Management Report: Improvements Needed in Controls over the Processes Used to Prepare the U.S. Consolidated Financial Statements
Released: 2019-09-04T00:00:00

Letter

Scope and Methodology

As part of our audit of the fiscal years 2018 and 2017 CFS, we considered the federal government’s financial reporting procedures and related internal control. Also, we determined the status of corrective actions Treasury and OMB have taken to address open recommendations relating to their processes to prepare the CFS, detailed in our previous reports that remained open as of the completion of our fiscal year 2017 audit. A full discussion of our scope and methodology is included in our March 2019 report on our audit of the fiscal years 2018 and 2017 CFS. We have communicated each of the control deficiencies discussed in this report to your staff. We performed our audit in accordance with U.S. generally accepted government auditing standards. We believe that our audit provides a reasonable basis for our findings and recommendations in this report.

Control Deficiencies Identified during Our Fiscal Year 2018 Audit

During our audit of the fiscal year 2018 CFS, we identified three new internal control deficiencies in Treasury’s processes used to prepare the CFS. Specifically, we found that (1) Treasury did not have sufficient procedures to analyze and determine whether appropriate disclosures related to new federal accounting standards were included in the draft fiscal year 2018 Financial Report; (2) Treasury did not have sufficient procedures to properly support and consistently report restatements, reclassifications, and adjustments to beginning net position reported in the draft fiscal year 2018 Financial Report; and (3) Treasury and OMB did not have adequate processes and procedures for reporting appropriate information regarding legal contingency losses in the fiscal year 2018 CFS.

New Federal Accounting Standards

During our fiscal year 2018 CFS audit, we found that Treasury did not have sufficient procedures to analyze and determine whether appropriate disclosures related to new federal accounting standards were included in the draft fiscal year 2018 Financial Report. Treasury uses working groups, disclosure checklists, and other tools to assist in determining appropriate reporting in accordance with new standards. Treasury’s procedures include working with federal entities during the fiscal year to determine the reporting required based on new standards. Treasury presents the new standards for discussion at monthly Central Reporting Team meetings that include financial reporting representatives from federal entities. Treasury also establishes working groups for certain new standards, such as the working group established for the Federal Accounting Standards Advisory Board’s (FASAB) Statement of Federal Financial Accounting Standards (SFFAS) 47, Reporting Entity, to work with federal entities on their implementation. Treasury also utilizes a financial reporting disclosure checklist to help determine that all disclosures required by FASAB standards are included in the CFS. Treasury updates this disclosure checklist throughout the fiscal year and completes the checklist as a key focus of the CFS compilation process.

Although Treasury has processes in place for the implementation of new standards, certain disclosures required by new standards were not included in the draft fiscal year 2018 Financial Report. For example, the draft fiscal year 2018 Financial Report did not include disclosures related to federal government land assets, such as the number of acres held at the end of each reporting period, explanations of federal entities’ election to include or exclude land and land rights from their opening balances, and a reference to the component reporting entity’s financial report, as required by SFFAS 50, Establishing Opening Balances for General Property, Plant, and Equipment. In addition, the draft fiscal year 2018 Financial Report did not include disclosures related to significant component entity amounts included in certain CFS line items that were determined in accordance with Financial Accounting Standards Board (FASB) standards rather than FASAB standards, in accordance with SFFAS 47. SFFAS 34, The Hierarchy of Generally Accepted Accounting Principles, Including the Application of Standards Issued by the Financial Accounting Standards Board, provides that general purpose federal financial reports prepared in conformity with accounting standards issued by FASB also may be regarded as in conformity with U.S. generally accepted auditing principles (U.S. GAAP). SFFAS 47 permits the consolidation of amounts determined in accordance with FASAB and FASB standards into a single line item without conversion for differences in accounting policies and also provides application guidance that emphasizes the need for disclosures of the different accounting policies and the related amounts to aid financial statement users’ understanding of the information provided.

Treasury’s disclosure checklist was not updated in sufficient detail for Treasury accountants to identify appropriate disclosures for inclusion in the draft fiscal year 2018 Financial Report in accordance with these new federal accounting standards. The updated disclosure checklist used for fiscal year 2018 did not include (1) specific details about disclosures required by SFFAS 50 for land assets, such as the number of acres added or disposed of during the reporting period, and (2) questions to help determine the need for disclosures to communicate the effect on certain CFS line items that include material amounts determined using accounting policies in accordance with FASB standards rather than FASAB standards, as SFFAS 47 allows. Also, Treasury did not calculate in aggregate the amounts that are reported in the CFS on a FASB basis by line item in order to determine line items where the disclosures were needed. We communicated these matters to Treasury officials, who conducted a comprehensive analysis and included disclosures in the final fiscal year 2018 Financial Report, as appropriate. In addition, although Treasury established a working group to help implement SFFAS 47, Treasury’s procedures did not provide for sufficient consultation with technical experts in interpreting new standards and updating the disclosure checklist to reasonably assure that all requirements related to the new standard were incorporated during implementation. Actively consulting with technical experts, such as members of FASAB, the body designated as the source of U.S. GAAP for federal reporting entities, would help minimize the risk of misinterpreting the standards or presenting and disclosing information in the Financial Report that is incorrect, inconsistent, or incomplete.

Standards for Internal Control in the Federal Government states that one of the key objectives of an organization’s internal control over financial reporting is to provide reasonable assurance as to the reliability of its financial reporting, including its financial statements and note disclosures. Accompanying notes are an integral part of financial statements and provide additional disclosures that are necessary to make the financial statements more informative.

Without sufficient procedures for analyzing and determining the appropriate reporting of disclosures required by new federal accounting standards, Treasury cannot reasonably assure that disclosures included in the Financial Report are reliable and complete.

Recommendation for Executive Action

We recommend that the Secretary of the Treasury should ensure that the Fiscal Assistant Secretary develops and implements procedures to enhance Treasury’s processes for reasonably assuring that the Financial Report includes disclosures required by new federal accounting standards, such as conducting an appropriate level of analysis to determine whether disclosures are needed, consulting with technical experts, and including additional details on these requirements in its financial reporting disclosure checklists. (Recommendation 1)

Restatements, Reclassifications, and Adjustments to Beginning Net Position

During our fiscal year 2018 CFS audit, we found that Treasury did not have sufficient procedures to properly support and consistently report restatements, reclassifications, and adjustments to beginning net position in the draft fiscal year 2018 Financial Report. Treasury identifies changes to prior year amounts (either restatements or reclassifications) and adjustments to current year beginning net position based on its review of information that significant component entities submit to Treasury and applicable FASAB standards. Treasury also performs procedures to determine the consistency of such reporting with significant component entities’ audited financial statements.

Treasury’s Subject Matter Analysis standard operating procedure includes steps for Treasury’s staff to obtain financial information from significant component entities and to prepare the draft Financial Report. According to these procedures, Treasury’s staff uses third quarter financial data that significant component entities report and other information to obtain a preliminary understanding of potential changes to prior year amounts and adjustments to beginning net position. Treasury’s staff compares these preliminary results to the entities’ year-end information and compares beginning net position amounts reported for the current year to ending net position amounts reported the prior year to identify changes to prior year amounts. The staff then prepares a table categorizing such changes as restatements, reclassifications, or adjustments to beginning net position. This table includes a separate line for each of the significant component entities but does not include separate lines for each line item or note disclosure affected. Treasury uses this table to prepare a summary analysis of its conclusions for reporting restatements, reclassifications, and adjustments to beginning net position and related note disclosures presented in the draft Financial Report. The subject area manager reviews the results of the procedures that Treasury’s staff performed and documented.

Although Treasury’s staff followed these procedures for fiscal year 2018, we found that Treasury did not always maintain sufficient support for restatements, reclassifications, and adjustments to beginning net position included in the draft fiscal year 2018 Financial Report. For example, Treasury reported an adjustment to beginning net position but did not identify errors made in prior years to support such an adjustment. Treasury also reported that restatements affected the Statement of Changes in Cash Balance from Budget and Other Activities, but supporting documentation provided by Treasury for the draft fiscal year 2018 Financial Report did not clearly indicate how this statement was affected by restatements. Treasury included a summary of significant accounting policies in Note 1 to the CFS as required by U.S. GAAP, which contained information about restatements, reclassifications, and adjustments to beginning net position. However, Treasury did not disclose consistent information in related line item notes, such as those for loans receivable and loan guarantee liabilities, federal employee and veteran benefits payable, and funds from dedicated collections in the draft fiscal year 2018 Financial Report. Treasury included information in its summary analysis and supporting documentation that was not consistent with information that significant component entities reported. Although Treasury’s processes did not identify these inconsistencies, Treasury corrected them in response to our questions.

We found that Treasury did not identify these inconsistencies, in part, because its subject matter review procedures did not include steps for coordinating with Treasury managers of other subject matter areas to reasonably assure consistency and appropriate support for conclusions. Also, although Treasury’s process involved preparing a summary of analyses performed, Treasury’s process did not include steps or other tools to reasonably assure that consistent information was communicated in all financial statement line items and note disclosures affected by restatements, reclassifications, and adjustments to net position.

SFFAS 21, Reporting of Corrections of Errors and Changes in Accounting Principles, requires that reporting entities restate prior period financial statements for material errors discovered in the current period, if such statements are provided for comparative purposes and if the effect of an error would be material to the financial statements in either period. If not material, corrections should be made to the beginning balance of cumulative results of operations in the statement of changes in net position. A reclassification is the movement of a prior year amount in comparative financial statements in order to conform to the current year presentation. Standards for Internal Control in the Federal Government states that management should (1) design control activities to achieve objectives and respond to risks, such as procedures to help reasonably assure that financial information is completely and accurately reported, and (2) implement control activities, such as documenting responsibilities through policies and procedures. Management should periodically review policies, procedures, and related control activities for continued relevance and effectiveness in achieving objectives.

Without sufficient procedures for reporting restatements, reclassifications, and adjustments to beginning net position, there is an increased risk of presenting information that is inaccurate or incomplete in the Financial Report.

Recommendations for Executive Action

We are making the following two recommendations to Treasury:

The Secretary of the Treasury should ensure that the Fiscal Assistant Secretary enhances existing procedures for Treasury management to perform additional reviews for restatements, reclassifications, and adjustments to beginning net position to reasonably assure that they are properly supported and accurately reported. (Recommendation 2)

The Secretary of the Treasury should ensure that the Fiscal Assistant Secretary develops and implements steps to reasonably assure that restatements, reclassifications, and adjustments to beginning net position are consistently reported in the Financial Report, such as developing a tool that identifies all affected financial statement line items and note disclosures. (Recommendation 3)

Contingencies for Legal Representation Letters

During our fiscal year 2018 CFS audit, we found that Treasury and OMB did not have adequate processes and procedures for reporting appropriate information regarding legal contingency losses in the fiscal year 2018 CFS. Significant component entities are responsible for properly accounting for and reporting legal contingency losses in their entity-level financial statements and submitting this information to Treasury for inclusion in the CFS. For each entity-level financial statement audit, U.S. generally accepted government auditing standards require that component entity auditors obtain written legal representations as part of the audit. The significant component entities provide interim and final legal representation letters, along with management schedules, to Treasury, the Department of Justice (DOJ), and GAO.

According to DOJ’s established process, its legal counsel reviews individual cases included in these legal representation letters for which the potential loss exceeds $500 million individually or in the aggregate for similar cases. DOJ is responsible for preparing and submitting an interim and final government-wide legal representation letter to Treasury and GAO, containing its assessment of the potential litigation losses, including whether there are litigation, claims, or assessments that were not addressed in the significant component entities’ legal representation letters that DOJ believes should have been reported or which DOJ believes should have been reported differently.

Treasury’s procedures call for it to determine whether the financial statement information that the significant component entities submitted and Treasury used to compile the fiscal year 2018 CFS is consistent with the significant component entities’ management schedules, legal representation letters, and the government-wide legal representation letter. For fiscal year 2018, Treasury identified various inconsistencies among the significant component entities’ financial statement information, management schedules, and legal representation letters as well as inconsistencies between the government-wide legal representation letter and the significant component entities’ management schedules and legal representation letters. There may be appropriate reasons for these differences. For example, although management often relies on advice of legal counsel on the likelihood of loss and estimate of the amount or range of potential loss, as reflected in the legal representation letter, management is ultimately responsible for determining whether the loss should be recognized as a liability or disclosed in the notes to the financial statements. As such, management may make a different determination as to the likelihood of loss or estimated loss amounts than those in the legal counsel’s assessment. Also, differences between the government-wide legal representation letter and the significant component entities’ legal representation letters can occur in situations in which DOJ has more current information on the likelihood of loss and estimated loss amounts.

However, Treasury was not always able to timely determine whether there were appropriate reasons for the differences it identified or whether adjustments were needed to the legal contingency loss information reported in the fiscal year 2018 CFS. Based on our work, we found that certain of these differences required correction in the fiscal year 2018 CFS. For example, Treasury noted that one significant component entity included estimated loss amounts for reasonably possible cases in its management schedule and that such amounts were not reported in the financial information provided to Treasury for consolidation. Because Treasury was unable to timely resolve the issue, the fiscal year 2018 CFS was not appropriately adjusted to include these amounts. Further, DOJ did not provide us the final government-wide legal representation letter as of our audit completion date.

Although Treasury has procedures for reviewing and analyzing the significant component entities’ legal contingency loss information and the government-wide legal representation letter, we found that Treasury lacked effective processes and procedures to reasonably assure that appropriate information regarding legal contingency losses was reported in the fiscal year 2018 CFS. Specifically, Treasury did not have sufficient processes and procedures to obtain the needed information in a manner that would facilitate the timely compilation of the legal contingency loss information for inclusion in the fiscal year 2018 CFS or for timely resolving issues identified during its review. For example, as part of Treasury’s procedures, it compares the estimated loss amounts for reasonably possible and probable cases included in the significant component entities’ management schedules with the financial statement information that the significant component entities report for inclusion in the fiscal year 2018 CFS. If discrepancies are greater than 10 percent, Treasury’s procedures call for significant component entities to provide an explanation. However, because of the extensive amount of time needed to perform this analysis, Treasury was not always able to timely follow up and resolve the differences with the significant component entities.

SFFAS 5, Accounting for Liabilities of The Federal Government, as amended by SFFAS 12, Recognition of Contingent Liabilities Arising from Litigation, contains accounting and reporting standards for loss contingencies, including those arising from litigation, claims, and assessments. An entity should recognize a liability and a related charge to expense for an estimated loss from a loss contingency only when (1) a past event or exchange transaction has occurred, (2) a future outflow or other sacrifice of resources is probable, and (3) the future outflow or sacrifice of resources is measurable. A contingent liability should be disclosed if any of the conditions for liability recognition are not met and there is at least a reasonable possibility that a loss or an additional loss may have been incurred. Disclosure should include the nature of the contingency and an estimate of the possible liability, an estimate of the range of possible liability, or a statement that such an estimate cannot be made. OMB Bulletin 19-01 provides guidance to federal agencies on the preparation of legal letters and management schedules, and the Treasury Financial Manual provides federal agencies the legal letter reporting requirements. Also, Standards for Internal Control in the Federal Government provides that management should design control activities to achieve objectives and respond to risks. For example, management should design control activities so that financial information is completely and accurately reported.

Until the federal government implements effective processes and procedures to obtain and assess information regarding legal contingency losses, the reliability of amounts and disclosures associated with legal loss contingencies reported in the CFS and the ability to assess their potential effect on the financial condition of the federal government will be limited.

Recommendation for Executive Action

We recommend that the Secretary of the Treasury should ensure that the Fiscal Assistant Secretary, working in coordination with the Controller of OMB, establishes effective processes and procedures to reasonably assure that appropriate information regarding legal contingency losses is reported in the CFS. (Recommendation 4)

Status of Recommendations from Prior Reports

At the completion of our fiscal year 2017 audit, 14 recommendations were open from our prior reports regarding control deficiencies in the processes used to prepare the CFS. During our fiscal year 2018 CFS audit, we found that Treasury, in coordination with OMB, implemented corrective actions that resulted in significant progress in resolving certain of the control deficiencies addressed by our prior recommendations. For two recommendations, the corrective actions resolved the related control deficiencies, and we closed the recommendations.

While progress was made, 12 recommendations from our prior reports remained open as of March 20, 2019, the date of our report on the audit of the fiscal year 2018 CFS. These continuing control deficiencies contributed to the three material weaknesses that relate to the federal government’s processes used to prepare the CFS. Consequently, a total of 16 recommendations need to be addressed—12 remaining from prior reports and the four new recommendations we are making in this report.

Appendix I summarizes the status as of March 20, 2019, of the 14 open recommendations from our prior years’ reports according to Treasury and OMB, as well as our own assessment and additional comments, where appropriate. Various efforts are under way to address these recommendations. As part of our fiscal year 2019 CFS audit, we will continue to monitor Treasury’s and OMB’s progress in addressing our recommendations.

Agency Comments and Our Evaluation

Treasury Comments

We provided a draft of this report to Treasury for comment. In its written comments, reproduced in appendix II, Treasury concurred with our four new recommendations. Treasury agreed that new processes and procedures would enhance its internal controls over the processes used to prepare the CFS. It also described actions it will take, and has taken, to address these recommendations as well as certain open recommendations from our prior reports that are summarized in appendix I of this report. Treasury also provided technical comments, which we incorporated as appropriate.

Treasury stated that it implemented process improvements that addressed three of the new recommendations, which resulted from our review of the draft fiscal year 2018 Financial Report, prior to the publication of the final report. These three recommendations are aimed at enhancing Treasury’s processes related to (1) including appropriate disclosures required by new federal accounting standards in the Financial Report and (2) supporting and consistently reporting restatements, reclassifications, and adjustments to beginning net position. In our report, we acknowledged that Treasury addressed the need for certain additional disclosures related to new federal accounting standards and inconsistencies related to restatements, reclassifications, and adjustments to beginning net position in the final fiscal year 2018 Financial Report. However, addressing the specific issues we identified in the draft fiscal year 2018 Financial Report does not fully address our recommendations and Treasury did not provide sufficient documentation supporting its efforts to develop and implement or enhance procedures or other steps to reasonably assure that the Financial Report is complete and accurate related to these areas. Treasury also stated that it will work on addressing the remaining recommendation.

Regarding five open recommendations from our prior year reports related to treaties and other international agreements, Treasury stated that its existing controls provide reasonable assurance that there are no material misstatements in the Financial Report and that it worked with federal entities in fiscal year 2018 to obtain reasonable assurance that proper amounts and disclosures are reported as commitments and contingencies. As noted in appendix I, Treasury established three broad categories to help agencies in classifying treaties and other international agreements with respect to their potential financial implications. The establishment of three standard categories provides some guidance for identifying and reporting treaties and other international agreements; however, as stated in appendix I, we continue to believe further guidance is needed to determine whether additional disclosure in the CFS is required by U.S. GAAP. The guidance should be consistent with FASAB standards and provide procedures for identifying and assessing all treaties and other international agreements for potential contingencies.

Treasury also stated that its efforts to validate the material completeness of budgetary information included in the Financial Report and verify the consistency of such information with federal entity reports are sufficient to address the two open recommendations from our prior year reports related to the Reconciliations of Net Operating Cost and Budget Deficit and the Statements of Changes in Cash Balance from Budget and Other Activities (Reconciliation Statements). As noted in appendix I, Treasury has improved its process by documenting its detailed analyses related to the accrual-based and cash-based effects of federal entities’ transactions included in net operating cost and the budget deficit and by continuing to identify items needed to prepare the Reconciliation Statements. However, as noted in appendix I, we continue to believe additional work is needed to (1) reconcile line items to audited federal entity financial statements and (2) determine the appropriate presentation for the reconciling items, which could affect the line items included.

Treasury stated that it appreciates our perspective and will continue to focus its efforts on cost-beneficial solutions to resolve the material conditions that preclude having an opinion rendered on the CFS. Treasury also indicated that it plans to work with GAO as it fulfills its commitment to improving federal financial reporting. As part of our fiscal year 2019 CFS audit, we will determine the status of corrective actions to address the four new recommendations made in this report and the 12 remaining open recommendations from our prior year reports.

OMB Comments

We provided a draft of this report to OMB for comment. In oral comments, OMB staff in the Office of Federal Financial Management stated that OMB generally agreed with the draft report and Treasury’s written response. OMB noted that the current administration is committed to continuing to work with Treasury and federal agencies to achieve sound financial management across the federal government.

This report contains three recommendations to the Secretary of the Treasury and one recommendation to the Secretary of the Treasury, working in coordination with the Controller of OMB. The head of a federal entity is required by 31 U.S.C. § 720, to submit a written statement on actions taken or planned on our recommendations to the Senate Committee on Homeland Security and Governmental Affairs and to the House Committee on Oversight and Reform, the congressional committees with jurisdiction over the programs and activities that are the subject of our recommendations, and GAO not later than 180 days after the date of this report. A written statement must also be sent to the Senate and House Committees on Appropriations with the entity’s first request for appropriations made more than 180 days after the date of this report. Please send your statement of actions to me at simpsondb@gao.gov.

We are sending copies of this report to appropriate congressional committees, the Fiscal Assistant Secretary of the Treasury, the Controller of the Office of Management and Budget’s Office of Federal Financial Management, and other interested parties. In addition, the report is available at no charge on the GAO website at http://www.gao.gov/.

We acknowledge and appreciate the cooperation and assistance that Treasury and OMB staff members provided during our audit. If you or your staffs have any questions or wish to discuss this report, please contact me at (202) 512-3406 or simpsondb@gao.gov. Contacts points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff members who made major contributions to this report are listed in appendix III.

Appendix I: Status of GAO’s Prior Recommendations Related to the Processes Used to Prepare the CFS

Table 1 shows the status of GAO’s prior year recommendations related to the processes used to prepare the consolidated financial statements of the U.S. government. The abbreviations used are defined in the legend at the end of the table.

Appendix II: Comments from the Department of the Treasury

Appendix III: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact named above, the following individuals made major contributions to this report: Carolyn M. Voltz and Paul F. Foderaro (Assistant Directors), LaTasha L. Freeman (Auditor-in-Charge), Youssef R. Amrani, Maria Hasan, W. Stephen Lowrey, Fabian J. Mendive, Maria M. Morton, and Kristine A. Papa.