As I mentioned earlier, as has been the case for the previous 6 fiscal years, the federal government continues to have a significant number of material weaknesses related to financial systems, fundamental recordkeeping and financial reporting, and incomplete documentation. Several of these material weaknesses (referred to hereafter as material deficiencies) resulted in conditions that continued to prevent us from forming and expressing an opinion on the U.S. government’s consolidated financial statements for the fiscal years ended September 30, 2003 and 2002. There may also be additional issues that could affect the consolidated financial statements that have not been identified. Major challenges include the federal government’s inability to properly account for and report property, plant, and equipment and inventories and related property, primarily at the Department of Defense (DOD); reasonably estimate or adequately support amounts reported for certain liabilities, such as environmental and disposal liabilities and related costs at DOD, and ensure complete and proper reporting for commitments and contingencies; support major portions of the total net cost of government operations, most notably related to DOD, and ensure that all disbursements are properly recorded; fully account for and reconcile intragovernmental activity and balances; demonstrate how net outlay amounts reported in the consolidated financial statements were related to net outlay amounts reported in the underlying federal agencies’ financial statements; and effectively prepare the federal government’s financial statements, including ensuring that the consolidated financial statements are consistent with the underlying audited agency financial statements, balanced, and in conformity with GAAP. In addition to these material deficiencies, we identified four other material weaknesses in internal control related to loans receivable and loan guarantee liabilities, improper payments, information security, and tax collection activities. The material weaknesses identified by our work are discussed in more detail in appendix II, and their primary effects are described in appendix III. The ability to produce the data needed to efficiently and effectively manage the day-to-day operations of the federal government and provide accountability to taxpayers and the Congress has been a long-standing challenge at most federal agencies. The results of the fiscal year 2003 assessments performed by agency inspectors general or their contract auditors under FFMIA show that these problems continue to plague the financial management systems used by most of the CFO Act agencies. While the problems are much more severe at some agencies than at others, their nature and severity indicate that overall, management at most CFO Act agencies lacks the full range of information needed for accountability, performance reporting, and decision making. These problems include nonintegrated financial systems, lack of accurate and timely recording of data, inadequate reconciliation procedures, and noncompliance with accounting standards and the U.S. Government Standard General Ledger (SGL). Agencies’ inability to meet the federal financial management systems requirements continues to be the major barrier to achieving compliance with FFMIA. Under FFMIA, CFO Act agency auditors are required to report, as part of the agencies’ financial statement audits, whether agencies’ financial management systems substantially comply with (1) federal financial management systems requirements, (2) applicable federal accounting standards, and (3) the SGL at the transaction level. As shown in figure 1, auditors most frequently reported instances of noncompliance with federal financial management systems requirements. These instances of noncompliance involved not only core financial systems, but also administrative and programmatic systems. For fiscal year 2003, auditors for 17 of the 23 CFO Act agencies reported that the agencies’ financial management systems did not comply substantially with one or more of FFMIA’s three requirements. For the remaining 6 CFO Act agencies, auditors provided negative assurance, meaning that nothing came to their attention indicating that the agencies’ financial management systems did not substantially meet FFMIA requirements. The auditors for these 6 agencies did not definitively state whether the agencies’ systems substantially complied with FFMIA requirements, as is required under the statute. DHS is not subject to the requirements of the CFO Act and, consequently, is not required to comply with FFMIA. Accordingly, DHS’s auditors did not report on DHS’s compliance with FFMIA. However, the auditors identified and reported deficiencies that related to the aforementioned three requirements of FFMIA. Federal agencies have recognized the seriousness of their financial systems weaknesses and have efforts under way to implement or upgrade their financial systems to alleviate long-standing problems, but some of these efforts face significant challenges. For example, as we testified in May 2004, we have identified several issues related to NASA’s financial management systems modernization effort: (1) NASA did not involve key stakeholders in the design and implementation of the agency’s new financial management system’s core financial module; (2) NASA did not follow key best practices for acquiring and implementing this system; and (3) the new system lacks key external reporting capabilities for property and budgetary data. In addition, as I will discuss later in this testimony, DOD faces major challenges in its efforts to develop a business enterprise architecture. We recognize that it will take time, investment, and sustained emphasis to improve agencies’ underlying financial management systems. As I mentioned earlier, for the past 7 fiscal years, the federal government has been required to prepare, and have audited, consolidated financial statements. Successfully meeting this requirement is tightly linked to the requirements for the CFO Act agencies to also have audited financial statements. This has stimulated extensive cooperative efforts and considerable attention by agency chief financial officers, inspectors general, Treasury and OMB officials, and GAO. With the benefit of the past 7 years’ experience by the federal government in having the required financial statements subjected to audit, more intensified attention will be needed on the most serious obstacles to achieving an opinion on the U.S. government’s consolidated financial statements. Three major impediments to an opinion on the consolidated financial statements are (1) serious financial management problems at DOD, (2) the federal government’s inability to fully account for and reconcile transactions between federal government entities, and (3) the federal government’s ineffective process for preparing the consolidated financial statements. Essential to achieving an opinion on the consolidated financial statements is resolution of the serious financial management problems at DOD, which we have designated as high risk since 1995. In accordance with section 1008 of the National Defense Authorization Act for Fiscal Year 2002, DOD reported that for fiscal year 2003, it was not able to provide adequate evidence supporting material amounts in its financial statements. DOD stated that it is unable to comply with applicable financial reporting requirements for (1) property, plant, and equipment (PP&E); (2) inventory and operating materials and supplies; (3) environmental liabilities; (4) intragovernmental eliminations and related accounting adjustments; (5) disbursement activity; and (6) cost accounting by responsibility segment. Although DOD represented that the military retirement health care liability data had improved for fiscal year 2003, the cost of direct health care provided by DOD-managed military treatment facilities was a significant amount of DOD’s total recorded health care liability and was based on estimates for which adequate support was not available. DOD continues to confront pervasive decades-old financial management and business problems related to its systems, processes (including internal controls), and people (human capital). These problems preclude the department from producing accurate, reliable, and timely information to make sound decisions and to accurately report on its billions of dollars of assets. DOD’s long-standing business management systems problems adversely affect the economy, effectiveness, and efficiency of its operations and have resulted in a lack of adequate accountability across all major business areas. To date, none of the military services or major DOD components has passed the test of an independent financial audit because of pervasive weaknesses in financial management systems, operations, and controls. Additionally, the department’s stovepiped, duplicative, and nonintegrated systems contribute to its vulnerability to fraud, waste, and abuse. In this regard, we have recently testified on problems related to military pay and unused airline tickets. Vulnerability to fraud, waste, and abuse continues despite substantial systems investment. For fiscal year 2004, DOD requested approximately $19 billion to operate, maintain, and modernize its reported 2,274 business systems. The duplicative and stovepiped nature of DOD’s systems environment is illustrated by the numerous systems it has in the same functional areas. For example, DOD reported that it has 565 systems to support logistics functions. These systems are not integrated and thus have multiple points of data entry, which can result in significant data integrity problems. Further, DOD continues to lack effective management oversight and control over business systems modernization investments. The actual funding continues to be distributed among the military services and defense agencies, thereby enabling the numerous DOD components to continue to develop stovepiped, parochial solutions to the department’s long-standing financial management and business operation challenges. Lacking a departmentwide focus and effective management oversight and control of business systems investment, DOD continues to invest billions of dollars in systems that fail to provide integrated corporate solutions to its long-standing business operations problems. Over the past 14 years, DOD has initiated several broad-based reform efforts intended to fundamentally reform its business operations and improve the reliability of information used in the decision-making process. While these initiatives produced some incremental improvements, they did not result in the fundamental reform necessary to resolve the department’s long-standing management challenges. Secretary Rumsfeld has made business transformation a priority. For example, through its Business Management Modernization Program, DOD is continuing its efforts to develop and implement a business enterprise architecture and establish effective management and control over its business system modernization investments. However, we recently reported that after about 3 years of effort and over $203 million in obligations, we have not seen significant change in the content of DOD’s architecture or in DOD’s approach to investing billions of dollars annually in existing and new systems. Few actions have been taken to address the recommendations we made in our previous reports, which were aimed at improving DOD’s plans for developing the next version of the architecture and implementing the institutional means for selecting and controlling both planned and ongoing business systems investments. To date, DOD has not addressed 22 of our 24 recommendations. Currently, DOD has various initiatives under way to support its efforts to obtain an unqualified audit opinion on its fiscal year 2007 financial statements. Because there are not yet detailed plans guiding these activities, however, it is unclear whether and how they support each other and whether they support this goal. Therefore, the feasibility of meeting this goal is as yet unknown. The seriousness of DOD’s business management weaknesses underscores the importance of no longer condoning “status quo” business operations at DOD. Cultural resistance to change, military service parochialism, and stovepiped operations have all contributed significantly to the failure of previous attempts to implement broad-based management reforms at DOD. The department has acknowledged that it confronts decades-old problems deeply grounded in the bureaucratic history and operating practices of a complex, multifaceted organization and that many of these practices were developed piecemeal and evolved to accommodate different organizations, each with its own policies and procedures. To improve the likelihood that the department’s current business transformation efforts will be successful, we have previously suggested that a chief management official position be created. Previous failed attempts to improve DOD’s business operations illustrate the need for sustained involvement of DOD leadership in helping to assure that DOD’s financial and overall business process transformation efforts remain a priority. While the Secretary and other key DOD leaders have demonstrated their commitment to the current business transformation efforts, the long- term nature of these efforts requires the development of an executive position capable of providing strong and sustained executive leadership over a number of years and various administrations. This position would provide the sustained attention essential for addressing key stewardship responsibilities such as strategic planning, performance and financial management, and business systems modernization in an integrated manner. This position could be filled by an individual, appointed by the President and confirmed by the Senate, for a set term of 7 years with the potential for reappointment. Such an individual should have a proven track record as a business process change agent in large, complex, and diverse organizations—experience necessary to spearhead business process transformation across the department, and potentially administrations, and serve as an integrator for the needed business transformation efforts. Further, in a recent report we also suggest that to improve management oversight, accountability, and control of the department’s business systems funding, Congress may wish to consider providing the funds to operate, maintain, and modernize DOD’s business systems to the functional areas, known as domains, rather than the military services and the defense agencies. Currently, each military service and defense agency receives its own funding and is largely autonomous in deciding how to spend these funds, thereby hindering the development of broad-based, integrated corporate system solutions to common DOD-wide problems. We believe it is critical that funds for DOD business systems be appropriated to the domain owners in order to provide for accountability and the ability to prevent the continued parochial approach to systems investment that exists today. The domains would establish a hierarchy of investment review boards with DOD-wide representation, including the military services and defense agencies. These boards would be responsible for reviewing and approving investments to develop, operate, maintain, and modernize business systems for the domain portfolio, including ensuring that investments were consistent with DOD’s business enterprise architecture. DOD still has a long way to go, and top leadership must continue to stress the importance of achieving lasting improvement that truly transforms the department’s business systems and operations. Only through major transformation, which will take time and sustained leadership from top management, will DOD be able to meet the mandate of the CFO Act and achieve the President’s Management Agenda goal of improved financial performance. OMB and Treasury require the CFOs of 35 executive departments and agencies, including the 23 CFO Act agencies, to reconcile selected intragovernmental activity and balances with their “trading partners” and to report to Treasury, the agency’s inspector general, and GAO on the extent and results of intragovernmental activity and balances reconciliation efforts. A substantial number of the agencies continue to be unable to fully perform reconciliations of intragovernmental activity and balances with their trading partners, citing reasons such as (1) trading partners not providing needed data; (2) limitations and incompatibility of agency and trading partner information systems; and (3) lack of human resources. Amounts reported for federal agency trading partners for certain intragovernmental accounts were significantly out of balance in the aggregate for both fiscal years 2003 and 2002. We reported in previous years that the heart of the intragovernmental transactions issue was that the federal government lacked clearly articulated business rules for these transactions so that they would be handled consistently by agencies. In this regard, at the start of fiscal year 2003, OMB issued business rules to transform and standardize intragovernmental ordering and billing. To address long-standing problems with intragovernmental exchange transactions between federal agencies, Treasury provided federal agencies with quarterly detailed trading partner information during fiscal year 2003 to help them better perform their trading partner reconciliations. In addition, the federal government began a three-phase Intragovernmental Transactions e-gov project to define a governmentwide data architecture and provide a single source of detailed trading partner data. On April 20, 2004, however, OMB announced that it was appropriate to pause and evaluate the results of the project to date. OMB estimated that the evaluation will take 120 days and will be followed by a phased deployment. Resolving the intragovernmental transactions problem remains a difficult challenge and will require a commitment by the CFO Act agencies and continued strong leadership by OMB. The federal government did not have adequate systems, controls, and procedures to ensure that the consolidated financial statements are consistent with the underlying audited agency financial statements, balanced, and in conformity with GAAP. In this regard, Treasury is developing a new system and procedures to prepare the consolidated financial statements beginning with the statements for fiscal year 2004. Treasury officials have stated that these actions are intended to, among other things, directly link information from federal agencies’ audited financial statements to amounts reported in the consolidated financial statements and resolve many of the issues we identified in the process for preparing the consolidated financial statements. As part of our fiscal year 2004 audit, we will evaluate the new system and procedures as they are fully developed and implemented and determine the extent of linkage accomplished for the fiscal year 2004 financial statements. Resolving issues surrounding preparing the consolidated financial statements has been a significant challenge and will require continued strong leadership by Treasury management. Our nation’s large and growing long-term fiscal imbalance, which is driven largely by known demographic trends and rising health care costs—coupled with new homeland security and defense commitments—serves to sharpen the need to fundamentally review and re-examine basic federal entitlements, as well as other mandatory and discretionary spending, and tax policies. As we look ahead, our nation faces an unprecedented demographic challenge with significant implications, among them budgetary and economic. Between now and 2035, the number of people who are 65 years old or over will double, driving federal spending on the elderly to a larger and ultimately unsustainable share of the federal budget. As a result, tough choices will be required to address the resulting structural imbalance. GAO prepares long-term budget simulations that seek to illustrate the likely fiscal consequences of the coming demographics and rising health care costs. Our latest long-term budget simulations reinforce the need for change in the major cost drivers—Social Security and health care programs. As shown in figure 2, by 2040, absent reform of these entitlement programs, projected federal revenues may be adequate to pay little beyond interest on the debt. Current financial reporting does not clearly and transparently show the wide range of responsibilities, programs, and activities that may either obligate the federal government to future spending or create an expectation for such spending and provides an unrealistic and even misleading picture of the federal government’s overall performance and financial condition. Few agencies adequately show the results they are getting with the taxpayer dollars they spend. In addition, too many significant federal government commitments and obligations, such as Social Security and Medicare, are not fully and consistently disclosed in the federal government’s consolidated financial statements and budget, and current federal financial reporting standards do not require such disclosure. Figure 3 shows some selected fiscal exposures. The spectrum of these exposures ranges from covering only the explicit liabilities that are shown on the consolidated financial statements to implicit promises embedded in current policy or public expectations. These liabilities, commitments, and promises have created a fiscal imbalance that will put unprecedented strains on the nation’s spending and tax policies. Although economic growth can help, the projected fiscal gap is now so large that the federal government will not be able to simply grow its way out of the problem. Tough choices are inevitable. Particularly troubling are the many big-ticket items that taxpayers will eventually have to deal with. The federal government has pledged its support to a long list of programs and activities, including pension and health care benefits for senior citizens, medical care for veterans, and contingencies associated with various government-sponsored entities, whose claims on future spending total trillions of dollars. Despite their serious implications for future budgets, tax burdens, and spending flexibilities, these unfunded commitments get short shrift in the federal government’s current financial statements and in budgetary deliberations. The federal government’s gross debt as of September 2003 was about $7 trillion, or about $24,000 for every man, woman, and child in this country today. But that number excludes many big-ticket items, including the gap between promised and funded Social Security and Medicare benefits, veterans’ health care, and a range of other commitments and contingencies. If these items are factored in, the total burden in current dollars is at least $42 trillion. To put that number into perspective, $42 trillion is 18 times the current federal budget, or 3.5 times our current annual gross domestic product. One of the biggest contributors to this total bill will be the new Medicare prescription drug benefit, whose estimated current-dollar cost over the next 75 years is more than $8 trillion. Stated differently, the current total burden for every American is more than $140,000—and every day that burden is growing larger. GAO’s long-term budget simulations show that by 2040, the federal government may have to cut federal spending by 60 percent or raise taxes to about 2.5 times today’s level to pay for the mounting cost of the federal government’s current unfunded commitments. Either would be devastating. Proper accounting and reporting practices are essential in the public sector. After all, the U.S. government is the largest, most diverse, most complex, and arguably the most important entity on earth today. Its services—homeland security, national defense, Social Security, mail delivery, and food inspection, to name a few—directly affect the well-being of almost every American. But sound decisions on the future direction of vital federal government programs and policies are made more difficult without timely, accurate, and useful financial and performance information. Fortunately, we are starting to see efforts to address the shortcomings in federal financial reporting. The President’s Management Agenda, which closely reflects GAO’s list of high-risk government programs, is bringing attention to troubled areas across the federal government and is taking steps to better assess the results that programs are getting with the resources they are given. The Federal Accounting Standards Advisory Board is also making progress on many key financial reporting issues. In addition to these efforts, we have published frameworks for analyzing various Social Security reform proposals and for analyzing health care reform proposals. We have also helped to create a consortium of “good government” organizations to stimulate the development of a set of key national indicators to assess the United States’ overall position and progress over time and in comparison to those of other industrialized nations. Budget experts at the Congressional Budget Office (CBO) and GAO continue to encourage reforms to the federal budget process to better reflect the federal government’s commitments and signal emerging problems. Among other things, we have recommended that the federal government issue an annual report on major fiscal exposures. The President’s fiscal year 2005 budget also proposes that future President’s budgets report on any enacted legislation in the past year that worsens the unfunded obligations of programs with long-term actuarial projections, with CBO to make a similar report. Such reporting could be a good starting point. Although these are positive initial steps, much more must be done given the magnitude of the federal government’s fiscal challenge. A top-to-bottom review of government activities to ensure their relevance and fit for the 21st century and their relative priority is long overdue. As I have spoken about in the past, the federal government needs a three-pronged approach to (1) restructure existing entitlement programs, (2) reexamine the base of discretionary and other spending, and (3) review and revise the federal government’s tax policy, including major tax preferences, and enforcement programs. New accounting and reporting approaches, budget control mechanisms, and metrics are needed for considering and measuring the impact of spending and tax policies and decisions over the long term. Our report on the U.S. government’s consolidated financial statements for fiscal years 2003 and 2002 highlights the need to continue addressing the federal government’s serious financial management weaknesses. With the significantly accelerated financial reporting time frame for fiscal year 2004 and beyond, it is essential that the federal government move away from the extraordinary efforts many federal agencies continue to make to prepare financial statements and toward giving prominence to strengthening the federal government’s financial systems, reporting, and controls. This is the only way the federal government can meet the end goal of making timely, accurate, and useful financial and performance information routinely available to the Congress, other policymakers, and the American public. The requirement for timely, accurate, and useful financial and performance management information is greater than ever as our nation faces major long-term fiscal challenges that will require tough choices in setting priorities and linking resources to results. The Congress and the President face the challenge of sorting out the many claims on the federal budget without the budget enforcement mechanisms or fiscal benchmarks that guided the federal government through the previous years of deficit reduction into the brief period of surplus. While a number of steps will be necessary to address this challenge, truth and transparency in federal government reporting are essential elements of any attempt to address the nation’s long-term fiscal challenges. The fiscal risks I mentioned earlier can be managed only if they are properly accounted for and publicly disclosed. A crucial first step will be to face facts and identify the significant commitments facing the federal government. If citizens and federal government officials come to understand various fiscal exposures and their potential claims on future budgets, they are more likely to insist on prudent policy choices today and sensible levels of fiscal risk in the future. In addition, new budget control mechanisms will be required, along with effective approaches to successfully engage in a fundamental review, reassessment, and reprioritization of the base of federal government programs and policies that I have recommended previously. Public officials will have more incentive to make difficult but necessary choices if the public has the facts and comes to support serious and sustained action to address the nation’s fiscal challenges. Without meaningful public debate, however, real and lasting change is unlikely. Clearly, the sooner action is taken, the easier it will be to turn things around. I believe that nothing less than a national education campaign and outreach effort is needed to help the public understand the nature and magnitude of the long-term financial challenge facing this nation. An informed electorate is essential for a healthy democracy. Members of Generations X and Y especially need to become active in this discussion because they and their children will bear the heaviest burden if policymakers fail to act in a timely and responsible manner. We at GAO are committed to doing our part, but others also need to step up to the plate. By working together, I believe we can make a meaningful difference for our nation, fellow citizens, and future generations of Americans. In closing, Mr. Chairman, I want to reiterate the value of sustained congressional interest in these issues, as demonstrated by the Congress’s annual hearings on the results of our audit of the consolidated financial statements and of audits of certain federal agencies’ financial statements. It will also be key that the appropriations, budget, authorizing, and oversight committees hold agency top leadership accountable for resolving these problems and that they support improvement efforts. For further information regarding this testimony, please contact Jeffrey C. Steinhoff, Managing Director, or Gary T. Engel, Director, Financial Management and Assurance, at (202) 512-2600. R. Navarro & Associates, Inc. R. Navarro & Associates, Inc. The federal government did not maintain adequate systems or have sufficient, reliable evidence to support information reported in the consolidated financial statements of the U.S. government, as described below. These material deficiencies contributed to our disclaimer of opinion on the consolidated financial statements and also constitute material weaknesses in internal control. In addition to the material deficiencies noted above, we found four other material weaknesses in internal control as of September 30, 2003: (1) several federal agencies continue to have deficiencies in the processes and procedures used to estimate the costs of their lending programs and value their related loans receivable; (2) most federal agencies have not reported the magnitude of improper payments in their programs and activities; (3) federal agencies have not yet fully institutionalized comprehensive security management programs; and (4) material internal control weaknesses and systems deficiencies continue to affect the federal government’s ability to effectively manage its tax collection activities. In general, federal agencies continue to make progress in reducing the number of material weaknesses and reportable conditions related to their lending activities. However, significant deficiencies in the processes and procedures used to estimate the costs of certain lending programs and value the related loans receivable still remain. These deficiencies continue to adversely affect the government’s ability to support annual budget requests for these programs, make future budgetary decisions, manage program costs, and measure the performance of lending activities. The most notable deficiencies existed at the Small Business Administration (SBA), which, while improved from last year, continues to have a material weakness related to this area. For example, SBA did not adequately document its estimation methodologies, lacked the management controls necessary to ensure that appropriate estimates were prepared and reported based on complete and accurate data, and could not fully support the reasonableness of the costs of its lending programs and valuations of its loan portfolio. We are currently assessing SBA’s actions to resolve certain of these deficiencies related to accounting for previous loan sales and cost estimates for disaster loans. Across the federal government, improper payments occur in a variety of programs and activities, including those related to health care, contract management, federal financial assistance, and tax refunds. While complete information on the magnitude of improper payments is not yet available, based on available data, OMB has estimated that improper payments exceed $35 billion annually. Many improper payments occur in federal programs that are administered by entities other than the federal government, such as states. Improper payments often result from a lack of or an inadequate system of internal controls. Although the President’s Management Agenda includes an initiative to reduce improper payments, most federal agencies have not reported the magnitude of improper payments in their programs and activities. The Improper Payments Information Act of 2002 provides for federal agencies to estimate and report on their improper payments. It requires federal agencies to (1) annually review programs and activities that they administer to identify those that may be susceptible to significant improper payments, (2) estimate improper payments in susceptible programs and activities, and (3) provide reports to the Congress that discuss the causes of improper payments identified and the status of actions to reduce them. In accordance with the legislation, OMB issued guidance for federal agencies’ use in implementing the act. Among other things, the guidance requires federal agencies to report on their improper payment-related activities in the Management Discussion and Analysis section of their annual Performance and Accountability Reports (PAR). While the act does not require such reporting by all federal agencies until fiscal year 2004, OMB required 44 programs and 14 CFO Act agencies to report improper payment information in their fiscal year 2003 PARs. Our preliminary review of the PARs found that 12 of the 14 agencies reported improper payment amounts for 27 of the 44 programs identified in the guidance. We also found that, for the programs where improper payments were identified, the reports often contained information on the causes of the payments but little information that addressed the other reporting requirements cited in the legislation. Although progress has been made, serious and widespread information security weaknesses continue to place federal assets at risk of inadvertent or deliberate misuse, financial information at risk of unauthorized modification or destruction, sensitive information at risk of inappropriate disclosure, and critical operations at risk of disruption. GAO has reported information security as a high-risk area across government since February 1997. Such information security weaknesses could result in compromising the reliability and availability of data that are recorded in or transmitted by federal financial management systems. A primary reason for these weaknesses is that federal agencies have not yet fully institutionalized comprehensive security management programs, which are critical to identifying information security weaknesses, resolving information security problems, and managing information security risks on an ongoing basis. The Congress has shown continuing interest in addressing these risks, as evidenced by recent hearings on information security and enactment of the Federal Information Security Management Act of 2002 and the Cyber Security Research and Development Act. In addition, the administration has taken important actions to improve information security, such as integrating information security into the Executive Branch Management Scorecard. Material internal control weaknesses and systems deficiencies continue to affect the federal government’s ability to effectively manage its tax collection activities. Due to errors and delays in recording activity in taxpayer accounts, taxpayers were not always credited for payments made on their taxes owed, which could result in undue taxpayer burden. In addition, the federal government did not always follow up on potential unreported or underreported taxes and did not always pursue collection efforts against taxpayers owing taxes to the federal government. Primary Effects on the Fiscal Years 2003 and 2002 Consolidated Financial Statements and the Management of Government Operations Without accurate asset information, the federal government does not fully know the assets it owns and their location and condition and cannot effectively (1) safeguard assets from physical deterioration, theft, or loss, (2) account for acquisitions and disposals of such assets, (3) ensure the assets are available for use when needed, (4) prevent unnecessary storage and maintenance costs or purchase of assets already on hand, and (5) determine the full costs of programs that use these assets. Problems in accounting for liabilities affect the determination of the full cost of the federal government’s current operations and the extent of its liabilities. Also, improperly stated environmental and disposal liabilities and weak internal control supporting the process for their estimation affect the federal government’s ability to determine priorities for cleanup and disposal activities and to allow for appropriate consideration of future budgetary resources needed to carry out these activities. In addition, when disclosures of commitments and contingencies are incomplete or incorrect, reliable information is not available about the extent of the federal government’s obligations. Inaccurate cost information affects the federal government’s ability to control and reduce costs, assess performance, evaluate programs, and set fees to recover costs where required. Improperly recorded disbursements could result in misstatements in the financial statements and in certain data provided by federal agencies for inclusion in the President’s budget concerning obligations and outlays. Problems in accounting for and reconciling intragovernmental activity and balances impair the government’s ability to account for billions of dollars of transactions between governmental entities. Until the differences between the total net outlays reported in federal agencies’ Statements of Budgetary Resources and the records used by the Department of the Treasury to prepare the Statement of Changes in Cash Balance from Unified Budget and Other Activities are reconciled, the effect that these differences may have on the U.S. government’s consolidated financial statements will be unknown. Because the federal government did not have adequate systems, controls, and procedures to prepare its consolidated financial statements, the federal government’s ability to ensure that the consolidated financial statements are consistent with the underlying audited agency financial statements, balanced, and in conformity with U.S. generally accepted accounting principles was impaired. Without a systematic measurement of the extent of improper payments, federal agency management cannot determine (1) if improper payment problems exist that require corrective action, (2) mitigation strategies and the appropriate amount of investments to reduce them, and (3) the success of efforts implemented to reduce improper payments. Weaknesses in the processes and procedures for estimating credit program costs affect the government’s ability to support annual budget requests for these programs, make future budgetary decisions, manage program costs, and measure the performance of lending activities. Information security weaknesses Information security weaknesses over computerized operations are placing enormous amounts of federal assets at risk of inadvertent or deliberate misuse, financial information at risk of unauthorized modification or destruction, sensitive information at risk of inappropriate disclosure, and critical operations at risk of disruption. Primary Effects on the Fiscal Years 2003 and 2002 Consolidated Financial Statements and the Management of Government Operations Weaknesses in controls over tax collection activities continue to affect the federal government’s ability to efficiently and effectively account for and collect revenue. Additionally, weaknesses in financial reporting affect the federal government’s ability to make informed decisions about collection efforts. As a result, the federal government is vulnerable to loss of tax revenue and exposed to potentially billions of dollars in losses due to inappropriate refund disbursements. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately. 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Summary: GAO is required to annually audit the consolidated financial statements of the U.S. government. Proper accounting and reporting practices are essential in the public sector. The U.S. government is the largest, most diverse, most complex, and arguably the most important entity on earth today. Its services--homeland security, national defense, Social Security, mail delivery, and food inspection, to name a few--directly affect the well-being of almost every American. But sound decisions on the future direction of vital federal government programs and policies are made more difficult without timely, accurate, and useful financial and performance information. Until the problems discussed in GAO's audit report on the U.S. government's consolidated financial statements are adequately addressed, they will continue to (1) hamper the federal government's ability to accurately report a significant portion of its assets, liabilities, and costs; (2) affect the federal government's ability to accurately measure the full cost as well as the financial and nonfinancial performance of certain programs while effectively managing related operations; and (3) significantly impair the federal government's ability to adequately safeguard certain significant assets and properly record various transactions. As in the 6 previous fiscal years, certain material weaknesses in internal control and in selected accounting and reporting practices resulted in conditions that continued to prevent GAO from being able to provide the Congress and American citizens an opinion as to whether the consolidated financial statements of the U.S. government are fairly stated in conformity with U.S. generally accepted accounting principles. Three major impediments to an opinion on the consolidated financial statements continue to be (1) serious financial management problems at DOD, (2) the federal government's inability to fully account for and reconcile transactions between federal government entities, and (3) the federal government's ineffective process for preparing the consolidated financial statements. For fiscal year 2003, 20 of 23 Chief Financial Officers (CFO) Act agencies received unqualified opinions, the same number received by these agencies in fiscal year 2002, up from 6 for fiscal year 1996. However, only 3 of the CFO Act agencies had neither a material weakness in internal control, an issue involving compliance with applicable laws and regulations, nor an instance of lack of substantial compliance with Federal Financial Management Improvement Act requirements. The requirement for timely, accurate, and useful financial and performance management information is greater than ever as our nation faces major longterm fiscal challenges that will require tough choices in setting priorities and linking resources to results. Given the nation's large and growing long-term fiscal imbalance, which is driven largely by known demographic trends and health care costs, coupled with new homeland security and defense commitments, the status quo is unsustainable. Current financial reporting does not clearly and transparently show the wide range of responsibilities, programs, and activities that may either obligate the federal government to future spending or create an expectation for such spending and provides an unrealistic and even misleading picture of the federal government's overall performance and financial condition. In addition, too many significant federal government commitments and obligations, such as Social Security and Medicare, are not adequately addressed in the federal government's financial statements and budget process, and current federal financial reporting standards do not require such disclosure. A top-to-bottom review of government activities to ensure their relevance and fit for the 21st century and their relative priority is long overdue. The federal government needs a three-pronged approach to (1) restructure existing entitlement programs, (2) reexamine the base of discretionary and other spending, and (3) review and revise the federal government's tax policy and enforcement programs. New accounting and reporting approaches, budget control mechanisms, and metrics are needed for considering and measuring the impact of spending and tax policies and decisions over the long term.