As has been the case for the previous 10 fiscal years, the federal government did not maintain adequate systems or have sufficient and reliable evidence to support certain material information reported in the U.S. government’s accrual basis consolidated financial statements. The underlying material weaknesses in internal control, which generally have existed for years, contributed to our disclaimer of opinion on the U.S. government’s accrual basis consolidated financial statements for the fiscal years ended 2007 and 2006. Appendix I describes the material weaknesses that contributed to our disclaimer of opinion in more detail and highlights the primary effects of these material weaknesses on the accrual basis consolidated financial statements and on the management of federal government operations. The material weaknesses that contributed to our disclaimer of opinion were the federal government’s inability to satisfactorily determine that property, plant, and equipment and inventories and related property, primarily held by the Department of Defense (DOD), were properly reported in the consolidated financial statements; implement effective credit reform estimation and related financial reporting processes at certain federal credit agencies; reasonably estimate or adequately support amounts reported for certain liabilities, such as environmental and disposal liabilities, or determine whether commitments and contingencies were complete and properly reported; support significant portions of the total net cost of operations, most notably related to DOD, and adequately reconcile disbursement activity at certain agencies; adequately account for and reconcile intragovernmental activity and balances between federal agencies; ensure that the federal government’s consolidated financial statements were (1) consistent with the underlying audited agency financial statements, (2) properly balanced, and (3) in conformity with Generally Accepted Accounting Principles; and, identify and either resolve or explain material differences that exist between certain components of the budget deficit reported in Treasury’s records, used to prepare the Reconciliation of Net Operating Cost and Unified Budget Deficit and Statement of Changes in Cash Balance from Unified Budget and Other Activities, and related amounts reported in federal agencies’ financial statements and underlying financial information and records. Due to the material weaknesses and the additional limitations on the scope of our work, as discussed in our audit report, there may also be additional issues that could affect the accrual basis consolidated financial statements that have not been identified. In addition to the material weaknesses that contributed to our disclaimer of opinion, which were discussed above, we found three other material weaknesses in internal control as of September 30, 2007. These weaknesses are discussed in more detail in appendix II, including the primary effects of the material weaknesses on the accrual basis consolidated financial statements and on the management of federal government operations. These other material weaknesses were the federal government’s inability to determine the full extent to which improper payments occur, identify and resolve information security control weaknesses and manage information security risks on an ongoing basis, and effectively manage its tax collection activities. Further, our audit report discusses certain significant deficiencies in internal control at the governmentwide level. These significant deficiencies involve the following areas: preparing the Statement of Social Insurance for certain programs, and monitoring and oversight regarding certain federal grants and entities that offer Medicare health plan options. Individual federal agency financial statement audit reports identify additional control deficiencies which were reported by agency auditors as material weaknesses or significant deficiencies at the individual agency level. We do not deem these additional control deficiencies to be material weaknesses at the governmentwide level. Regarding agencies’ internal controls, in December 2004, OMB revised OMB Circular No. A-123, Management’s Responsibility for Internal Control, which became effective for fiscal year 2006. In fiscal year 2006, agencies began to implement the more rigorous requirements of the revised OMB Circular No. A-123, which include management identification, assessment, testing, correction, and documentation of internal controls over financial reporting for each account or group of accounts, as well as an annual assurance statement from the agency head as to whether internal control over financial reporting is effective. OMB recognized that due to the complexity of some agencies, implementation of these new requirements may span more than 1 year. Accordingly, certain agencies have adopted multiyear implementation plans. According to OMB’s Federal Financial Management Report for 2007, 16 of the 24 CFO Act agencies have performed assessments required by OMB Circular No. A-123 for all key processes, while the remaining 8 CFO Act agencies are phasing in implementation of the requirements by testing a portion of the key processes and providing plans for testing the remaining processes within 3 years. Also, according to that report, to achieve its strategic goal of improving effectiveness of internal control over financial reporting, OMB has developed priority actions that include updating guidance, as necessary, based on lessons learned from agencies’ implementation of the circular. It will be important that OMB continue to monitor and oversee federal agencies’ implementation of these new requirements. Three major impediments to our ability to render an opinion on the U.S. government’s accrual basis consolidated financial statements continued to be: (1) serious financial management problems at DOD, (2) the federal government’s inability to adequately account for and reconcile intragovernmental activity and balances between federal agencies, and (3) the federal government’s ineffective process for preparing the consolidated financial statements. Extensive efforts by DOD officials and cooperative efforts between agency chief financial officers, Treasury officials, and OMB officials will be needed to resolve these serious obstacles to achieving an opinion on the U.S. government’s accrual basis consolidated financial statements. Essential to further improving financial management governmentwide and ultimately to achieving an opinion on the U.S. government’s consolidated financial statements is the resolution of serious weaknesses in DOD’s business operations. DOD is one of the largest and most complex organizations in the world. Since the first financial statement audit of a major DOD component was attempted almost 20 years ago, we have reported that weaknesses in DOD’s business operations, including financial management, not only adversely affect the reliability of reported financial data, but also the economy, efficiency, and effectiveness of its operations. DOD continues to dominate GAO’s list of high-risk programs designated as vulnerable to waste, fraud, abuse, and mismanagement, bearing responsibility, in whole or in part, for 15 of 27 high-risk areas. Eight of these areas are specific to DOD and include DOD’s overall approach to business transformation, as well as business systems modernization and financial management. Collectively, these high-risk areas relate to DOD’s major business operations, including financial management, which directly support the warfighters, including their pay, the benefits provided to their families, and the availability and condition of equipment and supplies they use both on and off the battlefield. Successful transformation of DOD’s financial management operations will require a multifaceted, cross-organizational approach that addresses the contribution and alignment of key elements, including sustained leadership, strategic plans, people, processes, and technology. Congress clearly recognized, in the National Defense Authorization Act for Fiscal Year 2008, the need for executive-level attention in ensuring that DOD was on a sustainable path toward achieving business transformation. This legislation codifies Chief Management Officer (CMO) responsibilities at a high level in the department—assigning them to the Deputy Secretary of Defense—and establishing a full-time Deputy CMO and designating CMO responsibilities within the military services. However, in less than a year, our government will undergo a change in administrations, which raises questions about the continuity of effort and the sustainability of the progress that DOD has made to date. As such, we believe the CMO position should be codified as a separate position from the Deputy Secretary of Defense in order to provide full-time attention to business transformation over the long term, subject to an extended term appointment. Because business transformation is a long-term and complex process, we have recommended a term of at least 5 to 7 years to provide sustained leadership and accountability. Importantly, DOD has taken steps toward developing and implementing a framework for addressing the department’s long-standing financial management weaknesses and improving its capability to provide timely, reliable, and relevant financial information for analysis, decision making, and reporting, a key defense transformation priority. Specifically, this framework, which is discussed in both the department’s Enterprise Transition Plan (ETP) and the Financial Improvement and Audit Readiness (FIAR) Plan, includes the department’s Standard Financial Information Structure (SFIS) and Business Enterprise Information System (BEIS). DOD intends this framework to define and put into practice a standard DOD-wide financial management data structure as well as enterprise-level capabilities to facilitate reporting and comparison of financial data across the department. DOD’s efforts to develop and implement SFIS and BEIS should help to improve the consistency and comparability of the department’s financial information and reporting; however, a great deal of work remains before the financial management capabilities of DOD and its components’ transformation efforts achieve financial visibility. Examples of work remaining include data cleansing; improvements to current policies, processes, procedures, and controls; and implementation of fully integrated systems. In 2007, DOD introduced refinements to its approach for achieving financial statement auditability. These refinements include the following: Requesting audits of entire financial statements rather than attempting to build upon audits of individual financial statement line items. Focusing on improvements in end-to-end business processes, or segments that underlie the amounts reported on the financial statements. Using audit readiness validations and annual verification reviews of segment improvements to help ensure sustainability of corrective actions and improvements. Forming a working group to begin auditability risk assessments of financial systems at key decision points in their development and deployment life cycle to help ensure that the processes and internal controls support repeatable production of auditable financial statements. We are encouraged by DOD’s efforts and emphasize the necessity for consistent management oversight toward achieving financial management capabilities and reporting of meaningful and measurable transformation effort benchmarks and accomplishments.