Financial Audit: Material Weaknesses in Internal Control Continue to Impact Preparation of the Consolidated Financial Statements of the U.S. Government
Released: 2009-04-21T00:00:00

Letter

Scope and Methodology

As part of our audit of the fiscal years 2008 and 2007 CFS, we evaluated the federal government’s financial reporting procedures and related internal control. Also, we determined the status of corrective actions by Treasury and OMB to address open recommendations relating to the processes used to prepare the CFS detailed in our previous reports. In our audit report on the fiscal year 2008 CFS, which is included in the fiscal year 2008 Financial Report of the United States Government (Financial Report), we discussed the material weaknesses related to the federal government’s processes used to prepare the CFS. These material weaknesses contributed to our disclaimer of opinion on the accrual basis consolidated financial statements and also contributed to our adverse opinion on internal control. We performed sufficient audit procedures to provide the disclaimer of opinion on the accrual basis consolidated financial statements in accordance with U.S. generally accepted government auditing standards. This report provides the details of the material weaknesses identified during the fiscal year 2008 audit that relate to the processes used to prepare the CFS and our recommendations to correct these weaknesses, as well as the status of corrective actions by Treasury and OMB to address recommendations from previous 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 summarized in the Agency Comments and Our Evaluation section of this report. Treasury’s comments are reprinted in appendix II and are also summarized in the Agency Comments section.

Treatment of Intragovernmental Payroll Tax Amounts in Compiling the CFS

Treasury did not establish policies and procedures to provide assurance that federal agencies’ intragovernmental payroll tax amounts are identified and eliminated at the governmentwide level when compiling the CFS. Consolidated financial statements are intended to present the results of operations and financial position of all of the components that make up the reporting entity as if the entity were a single enterprise. Therefore, when preparing the CFS, Treasury should ensure that intragovernmental activity and balances between federal agencies are eliminated. Federal agencies, as well as other employers, are required to pay, among other taxes, a matching amount of Social Security and Medicare taxes for their employees (payroll taxes). Federal agencies’ payments of payroll taxes to the Internal Revenue Service represent intragovernmental transactions. If these amounts are not eliminated at the governmentwide level when compiling the CFS, revenues and expenses become overstated in the CFS. However, in disclosing the types of revenues included in the Statement of Operations and Changes in Net Position in the draft CFS, Treasury’s description stated that “individual income tax and tax withholdings include….payroll taxes collected from other agencies.” We inquired of Treasury as to why these amounts would be included in the CFS and not eliminated during the preparation process. Treasury subsequently deleted the language regarding the inclusion of federal agency payroll taxes from the CFS. However, Treasury was unable to provide any documentation demonstrating that these amounts were appropriately classified as intragovernmental transactions and eliminated from the CFS. Without adequate policies and procedures to accurately identify and eliminate intragovernmental payroll tax amounts in the process used to prepare the CFS, the federal government’s ability to determine the impact of these amounts on the CFS is impaired and, consequently, the CFS may be misstated.

Recommendation for Executive Action

We recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary to design, document, and implement policies and procedures to identify and eliminate intragovernmental payroll tax amounts at the governmentwide level when compiling the CFS.

Consistency and Accuracy of Key Sections of the Financial Report

Treasury, in coordination with OMB, did not take the steps necessary to help assure that certain key information related to significant financial events and conditions were consistent and accurately presented throughout the fiscal year 2008 Financial Report. Specifically, Treasury, in coordination with OMB, has not fully established an effective process for preparing and reviewing information included in the Management’s Discussion and Analysis (MD&A), and “The Federal Government’s Financial Health: A Citizen’s Guide to the Financial Report of the United States Government” (Citizen’s Guide) sections of the Financial Report. According to Statement of Federal Financial Accounting Standards No. 15, Management’s Discussion and Analysis, the MD&A should highlight key information and increase the understanding and usefulness of the Financial Report. Similarly, the Citizen’s Guide is intended to provide readers with a brief, high-level summary of key financial information from the Financial Report on our nation’s current fiscal condition and the long- term sustainability. Further, data presented in both the MD&A and Citizen’s Guide must be consistent with related data in the CFS.

Treasury, in coordination with OMB, performed certain procedures to prepare and review the MD&A and Citizen’s Guide. However, these procedures were not effective in helping assure that (1) information was consistently reported in the CFS and these related sections of the Financial Report and (2) information reported in the MD&A and Citizen’s Guide was consistent, complete, and accurate. During our comparison of information reported in draft versions of the MD&A and Citizen’s Guide with information reported in the fiscal year 2008 draft CFS, we identified (1) several inconsistencies and (2) numerous instances in which information was omitted from, or incorrectly reported in, these draft sections of the Financial Report that were not detected by Treasury’s review process. For example, information in the draft MD&A and Citizen’s Guide regarding certain federal actions for addressing the financial crisis was incomplete or incorrectly reported. In addition, the $339 billion change in veterans benefit liability in fiscal year 2008 reported in the draft CFS was incorrectly reported as $365 billion in the draft versions of the MD&A and Citizen’s Guide. We communicated our findings to Treasury officials who corrected the data presented in the MD&A and Citizen’s Guide sections of the final Financial Report. Without effective procedures for preparing and reviewing the MD&A and Citizen’s Guide to ensure that the information is complete, accurate, and consistent with the information reported in the CFS, Treasury is at risk that information provided in these key sections of the Financial Report will not be reliable.

A contributing factor to the reporting errors and inconsistencies we detected is that Treasury does not have documented procedures for preparing and reviewing the MD&A and Citizen’s Guide sections of the Financial Report in comparison with data presented in the CFS. As preparer of the Financial Report, Treasury management, in coordination with OMB, is responsible for developing and documenting detailed policies, procedures, and practices and for ensuring that internal control is built into and is an integral part of operations to ensure that information is consistent and accurate throughout the Financial Report. GAO’s Standards for Internal Control in the Federal Government calls for clear documentation of policies and procedures. Although, Treasury has documented policies and procedures used to compile the CFS in its Standard Operating Procedures (SOP) entitled “Preparing the Financial Report of the U.S. Government,” the SOP does not provide procedures for preparing and reviewing the MD&A and Citizen’s Guide—two key report sections providing information to the Congress and the public regarding the fiscal condition of the U.S. government—to help assure they are consistent and accurate in comparison with related information presented elsewhere in the Financial Report.

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, document, and implement processes and procedures for preparing and reviewing the MD&A and Citizen’s Guide sections of the Financial Report to help assure that information reported in these sections is complete, accurate, and consistent with related information reported elsewhere in the Financial Report.

Identifying Federal Entities Significant to the CFS

Treasury, in coordination with OMB, has not established and documented criteria for identifying which federal entities are significant to the CFS for purposes of verifying and validating the information submitted by federal entities for inclusion in the CFS. Treasury, through the Treasury Financial Manual (TFM), identified 35 significant federal agencies and entities, referred to as “verifying agencies.” Those agencies are required to perform a number of procedures to provide audit assurance over the information submitted to Treasury for the CFS. However, Treasury and OMB have not (1) established and documented criteria for designating federal entities as “verifying agencies” significant to the CFS, and (2) established policies and procedures for assessing and documenting, on an annual basis, which entities meet the criteria.

Treasury, in coordination with OMB, is required to prepare the CFS. According to the Federal Accounting Standards Advisory Board’s Statement of Federal Financial Accounting Concepts No. 4, Intended Audience and Qualitative Characteristics for the Consolidated Financial Report of the United States Government, the consolidated financial report should be a general purpose report that is aggregated from federal agencies’ and other federal entities’ financial reports. The TFM provides policies and procedures on how federal agencies are to provide their financial data to Treasury for consolidation.

In accordance with the TFM, verifying agencies are required to submit their financial data to Treasury using a Closing Package. The verifying agency’s Chief Financial Officer must certify the accuracy of the data in the Closing Package and have the Closing Package audited by the agency’s Inspector General. In addition, the Closing Package process requires verifying agencies to reclassify their audited financial statements to the Closing Package “special purpose financial statements.” Verifying agencies must also identify trading partners and enter certain financial statement notes. The special purpose financial statements are audited to obtain reasonable assurance about whether the financial statements are (1) free of material misstatements, (2) in conformity with accounting principles generally accepted in the United States, and (3) presented pursuant to the requirements of the TFM. Because the Closing Package process requires verifying agencies to verify and validate the information in the special purpose financial statements with their audited information and receive an audit opinion, Treasury is provided a level of assurance that it is compiling the CFS with audited financial information. All other federal entities that contribute financial information to the CFS are classified by Treasury as “nonverifying agencies.” Over 100 nonverifying federal agencies and entities submitted data for fiscal year 2008. Currently these entities are only required to submit adjusted trial balance data to Treasury instead of an audited Closing Package. Because of a lack of criteria for determining an entity’s significance to the CFS, it is unclear whether any of these “nonverifying agencies” should be classified as “verifying agencies.”

One of Treasury’s and OMB’s goals for preparing the CFS is to link the agencies’ audited financial statements to the CFS. To accomplish this goal, Treasury needs an appropriate level of assurance that it compiles the CFS using audited Closing Packages from the federal entities contributing the most significant amounts of financial information. However, without establishing the criteria for identifying federal entities as significant to the CFS and establishing related policies and procedures to assess, on an annual basis, which entities meet such criteria, Treasury and OMB cannot obtain this level of assurance.

Recommendations for Executive Action

We recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary, in coordination with the Controller of OMB, to (1) establish and document criteria to be used in identifying federal entities as significant to the CFS for purposes of obtaining assurance over the information being submitted by those entities for the CFS and (2) develop and implement policies and procedures for assessing and documenting, on an annual basis, which entities met such criteria. These actions will help provide Treasury and OMB with assurance that the information being used to prepare the CFS is consistent with the audited financial statements of the federal agencies, in all material respects.

Procedures for Reviewing the Statements of Net Cost

During fiscal year 2008, Treasury enhanced its SOP entitled “Preparing the Financial Report of the U.S. Government” to require an overall analysis of the consolidated numbers in the financial statements to include a review for reasonableness of changes from the prior year to the current year. However, because of a lack of details on the objectives of the analysis and the procedures to be performed, the overall analysis did not detect significant errors in amounts used to prepare the Statements of Net Cost (SNC).

Internal control should provide, among other things, reasonable assurance that financial reporting is reliable. GAO’s Standards for Internal Control in the Federal Government defines the minimum level of quality acceptable for internal control in the federal government and provides the standards against which internal control is to be evaluated. These standards state that internal controls should include, among other items, reviews by management at the functional or activity level.

Treasury categorizes and allocates costs in the SNC by agency. For example, most of the costs associated with pension and health benefits that are reported by the Office of Personnel Management (OPM) in its financial statements are allocated to the costs of OPM’s federal user agencies for governmentwide federal reporting purposes. Treasury uses head count figures reported by OPM in its Closing Package to perform the allocation of pension and health benefit costs across all user federal agencies. However, we found that Treasury did not detect a significant variance in head count between certain federal entities from 2007 to 2008, which resulted in significant errors in the draft SNC. Specifically, we found that, in fiscal year 2007, the head count used for the Department of Defense (DOD) was 497,724, and the head count used for “all other entities” was 92,566. In fiscal year 2008, we found that the head counts were erroneously reversed. The head count used for DOD was 95,157, while the head count used for “all other entities” was 495,673. Treasury’s review process and overall analysis did not detect this error. As a result, Treasury’s draft SNC understated DOD’s reported costs on the fiscal year 2008 SNC by approximately $10 billion and costs for the “all other entities” line item was equally overstated. Without sufficiently detailed procedures including guidance for performing the analysis and review of data used in the allocation process for compiling the SNC, significant errors could occur in the SNC and not be detected.

Recommendation for Executive Action

We reaffirm our recommendation that the Secretary of the Treasury direct the Fiscal Assistant Secretary to further enhance the SOP entitled “Standard Operating Procedures for Preparing the Financial Report of the U.S. Government” to better ensure that CFS compilation practices are proper, complete, and can be consistently applied, including detailed procedures for conducting reviews and documenting reasonableness of data used in the process for compiling the CFS.

Agency Comments and Our Evaluation

OMB Comments

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

Treasury Comments

In its April 15, 2009, written comments on a draft of this report, which are reprinted in appendix II, Treasury stated that it concurs with the new recommendations and expects to implement them by the end of fiscal year 2009. We will evaluate the actions taken to address our recommendations as part of our fiscal year 2009 CFS audit.

This report contains recommendations to the Secretary of the Treasury. 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 Oversight and 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 Chairman and Ranking Member of the Senate Committee on Homeland Security and Governmental Affairs and its Subcommittee on Federal Financial Management, Government Information, Federal Services, and International Security and the Chairman and Ranking Member of the House Committee on Oversight and Government Reform and its Subcommittee on Government Management, Organization, and Procurement. In addition, we are sending copies to the Fiscal Assistant Secretary of the Treasury, the Director of OMB, the Deputy Director for Management of OMB, and the Acting Controller of OMB’s Office of Federal Financial Management. 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 me (202) 512-3406 or engelg@gao.gov. Key contributors to this report are listed in appendix III.

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

This appendix includes the status of recommendations from the following six reports that were open at the beginning of our fiscal year 2008 audit: 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); 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); Financial Audit: Significant Internal Control Weaknesses Remain in Preparing the Consolidated Financial Statements of the U.S. Government, GAO-06-415 (Washington, D.C.: Apr. 21, 2006); Financial Audit: Significant Internal Control Weaknesses Remain in the Preparation of the Consolidated Financial Statements of the U.S. Government, GAO-07-805 (Washington, D.C.: July 23, 2007); and Financial Audit: Material Weaknesses in Internal Control over the Processes Used to Prepare the Consolidated Financial Statements of the U.S. Government, GAO-08-748 (Washington, D.C.: June 17, 2008).

Recommendations from these reports that were closed in prior years are not included in this appendix. This appendix includes the status of the 56 remaining open 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 or our assessment of the status of a recommendation. We will continue to monitor Treasury’s and OMB’s progress in addressing GAO’s recommendations.

Of the 56 recommendations relating to the processes used to prepare the consolidated financial statements of the U.S. government (CFS) that are listed in this appendix, 16 were closed and 40 remained open as of December 9, 2008, the date of our report on the audit of the fiscal year 2008 CFS.

Appendix II: Comments from the Department of the Treasury

Appendix III: GAO Contact and Staff Acknowledgments

GAO Contact

Acknowledgments

In addition to the above contact, the following individuals made key contributions to this report: Louise DiBenedetto, Assistant Director; Lynda Downing, Assistant Director; Cole Haase; Dragan Matic; Maria Morton; Thanomsri Piyapongroj; and Taya Tasse.