As part of our audit of the fiscal years 2006 and 2005 CFS, we evaluated the federal government’s financial reporting procedures and related internal control, and we followed up on the status of Treasury and OMB corrective actions to address open recommendations regarding the process for preparing the CFS that were in our prior years’ reports. In our disclaimer of opinion on the fiscal year 2006 CFS, which is included in the fiscal year 2006 Financial Report of the United States Government, we discussed material deficiencies related to the federal government’s process for preparing the CFS. These material deficiencies contributed to our disclaimer of opinion on the CFS and also constitute material weaknesses in internal control, which contributed to our adverse opinion on internal control. We performed sufficient audit procedures to provide the disclaimer of opinion in accordance with U.S. generally accepted government auditing standards. This report provides the details of the weaknesses we identified in performing our fiscal year 2006 audit procedures related to the process for preparing the CFS and our recommendations to correct those weaknesses, as well as the status of corrective actions taken by Treasury and OMB to address recommendations in our prior reports. We requested comments on a draft of this report from the Director of OMB and the Secretary of the Treasury or their designees. OMB provided oral comments, which are discussed in the Agency Comments and Our Evaluation section of this report. Treasury’s comments are reprinted in appendix II and are also discussed in the Agency Comments and Our Evaluation section. The federal government reports a unified budget deficit (budget deficit) in the Reconciliation of Net Operating Cost and the Unified Budget Deficit and in the Statement of Changes in Cash Balance from Unified Budget and Other Activities. The budget deficit is calculated by subtracting actual budget outlays from actual budget receipts. Budget outlays consist of federal agencies’ outlay amounts and undistributed offsetting receipts. For several years, we have been reporting material unreconciled differences between the total net outlays reported in selected federal agencies’ Statements of Budgetary Resources (SBR) and Treasury’s central accounting records used to compute the budget deficit reported in the CFS. OMB and Treasury have been working with federal agencies to reduce these material unreconciled differences. Such efforts have resulted in significantly reducing the net outlay differences in fiscal year 2006. However, billions of dollars of differences still exist in this and other components of the budget deficit because the federal government does not have effective processes and procedures for identifying and either resolving or explaining material differences in the components of the budget deficit between Treasury’s central accounting records and information reported in agency financial statements and underlying agency financial information and records. For example, during our audit of the 2006 CFS, we found that undistributed offsetting receipts related to two intragovernmental activities: both (1) federal employers’ contributions to their employees’ retirement and (2) interest received by federal trust funds did not always link to related amounts reported in federal agencies’ financial statements. For fiscal year 2006, Treasury’s central accounting records used to compute the budget deficit reported in the CFS showed (1) undistributed offsetting receipts for federal employers’ contributions to their employees’ retirement of $60.9 billion and (2) $169.3 billion of interest received by certain federal agencies’ trust funds on Treasury’s borrowings from the trust funds. These activities, which totaled $230.2 billion, were material components of the budget deficit. We compared components of undistributed offsetting receipts reflected in Treasury’s central accounting records of about $54.7 billion, or about 24 percent of the $230.2 billion balance, to amounts reported in certain federal agency financial statement information and found differences. However, neither Treasury nor the respective federal agencies had identified that differences existed. In addition, we were not able to link the remainder of these undistributed offsetting receipts, $175.5 billion, to related information in other federal agencies’ financial statements because the information was not separately disclosed in such statements. Neither OMB nor Treasury was able to explain how undistributed offsetting receipts reflected in Treasury’s central accounting records linked to related amounts reported in federal agency financial statements. Consolidated financial statements are intended to present the results of operations and financial position of the components that make up a reporting entity as if the entity were a single enterprise. When preparing consolidated financial statements, the preparer must eliminate intragovernmental activity and balances between federal agencies. For fiscal year 2006, we found that Treasury was unable to demonstrate that it fully eliminated amounts related to intragovernmental interest from the reported budget deficit. As noted above, for fiscal year 2006, Treasury’s central accounting records reflected $169.3 billion of intragovernmental interest received by certain federal agencies’ trust funds. Treasury’s central accounting records also reflected outlays by Treasury to such trust funds for intragovernmental interest of $187.4 billion. Treasury was unable to provide support to demonstrate where and how the $18.1 billion difference between these two intragovernmental amounts was eliminated in the calculation of the budget deficit. Until these types of differences are timely reconciled by the federal government, their effect on the CFS will be unknown. We recommend that the Director of OMB and Secretary of the Treasury direct the Controller of the Office of Federal Financial Management and Fiscal Assistant Secretary, respectively, to develop formal processes and procedures for identifying and either resolving or explaining any material differences in undistributed offsetting receipt amounts between Treasury’s central accounting records and information reported in agency financial statements and underlying agency financial information and records. We also recommend that the Secretary of the Treasury direct the Fiscal Assistant Secretary to develop formal processes and procedures for ensuring that intragovernmental activity and balances, including intragovernmental interest, are fully eliminated in the calculation of the budget deficit. As discussed in our report on our audit of the fiscal year 2006 CFS, fiscal year 2006 was the third year that Treasury used the Governmentwide Financial Report System (GFRS) to collect agency financial statement information taken directly from federal agencies’ audited financial statements. The goal of GFRS, which we strongly support, is to be able to directly link information from federal agencies’ audited financial statements to amounts reported in the CFS and resolve many of the weaknesses we previously identified in the process for preparing the CFS. However, GFRS was still undergoing development and was not yet fully operational. As we have reported in the past, Treasury’s process for compiling the CFS does not yet fully ensure that financial information from federal agencies’ audited financial statements and other financial data directly link to amounts reported in the CFS. In our report on our audit of the fiscal year 2006 CFS, we noted that Treasury showed progress by demonstrating that amounts in the SOSI were consistent with the underlying federal agencies’ audited financial statements and that the Balance Sheet and the Statement of Net Cost were consistent with federal agencies’ audited financial statements prior to eliminating intragovernmental activity and balances. However, Treasury’s process for compiling the CFS did not ensure that the information in the remaining three principal financial statements and notes was consistent with the underlying information in federal agencies’ audited financial statements and other financial data. We reaffirm the recommendation in our prior report that as Treasury continues to design and further implement its process for compiling the CFS, the Secretary of the Treasury should direct the Fiscal Assistant Secretary, in coordination with the Controller of OMB, to modify Treasury’s closing package to (1) require federal agencies to directly link their audited financial statement notes to the CFS notes and (2) provide the necessary information to demonstrate that all of the six principal consolidated financial statements are consistent with the underlying information in federal agencies’ audited financial statements and other financial data. Treasury lacked effective processes and procedures for ensuring that unexpended balances of budget authority (unexpended budget balances) are properly reported in the supplemental information section of the CFS. Instead of obtaining federal agencies’ unobligated and obligated amounts through the closing packages, Treasury reported estimated amounts for unobligated and obligated balances (which comprise the unexpended budget balances). Specifically, in the supplemental information section of the fiscal year 2006 CFS, Treasury noted that because the President’s Budget with fiscal year 2006 actual amounts would not be published until February 2007, it used the estimated fiscal year 2006 amounts from the previous fiscal year’s President’s Budget, which was issued in February 2006, to report unobligated and obligated budget balances for fiscal year 2006. Subsequent to our fiscal year 2006 CFS audit, we compared the fiscal year 2006 unobligated and obligated budget balances reported in the fiscal year 2006 CFS to the fiscal year 2006 actual amounts reported in the President’s Budget, issued in February 2007, and noted a material difference. Specifically, for fiscal year 2006, we identified an absolute difference of $118.4 billion—an $82.2 billion understatement in unobligated balances and a $36.2 billion overstatement in obligated balances—between the estimated amounts reported by Treasury and the actual amounts reported in the President’s Budget. Actual amounts reported in the President’s Budget are compiled from amounts reported in agencies’ SF-133s. The SBR is an agencywide report, which aggregates account-level information reported in the SF-133. Agency auditors have also reported internal control issues regarding differences and the lack of effective reconciliation between the unexpended budget balances reported in agencies’ financial statements and amounts reported in agencies’ SF- 133s. To address these reporting issues, OMB recently issued requirements for agencies to reconcile these amounts quarterly.