Annually, the federal government expends hundreds of billions of dollars for a variety of grants, transfer payments, and procurement of goods and services. Because of its size, complexity, weak control environment, and insufficient preventive controls, the federal government risks disbursing improper payments. Agency-specific studies and audits have indicated that improper payments are a widespread and significant problem. They occur in a variety of programs and activities including those involving contract management, financial assistance benefits—such as Food Stamps and Veterans Benefits—and tax refunds. However, some overpayments, by their nature, are not considered improper payments, such as routine contract price adjustments. Legislative efforts have focused on improving the federal government’s control environment. For example, under the Federal Managers’ Financial Integrity Act of 1982 and the Federal Financial Management Improvement Act of 1996, agency managers are responsible for ensuring that adequate systems of internal controls are developed and implemented. An adequate system of internal controls, as defined by the Comptroller General’s internal control standards, which are issued pursuant to the Financial Integrity Act, should provide reasonable assurance that an agency is effectively and efficiently using resources, producing reliable financial reports, and complying with applicable laws and regulations. Accordingly, cost-effective internal controls should be designed to provide reasonable assurance regarding prevention of or prompt detection of unauthorized acquisition, use, or disposition of an agency’s assets. Recent legislation has provided an impetus for agencies to systematically measure and reduce the extent of improper payments. For example, with the advent of the CFO Act, GMRA, and the Results Act, agencies are challenged to increase attention on identifying and addressing improper payments. The CFO Act, as expanded by GMRA, requires 24 major departments/agencies to prepare and have audited agencywide financial statements, which are intended to report an agency’s stewardship over its financial resources—including how it expended available funds. The Office of Management and Budget’s Bulletin 97-01, Form and Content of Agency Financial Statements, provides implementing guidance on these CFO Act requirements. In addition, the CFO Act sets expectations for agencies to routinely produce sound cost and operating performance information. Effective implementation of this requirement would enable managers to have timely information for day-to-day management decisions. The CFO Act also requires OMB to prepare and annually revise a governmentwide 5- year financial management plan and status report that discusses the activities the executive branch plans to and has undertaken to improve financial management in the federal government. Additionally, each agency CFO is responsible for developing annual plans to support the governmentwide 5-year financial management plan. The Results Act seeks to improve the effectiveness and efficiency of the federal government by requiring that agencies develop strategic and annual performance goals and report on their progress in achieving these goals. Agency strategic plans are required to include the agency’s mission statement; identify long-term general goals, including outcome-related goals and objectives; and describe how the agency intends to achieve these goals. Agencies are required to consult with the Congress when developing their strategic plans and consider the views of other interested parties. In their annual performance plans, agencies are required to set annual goals, covering each program activity in an agency’s budget, with measurable target levels of performance. Agencies are also required to issue annual performance reports that compare actual performance to the annual goals. Together, these plans and reports are the basis for the federal government to manage for results. The Results Act is supported by the development of federal cost accounting standards under the CFO Act, which require agencies to identify the costs of government activities. These standards can lead to and support linking costs with achieving performance levels. This can give managers information for assessing the full costs of goods, services, and benefits compared to program outputs and results. Such information can provide the basis for agencies to develop performance goals to monitor and track improper payments as well as strategies for preventing such future disbursements. The risk of improper payments and the government’s ability to prevent them will continue to be of concern in the future. Under current federal budget policies, as the baby boom generation leaves the workforce, spending pressures will grow rapidly due to increased costs of Medicare, Medicaid, and Social Security. Other federal expenditures are also likely to increase. Thus, absent improvements over internal controls, the potential for additional or larger volumes of improper payments will be present. Figure 1 illustrates the reported and projected trends in federal expenditures, excluding interest on the public debt, for fiscal years 1978 through 2004. Historically, the recovery rates for certain programs identified as having improper payments have been low. Therefore, it is critical that adequate attention be directed to strengthen controls to prevent improper payments. This report is based on our reviews of available major agencies’ fiscal year 1998 financial statement reports prepared under the CFO Act, as expanded by GMRA. We reviewed these reports to identify amounts of reported improper payments. We also identified and reviewed recent GAO reports to identify additional types of programs at risk. We supplemented our review with IG reports from CFO Act agencies and other information obtained from a variety of sources, such as agency studies. In addition, we reviewed these data sources to discern the causes of improper payments. For the nine agencies that reported improper payments in their financial statement reports, we reviewed the agencies’ Results Act performance plans for fiscal year 2000 to determine the extent to which the plans addressed improper payments. We relied on recent GAO reports and guidance to consider any impact from potential Year 2000 computing problems on improper payments. In selected cases, we interviewed agency CFO and IG personnel. Because of the nature of improper payments, our review would not capture all reported instances of such payments. As requested, relevant GAO reports covering our work in these areas for the past 4 fiscal years are listed at the end of this report. To gather information on existing financial statement and performance reporting criteria, we reviewed relevant professional literature, including the American Institute of Certified Public Accountants’ Codification of Statements on Auditing Standards and the Federal Accounting Standards Advisory Board’s (FASAB) Statements of Federal Financial Accounting Concepts and Standards. In addition, we reviewed OMB Bulletin 97-01, Form and Content of Agency Financial Statements and OMB Circular A-11, Part 2, Preparation and Submission of Strategic Plans, Annual Performance Plans, and Annual Program Performance Reports. We performed our work from June 1998 through August 1999. Our work was conducted in accordance with generally accepted government auditing standards. We provided a draft of this report for comment to the Director of the Office of Management and Budget (OMB). These comments are presented and evaluated in the “OMB Comments and Our Evaluation” section and reprinted in appendix IV. Agency-specific studies performed by GAO, IGs, and others indicate that improper payments are a widespread and significant problem. However, efforts by agencies to develop comprehensive estimates have varied. Nine agencies have taken the initiative to disclose improper payments for 17 of their programs in their financial statement reports, which has resulted in the disclosure of important information for oversight and decision-making. At the same time, the methodologies used by some agencies to estimate improper payments do not always result in complete estimates, and many other agencies have not even attempted to identify or estimate improper payments. As a result, the full extent of improper payments governmentwide is largely unknown, which hampers efforts to reduce such payments. Ascertaining the full extent of improper payments governmentwide is critical to determining related causes. Obtaining these data would give agencies baseline information for making cost-effective decisions about enhancing controls to minimize improper use of federal resources. Nine of the CFO Act agencies that had issued their fiscal year 1998 audited financial statements as of the end of our field work, acknowledged making improper payments. For fiscal year 1998, HHS, USDA, and HUD collectively reported improper payments of $14.9 billion as part of their program expenses in their financial statement reports. HHS’ estimated improper Medicare benefit payments constitute $12.6 billion of this amount, which represents 7.1 percent of the $177 billion in Fee-for-Service payments processed in fiscal year 1998. USDA disclosed $1.4 billion in food stamp overissuances or approximately 7 percent of its annual program cost of $20.4 billion. HUD’s excess housing subsidy payments totaled $857 million, or 4.6 percent of its rental assistance payments for this $18.6 billion program. These agencies have made significant progress in estimating and reporting improper payments for these programs by implementing methodologies that use statistical sampling. However, implementing a statistically valid methodology will pose challenges to agencies for certain programs. The disclosure methods used by HHS, USDA, HUD, and the other six agencies varied. Some agencies, such as the Social Security Administration (SSA), reported known improper payments as receivables and provided explanatory disclosures in the notes accompanying their financial statements. Other agencies disclosed explanatory information in other sections of their financial statement reports, such as in management’s discussion and analysis or in supplemental data sections. In addition, reporting within agencies for different programs also varied. For example, USDA disclosed improper payments of $1.4 billion for the Food Stamp Program, but only acknowledged making improper payments without providing a specific amount for its Federal Crop Insurance Corporation (FCIC). Three of the nine agencies reported improper payments as expenses for 4 programs, while five agencies reported them as accounts receivable for 10 programs. Three agencies acknowledged making improper payments, but did not quantify the dollar amounts for three programs. Eleven of the CFO Act agencies did not report any information related to improper payments in their financial statement reports. Such inconsistent financial reporting makes it difficult to quantify the extent of the problem governmentwide and indicates a need for more guidance. To address this issue, OMB is contemplating revising its guidance to provide uniform reporting and disclosure of improper payments by management.