) identify and authenticate users to prevent unauthorized access;  (2) enforce the principle of least privilege to ensure that authorized access  was necessary and appropriate; (3) apply encryption to protect sensitive  data on networks and portable devices; (4) log, audit, and monitor  security-relevant events; and (5) restrict physical access to information  assets. In addition, agencies did not consistently configure network  devices and services to prevent unauthorized access and ensure system  integrity, such as patching key servers and workstations in a timely  manner; assign incompatible duties to different individuals or groups so  that one individual does not control all aspects of a process or transaction;  and maintain or test continuity of operations plans for key information  systems. Such information security control weaknesses unnecessarily  increase the risk that the reliability and availability of data that are  recorded in or transmitted by federal financial management systems could  be compromised. 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  administration has taken important actions to improve information  security, such as issuing extensive guidance on information security and  requiring agencies to perform specific actions to protect certain personally  identifiable information. However, until agencies effectively and fully  implement agencywide information security programs, federal data and  systems, including financial information, will remain at risk.
section_title: Tax Collection Activities
paragraphs: During fiscal year 2007, material internal control weaknesses and systems  deficiencies continued 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 10 years. Due  to errors and delays in recording taxpayer information, payments, and  other activities, 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.  Moreover, the federal government did not have cost benefit information,  related cost-based performance measures, or a systematic process for  ensuring it is using its resources to maximize its ability to collect what is  owed and minimize the disbursements of improper tax refunds. 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.