The Schedules of Federal Debt including the accompanying notes present fairly, in all material respects, in conformity with U.S. generally accepted accounting principles, the balances as of September 30, 2004, 2003, and 2002, for Federal Debt Managed by BPD; the related Accrued Interest Payables and Net Unamortized Premiums and Discounts; and the related increases and decreases for the fiscal years ended September 30, 2004 and 2003. BPD maintained, in all material respects, effective internal control relevant to the Schedule of Federal Debt related to financial reporting and compliance with applicable laws and regulations as of September 30, 2004, that provided reasonable assurance that misstatements, losses, or noncompliance material in relation to the Schedule of Federal Debt would be prevented or detected on a timely basis. Our opinion is based on criteria established under 31 U.S.C. SS 3512 (c), (d) (commonly referred to as the Federal Managers' Financial Integrity Act) and the Office of Management and Budget (OMB) Circular A-123, revised June 21, 1995, Management Accountability and Control. We found matters involving information security controls that we do not consider to be reportable conditions. We will communicate these matters to BPD's management, along with our recommendations for improvement, in a separate letter to be issued at a later date. Our tests for compliance in fiscal year 2004 with the statutory debt limit disclosed no instances of noncompliance that would be reportable under U.S. generally accepted government auditing standards or OMB audit guidance. However, the objective of our audit of the Schedule of Federal Debt for the fiscal year ended September 30, 2004, was not to provide an opinion on overall compliance with laws and regulations. Accordingly, we do not express such an opinion. BPD's Overview on Federal Debt Managed by the Bureau of the Public Debt contains information, some of which is not directly related to the Schedules of Federal Debt. We do not express an opinion on this information. However, we compared this information for consistency with the schedules and discussed the methods of measurement and presentation with BPD officials. Based on this limited work, we found no material inconsistencies with the schedules. Management is responsible for the following: preparing the Schedules of Federal Debt in conformity with U.S. generally accepted accounting principles; establishing, maintaining, and assessing internal control to provide reasonable assurance that the broad control objectives of the Federal Managers' Financial Integrity Act are met; and complying with applicable laws and regulations. We are responsible for obtaining reasonable assurance about whether (1) the Schedules of Federal Debt are presented fairly, in all material respects, in conformity with U.S. generally accepted accounting principles and (2) management maintained effective related internal control as of September 30, 2004, the objectives of which are the following: Financial reporting: Transactions are properly recorded, processed, and summarized to permit the preparation of the Schedule of Federal Debt for the fiscal year ended September 30, 2004, in conformity with U.S. generally accepted accounting principles. Compliance with laws and regulations: Transactions related to the Schedule of Federal Debt for the fiscal year ended September 30, 2004, are executed in accordance with laws governing the use of budget authority and with other laws and regulations that could have a direct and material effect on the Schedule of Federal Debt. We are also responsible for testing compliance with selected provisions of laws and regulations that have a direct and material effect on the Schedule of Federal Debt. Further, we are responsible for performing limited procedures with respect to certain other information appearing with the Schedules of Federal Debt. In order to fulfill these responsibilities, we examined, on a test basis, evidence supporting the amounts and disclosures in the Schedules of Federal Debt; assessed the accounting principles used and any significant estimates evaluated the overall presentation of the Schedules of Federal Debt; obtained an understanding of internal control relevant to the Schedule of Federal Debt as of September 30, 2004, related to financial reporting and compliance with laws and regulations (including execution of transactions in accordance with budget authority); tested relevant internal controls over financial reporting and compliance, and evaluated the design and operating effectiveness of internal control related to the Schedule of Federal Debt as of September 30, 2004; considered the process for evaluating and reporting on internal control and financial management systems under the Federal Managers' Financial Integrity Act; and tested compliance in fiscal year 2004 with the statutory debt limit (31 U.S.C. SS 3101(b), as amended by Pub. L. No. 107-199, SS 1, 116 Stat. 734 (2002) and Pub. L. No. 108-24, 117 Stat. 710 (2003)). We did not evaluate all internal controls relevant to operating objectives as broadly described by the Federal Managers' Financial Integrity Act, such as those controls relevant to preparing statistical reports and ensuring efficient operations. We limited our internal control testing to controls over financial reporting and compliance. Because of inherent limitations in internal control, misstatements due to error or fraud, losses, or noncompliance may nevertheless occur and not be detected. We also caution that projecting our evaluation to future periods is subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with controls may deteriorate. We did not test compliance with all laws and regulations applicable to BPD. We limited our tests of compliance to a selected provision of a law that has a direct and material effect on the Schedule of Federal Debt for the fiscal year ended September 30, 2004. We caution that noncompliance may occur and not be detected by these tests and that such testing may not be sufficient for other purposes. We performed our work in accordance with U.S. generally accepted government auditing standards and applicable OMB audit guidance. In commenting on a draft of this report, BPD concurred with the facts and conclusions in our report. The comments are reprinted in appendix I. Federal debt managed by the Bureau of the Public Debt comprises debt held by the public and debt held by certain federal government accounts, the latter of which is referred to as intragovernmental debt holdings. As of September 30, 2004 and 2003, outstanding gross federal debt managed by the bureau totaled $7,379 and $6,783 billion, respectively. The increase in gross federal debt of $596 billion during fiscal year 2004 was due to an increase in gross intragovernmental debt holdings of $213 billion and an increase in gross debt held by the public of $383 billion. As Figure 1 illustrates, intragovernmental debt holdings have steadily increased since fiscal year 2000 and debt held by the public decreased in fiscal year 2001, but increased in fiscal years 2002 through 2004. The primary reason for the increases in intragovernmental debt holdings is the annual surpluses in the Federal Old-Age and Survivors Insurance Trust Fund, Civil Service Retirement and Disability Trust Fund, Federal Hospital Insurance Trust Fund, Federal Disability Insurance Trust Fund, and Military Retirement Fund. The fiscal years 2002 through 2004 increases in debt held by the public are due primarily to total federal spending exceeding total federal revenues. As of September 30, 2004, gross debt held by the public totaled $4,307 billion and gross intragovernmental debt holdings totaled $3,072 billion. Total Gross Federal Debt Outstanding (in billions) Interest expense incurred during fiscal year 2004 consists of (1) interest accrued and paid on debt held by the public or credited to accounts holding intragovernmental debt during the fiscal year, (2) interest accrued during the fiscal year, but not yet paid on debt held by the public or credited to accounts holding intragovernmental debt, and (3) net amortization of premiums and discounts. The primary components of interest expense are interest paid on the debt held by the public and interest credited to federal government trust funds and other federal government accounts that hold Treasury securities. The interest paid on the debt held by the public affects the current spending of the federal government and represents the burden in servicing its debt (i.e., payments to outside creditors). Interest credited to federal government trust funds and other federal government accounts, on the other hand, does not result in an immediate outlay of the federal government because one part of the government pays the interest and another part receives it. However, this interest represents a claim on future budgetary resources and hence an obligation on future taxpayers. This interest, when reinvested by the trust funds and other federal government accounts, is included in the programs' excess funds not currently needed in operations, which are invested in federal securities. During fiscal year 2004, interest expense incurred totaled $322 billion, interest expense on debt held by the public was $158 billion, and $164 billion was interest incurred for intragovernmental debt holdings. As Figure 2 illustrates, total interest expense decreased each year from fiscal year 2001 through 2003, but increased in fiscal year 2004. Average interest rates on principal balances outstanding as of fiscal year end are disclosed in the Notes to the Schedules of Federal Debt. (in billions) Debt held by the public reflects how much of the nation's wealth has been absorbed by the federal government to finance prior federal spending in excess of total federal revenues. As of September 30, 2004 and 2003, gross debt held by the public totaled $4,307 billion and $3,924 billion, respectively (see Figure 1), an increase of $383 billion. The borrowings and repayments of debt held by the public increased from fiscal year 2003 to 2004 primarily due to Treasury's decision to finance current operations using more short-term securities. As of September 30, 2004, $3,846 billion, or 89 percent, of the securities that constitute debt held by the public were marketable, meaning that once the government issues them, they can be resold by whoever owns them. Marketable debt is made up of Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation-Protected Securities (TIPS) with maturity dates ranging from less than 1 year out to 30 years. Of the marketable securities currently held by the public as of September 30, 2004, $2,576 billion or 67 percent will mature within the next 4 years (see Figure 3). As of September 30, 2004 and 2003, notes and TIPS held by the public maturing within the next 10 years totaled $2,274 billion and $1,919 billion, respectively, an increase of $355 billion. The government also issues to the public, state and local governments, and foreign governments and central banks nonmarketable securities, which cannot be resold, and have maturity dates from on demand to more than 10 years. As of September 30, 2004, nonmarketable securities totaled $461 billion, or 11 percent of debt held by the public. As of that date, nonmarketable securities primarily consisted of savings securities totaling $204 billion and special securities for state and local governments totaling $158 billion. Intragovernmental debt holdings represent balances of Treasury securities held by over 200 individual federal government accounts with either the authority or the requirement to invest excess receipts in special U.S. Treasury securities that are guaranteed for principal and interest by the full faith and credit of the U.S. Government. Intragovernmental debt holdings primarily consist of balances in the Social Security, Medicare, Military Retirement, and Civil Service Retirement and Disability trust funds. As of September 30, 2004, such funds accounted for $2,726 billion, or 89 percent, of the $3,072 billion intragovernmental debt holdings balances (see Figure 4). As of September 30, 2004 and 2003, gross intragovernmental debt holdings totaled $3,072 billion and $2,859 billion, respectively (see Figure 1), an increase of $213 The majority of intragovernmental debt holdings are Government Account Series (GAS) securities. GAS securities consist of par value securities and market-based securities, with terms ranging from on demand out to 30 years. Par value securities are issued and redeemed at par (100 percent of the face value), regardless of current market conditions. Market-based securities, however, can be issued at a premium or discount and are redeemed at par value on the maturity date or at market value if redeemed before the maturity date. Significant Events in FY 2004 Increased Issuance of Treasury Inflation-Protected Securities (TIPS) During fiscal year 2004, Treasury increased the issuances of inflation-indexed securities known as Treasury Inflation-Protected Securities (TIPS). In the May 5, 2004, Quarterly Refunding Statement, Treasury introduced both a 5-year TIPS and a 20-year TIPS. Each security will be issued semiannually with the 5-year TIPS issued in April and October and the 20-year TIPS issued in January and July. A 10-year TIPS will continue to be issued in January, April, July and October. The first 20-year TIPS was issued on July 30, 2004, in the amount of $11 billion and will be reopened in January 2005 and July 2005. Similarly, the 5-year TIPS will be issued in late October 2004, and will be reissued in April 2005 and October 2005. In the February 2004 Quarterly Refunding Statement, Treasury announced its intentions to compute price awards in auctions to six decimal places per hundred. Calculating prices to six decimals ensures price uniqueness for all discount rates or yields bid in all marketable Treasury securities auctions. This change also makes Treasury's pricing practice consistent with secondary market practices. In addition, the August 2004 Quarterly Refunding Statement announced that the limit on non-competitive Treasury auction awards will be $5 million for all auctions. The previous limit on non-competitive awards, in effect since 1991, was $1 million for bill auctions and $5 million for coupon auctions. These changes were effective on September 20, The Uniform Offering Circular (UOC), in conjunction with the announcement for each auction, provides the terms and conditions for the auction and issuance of marketable Treasury securities to the public. Treasury has rewritten the UOC in plain language because the wide variety of bidders in our securities auctions - broker-dealers, depository institutions, non- financial firms, individuals, etc. - have widely different levels of experience in dealing with federal regulations in general and with securities-related concepts and regulations in particular. On July 28, 2004, the rewritten UOC was published in the Federal Register. Treasury believes that a better understanding of the auction rules may increase direct participation in our auctions and improve the auction process overall, resulting in lower borrowing costs. Significant Events in FY 2004, cont. Series HH Savings Bonds Discontinued As announced on February 18, 2004, the final Series HH Savings Bonds were issued to the public on August 31, 2004. These bonds are current-income securities that pay interest to their owners semiannually. Series HH Savings Bonds issued through August 2004 will continue to earn interest until they reach final maturity 20 years after issue. Treasury withdrew the offering of HH bonds due to the high cost in relation to the relatively small value of transactions. These bonds were initially issued in 1980 and were available in exchange for Series E or EE Savings Bonds. After August 31, 2004, holders of eligible E and/or EE bonds may choose to accept the proceeds of maturing issues or invest them in marketable bills, notes, or TIPS at auction, or they may choose to purchase Series EE or I Savings Bonds. EasySaver Program To Be Discontinued EasySaver was introduced in November 1998 to encourage savings and broaden access to Treasury securities. Customers enrolled in EasySaver could buy U.S. Savings Bonds through authorized debits to their bank accounts thus allowing employees of smaller businesses to have access to a regular savings plan like the millions of Americans who buy bonds through payroll savings plans at work. Since some of the same EasySaver features and even more features are available in TreasuryDirect (www.treasurydirect.gov), the Bureau of the Public Debt stopped accepting EasySaver enrollments on December 31, 2003. All existing automatic EasySaver debits will be discontinued in March 2005. Customers are encouraged to enroll in TreasuryDirect to buy, manage, and redeem their securities online. TreasuryDirect represents a direct relationship between customers -- individuals and financial professionals alike -- and the U.S. Treasury. The TreasuryDirect website (www.treasurydirect.gov) provides complete information for people who want to buy securities directly from the Treasury -- in a way that's easy for everyone to understand. Electronic purchasers can use TreasuryDirect to schedule electronic Series EE and I Savings Bond purchases. TreasuryDirect enhanced its Internet website capability during fiscal year 2004. One new feature offered is a payroll deduction option to purchase a Zero-Percent Certificate of Indebtedness (C of I). While these securities do not earn any interest, they can be used as a source of funds to purchase savings bonds within a TreasuryDirect account after accumulating a minimum of $25 in the C of I or by scheduling a purchase in advance. Customers may purchase electronic Series EE and I Savings Bonds ranging in value from $25 - $30,000 in increments as low as $0.01. There is a $30,000 annual limit per series per person. Customers may redeem a bond one year after purchase, or hold the bond to maturity. Significant Events in FY 2004, cont. Depositary Compensation Securities Redeemed, Replaced By Appropriation In July 2003, Treasury began issuing Depositary Compensation Securities (DCS), a non-marketable security, to compensate those financial institutions serving as financial agents of the United States for essential banking services provided to the Government. These securities were issued to financial agents in an amount sufficient to generate interest payments equal to the monthly expenses for financial agent services provided to Treasury. As part of the fiscal year 2004 Treasury appropriation, a permanent and indefinite appropriation was enacted to reimburse financial institutions serving as financial agents for the United States. As a result, more than $16 billion of DCS were called on February 29, 2004. Statutory Debt Limit Being Evaluated As a consequence of the changes in the government's financing needs, resulting in part from the current economic environment, Treasury Secretary John Snow urged the Congress on August 2, 2004, to raise the debt limit. Delays in raising the current debt limit of $7,384 billion have forced Treasury to enter into a debt issuance suspension period (DISP) that involves Treasury's departure from its normal investment and redemption procedures for certain federal government accounts. Consistent with legal authorities available to the Secretary, on October 14, 2004, Treasury suspended sales of State and Local Government series (SLGS) nonmarketable securities and was unable to fully invest contributions in the Government Securities Investment Fund (G-Fund) of the federal employee 401(k) retirement plan. Federal debt outstanding is one of the largest legally binding obligations of the federal government. Nearly all the federal debt has been issued by the Treasury with a small portion being issued by other federal government agencies. Treasury issues debt securities for two principal reasons, (1) to borrow needed funds to finance the current operations of the federal government and (2) to provide an investment and accounting mechanism for certain federal government accounts' excess receipts, primarily trust funds. Total gross federal debt outstanding has dramatically increased over the past 25 years from $827 billion as of September 30, 1979 to $7,379 billion as of September 30, 2004 (see Figure 5). Large budget deficits emerged during the 1980's due to tax policy decisions and increased outlays for defense and domestic programs. Through fiscal year 1997, annual federal deficits continued to be large and debt continued to grow at a rapid pace. As a result, total federal debt increased more than five fold between 1980 and 1997. Historical Perspective, cont. However, by fiscal year 1998, federal debt held by the public was beginning to decline. In fiscal years 1998 through 2001, the amount of debt held by the public fell by $476 billion, from $3,815 billion to $3,339 billion. As a consequence of the changes in the federal government's financing needs, resulting from increased federal outlays, tax policy decisions, and the deterioration of overall economic performance, from fiscal year 2001 to 2004 debt held by the public rose by $968 billion, from $3,339 billion to $4,307 billion. Even in those years where debt held by the public declined, total federal debt increased because of increases in intragovernmental debt holdings. Over the past 4 fiscal years, intragovernmental debt holdings increased by $852 billion, from $2,220 billion as of September 30, 2000, to $3,072 billion as of September 30, 2004. By law, trust funds have the authority or are required to invest surpluses in federal securities. As a result, the intragovernmental debt holdings balances primarily represent the cumulative surplus of funds due to the trust funds' cumulative annual excess of tax receipts, interest credited, and other collections compared to spending. As shown in Figure 6, interest rates have fluctuated over the past 25 years. The average interest rates reflected here represent the original issue weighted effective yield on securities outstanding at the end of the fiscal year. Average Interest Rates of Federal Debt Outstanding (Unaudited) Managed by the Bureau of the Public Debt For the Fiscal Years Ended September 30, 2004 and 2003 (Note 2) (Note 3) (Discounts) (Discounts) (39,945) (10,362) Accrued Interest (Note 4) (10,362) Net Amortization (Note 4) (13,461) (13,461) (36,846) (312) (10,667) Accrued Interest (Note 4) (10,667) Net Amortization (Note 4) (12,735) (12,735) ($34,778) ($589) The accompanying notes are an integral part of these schedules. Notes to the Schedules of Federal Debt Managed by the Bureau of the Public Debt For the Fiscal Years Ended September 30, 2004 and 2003 Note 1. Significant Accounting Policies The Schedules of Federal Debt Managed by the Bureau of the Public Debt (BPD) have been prepared to report fiscal year 2004 and 2003 balances and activity relating to monies borrowed from the public and certain federal government accounts to fund the U.S. government's operations. Permanent, indefinite appropriations are available for the payment of interest on the federal debt and the redemption of Treasury securities. The Constitution empowers the Congress to borrow money on the credit of the United States. The Congress has authorized the Secretary of the Treasury to borrow monies to operate the federal government within a statutory debt limit. Title 31 U.S.C. authorizes Treasury to prescribe the debt instruments and otherwise limit and restrict the amount and composition of the debt. BPD, an organizational entity within the Fiscal Service of the Department of the Treasury, is responsible for issuing Treasury securities in accordance with such authority and to account for the resulting debt. In addition, BPD has been given the responsibility to issue Treasury securities to trust funds for trust fund receipts not needed for current benefits and expenses. BPD issues and redeems Treasury securities for the trust funds based on data provided by program agencies and other Treasury entities. The schedules were prepared in conformity with U.S. generally accepted accounting principles and from BPD's automated accounting system, Public Debt Accounting and Reporting System. Interest costs are recorded as expenses when incurred, instead of when paid. Certain Treasury securities are issued at a discount or premium. These discounts and premiums are amortized over the term of the security using an interest method for all long term securities and the straight line method for short term securities. The Department of the Treasury also issues Treasury Inflation-Protected Securities (TIPS). The principal for TIPS is adjusted over the life of the security based on the Consumer Price Index for all Urban Consumers. Notes to the Schedules of Federal Debt Managed by the Bureau of the Public Debt For the Fiscal Years Ended September 30, 2004 and 2003 Note 2. Federal Debt Held by the Public As of September 30, 2004 and 2003, Federal Debt Held by the Public consisted of the following: Total Federal Debt Held by the Public Treasury issues marketable bills at a discount and pays the par amount of the security upon maturity. The average interest rate on Treasury bills represents the original issue effective yield on securities outstanding as of September 30, 2004 and 2003, respectively. Treasury bills are issued with a term of one year or less. Treasury issues marketable notes and bonds as long-term securities that pay semi-annual interest based on the securities' stated interest rate. These securities are issued at either par value or at an amount that reflects a discount or a premium. The average interest rate on marketable notes and bonds represents the stated interest rate adjusted by any discount or premium on securities outstanding as of September 30, 2004 and 2003. Treasury notes are issued with a term of 2 - 10 years and Treasury bonds are issued with a term of more than 10 years. Treasury also issues TIPS that have interest and redemption payments, which are tied to the Consumer Price Index, the leading measurement of inflation. TIPS are issued with a term of more than 5 years. At maturity, TIPS are redeemed at the inflation-adjusted principal amount, or the original par value, whichever is greater. TIPS pay a semi-annual fixed rate of interest applied to the inflation-adjusted principal. Inflation-indexed securities, TIPS, were previously included with Treasury notes and bonds. The fiscal year 2003 amounts and average interest rates have been reclassified to conform with the presentation adopted in fiscal year 2004. Notes to the Schedules of Federal Debt Managed by the Bureau of the Public Debt For the Fiscal Years Ended September 30, 2004 and 2003 Note 2. Federal Debt Held by the Public (continued) As of September 30, 2004, nonmarketable securities primarily consisted of $204,246 million in U.S. Savings Securities, $158,214 million in securities issued to State and Local Governments, $5,881 million in Foreign Series Securities, and $29,995 million in Domestic Series Securities. As of September 30, 2003, nonmarketable securities primarily consisted of $201,606 million in U.S. Savings Securities, $148,366 million in securities issued to State and Local Governments, $11,007 million in Foreign Series Securities, $29,995 million in Domestic Series Securities, and $14,991 million in Depositary Compensation Securities. Treasury issues nonmarketable securities at either par value or at an amount that reflects a discount or a premium. The average interest rate on the nonmarketable securities represents the original issue weighted effective yield on securities outstanding as of September 30, 2004 and 2003. Nonmarketable securities are issued with a term of on demand to more than 10 Government Account Series (GAS) securities are nonmarketable securities issued to federal government accounts. Federal Debt Held by the Public includes GAS securities issued to certain federal government accounts. One example is the GAS securities held by the Government Securities Investment Fund (G-Fund) of the federal employees' Thrift Savings Plan. Federal employees and retirees who have individual accounts own the GAS securities held by the fund. For this reason, these securities are considered part of the Federal Debt Held by the Public rather than Intragovernmental Debt Holdings. The GAS securities held by the G-Fund consist of overnight investments redeemed one business day after their issue. The net increase in amounts borrowed from the fund during fiscal years 2004 and 2003 are included in the respective Borrowings from the Public amounts reported on the Schedules of Federal Debt. Federal Debt Held by the Public includes federal debt held outside of the U. S. government by individuals, corporations, Federal Reserve Banks (FRB), state and local governments, and foreign governments and central banks. The FRB owned $698 billion and $654 billion of Federal Debt Held by the Public as of September 30, 2004 and 2003, respectively. These securities are held in the FRB System Open Market Account (SOMA) for the purpose of conducting monetary policy. Notes to the Schedules of Federal Debt Managed by the Bureau of the Public Debt For the Fiscal Years Ended September 30, 2004 and 2003 Note 3. Intragovernmental Debt Holdings As of September 30, 2004 and 2003, Intragovernmental Debt Holdings are owed to the following: Federal Old-Age and Survivors Insurance Trust Fund Civil Service Retirement and Disability Fund Federal Hospital Insurance Trust Fund Federal Disability Insurance Trust Fund Employees' Life Insurance Fund Federal Supplementary Medical Insurance Trust Fund Pension Benefit Guaranty Corporation Fund Foreign Service Retirement & Disability Fund Savings Association Insurance Fund (SAIF) Treasury: Exchange Stabilization Fund Airport & Airway Trust Fund These amounts include marketable Treasury securities as well as GAS securities as follows: As of September 30, 2004: Civil Service Retirement and Disability Fund Federal Disability Insurance Trust Fund As of September 30, 2003: Civil Service Retirement and Disability Fund Federal Disability Insurance Trust Fund Social Security Administration (SSA); Office of Personnel Management (OPM); Department of Health and Human Services (HHS); Department of Defense (DOD); Department of Labor (DOL); Federal Deposit Insurance Corporation (FDIC); Department of Energy (DOE); Department of Housing and Urban Development (HUD); Department of Transportation (DOT); Department of State (DOS); Department of Veterans Affairs (VA); Department of the Treasury (Treasury). Notes to the Schedules of Federal Debt Managed by the Bureau of the Public Debt For the Fiscal Years Ended September 30, 2004 and 2003 Note 3. Intragovernmental Debt Holdings (continued) Intragovernmental Debt Holdings primarily consist of GAS securities. Treasury issues GAS securities at either par value or at an amount that reflects a discount or a premium. The average interest rates for fiscal years 2004 and 2003 were 5.4 percent and 5.5 percent, respectively. The average interest rate represents the original issue weighted effective yield on securities outstanding as of September 30, 2004 and 2003. GAS securities are issued with a term of on demand to 30 years. Note 4. Interest Expense Interest expense on Federal Debt Managed by BPD for fiscal years 2004 and 2003 consisted of Federal Debt Held by the Public Net Amortization of Premiums and Discounts Total Interest Expense on Federal Debt Held by the Public Net Amortization of Premiums and Discounts (3,717) (6,670) Total Interest Expense on Intragovernmental Debt Total Interest Expense on Federal Debt Managed by BPD Note 5. Fund Balance With Treasury The Fund Balance with Treasury, a non-entity, intragovernmental account, is not included on the Schedules of Federal Debt and is presented for informational purposes. In addition to the individual named above, Erik A. Braun, Dean D. Carpenter, Dennis L. Clarke, Chau L. Dinh, Mickie E. Gray, Jennifer L. Hall, Jay McTigue, Lori B. Ryza, Kathryn J. Peterson, and Jason O. Strange made key contributions to this report.

Summary:
GAO is required to audit the consolidated financial statements of the U.S. government. Due to the significance of the federal debt held by the public to the governmentwide financial statements, GAO has also been auditing the Bureau of the Public Debt's (BPD) Schedules of Federal Debt annually. The audit of these schedules is done to determine whether, in all material respects, (1) the schedules prepared are reliable, (2) BPD management maintained effective internal control relevant to the Schedule of Federal Debt, and (3) BPD complies with selected provisions of significant laws related to the Schedule of Federal Debt. Federal debt managed by BPD consists of Treasury securities held by the public and by certain federal government accounts, referred to as intragovernmental debt holdings. The level of debt held by the public reflects how much of the nation's wealth has been absorbed by the federal government to finance prior federal spending in excess of total federal revenues. Intragovernmental debt holdings represent balances of Treasury securities held by federal government accounts, primarily federal trust funds such as Social Security, that typically have an obligation to invest their excess annual receipts over disbursements in federal securities. In GAO's opinion, BPD's Schedules of Federal Debt for fiscal years 2004 and 2003 were fairly presented in all material respects and BPD maintained effective internal control related to the Schedule of Federal Debt as of September 30, 2004. GAO also found no instances of noncompliance in fiscal year 2004 with the statutory debt limit. A s of September 30, 2004 and 2003, federal debt managed by BPD totaled about $7,379 billion and $6,783 billion, respectively. At the end of fiscal year 2004, debt held by the public as a percentage of the U.S. economy is estimated at 37.5 percent, up from 33.1 percent at the end of fiscal year 2001. Further, certain trust funds (e.g., Social Security) continue to run surpluses, resulting in increased intragovernmental debt holdings. These debt holdings are backed by the full faith and credit of the U.S. government and represent a priority call on future budgetary resources. Gross federal debt has increased 27 percent between the end of fiscal years 2001 and 2004. As a result of the increasing federal debt, on October 14, 2004, Treasury entered into a debt issuance suspension period to avoid exceeding the current $7,384 billion statutory debt limit and requested the Congress take action to raise the debt limit by mid- November 2004. The total federal debt increased over each of the last 4 fiscal years. Debt held by the public decreased as a result of cash surpluses for fiscal year 2001, but increased during fiscal years 2002 through 2004, with the return of annual unified budget deficits. Intragovernmental debt holdings steadily increased during this 4-year period primarily due to excess receipts over disbursements in federal trust funds.