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, 2006, 2005, and 2004, 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, 2006 and 2005. 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, 2006, 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. § 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 December 21, 2004, Management’s Responsibility for Internal Control. We found matters involving information security controls that we consider not 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 2006 with selected provisions of laws disclosed no instances of noncompliance that would be reportable under U.S. generally accepted government auditing standards or applicable OMB audit guidance. However, the objective of our audit of the Schedule of Federal Debt for the fiscal year ended September 30, 2006, 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 relevant internal control as of September 30, 2006, 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, 2006, 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, 2006, 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, 2006, 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 relevant to the Schedule of Federal Debt as of September 30, 2006; 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 2006 with the (1) statutory debt limit (31 U.S.C. § 3101(b), as amended by Pub. L. No. 107-199, § 1, 116 Stat. 734 (2002), Pub. L. No. 108-24, 117 Stat. 710 (2003), Pub. L. No. 108-415, § 1, 118 Stat. 2337 (2004), and Pub. L. No. 109-182, 120 Stat. 289 (2006)); (2) suspension and early redemption of investments from the Civil Service Retirement and Disability Trust Fund (5 U.S.C. § 8348(j)(k)); and (3) suspension of investments from the G-Fund (5 U.S.C. § 8438(g)). 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 selected provisions of laws that have a direct and material effect on the Schedule of Federal Debt for the fiscal year ended September 30, 2006. 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 conclusions in our report. The comments are reprinted in appendix I. Federal debt managed by the Bureau of the Public Debt (BPD) 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, 2006 and 2005, outstanding gross federal debt managed by the bureau totaled $8,493 and $7,918 billion, respectively. The increase in gross federal debt of $575 billion during fiscal year 2006 was due to an increase in gross intragovernmental debt holdings of $333 billion and an increase in gross debt held by the public of $242 billion. As Figure 1 illustrates, both intragovernmental debt holdings and debt held by the public have steadily increased since fiscal year 2002. 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 Fund, Federal Hospital Insurance Trust Fund, Federal Disability Insurance Trust Fund, and Military Retirement Fund. The increases in debt held by the public are due primarily to total federal spending exceeding total federal revenues. As of September 30, 2006, gross debt held by the public totaled $4,843 billion and gross intragovernmental debt holdings totaled $3,650 billion. (in billions) Interest expense incurred during fiscal year 2006 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 2006, interest expense incurred totaled $404 billion, interest expense on debt held by the public was $221 billion, and $183 billion was interest incurred for intragovernmental debt holdings. As Figure 2 illustrates, total interest expense decreased from fiscal year 2002 to 2003, but increased in fiscal years 2004 through 2006. Average interest rates on principal balances outstanding as of September 30, 2006 and 2005 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, 2006, and 2005, gross debt held by the public totaled $4,843 billion and $4,601 billion, respectively (see Figure 1), an increase of $242 billion.