Financial Audit: Significant Internal Control Weaknesses Remain in Preparing the Consolidated Financial Statements of the U.S. Government
Released: 2006-04-21T00:00:00

Letter

Scope and Methodology

As part of our audit of the fiscal years 2005 and 2004 CFS, we evaluated Treasury’s financial reporting procedures and related internal control, and we followed up on the status of Treasury and OMB corrective actions to address open recommendations regarding the process for preparing the CFS that were in our prior years’ reports. In our disclaimer of opinion on the fiscal year 2005 CFS, which is included in the fiscal year 2005 Financial Report of the United States Government, we discussed material deficiencies relating to Treasury’s preparation of the CFS. These material deficiencies contributed to our disclaimer of opinion on the CFS and also constitute a material weakness in internal control, which contributed to our adverse opinion on internal control. We performed sufficient audit procedures to provide the disclaimer of opinion in accordance with U.S. generally accepted government auditing standards. This report provides the details of the additional weaknesses we identified in performing our fiscal year 2005 audit procedures related to the process for preparing the CFS and our recommendations to correct those weaknesses, as well as the status of corrective actions taken by Treasury and OMB to address recommendations in our prior reports.

We requested comments on a draft of this report from the Director of OMB and the Secretary of the Treasury or their designees. OMB provided oral comments, which are discussed in the Agency Comments and Our Evaluation section of this report. Treasury’s comments are reprinted in appendix II and are also discussed in the Agency Comments and Our Evaluation section.

Directly Linking Audited Federal Agency Financial Statements to the CFS

As discussed in our fiscal year 2005 audit report, fiscal year 2005 was the second year that Treasury used GFRS to collect agency financial statement information taken directly from federal agencies’ audited financial statements. The goal of GFRS is to be able to directly link information from federal agencies’ audited financial statements to amounts reported in the consolidated financial statements and resolve many of the weaknesses we previously identified in the process for preparing the consolidated financial statements, a goal we strongly support. For both the fiscal year 2005 and 2004 reporting processes, GFRS was able to capture agency financial information submitted to Treasury, but GFRS is still under development and not at the stage that it could be used to fully compile the consolidated financial statements from the information captured.

As we have reported in the past, Treasury’s process for compiling the CFS does not yet fully ensure that financial information from federal agencies’ audited financial statements and other financial data directly link to amounts reported in the CFS. In our fiscal year 2005 audit report, we noted that Treasury made progress in demonstrating amounts in the Balance Sheet and the Statement of Net Cost were consistent with federal agencies’ audited financial statements prior to eliminating intragovernmental activity and balances. However, about 25 percent of the significant federal agencies’ auditors reported internal control weaknesses related to the processes the agencies perform to provide financial statement information to Treasury for preparing the consolidated financial statements.

In our prior report, we recommended that as Treasury continues to design and further implement its new process for compiling the CFS, the Secretary of the Treasury should direct the Fiscal Assistant Secretary, in coordination with the Controller of OMB, to modify Treasury’s closing package to (1) require federal agencies to directly link their audited financial statement notes to the CFS notes and (2) provide the necessary information to demonstrate that all of the five principal consolidated financial statements are consistent with the underlying information in federal agencies’ audited financial statements and other financial data.

Progress was made during fiscal year 2005. Treasury has been continuing to design and further implement its new process for compiling the CFS with the development of GFRS. We continue, though, to be concerned that the disciplined processes necessary to reduce risks to acceptable levels have not yet been effectively implemented. For example, Treasury moved forward with the project before ensuring that certain key elements, such as a concept of operations, were developed or even defining and documenting the financial reporting weaknesses that were expected to be addressed by the system. Not effectively implementing such disciplined processes creates an unnecessary risk that the system will cost more and take longer than expected to deploy, while not providing all of the intended system functionality. The implementation of any major system, such as GFRS, is not without risk; however, organizations that follow and effectively implement accepted best practices in systems development and implementation have been shown to reduce these risks to acceptable levels. A more detailed discussion of our assessment of Treasury’s ongoing effort to develop and implement GFRS, along with recommendations to reduce the risk noted above, can be found in a separate report.

Comparability of Financial Statements

The CFS includes 2 years of financial information. Because comparative financial statements are intended to furnish useful data about the differences in activity and balances between the 2 years shown, consistency in how amounts are reported for the 2 years is a major factor in creating comparability. We found that Treasury lacked a process to ensure that consolidated financial statements and notes for fiscal years 2005 and 2004 were consistently reported and therefore comparable. During fiscal year 2005, Treasury requested that agencies resubmit fiscal year 2004 financial information along with their fiscal year 2005 financial information. Some agencies resubmitted fiscal year 2004 amounts in fiscal year 2005 that differed from what Treasury published in fiscal year 2004. Also, certain information reported for fiscal 2004 may have required reclassification to be comparable to the fiscal year 2005 amounts. Treasury did not analyze the fiscal year 2004 information submitted in fiscal year 2005 or reclassify amounts within various financial statement line items and notes to achieve comparability and chose to continue to report what was published for fiscal year 2004. For example, the Reconciliations of Net Operating Cost and Unified Budget Deficit showed $47.8 billion and $.2 billion for property, plant, and equipment disposals and revaluations for fiscal years 2005 and 2004, respectively. However, based on the audited financial information provided by agencies to Treasury in GFRS in fiscal year 2005, the fiscal year 2004 amount should be $25.4 billion, rather than $.2 billion. The difference should have been reclassified from the Net Amount of All Other Differences line item on the Reconciliations of Net Operating Cost and Unified Budget Deficit.

Recommendation for Executive Action

We recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary to develop a process to help ensure that, for each reporting year, the 2 years of consolidated financial statements and note information presented are consistently and comparably reported, in all material respects.

Audit Assurance over Certain Federal Agencies’ Closing Packages

Treasury and OMB did not require closing packages from 4 of the 35 verifying agencies to be audited. Specifically, the Treasury Financial Manual (TFM) states that the Inspector General or a contracted independent public accountant for each federal verifying agency—except those agencies whose fiscal year ends on a date other than September 30— must opine on the closing package data entered by the Chief Financial Officer into GFRS. Because of these year-end differences, the TFM does not require the Federal Deposit Insurance Corporation’s Funds, National Credit Union Administration, and Farm Credit System Insurance Corporation—all of which have a year end other than September 30—to have their closing package data be audited. In addition, for fiscal years 2004 and 2005, OMB waived the closing package audit requirement for the Tennessee Valley Authority (TVA), which does have a September 30 fiscal year end. In these four cases, Treasury and OMB did not develop any alternative solutions that include the requirement for adequate audit procedures to be performed over significant information included in the CFS. As a result, unaudited September 30 information was included in the CFS for 4 agencies that Treasury and OMB consider to be significant. Treasury, therefore, has less assurance that the information included in the CFS for these agencies is fairly stated and directly links to the agencies’ audited financial statements.

Recommendation for Executive Action

We recommend that the Director of OMB direct the Controller of the Office of Federal Financial Management, in coordination with the Treasury Fiscal Assistant Secretary, to develop an alternative solution for obtaining audit assurance related to the Federal Deposit Insurance Corporation’s Funds, National Credit Union Administration, and Farm Credit System Insurance Corporation, which includes the requirement for adequate audit procedures to be performed over significant information included in the CFS for these agencies.

We also recommend that the Director of OMB direct the Controller of the Office of Federal Financial Management to consider not waiving the closing package audit requirement for any verifying agency in future years, such as TVA.

Internal Control Monitoring

GAO’s Standards for Internal Control in the Federal Government states that internal control is a major part of managing an organization and should include monitoring. Monitoring of internal control should include assessing the quality of performance over time and implementing policies and procedures for the timely follow-up and resolution of findings of audits and other reviews. The goal of these policies and procedures is to ensure that managers (1) promptly evaluate findings from audits and other reviews, including those showing deficiencies and recommendations reported by auditors and others who evaluate agencies’ operations; (2) determine proper actions in response to findings and recommendations from audits and reviews; and (3) complete, within established time frames, all actions that correct or otherwise resolve the matters brought to management’s attention. However, Treasury, in coordination with OMB, had not developed policies and procedures for monitoring internal control or provided us with adequate documentation evidencing an executable plan of action and milestones for short-term and long-range solutions for certain internal control weaknesses we have previously reported regarding the process for preparing the CFS. Without effective monitoring of internal control, findings of audits may not be resolved timely and properly.

Recommendation for Executive Action

We recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary, in coordination with the Controller of OMB, to develop policies and procedures for monitoring internal control to help ensure that (1) audit findings are promptly evaluated, (2) proper actions are determined in response to audit findings and recommendations such as a documented plan of action with milestones for short-term and long- range solutions, and (3) all actions that correct or otherwise resolve the audit findings are completed within established time frames; and an executable plan of action and milestones for short-term and long- range solutions for certain internal control weaknesses we have previously reported regarding the process for preparing the CFS.

Consolidated Reporting Guidance to Federal Agencies

The TFM prescribes how federal agencies are to submit financial information to Treasury to be used in compiling the CFS. While our planned audit procedures were not to review the entire TFM to determine if its guidance to agencies was clear, we found several areas where the TFM did not give clear guidance to federal agencies about the information that they were required to provide to Treasury, GAO, and OMB. Specifically, we found that the TFM did not give clear guidance for (1) reporting note disclosures for restricted cash, (2) reporting note disclosures for accounts payable, (3) preparing summaries of unadjusted misstatements to be included with federal agencies’ closing package management representation letters, and (4) certain information to be reported by OPM to Treasury that is used to allocate costs on the Statement of Net Cost. For example, the TFM defines restricted cash as “amounts of cash that an entity holds and does not have authority to spend” and cash that is not restricted as “amounts of cash that an entity holds for which it has the authority to spend.” Although these definitions are accurate at the agency level, these definitions are not accurate at the CFS level. For example, an agency may hold cash that it does not have the authority to spend because of a certain law or regulation, but when this cash is consolidated at the governmentwide level, the federal government as a whole may have the authority to spend the cash. Therefore, this cash would appropriately be restricted at the agency level, but not at the governmentwide level. As a result of the unclear guidance, agencies reported certain financial information inconsistently. This increases the risk of incomplete and inaccurate summarization of data in the CFS.

Recommendations for Executive Action

We recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary to ensure that the TFM and any other guidance to federal agencies provide clear instructions for providing reliable data to Treasury in the following specific areas: summaries of unadjusted misstatements, and certain information reported by OPM that is used to allocate costs on the Statement of Net Cost.

Reconciling of Intragovernmental Activity and Balances

OMB and Treasury require federal agencies to reconcile selected intragovernmental activity and balances with their “trading partners” and report on the extent and results of the reconciliation efforts to Treasury. As part of the reconciliation report, federal agencies were required to categorize any material differences, as determined by Treasury, with their trading partners at fiscal year end within five categories: (1) confirmed reporting; (2) accounting methodology differences; (3) accounting or reporting errors; (4) timing difference—current year, timing difference— prior year; and (5) unknown/unreconciled. According to Treasury, confirmed reporting, the first category listed above, is intended to indicate that the agency has verified that the amount it has reported is accurate. The TFM requires a federal agency that selects the category “confirmed reporting” to provide a detailed explanation to support its response.

However, we found that in many cases where a federal agency selected the “confirmed reporting” category, the agency did not provide detailed explanations. We also found cases where both trading partners selected “confirmed reporting” for the same material difference and the agencies did not provide detailed explanations for how both trading partners’ amounts could be accurate when the material difference remained. When this situation occurs, we found that Treasury and OMB do not have an effective process to obtain clarification for inconsistent explanations provided and that agencies may be unclear as to when to select this category. Incorrect use of the confirmed reporting category and lack of detailed explanations may hinder efforts to identify and correct problems that federal agencies are experiencing in reconciling with their trading partners.

Further, Treasury received the closing packages that contained each agency’s intragovernmental activity and balances amounts on November 18, 2005, and provided agencies with reconciliation reports that showed material differences with their trading partners on November 21, 2005. Treasury and OMB also require federal agencies’ IGs to annually perform agreed-upon procedures on the intragovernmental activity and balances reported in the closing package. For fiscal year 2005, Treasury required agency IGs for the 35 verifying agencies to complete and report on these agreed-upon procedures by December 2, 2005. The timing of these procedures did not optimize their value because (1) this reporting date is over 2 weeks after federal agencies’ audited financial statements were required to be issued to OMB, and (2) did not allow Treasury sufficient time to review the results and make any necessary adjustments to the CFS.

Recommendation for Executive Action

We recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary, working in coordination with the Controller of OMB, to provide clear guidance to federal agencies as to when the “confirmed reporting” category in the intragovernmental reconciliation report should be selected, develop an effective process for obtaining clarification from federal agencies for inconsistent or incomplete explanations provided in all material difference categories, and accelerate the due date for IGs to complete and report on the results of agreed-upon procedures on the intragovernmental activity and balances or develop an alternative solution that would allow Treasury sufficient time to review the results and make any necessary adjustments to the CFS.

Agency Comments and Our Evaluation

OMB Comments

In oral comments on a draft of this report, OMB stated that it generally agreed with the new findings and related recommendations in this report. In addition, OMB provided some technical comments, which we have incorporated as appropriate.

Treasury Comments

In written comments on a draft of this report, which are reprinted in appendix II, Treasury stated that it agrees that the preparation process still needs improvement and that it is addressing many of the recommendations in our previous reports. Treasury also stated that it concurs with all of the new recommendations in this report except for the recommendation to accelerate the due date for IGs to complete the agreed-upon procedures on the intragovernmental activity and balances. For fiscal year 2006, Treasury does not plan to accelerate the due date for completing these intragovernmental agreed-upon procedures. However, Treasury stated that for fiscal year 2006, it plans to expand the audit coverage for intragovernmental activity and balances by requiring the IGs to opine on such information in their audit of the closing package, which is due to Treasury by November 17, 2006. This is an appropriate alternative solution to accelerating the due date for the IGs to complete the intragovernmental agreed-upon procedures. We have modified our recommendation to also include developing an alternative solution to address this finding.

This report contains recommendations to the Secretary of the Treasury and the Director of OMB. The head of a federal agency is required by 31 U.S.C. 720 to submit a written statement on actions taken on these recommendations. You should submit your statement to the Senate Committee on Homeland Security and Governmental Affairs and the House Committee on Government Reform within 60 days of the date of this report. A written statement must also be sent to the House and Senate Committees on Appropriations with the agency’s first request for appropriations made more than 60 days after the date of the report.

We are sending copies of this report to the Chairmen and Ranking Minority Members of the Senate Committee on Homeland Security and Governmental Affairs; the Subcommittee on Federal Financial Management, Government Information, and International Security, Senate Committee on Homeland Security and Governmental Affairs; the House Committee on Government Reform; and the Subcommittee on Government Management, Finance, and Accountability, House Committee on Government Reform. In addition, we are sending copies to the Fiscal Assistant Secretary of the Treasury and the Deputy Director for Management of OMB. Copies will be made available to others upon request. This report is also available at no charge on GAO’s Web site at http://www.gao.gov.

We acknowledge and appreciate the cooperation and assistance provided by Treasury and OMB during our audit. If you or your staff have any questions or wish to discuss this report, please contact Jeffrey C. Steinhoff, Managing Director, Financial Management and Assurance, on (202) 512-2600, or Gary T. Engel, Director, Financial Management and Assurance, on (202) 512-3406. Staff contacts and other key contributors to this report are listed in appendix II.

Status of Treasury’s and OMB’s Progress in Addressing GAO’s Prior Year Recommendations for Preparing the CFS

This appendix includes open recommendations from three of our prior reports: Financial Audit: Process for Preparing the Consolidated Financial Statements of the U.S. Government Needs Improvement, GAO- 04-45 (Washington, D.C.: Oct. 30, 2003); Financial Audit: Process for Preparing the Consolidated Financial Statements of the U.S. Government Needs Further Improvement, GAO-04-866 (Washington, D.C.: Sept. 10, 2004); and Financial Audit: Process for Preparing the Consolidated Financial Statements of the U.S. Government Continues to Need Improvement, GAO-05-407 (Washington, D.C.: May 4, 2005). Recommendations that were closed in prior reports are not included in this appendix. This appendix includes the status of the recommendations according to the Department of the Treasury (Treasury) and the Office of Management and Budget (OMB) as well as our own assessments. Explanations are included in the status of recommendations per GAO when Treasury and OMB disagreed with our recommendation.

Of the 154 recommendations regarding the process for preparing the CFS that are listed in this appendix, 131 remained open as of December 2, 2005, the end of GAO’s fieldwork for the audit of the fiscal year 2005 CFS. Of these 131 recommendations, 76 relate to specific disclosures required under U.S. generally accepted accounting principles (GAAP). Treasury has submitted a proposal to the Federal Accounting Standards Advisory Board (FASAB) seeking to amend previously issued standards and eliminate or lessen the disclosure requirements for the consolidated financial statements so that GAAP would no longer require certain of the information Treasury has not been reporting. Comments on the exposure draft of a proposed FASAB standard, based on the Treasury proposal, are due March 1, 2006. Treasury stated that it is waiting for FASAB approval and issuance of this proposed standard to determine the disclosures that will be required in future consolidated financial statements.

Comments from the Department of the Treasury

GAO Comments

1. See “Agency Comments and Our Evaluation” section. 2. We continue to believe that our recommendations relating to the Statement of Changes in Cash Balance from Unified Budget and Other Activities, Reconciliations of Net Operating Cost and Unified Budget Deficit, and the adjustment process are sound. Our recommendations are intended to allow flexibility in developing viable solutions to address the issues. We will consider any alternative action that Treasury may take to satisfactorily address the recommendations with which it has disagreed. See appendix I for the status of related recommendations.

GAO Contacts and Staff Acknowledgments

GAO Contacts

Staff Acknowledgments

In addition to the above contact, the following individuals made key contributions to this report: Lynda Downing, Assistant Director; Keith Kronin; Katherine Schirano; and Taya Tasse.