Financial Audit: Material Weaknesses in Internal Control over the Processes Used to Prepare the Consolidated Financial Statements of the U.S. Government
Released: 2008-06-17T00:00:00

Letter

Scope and Methodology

As part of our audit of the fiscal years 2007 and 2006 CFS, we evaluated the federal government’s financial reporting procedures and related internal control, and we followed up on the status of corrective actions taken by Treasury and OMB to address open recommendations relating to the processes used to prepare the CFS that were in our previous reports. In our audit report on the fiscal year 2007 CFS, which is included in the fiscal year 2007 Financial Report of the United States Government, 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 we identified in performing our fiscal year 2007 audit procedures related to the processes used to prepare the CFS and our recommendations to correct these weaknesses, as well as the status of corrective actions taken by Treasury and OMB to address recommendations in our 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 described in the Agency Comments section of this report. Treasury’s comments are reprinted in appendix II and are also described in the Agency Comments section.

Standard Operating Procedures for Preparing the CFS

Over the past several years, Treasury has developed and documented numerous standard operating procedures (SOP) for preparing the CFS, which have substantially addressed GAO’s recommendation for Treasury to develop and document policies and procedures for preparing the CFS. However, one of Treasury’s SOPs entitled “Standard Operating Procedures for Preparing the Financial Report of the U.S. Government” is incomplete. For example, certain steps Treasury performs to prepare the CFS are not documented in this SOP and, for the key practices that are documented, the SOP is unclear as to who is responsible for performing the procedures. In connection with its role as preparer of the CFS, Treasury management is responsible for developing and documenting detailed policies, procedures, and practices for preparing the CFS and ensuring that internal control is built into and is an integral part of the related process. GAO’s Standards for Internal Control in the Federal Government calls for clear documentation of policies and procedures. Without adequately documented policies and procedures, standards and practices may not be consistently followed or followed at all. This potential for inconsistency increases the risk that errors in the compilation process could go undetected and could result in an incomplete and inaccurate summarization of data within the CFS.

Recommendation for Executive Action

We recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary to enhance and fully document all practices referred to in the SOP entitled “Standard Operating Procedures for Preparing the Financial Report of the U.S. Government” to better ensure that practices are proper, complete, and can be consistently applied by staff members.

Conformity with GAAP

For many years, we have reported that Treasury had not established a formal process to ensure that the financial statements, related notes, stewardship information and supplemental information in the CFS were presented in conformity with GAAP. Over the past several years, Treasury has developed a formal process that has significantly improved its ability to timely identify GAAP requirements, modify its closing package requirements to obtain information needed, assess the effect of omitted disclosures, and document decisions reached and the rationale for such decisions. However, there continue to be some instances where disclosures are not presented in conformity with GAAP. A contributing factor to the continued instances of nonconformity with GAAP is that the process Treasury developed to compile the CFS does not include adequately documenting its (1) timely assessment of the relevance, usefulness, or materiality of information reported by the federal agencies for use at the governmentwide level, (2) consideration of relevant accounting standards other than those issued by FASAB, and (3) final decisions regarding the inclusion or exclusion of federal agencies’ disclosure information in the existing notes to the CFS.

As part of the process Treasury developed, it created a checklist containing FASAB requirements for use as a tool to help determine if disclosures in the CFS are in conformity with GAAP. Due to the way the checklist was designed, Treasury primarily used it as a planning tool to ensure that it requested in the closing package the data that Treasury would need from federal agencies to report in compliance with GAAP. Although this is a useful and important first step, we found that Treasury’s checklist was limited by its design and was not used by staff to help ensure that the published CFS was in conformity with GAAP in all material respects. As a result, the checklist did not adequately assist Treasury in ensuring that all GAAP required disclosures were adequately disclosed in the CFS or documenting why certain disclosures were excluded.

Recommendations for Executive Action

We recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary to enhance its checklist or design an alternative and use it to adequately and timely document Treasury’s (1) assessment of the relevance, usefulness, or materiality of information reported by the federal agencies for use at the governmentwide level; (2) consideration of relevant accounting standards other than those issued by FASAB; and (3) final decisions regarding the inclusion or exclusion of federal agencies’ disclosure information in the existing notes to the CFS.

Reconciling Distributed Offsetting Receipts

The federal government reports a unified budget deficit (budget deficit) in the Reconciliation of Net Operating Cost and the Unified Budget Deficit and in the Statement of Changes in Cash Balance from Unified Budget and Other Activities. The budget deficit is calculated by subtracting actual budget outlays from actual budget receipts. Budget outlays consist of federal agencies’ outlay amounts, that is, gross outlays net of offsetting collections and distributed offsetting receipts at the agency level, and undistributed offsetting receipts at the governmentwide level. Federal agencies also report net outlays in their SBRs. Both the net outlays as a component of the budget deficit reported in the CFS and as reported in the federal agencies’ SBRs should generally match the budget outlays reported in the Budget of the United States Government.

For several years, we have reported material unreconciled differences between the total net outlays reported in selected federal agencies’ SBRs and Treasury’s central accounting records used to compute the budget deficit reported in the CFS. OMB and Treasury have continued to work with federal agencies to reduce these material unreconciled differences. However, in fiscal year 2007, billions of dollars of unreconciled differences still existed in this and other components of the budget deficit. One way OMB has been working with federal agencies has been to require the agencies, beginning with the first quarter in fiscal year 2007, to submit to OMB an analysis and reconciliation, based on certain criteria, of any material differences between the federal agency’s quarterly unaudited SBR and the agency’s related quarterly Standard Form (SF) 133 Report on Budget Execution and Budgetary Resources (SBR to SF 133 reconciliations). Agencies’ SF 133s are submitted to Treasury and serve as the main source for the CFS budget reporting and reconciliation. Material unreconciled differences remained at the end of fiscal year 2007 between the agencies’ SBRs and their related SF 133s. OMB conducted further analysis on the agencies’ quarterly SBR to SF 133 reconciliations and determined that many of these differences related to the recording of distributed offsetting receipts. Although distributed offsetting receipts are included in the net outlay calculation in federal agencies’ SBRs, as well as in the computation of the budget deficit in the CFS, they are not included as part of the SF 133s, and as such are not being identified and addressed by the agencies in the quarterly reconciliation process.

OMB is aware that the reporting of distributed offsetting receipts contributes to many of the material differences in net outlays and is currently determining how to reconcile distributed offsetting receipts included in the net outlay calculation of federal agencies’ SBRs and the amounts included in the computation of the budget deficit in the CFS. Until the federal government has effective processes and procedures in place for identifying and resolving material differences between the total net outlays reported in federal agencies’ SBRs and the records used to prepare the CFS, the actual extent of such differences and their effect on the CFS will be unknown.

Recommendation for Executive Action

We recommend that the Director of OMB direct the Controller of OMB’s Office of Federal Financial Management, in coordination with Treasury’s Fiscal Assistant Secretary, to develop formal processes and procedures for identifying and resolving any material differences in distributed offsetting receipt amounts included in the net outlay calculation of federal agencies’ SBRs and the amounts included in the computation of the budget deficit in the CFS.

Control over Spreadsheets Used to Prepare the CFS

Treasury developed the Governmentwide Financial Report System (GFRS) to collect federal agencies’ audited financial statement information to prepare the CFS. Federal agencies enter their audited financial information into GFRS, and Treasury exports the data into a database and then into various spreadsheets in order to compile the CFS. Treasury did not maintain adequate control over the spreadsheets used to summarize and array financial data for presentation in the CFS. Specifically, Treasury’s processes and procedures for management and control of the spreadsheets were largely undocumented. In addition, Treasury had not established adequate controls to ensure that certain key spreadsheets were (1) protected from inadvertent change and (2) documented to facilitate detection and tracking of changes to key formulas and data. Further, the column headings within many spreadsheets were either not labeled or the labels were not aligned with the data contained in the column. GAO’s Standards for Internal Control in the Federal Government calls for controls to be in place to safeguard financial information and help reduce the risk of errors, misuse, or unauthorized alteration. In addition, vendor documentation also provides guidance on maintaining and protecting spreadsheet integrity. OMB Circular No. A-127 requires that appropriate internal control be applied to all financial management system inputs, processing, and output. It also requires that financial management systems and associated instructions for maintenance and use be clearly documented in sufficient detail to permit an individual with appropriate background knowledge to obtain a comprehensive understanding of the entire operation of the system. Inadequate spreadsheet controls increase Treasury’s risk that its financial reporting data will be inaccurate, and that these inaccuracies will not be prevented or detected in a timely manner.

Recommendations for Executive Action

We recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary to establish effective internal control to ensure the spreadsheets used to compile the CFS are (1) protected from inadvertent change and (2) documented to facilitate detection and tracking of changes to key formulas and data. Further, we recommend that columns within key spreadsheets be labeled and properly aligned to reflect the data contained within.

Monitoring Internal Control over the CFS Preparation Process

Treasury, in coordination with OMB, has not established processes for monitoring and assessing the effectiveness of internal control over the processes used to prepare the CFS. According to OMB Circular No. A-123, management has a fundamental responsibility to develop and maintain effective internal control. Effective internal control provides reasonable assurance that significant weaknesses in the design or operation of internal control, that could adversely affect the entity’s ability to meet its objectives, would be prevented or detected in a timely manner. In addition, periodic reviews, reconciliations, or comparisons of data should be included as part of the regular assigned duties of personnel. Periodic assessments should be integrated as part of management’s continuous monitoring of internal control, which should be ingrained in the entity’s operations. If an effective continuous monitoring program is in place, it can leverage the resources needed to maintain effective internal controls throughout the year. In addition, 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. Without effective monitoring and assessment of internal control, there is a risk that errors in the compilation process could go undetected and could result in an incomplete and inaccurate summarization of data within the CFS.

Recommendation for Executive Action

We recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary, in coordination with the Controller of OMB’s Office of Federal Financial Management, to develop and implement effective processes for monitoring and assessing the effectiveness of internal control over the processes used to prepare the CFS.

Use of Interim Financial Information to Compile the CFS

As indicated in our most recent audit report on the CFS, and since fiscal year 2003, there have been limitations on the scope of our work that contribute to our disclaimer of opinion on the accrual basis consolidated financial statements. Since fiscal year 2003, Treasury and OMB began accelerating the time frame for preparation of the CFS. Consequently, GAO in turn has accelerated the time frame to issue our reports on the audits of the CFS.

For fiscal year 2007, we reported that Treasury was unable to provide the final accrual basis consolidated financial statements and certain supporting documentation in time for us to complete all of our planned auditing procedures related to the compilation of these financial statements. We also reported that personnel at Treasury’s Financial Management Service had excessive workloads that required an extraordinary amount of effort and dedication to compile the CFS and that quarterly compilations were not performed at the governmentwide level. This leads to almost all the compilation effort being performed during a condensed time period at the end of the year.

Federal agencies are required to produce unaudited quarterly financial statements and remit them to OMB; however, Treasury does not use these quarterly financial statements or request any other interim financial information that would enable it to perform some of the compilation effort before the end of the year. For example, if a federal agency changed the manner in which it was reporting certain information in its financial statements, by obtaining and utilizing the agency’s quarterly financial statements, Treasury would be aware of this change and could evaluate any effect this might have on the CFS during the year rather than during the condensed time period at the end of the year.

Until such time that interim financial information is obtained and utilized in some capacity to assist Treasury in overcoming the existing resource and time constraints, we believe that Treasury will continue to face significant challenges in being able to provide accrual basis consolidated financial statements and supporting documentation in time for us to complete our planned auditing procedures.

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’s Office of Federal Financial Management, to develop and implement alternative solutions to performing almost all of the compilation effort at the end of the year, including obtaining and utilizing interim financial information from federal agencies.

Agency Comments

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.

Treasury Comments

In written comments on a draft of this report, which are reprinted in appendix II, Treasury stated that it agrees with the new findings and related recommendations.

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 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 Chairmen and Ranking Members of the Senate Committee on Homeland Security and Governmental Affairs; the Subcommittee on Federal Financial Management, Government Information, Federal Services, and International Security, Senate Committee on Homeland Security and Governmental Affairs; the House Committee on Oversight and Government Reform; and the Subcommittee on Government Management, Organization, and Procurement, House Committee on Oversight and Government Reform. In addition, we are sending copies to the Fiscal Assistant Secretary of the Treasury, the Deputy Director for Management of OMB, and the Acting Controller of OMB’s Office of Federal Financial Management. 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 me on (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 recommendations that were open at the beginning of our fiscal year 2007 audit from five of our previous 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); 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); and 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).

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 or the status of a recommendation.

Of the 81 recommendations relating to the processes used to prepare the consolidated financial statements of the U.S. government (CFS) that are listed in this appendix, 35 were closed and 46 remained open as of December 10, 2007, the date of our report on the audit of the fiscal year 2007 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: Lynda Downing, Assistant Director; Mickie Gray; David Hayes; Sharon Kittrell; Dragan Matic; Maria Morton; and Taya Tasse.