Financial Management: IRS Does Not Adequately Manage Its Operating Funds
(Chapter Report, 02/09/94, GAO/AIMD-94-33).

Significant weaknesses exist in the systems that the Internal Revenue
Service (IRS) uses to manage, spend, account for, and report on its
operating funds; GAO was unable to audit $4.3 billion of the $6.7
billion in operating funds that IRS reported spending in fiscal year
1992 because IRS could not account for all the money.  Significant
control weaknesses included the following: (1) managers lacked current,
reliable information on available budget authority, (2) some types of
expenditures were recorded only after lengthy delays, and (3) reports
used to monitor compliance with laws governing the use of budget
authority contained unauthorized adjustments.  In addition, IRS reports
misclassified expenditures. Further, IRS did not periodically review and
adjust its records to reflect changes in obligations and remove canceled
appropriation or resolve billions of dollars in discrepancies between
its records and those of the Treasury Department.  Also, IRS could not
ensure that outlays for goods and services were proper because of
fundamental control weaknesses in its payment processes, including a
lack of proper review and approval of payments.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-94-33
     TITLE:  Financial Management: IRS Does Not Adequately Manage Its 
             Operating Funds
      DATE:  02/09/94
   SUBJECT:  Tax administration
             Administrative costs
             Internal controls
             Reporting requirements
             Federal agency accounting systems
             Chief financial officers
             Financial records
             Computerized information systems
             Financial statement audits
             Funds management
IDENTIFIER:  TSM
             IRS Tax System Modernization Program
             IRS Automated Financial System
             IRS Automated Accounting and Budget Execution System
             
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Cover
================================================================ COVER


Report to the Commissioner
Internal Revenue Service

February 1994

FINANCIAL MANAGEMENT - IRS DOES
NOT ADEQUATELY MANAGE
ITS OPERATING FUNDS

GAO/AIMD-94-33

IRS Operating Funds


Abbreviations
=============================================================== ABBREV

  AABES - Automated Accounting and Budget Execution System
  AFS - Automated Financial System
  CFO - Chief Financial Officer
  FMFIA - Federal Managers' Financial Integrity Act
  GAO - General Accounting Office
  GSA - General Services Administration
  IRS - Internal Revenue Service
  OMB - Office of Management and Budget
  TSM - Tax Systems Modernization
  TT&L - Treasury Tax and Loan

Letter
=============================================================== LETTER


B-254301

February 9, 1994

The Honorable Margaret Milner Richardson
Commissioner of Internal Revenue

Dear Ms.  Richardson: 

This report presents the results of our review of the Internal
Revenue Service's (IRS) management of its $6.7 billion in fiscal year
1992 appropriated operating funds.  We conducted this review as part
of our financial statement audit of IRS pursuant to the Chief
Financial Officers (CFO) Act of 1990 (Public Law 101-576). 

This report contains recommendations to you.  As you know, the head
of a federal agency is required by 31 U.S.C.  720 to submit a written
statement on actions taken on these recommendations.  You should send
the statement to the Senate Committee on Governmental Affairs and the
House Committee on Government Operations within 60 days of the date
of this letter and to the Senate and House Committees on
Appropriations with the agency's first request for appropriations
made over 60 days after the date of this letter. 

We are sending copies of this report to the Secretary of the
Treasury; Director of the Office of Management and Budget; Chairmen
and Ranking Minority Members of the Senate Committee on Governmental
Affairs, the Senate Committee on Finance, the House Committee on
Government Operations, the House Committee on Ways and Means, the
Subcommittee on Commerce, Consumer and Monetary Affairs of the House
Committee on Government Operations, and the Subcommittee on Oversight
of the House Committee on Ways and Means; the Chairman of the Joint
Committee on Taxation; and other interested parties.  Copies will be
made available to others upon request. 

Please contact me at (202) 512-9510 if you or your staff have any
questions.  Major contributors are listed in appendix III. 

Sincerely yours,




Gregory M.  Holloway
Director, Civil Audits


EXECUTIVE SUMMARY
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

The Internal Revenue Service (IRS) received appropriations of $6.7
billion in fiscal year 1992 to fund the cost of its operations. 
Appropriations increased to $7.1 billion in fiscal year 1993, and
further increases are expected as IRS continues its ongoing Tax
Systems Modernization effort and initiatives intended to increase
taxpayer compliance. 

GAO evaluated IRS' controls over the use of its operating funds to
determine if they provided reasonable assurance that these funds were
(1) managed and expended in accordance with the limitations and
purposes specified by the Congress and (2) properly reported.  GAO
conducted this assessment as part of its audit of IRS' fiscal year
1992 financial statements, which it elected to perform under
authority of the Chief Financial Officers (CFO) Act of 1990. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

IRS, a bureau of the Department of the Treasury, is the nation's
largest revenue collector.  IRS receives four annual congressional
appropriations to fund its operating costs, which primarily consist
of personnel costs and purchases of goods and services.  IRS also
administers other appropriations used primarily for payments to
taxpayers.  However, these appropriations are not available for
funding IRS' operating costs and, therefore, are not discussed in
this report. 

Under the direction of the CFO, a position established by IRS in
1989, IRS controls and accounts for its operating funds at its
national office and seven regional offices.  Although GAO performed
work at all eight of these locations, much of its detailed testing
was performed at IRS' national office and central region, which,
during fiscal year 1992, were using IRS' new administrative
accounting system.  By October 1, 1992, this new system had been
implemented servicewide. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3

GAO identified significant weaknesses in the systems and processes
IRS used to manage, spend, account for, and report on its operating
funds.  GAO was unable to audit approximately $4.3 billion, or 64
percent, of the $6.7 billion in operating funds that IRS reported
spending during fiscal year 1992 because IRS could not account for
all of the funds.  Although GAO tested transactions associated with
the remaining $2.4 billion of reported spending, which were processed
by IRS' new administrative accounting system, these tests identified
significant control weaknesses that affected IRS' ability to comply
with laws governing the use of its budget authority or properly
report on such use.  Specifically, (1) managers did not have current,
reliable information concerning available budget authority, (2)
significant delays existed in recording certain types of
expenditures, and (3) reports used to monitor compliance with laws
governing the use of budget authority contained unauthorized
adjustments.  In addition, IRS' reports included misclassifications
of expenditures.  Further, IRS did not periodically review and adjust
its records to reflect changes in obligations and remove canceled
appropriations or resolve billions of dollars in discrepancies
between its records and Treasury's records. 

Also, IRS could not ensure that expenditures for goods and services
were proper because of fundamental control weaknesses in its payment
processes, including a lack of proper review and approval of
payments.  In reviewing a sample of 280 payments to vendors, some of
which had more than one of the noted errors, GAO determined that
about 1.5 percent were duplicate payments, 40 percent were not
supported by complete documentation and, therefore, may have been
inappropriate, and about 59 percent were paid either late or earlier
than allowed by federal payment timing guidance.  Also, IRS either
underpaid or did not pay interest owed for over 50 percent of the
late payments in the sample.  Further, in its review of the sample
items, GAO identified 5 additional duplicate payments and 23
overpayments that were made to the same vendors but were not part of
the sample. 

Because of the weaknesses just described, IRS' records and reports on
its operating funds were unreliable.  Also, IRS' accounting systems
were not designed to provide cost data to support Office of
Management and Budget reporting requirements and did not provide
necessary data to account for costs by program. 


   PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4


      INADEQUATE CONTROLS OVER THE
      USE OF BUDGET AUTHORITY
-------------------------------------------------------- Chapter 0:4.1

IRS managers did not have up-to-date and reliable information on how
much of their appropriation balances were still available to be
obligated and, thus, could not ensure that they complied with laws
governing the use of budget authority.  Because of deficiencies in
IRS' systems, balances were updated only monthly rather than as
transactions occurred.  However, even if they had been updated more
frequently, the balances would still have been unreliable because IRS
did not promptly (1) resolve several billions of dollars of
differences between its records and cash transactions and balances
reported by Treasury, (2) investigate and properly record
$53 million in payments for which sufficient information was
initially unavailable to match payments against related obligations,
and (3) review and correct errors in obligated balances.  The
reliability of IRS' financial reports was further diminished when, at
fiscal year-end, IRS arbitrarily split the $53 million in unmatched
payments equally among three appropriations and then recorded an
unsupported receivable to eliminate the appearance that the budget
authority for one appropriation had been exceeded. 


      DEFICIENCIES IN IRS' PAYMENT
      PROCESS
-------------------------------------------------------- Chapter 0:4.2

IRS made improper, late, and early payments for goods and services
because review and approval procedures were not effective and payment
documents were not always processed promptly.  Further, IRS'
effectiveness in making and timing payments was hampered by
nonintegrated systems and critical features of the payment system not
being fully used.  In reviewing a sample of 280 payments totaling $42
million, GAO identified 4 duplicate payments.  GAO's analysis of
related documentation showed that vendors had notified IRS of an
additional 5 duplicate payments and 23 overpayments which were not
part of the sample.  Also, GAO found that 81 of the 280 payments
reviewed were paid after their due dates and 83 were paid earlier
than necessary--more than 7 days prior to their due dates.  These
practices resulted in ineffective cash management. 


      REPORTS ON OPERATING FUNDS
      WERE UNRELIABLE
-------------------------------------------------------- Chapter 0:4.3

Report reliability was further diminished because IRS systems had not
been designed to report reliable budgetary and related spending
information in budget categories required by the Office of Management
and Budget.  IRS' financial systems are designed for internal
reporting purposes to account for costs by management activities,
such as training.  To develop reports by budget category for three of
its appropriations, IRS converted information from its financial
systems based on the percentage of budget authority that each
management activity had received.  However, there is no assurance
that IRS' conversion method resulted in cost figures approximating
actual costs incurred for each budget category.  For the remaining
appropriation, IRS relied on informal records maintained by various
financial plan managers, records that were not reconciled to related
records maintained in IRS' financial management systems.  One effect
of these practices was that information on $10 million reported in
the President's Budget Submission to the Congress for fiscal year
1994 was misclassified among three of four budget categories. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5

GAO is recommending that the Commissioner of Internal Revenue direct
the Chief Financial Officer to improve controls over operating funds
to ensure that budget authority for operations is not exceeded;
improve processes and controls to ensure that payments for goods and
services are proper and timely; and improve systems and processes to
ensure that reports on operating funds are reliable. 


   AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:6

In commenting on a draft of this report, IRS agreed with the concerns
GAO reported and stated that it is making changes to correct and
eliminate the deficiencies in its systems and processes.  However,
IRS did not provide specific responses to GAO's recommendations.  GAO
plans to evaluate the effectiveness of IRS' efforts as part of its
ongoing audit of the IRS' fiscal year 1993 financial statements. 
IRS' comments are included in appendix I. 


INTRODUCTION
============================================================ Chapter 1

This report presents our review of how the Internal Revenue Service
(IRS), the nation's largest revenue collector, managed its $6.7
billion in operating appropriations for fiscal year 1992.  The report
discusses the effectiveness of IRS' systems and procedures intended
to ensure that IRS (1) did not exceed its budget authority,\1 (2)
properly spent its operating funds, and
(3) accurately reported on the use of these funds to IRS management,
the Department of the Treasury, the Congress, and the Office of
Management and Budget (OMB). 

We performed our review as part of our audit of IRS' fiscal year 1992
financial statements pursuant to the Chief Financial Officers (CFO)
Act of 1990 (Public Law 101-576).  Under the act, IRS is 1 of 10
pilot agencies required to prepare financial statements and have them
audited.  This is one of a series of reports resulting from our
audit.  Appendix I contains a list of our previously issued reports. 


--------------------
\1 Budget authority, which includes appropriations, borrowing
authority, and contract authority, is the authority provided by law
to enter into financial obligations that will result in immediate or
future outlays of federal funds. 


   BACKGROUND
---------------------------------------------------------- Chapter 1:1

IRS, a bureau of the Department of the Treasury, receives four annual
congressional appropriations to fund its operations.  These
appropriations are used for (1) administration and management, (2)
processing tax returns and providing taxpayer assistance, (3) tax law
enforcement, and (4) information systems.  IRS also administers other
appropriations used primarily for direct payments to taxpayers for
such items as interest on refunds and earned income credit payments. 
However, these appropriations are not used to fund IRS' operating
costs and, therefore, are not discussed in this report. 

For fiscal year 1992, IRS reported operating costs of $6.7 billion,
including $4.9 billion in personnel costs, $1.7 billion for goods and
services, and $0.1 billion in reimbursed costs.  IRS also reported
that $262 million of its operating appropriations were unobligated as
of September 30, 1992--$213 million of which its appropriations
allowed to be carried over for use in future years and $49 million
which expired.  IRS' balances of unobligated operating appropriations
as of September 30, 1992, are shown in table 1.1. 



                          Table 1.1
           
           IRS Unobligated Balances as of September
                           30, 1992

                    (Dollars in millions)

                                     Total
                                unobligate  Expire  Carryove
IRS operating appropriations             d       d         r
------------------------------  ----------  ------  --------
Administration and Management        $ 3.2   $ 2.5     $ 0.7
Processing Tax Returns and            29.0    15.3      13.7
 Assistance
Tax Law Enforcement                   25.3    17.1       8.2
Information Systems                  204.0    13.9     190.1
============================================================
Total                               $261.5   $48.8    $212.7
------------------------------------------------------------
IRS' fiscal year 1993 operating appropriations increased to $7.1
billion, including funding for initiatives to increase taxpayer
compliance, estimated at $150 million.  Further increases are
expected as IRS continues its ongoing Tax Systems Modernization (TSM)
effort, intended to provide for the long-term modernization of its
information systems, which it expects will cost $23.1 billion through
2008.  Treasury, OMB, and the CFO Act each require IRS to report on
the use of these operating funds. 

To more effectively manage operating appropriations, IRS appointed a
CFO in 1989.  The CFO reports to the Commissioner and oversees a wide
range of financial areas including budget, procurement, and
administrative accounting systems.  In 1990, IRS established the
position of Assistant Commissioner for Finance/Controller to assist
the CFO in overseeing financial management matters. 

Under the direction of the CFO, IRS' financial management functions
are performed in its national office and seven regions.  Although
regional managers report directly to the Service's Chief Operations
Officer, they are also required to submit financial management
information on their operations to the Controller for inclusion in
servicewide financial reports. 

As of October 1, 1992, IRS had implemented a new administrative
accounting system, the Automated Financial System (AFS) to improve
its control over the use of operating funds, payment processing, and
financial reporting.  However, only the national office and central
region used AFS during fiscal year 1992.  The six regions not on AFS
during fiscal year 1992 used the Automated Accounting and Budget
Execution System (AABES) to record their financial activity. 

AFS was selected to replace AABES because, as IRS stated in its
fiscal year 1992 report pursuant to the Federal Managers' Financial
Integrity Act (FMFIA) of 1982 (Public Law 97-255), AABES was outdated
and did not conform to current standards for financial management
systems.  In that report, IRS stated that AFS corrected reported
FMFIA weaknesses related to AABES. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
---------------------------------------------------------- Chapter 1:2

As part of our audit of IRS' fiscal year 1992 financial statements,
we assessed the effectiveness of the systems and internal controls
that IRS used to manage its operating funds.  Specifically, we
determined whether such systems and controls provided reasonable
assurance that

  budget authority was not exceeded,

  operating funds were properly spent for goods and services, and

  reports on the use of operating funds were reliable. 

To assess controls over compliance with laws governing budget
authority, we reviewed IRS' budgetary control policies and practices
to determine if IRS had implemented procedures to prevent or detect
obligations\2 and expenditures\3 that exceeded its budget authority. 
Also, we reviewed the effectiveness of procedures to review and
adjust existing obligation balances. 

To assess the effectiveness of IRS' systems and related internal
controls over its procurement actions and payments for goods and
services, we selected for examination 378 payments recorded in AFS,
including all payments equal to or over $2 million, and a random
selection of payments under $2 million.  Of these 378 payments, 280
were to vendors and 98 were to federal agencies.  Our sample was
drawn from transactions for procured goods and services recorded as
operating expenses in the AFS general ledger for the 11 months ended
August 31, 1992.  For each selected vendor payment, we examined
available accounting and procurement records to determine whether IRS
adhered to significant provisions of the Federal Acquisition
Regulation, Federal Information Resources Management Regulation,
Treasury Acquisition Procurement Regulation, IRS' internal control
policies and procedures, and requirements of the Prompt Payment Act
and OMB Circular A-125, "Prompt Payment." For each selected federal
agency payment, we examined supporting documentation, such as
invoices and obligation documents, to determine whether IRS adhered
to its internal controls and policies. 

We were unable to test procurement and payment controls in operation
for the six IRS regions that used AABES during fiscal year 1992
because IRS could not reconcile the summary records to the system's
detailed spending information for operating expenses.  According to
IRS records, the six regions that used AABES expended a total of $4.3
billion, or 64 percent, of IRS' $6.7 billion in operating
appropriations.  IRS discontinued AABES on October 1, 1992.  Because
of this audit scope limitation, our report focuses primarily on
procurement and payment operations at IRS' national office and
central region, which used AFS during fiscal year 1992. 

To determine if IRS' reports on the use of operating funds were
reliable, we (1) considered the results of the above procedures on
the information reported in IRS' financial reports and (2) examined
all IRS year-end reports to OMB, tracing each line item to the
supporting accounting records.  Also, we reviewed IRS' procedures for
reporting data on actual obligations for fiscal year 1992 in the
President's fiscal year 1994 Budget Submission to the Congress and
interviewed personnel responsible for preparing these reports.  We
also compared budgetary information in IRS' fiscal year 1992
principal financial statements to the requirements of OMB Bulletin
93-2, "Form and Content of Agency Financial Statements," and traced
line items to IRS' accounting records. 

To supplement our findings, we reviewed relevant IRS Internal Audit
Division and Treasury FMFIA reports.  IRS provided written comments
on a draft of this report.  These comments are included in appendix
I. 

We conducted our review from October 1991 through May 1993 in
accordance with generally accepted government auditing standards.  We
performed our work at IRS' national office in Washington, D.C., and
seven regional offices. 


--------------------
\2 Obligations are amounts of orders placed, contracts awarded,
services received, and similar transactions during a given period
that will require payments during the same or a future period. 

\3 The term expenditure, with respect to provisions of the
Anti-Deficiency Act, refers to the issuance of checks, disbursements
of cash, or electronic transfer of funds made to liquidate an
obligation. 


IRS HAD WEAK SYSTEMS AND CONTROLS
FOR ENSURING COMPLIANCE WITH LAWS
GOVERNING THE USE OF BUDGET
AUTHORITY
============================================================ Chapter 2

IRS did not have a reasonable basis for ensuring compliance with laws
and regulations governing the use of budget authority because of
weaknesses in its systems and controls over operating funds. 
Specifically, (1) managers did not have current information on
available appropriations and quarterly budget apportionments, (2)
significant delays occurred in recording certain types of
expenditures against appropriations, and (3) reports contained
unauthorized adjustments.  In addition, IRS' reports included
misclassifications of expenditures. 

The Anti-Deficiency Act and OMB Circular A-34, "Instructions on
Budget Execution," require agencies to establish controls to ensure
that obligations and expenditures comply with the purpose and do not
exceed the amount and time restrictions imposed in appropriations. 
More specifically, the act prohibits an officer or employee of the
agency from making or authorizing an obligation or expenditure in
excess of the amount available in the appropriation. 


   SYSTEMS DID NOT PROVIDE CURRENT
   DATA ON FUND AVAILABILITY
---------------------------------------------------------- Chapter 2:1

IRS managers could not reliably determine if funds were available to
be obligated because IRS' systems did not provide current information
on the balances of unobligated appropriations.  IRS only updated
information on budget authority to account for actual use of funds
once a month, principally because its systems for maintaining budget
information were not integrated with accounting systems used to
process and record obligations and expenditures.  Integrated systems
could have provided for the automatic updating of both accounting and
budget data based on the initial recording of a transaction in the
accounting system. 

The Anti-Deficiency Act and OMB regulations require the head of each
agency to prescribe, by regulation, a system for administrative
control of funds to ensure that obligations and expenditures do not
exceed apportionments or appropriations.  Once the Congress has
enacted budget authority, OMB apportions or distributes the funds,
typically quarterly, to each agency.  Many agencies then prepare
quarterly allotments\1 for their managers based on these
apportionments. 

IRS personnel responsible for approving the use of appropriations,
known as financial plan managers, had to rely on their own informal
records to determine fund availability due to the accounting system's
inability to provide up-to-date information.  However, because these
informal records were not consistently reconciled to the monthly
reports, the managers did not have reasonable assurance that their
data were reliable.  Also, such duplicate records resulted in
inefficient use of financial plan managers' time. 

Managers were further hampered in effectively monitoring the
availability of funds because, although IRS informed them of annual
spending limits, it did not inform them of quarterly spending limits
based on OMB's quarterly apportionments.  As a result, IRS lacked, in
both its accounting and budget systems and in managers' informal
records, adequate controls to ensure that IRS did not exceed
quarterly apportionments. 

In early fiscal year 1993, IRS implemented software changes in AFS
designed to address the problems discussed above.  IRS informed us
that financial plan managers received quarterly allotment data
starting in fiscal year 1993 and that controls were established with
the implementation of an integrated budget module within AFS to
highlight any situation where additional obligations would cause IRS
to exceed its quarterly apportionment.  Further, according to IRS
officials, enhancements to the new system provide personnel
responsible for obligating funds daily information on available
budget authority.  Because these changes were implemented during
fiscal year 1993, we have not assessed their effectiveness.  However,
these changes will not ensure the reliability of data on reported
spending if IRS does not address the problems discussed in the
following section. 


--------------------
\1 An allotment is an authorization by either the agency head or
another authorized employee to subordinates to incur obligations
within a specified amount. 


   IRS DID NOT PROMPTLY RECORD
   EXPENDITURES AGAINST
   APPROPRIATIONS
---------------------------------------------------------- Chapter 2:2

IRS reported spending was unreliable because it did not promptly (1)
resolve differences between its own records and cash transactions and
balances reported by Treasury, (2) investigate and properly record
expenditures for which sufficient information was initially
unavailable, and (3) review and adjust obligations to appropriate
amounts.  Without accurate information on spending, IRS cannot
determine if it exceeds its budget authority or provide reliable
reports. 


      DIFFERENCES IN CASH BALANCES
      WERE NOT RESOLVED
-------------------------------------------------------- Chapter 2:2.1

Treasury regulations require IRS to reconcile its cash accounts to
Treasury balances monthly.  Reconciling cash accounts involves
identifying differences between IRS and Treasury records, determining
the reason for the differences, and finally, correcting the
differences.  Differences arise when either IRS or Treasury
incorrectly records or delays recording of deposits and disbursements
to IRS cash accounts. 

IRS inappropriately reported, in its financial statements, cash
balances based on Treasury's records without resolving significant
differences between Treasury's and its own records.  As of September
30, 1992, there were several billions of dollars in cumulative gross
differences, originating as far back as 1986, some of which may
partially or wholly offset each other.  Correcting such differences
should result in adjustments to either Treasury's or IRS' records or
both.  Also, to balance its accounts for these cash differences, IRS
made unsupported adjustments to other line items, such as its
accounts payable, in its fiscal year 1992 financial reports.  Thus,
information on its use of funds and financial reports required under
the CFO Act were unreliable and of limited use in evaluating IRS'
financial performance. 

IRS' national office is responsible for identifying overall
differences between IRS and Treasury records and for reporting these
differences to appropriate regional offices for resolution.  The
regional offices are responsible for researching and making
appropriate adjustments to correct the differences.  As of September
30, 1992, the national office had identified and reported to its
regional offices approximately 7,000 unmatched differences between
IRS and Treasury records.  However, IRS' national office did not have
an effective follow-up system to ensure that these differences were
investigated and adjusted by the regions within a reasonable amount
of time.  The national office stated that about 61 percent of its
gross differences were older than 6 months and approximately 58
percent were attributable to payroll activities.  Figure 2.1 shows
how long IRS' differences had been outstanding as of September 30,
1992. 

   Figure 2.1:  IRS' Cash
   Differences by Age

   (See figure in printed
   edition.)

In addition, IRS had not resolved differences of $63 million at the
end of fiscal year 1992 between Treasury's cash balances and the
General Services Administration's (GSA) allocation account to IRS. 
Although appropriated to GSA, IRS is allowed to obligate and expend
from this GSA account for the cost of maintaining GSA-owned buildings
used by IRS.  IRS is required to maintain records of the activity in
this account and reconcile differences between its records and
Treasury's.  Because IRS did not resolve these differences, it had no
assurance that its reports to GSA on the cash balance in the
allocation account were accurate. 

IRS' management was previously notified of its cash reconciliation
problems.  In June 1991, IRS' Internal Audit Division recommended\2

that the Controller provide additional instructions and oversight to
ensure that cash reconciliations were properly performed.  Although
the Controller responded by providing technical assistance to
regional offices on how to perform reconciliations, almost 2 years
later the cash reconciliation problem still exists. 

Until IRS establishes a reliable means for periodically resolving its
cash differences with Treasury and promptly adjusting its accounting
records, it will not be able to produce reliable budgetary data and
reports.  In fiscal year 1993, IRS established a task force at its
national office to investigate and correct cash differences between
its accounting records and records maintained by Treasury. 


--------------------
\2 Review of the Reconciliation of Administrative Accounts (Reference
No.  013506, June 19, 1991). 


      CERTAIN DISBURSEMENTS WERE
      NOT PROMPTLY CHARGED TO
      APPROPRIATIONS
-------------------------------------------------------- Chapter 2:2.2

To obtain assurance that funds were actually used for the purposes
appropriated and within those dollar limits, agencies are required to
promptly match disbursements against applicable obligations.  IRS did
not promptly investigate and properly record certain expenditures for
which supporting documentation was initially unavailable to perform
such a match.  When IRS cannot determine which appropriation to
charge its expenditures, it records them in a suspense account until
they are investigated and charged to proper accounts.  One way these
expenditures occur is that another federal agency, such as GSA, uses
funds from IRS' accounts at Treasury to pay for rent and utilities
for IRS occupied buildings.  However, until GSA provides IRS with an
invoice supporting the amounts, IRS does not know which appropriation
to charge.  Of our sample of 98 payments to federal agencies, 25 for
$17 million remained in the suspense account from 2 to 6 months after
the funds were paid.  As of September 30, 1992, IRS records indicated
that the suspense account in AFS had a balance of $53 million that
had not been applied to appropriations. 

Instead of investigating all items in the suspense account and
charging them to their proper appropriations at the end of fiscal
year 1992, the national office arbitrarily charged one-third of the
balance of the suspense account as of September 30, 1992, or $18
million, to each of three operating appropriations.  The overall
effect of this was that IRS had no assurance that they were charged
against proper appropriations and, consequently, whether IRS'
reported available budget authority was accurate.  One result of
arbitrarily charging appropriations was that IRS reported to Treasury
and OMB that it had exceeded its spending limits in one
appropriation.  Upon inquiry from Treasury and OMB about the reported
overspending, IRS recorded an unsupported receivable from another
appropriation to eliminate the appearance that IRS had exceeded its
authority. 

An IRS official stated that amounts in suspense were not promptly
resolved because of delays in receiving supporting documentation for
the payments from the billing agencies and in reviewing this
documentation.  IRS also said that resolution was not prompt because
it had instead allocated staffing resources to promptly pay
commercial invoices to avoid interest payments.  IRS informed us that
it had hired a contractor to research and clear items in the suspense
account in fiscal year 1993.  However, we have not assessed the
effectiveness of this effort.  Until IRS investigates the items in
the suspense account and charges them to the appropriate account, it
cannot be sure that budget authority was not exceeded. 


      REVIEWS OF OBLIGATIONS WERE
      NOT PERFORMED
-------------------------------------------------------- Chapter 2:2.3

Treasury's Financial Manual requires federal agencies to ensure that
recorded obligations reflect amounts that are expected to be expended
and that balances of such obligations be accurately reported to
Treasury.  Further, the National Defense Authorization Act for Fiscal
Year 1991 (Public Law 101-510) requires IRS to remove canceled
appropriations for fiscal years 1983 through 1985 from its accounting
records by the end of fiscal year 1992.  However, during fiscal year
1992, IRS did not consistently review and adjust obligated balances,
which totaled $1.6 billion as of September 30, 1992, to reflect
current estimates of amounts that would ultimately be expended, nor
did it remove expired appropriation balances from its general ledger. 

As of fiscal year-end, the IRS national office did not review
obligations, and the central region began, but did not complete, a
review of obligations.  Any needed adjustments to obligations would
directly affect the balance of appropriations available for
obligation, and the balances of available funds reported by IRS. 
However, an IRS official told us that the national office did not
review and adjust obligations during fiscal year 1992 because such
actions were not considered a priority.  Also, IRS' new general
ledger system did not generate a list of open obligations for the
central region until August 1992, too late for the central region to
complete its review of its obligations. 

Further, IRS did not remove canceled appropriations from its
accounting records by the end of the fiscal year.  IRS stated that it
did not do this because of difficulties in completing its 1992 fiscal
year-end closing procedures.  Because these appropriations were not
removed, IRS records inappropriately showed that this canceled budget
authority was still available. 


   RECORDED TRANSACTIONS WERE
   UNAUTHORIZED AND IMPROPERLY
   CLASSIFIED
---------------------------------------------------------- Chapter 2:3

IRS' reported spending was susceptible to unauthorized adjustments
because it did not have adequate systems and controls to ensure that
all journal entries were properly approved and entered into its
financial records.  Further, IRS expenditures were charged to
inappropriate accounts due to a lack of adequate controls over the
assignment of accounting information to its transactions. 
Consequently, IRS did not have assurance that its reports accurately
reported how funds had been used. 

We noted instances where journal vouchers prepared at the national
office to consolidate and correct IRS' accounts did not contain
evidence that such journal vouchers were processed according to IRS'
policy.  Specifically, out of 421 journal vouchers prepared at the
national office during fiscal year 1992, 400 did not have evidence of
supervisory approval; 65 did not contain a preparer's name; and 290
did not indicate whether controls over the accuracy of data entry,
such as data verification by an individual other than the person who
keyed in the transaction, were applied. 

IRS informed us that, under the new AFS system implemented on October
1, 1992, the entry of a journal voucher requires three levels of
electronic approval, including supervisory approval, second-line
supervisory approval, and the financial systems office approval,
prior to processing.  We have not assessed the effectiveness of these
new processes. 

In our sample of 280 payments, we also found 12 instances in which
IRS inappropriately classified expenditures.  For example, IRS
recorded a $46,694 invoice for both maintenance ($19,662) and lease
($27,032) of computer equipment as entirely maintenance expense. 

IRS uses certain accounting information, such as (1) fiscal year, (2)
appropriation, (3) activity, and (4) subobject class, to charge a
procurement to a specific appropriation and type of expenditure.  The
accounting information, normally assigned by the financial plan
managers, is included on all procurement requisitions.  However, this
information is not consistently reviewed by procurement and
accounting personnel during processing.  None of the inappropriate
accounting data noted in our sample were identified either by the
procurement or accounting staffs.  While AFS has checks for certain
invalid combinations of accounting information, this control could
not detect data inappropriately recorded to otherwise valid accounts. 
To illustrate, in the earlier example involving the invoice for
maintenance and lease of computer equipment, the control did not
prevent this transaction from being processed because, although the
codes were valid and the combination was acceptable, the incorrect
expense classification was charged. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 2:4

During fiscal year 1992, IRS' systems and controls had fundamental
deficiencies that significantly impaired its ability to properly
monitor, account for, and report on use of its operating funds. 
During fiscal year 1993, IRS instituted some new procedures intended
to improve its fund control procedures.  However, unless IRS
routinely and promptly resolves differences between its records and
Treasury's and properly records expenditures, IRS will be unable to
reliably report on its use of operating funds or to determine if it
exceeds its budget authority. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 2:5

We recommend that the Commissioner of Internal Revenue direct the
Chief Financial Officer to strengthen controls over IRS' operating
funds by

  monitoring whether AFS effectively provides managers up-to-date
     information on available budget authority;

  promptly resolving differences between IRS and Treasury records of
     IRS' cash balances and adjusting accounts accordingly;

  promptly investigating and recording suspense account items to
     appropriate appropriation accounts;

  performing periodic reviews of obligations, adjusting the records
     for obligations to amounts expected to be paid, and removing
     expired appropriation balances from IRS records as stipulated by
     the National Defense Authorization Act for Fiscal Year 1991;

  monitoring compliance with IRS policies requiring approval of
     journal vouchers and enforcing controls intended to preclude
     data entry errors; and

  reviewing procurement transactions to ensure that accounting
     information assigned to these transactions accurately reflects
     the appropriate fiscal year, appropriation, activity, and
     subobject class. 


   AGENCY COMMENTS
---------------------------------------------------------- Chapter 2:6

In commenting on a draft of this report, IRS agreed with our
concerns, and stated that it was correcting and eliminating the
deficiencies in its systems and processes.  It did not, however,
specifically address our recommendations.  IRS' comments are included
in appendix I. 


FUNDAMENTAL DEFICIENCIES EXISTED
IN IRS' PROCEDURES AND INTERNAL
CONTROLS FOR PAYMENTS
============================================================ Chapter 3

IRS' procedures and internal controls over the use of about $900
million in operating funds by its national office and central region
for goods and services did not provide reasonable assurance that
these funds were properly used and that related reports were
reliable.  IRS' national office and central region used about 49
percent and 6 percent, respectively, of IRS' operating funds
designated for goods and services.  Our analysis of IRS payments to
vendors showed that IRS made (1) improper and unsupported payments,
(2) made some payments before and others after their due dates, and
(3) did not pay or paid too little interest on late payments.  IRS'
effectiveness in making and timing payments was hampered by
nonintegrated systems and critical features of AFS not being fully
used.  Further, IRS' detailed records for the spending of about $800
million for goods and services by the six IRS regions that used AABES
did not support the individual regions' summary records.  Thus, we
were unable to test those region's transactions. 


   IRS MADE IMPROPER AND
   UNSUPPORTED PAYMENTS
---------------------------------------------------------- Chapter 3:1

IRS lacked controls for ensuring that payments to vendors were
properly approved and supported by accurate and complete
documentation, such as receipt and acceptance documentation. 
Consequently, IRS made duplicate payments and overpayments (improper
payments) that were not identified by management.  Our analysis of
supporting documentation for our sample of 280 payments, totaling $42
million, to commercial vendors showed 32 improper payments for
$524,000 and 112 payments for $17.2 million for which IRS could not
provide complete supporting documentation.  The improper payments
resulted from the payment office's inadequate review of supporting
documentation, IRS' inadequate guidance for processing and approving
payments, and IRS' failure to integrate or reconcile its payment and
procurement systems.  IRS officials told us that some payments were
made without complete supporting documentation to reduce its backlog
of pending payments owed vendors for goods and services.  For its 32
improper payments, IRS has either received or requested reimbursement
from the vendors. 


      IRS LACKED ADEQUATE GUIDANCE
      AND OVERSIGHT FOR PROCESSING
      AND APPROVING PAYMENTS
-------------------------------------------------------- Chapter 3:1.1

GAO's Title 7, "Fiscal Guidance," of its Policy and Procedures Manual
for Guidance of Federal Agencies and IRS' procedures require the
matching of the original vendor invoice to the related procurement
order as well as the receipt and acceptance documentation prior to
supervisory approval to pay.  This is a critical control for
preventing improper payments.  However, at the national office, we
found evidence of nonconformity with these procedures in the form of
nine duplicate payments totaling $349,381.  Four of these payments
were included in our sample of payments, while the remaining five
were noted during analysis of accounting and procurement records for
the sample items.  Vendors were paid twice for the same goods and
services because IRS made payments based on copies of invoices and
related documentation, such as procurement orders and receipt and
acceptance documentation.  For example, a vendor's $13,854 invoice
was paid and a copy of the vendor invoice was subsequently used to
process a duplicate payment.  National office officials were not
aware of the duplicate payments until either we or the vendors
notified them. 

Also at the national office, we found 23 overpayments for almost
$175,000 to a single vendor since 1988.  These overpayments occurred
because IRS personnel mistakenly approved amounts for payment that
were actually vendor credits owed by the vendor to IRS.  IRS
officials informed us that these overpayments resulted because staff
responsible for processing payments were not provided adequate
guidance and training on processing vendor credits.  However, we
found that these overpayments also resulted from a lack of
supervision.  Specifically, we found that the overpayments continued
even after IRS' procurement personnel and the vendor brought them to
the attention of supervisors responsible for approving the payments. 

Although IRS' administrative accounting handbook includes general
processing procedures for payments, the above examples point out the
need for more detailed guidance to be provided to IRS personnel
responsible for processing and approving payments.  Such detailed
instructions, and training related to application of the
instructions, can provide personnel with a step-by-step process for
performing their duties, particularly with respect to unusual items. 
Further, IRS' inappropriate payment processing practices also showed
that supervisors did not provide the oversight and guidance needed to
prevent improper payments from occurring. 


      IRS DID NOT MAINTAIN SUPPORT
      FOR ITS PAYMENTS
-------------------------------------------------------- Chapter 3:1.2

We also found that IRS made payments without supporting documentation
such as invoices, procurement orders, and evidence of receipt and
acceptance.  Federal guidelines require administrative accounting
records for payments to be retained for 2 years.  However, IRS could
not provide supporting documentation for 112, or 40 percent, of the
280 payments to vendors included in our sample.  These 112 payments
which totaled $17.2 million, or 41 percent of the recorded value of
vendor payments we examined, were made by the national office.  As a
result, IRS did not have reasonable assurance that these payments
complied with the quantities and terms established by procurement
orders and were for goods and services actually received and
accepted. 

For example, a $24,949 vendor invoice was inappropriately approved
for payment and paid without evidence of receipt and acceptance 4
months after the vendor had notified IRS to ignore the invoice
because most of the invoiced services had not been rendered. 
However, since IRS could not provide supporting documentation for the
112 payments in our sample, we were unable to determine whether such
documentation was available when the payments were made or whether
the documentation was subsequently lost, destroyed, or misplaced. 

IRS officials told us that vendors were sometimes paid even if all
supporting documentation typically required for payment was not
available.  The officials stated that this was done to reduce IRS'
backlog of approximately 4,000 unpaid vendor invoices at the
beginning of fiscal year 1992.  While a task force assigned to
eliminate the backlog completed its assignment in February 1992, we
found that unsupported payments continued to be made throughout
fiscal year 1992. 


   IRS PAYMENTS WERE NOT PROPERLY
   TIMED
---------------------------------------------------------- Chapter 3:2

The Prompt Payment Act requires federal entities to make payments on
time, to pay interest when payments are late, and to take discounts
only when payments are made on or before the discount date.  OMB
Circular A-125 "Prompt Payment," which implements the act, also calls
for not paying commercial invoices too early.  Our review of 280
national office and central region payments subject to the timing
requirements of these regulations disclosed that 81 payments
amounting to $15.5 million were late and 83 payments amounting to
$15.5 million were earlier than necessary.  IRS either incorrectly
computed and underpaid interest or did not pay any interest for 56 of
the 81 late payments.  These ineffective cash management practices
resulted in costs to the federal government due to lost interest
earnings on early payments and additional interest expenses for late
payments. 


      PAYMENTS WERE OFTEN
      SIGNIFICANTLY LATE
-------------------------------------------------------- Chapter 3:2.1

The 81 late payments we noted were paid an average of 34 days after
their due dates.  The Prompt Payment Act generally requires that a
federal entity pay its bills within 30 days after (1) receiving an
invoice or (2) receipt and acceptance of goods or services, whichever
is later, unless other timing provisions are stated in the related
contract.  IRS, in its prompt payment report to Treasury, stated that
its late payments were due to delays in the payment offices obtaining
receiving reports. 

IRS anticipated that AFS would reduce the number of late payments by
automatically calculating an invoice's scheduled payment date based
on the invoice receipt date and the receipt and acceptance dates for
invoiced items.  However, we found that for 70 of the 81 instances,
staff did not accurately enter prompt payment related data in AFS. 
For these instances, either the invoice's receipt date or the
invoiced items' receipt and acceptance date on the transaction's
supporting documentation did not agree with AFS data.  Thus, AFS
could not accurately determine a payment's due date or determine if
and how much interest was owed.  For example, we found an instance
where AFS did not identify a vendor payment as late and compute
interest of $650 that was due because incorrect dates for both
invoice receipt and receipt and acceptance of the invoiced item were
entered in AFS.  IRS' supervisory personnel told us that these
discrepancies occurred because its staff lacked sufficient training
and familiarity with AFS. 


      INTEREST PAYMENTS WERE
      INACCURATE
-------------------------------------------------------- Chapter 3:2.2

The Prompt Payment Act requires interest to be paid through the
transaction's actual payment date when payments are late.  We
recomputed IRS' interest payments for the 81 late payments in our
sample and found that 56 were underpaid by at least $1.\1 IRS, in its
prompt payment report to Treasury, stated that it paid about $673,000
of its operating funds for interest on late payments during fiscal
year 1992, with $592,000 of that amount attributable to its national
office and central region. 

For AFS processed payments, IRS personnel stated that underpaid
interest resulted from the system not computing interest through the
payment's entire late period.  AFS computed interest through
scheduled payment dates which were generally 2 or 3 days before the
actual payment date.  As a result of our work, IRS reprogrammed AFS
during May 1992 to compute interest through the transaction's
projected actual payment date.  This interest on IRS' late payments
resulted in increased financing costs to the federal government. 
Although Treasury Tax and Loan (TT&L) accounts in commercial
financial institutions\2 earn interest on TT&L account balances, the
7-percent average interest rate specified by the Secretary of the
Treasury for late payments was higher than the 3 percent average rate
Treasury received on its TT&L account balances during fiscal year
1992. 

We also noted instances where interest on manually processed payments
was either not computed or inaccurately computed.  For example, the
national office did not pay $2,897 in interest on one late manual
payment in our sample.  We also found instances of inaccurate
interest computations.  For example, a $22,223 interest payment was
understated by $974 because interest was not properly compounded
every 30 days as required during the payment's 145-day late period. 
IRS, in its fiscal year 1992 prompt payment report to Treasury,
stated that it did not pay $87,000 in interest due to administrative
errors such as failing to compute interest. 


--------------------
\1 OMB Circular A-125's threshold for determining if interest on late
payments should be paid is $1. 

\2 Treasury invests a portion of its operating funds in depositories
maintaining Tax and Loan accounts until the funds are needed for its
operations. 


      SOME INVOICES WERE PAID TOO
      EARLY
-------------------------------------------------------- Chapter 3:2.3

Our analysis of IRS payments also showed that 83 were paid an average
of 16 days before their due dates.  Early payments result in lost
interest earnings since funds are used instead of being invested in
interest-bearing accounts.  OMB Circular A-125 states that unless
vendor discounts are cost-effective, an invoice should not be paid
more than 7 days before its due date.  This circular also permits an
agency to make early payments when the agency head or designee has
determined, on a case-by-case basis, that early payments are
necessary.  The circular also states that this authority must be used
cautiously and that good cash management practices must be
considered. 

Although AFS automatically schedules payments in accordance with the
requirements of OMB Circular A-125, an accounts payable supervisor at
the national office decided to pay certain invoices early.  The 83
payments' supporting documentation did not contain evidence of
approval by the agency head or designee to pay early nor did it show
why the early payments were made.  IRS, in its fiscal year 1992
prompt payment report to Treasury, reported that it made over 93,100
early payments that were not approved by the agency head or designee. 


   SYSTEMS COULD BE ENHANCED AND
   MORE EFFECTIVELY USED
---------------------------------------------------------- Chapter 3:3

IRS' effectiveness in preventing and detecting improper payments and
properly timing its payments was hampered because (1) AFS, the system
used to process and record payments, and the procurement system were
not integrated or reconciled and (2) critical features of AFS were
not fully used. 

IRS units receiving goods or services usually concurrently submit
receipt and acceptance documentation to the payment and procurement
offices, which enter this and other data such as amount to be paid in
their separate systems.  As discussed earlier, payment office
personnel made data input errors which contributed to both improper
and untimely payments.  Although IRS could have periodically
reconciled data in the two systems to identify potential payment
errors, this was not done. 

Integration of the payment and procurement systems could allow
payments to be made within required time frames.  In the short term,
periodic reconciliations of the two systems' data can identify (1)
payments made for invoices that were not certified for payment and
(2) invoices which were certified for payment but not properly paid. 
However, such reconciliations are not required by IRS until its
close-out process for completed contracts. 

Also, IRS did not fully use capabilities of AFS designed to identify
possible duplicate payments and properly time payments.  One feature
allows personnel responsible for making payments to scan all prior
payments related to a specific procurement order.  However, payment
office personnel did not consistently enter optional data such as
description of invoiced items or period of service, and thus they did
not have a sufficiently detailed payment history which would be an
effective basis for detecting and avoiding future duplicate payments. 

Further, although AFS contained certain edit and validity checks,
these were not designed to (1) prevent or identify duplicate payments
and overpayments or (2) prevent unintended assignment of multiple
vendor codes to a single vendor, which can contribute to duplicate
payments. 


   AABES DETAILED RECORDS DID NOT
   SUPPORT THE SUMMARY RECORDS
---------------------------------------------------------- Chapter 3:4

The records of detailed spending information for operating expenses
in the six IRS regions that used AABES for its administrative
accounting functions did not support the summary records.  Therefore,
IRS did not have reasonable assurance that its AABES general ledger
balances for operating expenses, which were used to provide financial
information to management, Treasury, OMB, and the Congress, were
complete and accurate. 

Since IRS did not reconcile its detailed records to summary records,
it was not aware that these records did not agree until we brought it
to its attention.  IRS then could not resolve the differences between
its detailed and summary records which, for three regions, ranged
from $9 million to $18 million.  Thus, the scope of our audit work
was limited in these six regions.  In these six regions, IRS replaced
AABES with AFS on October 1, 1992.  IRS does not expect similar
unresolved differences in AFS accounting records since the system
features onetime transaction processing in which accepted
transactions are simultaneously posted to the detailed and summary
records.  We did not note such differences in our audit of the
national office and central region, which switched from AABES to AFS
in October 1991 and May 1991, respectively. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 3:5

Although IRS' new accounting system is intended to enhance its
administrative accounting functions, weaknesses in related controls
continue.  This is primarily because IRS staff and supervisors were
not provided sufficient training and guidance stressing the
importance of properly reviewing, approving, and timing payments. 
IRS' effectiveness in making and timing payments also can benefit
from systems enhancements and a better use of existing system
capabilities.  Further, since the scope of our audit was limited, we
were unable to determine the effectiveness of procedures and internal
controls in six regions. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 3:6

We recommend that the Commissioner of Internal Revenue direct the
Chief Financial Officer to develop and implement internal controls to
ensure that IRS' payments are proper and timely.  Specifically, the
CFO should take the following actions. 

  Provide (1) detailed written guidance for all payment transactions,
     including unusual items such as vendor credits, and (2) training
     to all personnel responsible for processing and approving
     payments. 

  Revise procedures to require that vendor invoices, procurement
     orders, and receipt and acceptance documentation be matched
     prior to payment and that these documents be retained for 2
     years. 

  Revise procedures to incorporate the requirements that accurate
     receipt and acceptance data on invoiced items be obtained prior
     to payment and that supervisors ensure that these procedures are
     carried out. 

  Revise document control procedures to require IRS units that
     actually receive goods or services to promptly forward receiving
     reports to payment offices so that payments can be promptly
     processed. 

  Monitor manually computed interest on late payments to determine
     whether interest is accurately computed and paid. 

  Enforce existing requirements that early payments be approved in
     accordance with OMB Circular A-125. 

  Require payment and procurement personnel, until the integration of
     AFS and the procurement system is completed as planned, to
     periodically (monthly or quarterly) reconcile payment
     information maintained in AFS to amounts in the procurement
     records and promptly resolve noted discrepancies. 

  Require the description and period of service for all invoiced
     items to be input in AFS by personnel responsible for processing
     payments, and enhance the edit and validity checks in AFS to
     help prevent and detect improper payments. 


   AGENCY COMMENTS
---------------------------------------------------------- Chapter 3:7

In commenting on a draft of this report, IRS agreed with our
concerns, and stated that it was correcting and eliminating the
deficiencies in its systems and processes.  It did not, however,
specifically address our recommendations.  IRS' comments are included
in appendix I. 


IRS PROCESSES AND SYSTEMS DID NOT
SUPPORT REPORTING NEEDS
============================================================ Chapter 4

IRS' reports on the billions of dollars it spends each year to carry
out its operations were unreliable because (1) IRS systems did not
maintain actual costs by the budget categories\1 included in such
reports and (2) its method for allocating costs to these budget
categories did not result in amounts approximating actual cost.  For
three of its four appropriations, IRS reported cost information based
on the percentage of appropriated funds that management activities
received from each budget category instead of actual amounts incurred
for each budget category.  Further, IRS used unreliable, informal
records to meet the more detailed congressional reporting
requirements for its fourth appropriation--information
systems--because its financial system did not accumulate costs at the
project level.  This resulted in misclassifications of costs for the
fourth appropriation in the President's Budget Submission to the
Congress for fiscal year 1994.  Also, the underlying data used to
prepare IRS reports, as noted in chapters two and three of this
report, were inaccurate and incomplete.  Consequently, IRS, Treasury,
OMB, and the Congress did not have critical reliable information for
managing and evaluating IRS activities. 


--------------------
\1 A budget category is a program, project or activity, within a
budget account.  For annually appropriated accounts, the categories
are defined generally by the congressional committee reports and
other documentation accompanying appropriations acts. 


   REPORTING ON THE COSTS OF IRS
   PROGRAMS WAS UNRELIABLE
---------------------------------------------------------- Chapter 4:1

OMB Bulletin 93-2, "Form and Content of Agency Financial Statements,"
requires budget and actual costs to be presented at the budget
(category) activity code level.  However, IRS financial systems did
not identify the budget category for which costs were incurred.  To
report information in the format required by OMB in the President's
Budget Submission to the Congress, IRS allocated costs of management
activities maintained in its financial management system to budget
categories for 3 of its 4 operating appropriations.  However, this
allocation was not a reliable methodology for estimating and
reporting actual costs by budget activity.  Further, IRS reported
obligations in its fiscal year 1992 financial statements by
management activity rather than the OMB required budget activity. 

At the beginning of each fiscal year, IRS allocates appropriated
amounts from budget categories to various management activities.  For
example, a portion of the budget category "Collection," which
includes all costs related to IRS' tax collection activities, is
allocated among several management activities, such as training,
rent, and other expense classifications.  After these allocations,
each management activity will include spending authority from several
budget categories.  Although IRS' financial systems accumulated the
actual costs for each of its management activities, its systems did
not identify the budget categories for which the various management
activities' costs were incurred.  Therefore, to meet its requirement
for reporting on the use of appropriations by budget category, IRS
distributed actual costs recorded for each management activity among
budget categories using the same proportions as the original budget
allocation.  For example, if 36 percent, or $13.6 million, of the
total budget allocation of $38.2 million for training came from the
"Collection" budget category, then 36 percent, or $8.7 million, of
total fiscal year 1992 costs of $24.5 million incurred for training
would be allocated to that budget category. 

The allocation of costs by federal entities is common when reporting
requirements for budget and actual costs differ from the basis used
to record such costs in financial systems.  In order to provide
reasonable cost estimates, it is important that the allocation of
costs be based on factors which reliably approximate actual costs. 
However, IRS had no assurance that its funds were actually used in
the proportions reported for budget activities because its allocation
method was conceptually flawed and it did not attempt to validate the
results by analyzing the allocations to determine if they
approximated actual costs.  Because of these deficiencies, IRS
reported obligations by management activities in its fiscal year 1992
financial statements instead of the budget activities required by
OMB. 

As part of its planned cost management system, IRS intends to develop
procedures for allocating costs to its programs.  The results of this
effort could assist IRS in developing a rational basis for charging
costs to its budget categories that would approximate actual costs. 
However, the cost management system is not expected to be fully
implemented until fiscal year 1997. 


   REPORTING REQUIREMENTS FOR
   INFORMATION SYSTEMS COSTS WERE
   NOT MET
---------------------------------------------------------- Chapter 4:2

In addition to the requirements of OMB Bulletin 93-2, IRS had to meet
more detailed reporting requirements for its fourth operating
appropriation--information systems.  Primarily due to TSM, IRS is
required to report on its information systems' costs by project to
OMB and congressional committees.  However, since IRS systems did not
accumulate costs for goods and services at either the budget activity
or project level, IRS relied on financial plan managers' informal
records to satisfy these reporting requirements.  Also, since actual
labor costs by project were not maintained in IRS financial systems
or in the plan managers' informal records, these costs were estimated
based on an average cost per employee. 

To ensure the accuracy of their data, individual financial plan
managers were responsible for reconciling their detailed informal
records to financial plan totals in IRS financial systems and
resolving any differences.  However, because the financial plan
managers did not always perform these reconciliations, IRS had no
assurance that these records were reliable.  Based on reconciliations
completed by budget personnel subsequent to the preparation of the
President's Budget Submission to the Congress for fiscal year 1994,
IRS found that $10 million of fiscal year 1992 costs reported were
misclassified among three of the four budget categories in the
information systems appropriation.  Also, the use of informal records
increased IRS' administrative burden in preparing reports.  For
example, for the information systems appropriation, budget personnel
were required to enter data from the plan managers' records for each
project into a separate data base in order to prepare the necessary
reports. 

To address some of these problems, IRS enhanced AFS to accumulate the
actual costs of goods and services for TSM projects.  The basis for
this is accounting code data assigned to procurement orders which
represent individual TSM projects.  IRS began a pilot of this
enhancement on April 1, 1992, in its national office and central
region.  On October 1, 1992, IRS implemented the enhancement
servicewide for its information systems appropriation.  However, as
noted in chapter 2 of this report, the assignment of accounting code
data is not consistently reviewed and, thus, is subject to
misclassification and may not always be used. 

Another component of cost--payroll--cannot currently be accumulated
by project; however, beginning in fiscal year 1994, IRS began to
accumulate such data in AFS.  While accumulating TSM project costs
may address some congressional reporting requirements, it does not
fully address IRS' inability to record and report all costs by budget
category. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 4:3

IRS was not able to provide reliable reports on the cost of its
programs to its managers, Treasury, OMB, and the Congress due to
weaknesses in its processes and financial management systems. 
Weaknesses discussed in chapters two and three adversely affected
IRS' ability to adequately report on its financial activities, and
deficiencies in IRS' reporting processes and systems further
contributed to IRS' inability to prepare reliable financial reports. 
As a result, these reports did not provide reliable information for
users to effectively evaluate IRS' operations. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 4:4

We recommend that the Commissioner of Internal Revenue direct the
Chief Financial Officer to take the following actions. 

  Establish procedures, based on budget categories approved by OMB,
     to develop reliable data on budget and actual costs. 

  Use AFS' enhanced cost accumulation capabilities to monitor and
     report costs by project in all appropriations. 


   AGENCY COMMENTS
---------------------------------------------------------- Chapter 4:5

In commenting on a draft of this report, IRS agreed with our
concerns, and stated that it was correcting and eliminating the
deficiencies in its systems and processes.  It did not, however,
specifically address our recommendations.  IRS' comments are included
in appendix I. 




(See figure in printed edition.)Appendix I
COMMENTS FROM THE INTERNAL REVENUE
SERVICE
============================================================ Chapter 4



(See figure in printed edition.)


REPORTS RESULTING FROM GAO'S AUDIT
OF IRS' FISCAL YEAR 1992 FINANCIAL
STATEMENTS
========================================================== Appendix II

Financial Management:  IRS Self-Assessment of Its Internal Control
and Accounting Systems Is Inadequate (GAO/AIMD-94-2, October 13,
1993). 

Financial Management:  IRS Lacks Accountability Over Its ADP
Resources (GAO/AIMD-93-24, August 5, 1993). 

Financial Audit:  Examination of IRS' Fiscal Year 1992 Financial
Statements (GAO/AIMD-93-2, June 30, 1993). 

Financial Audit:  IRS Significantly Overstated Its Accounts
Receivable Balance (GAO/AFMD-93-42, May 6, 1993). 

Federal Tax Deposit System:  IRS Can Improve the Federal Tax Deposit
System (GAO/AFMD-93-40, April 28, 1993). 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III


   ACCOUNTING AND INFORMATION
   MANAGEMENT DIVISION,
   WASHINGTON, D.C. 
------------------------------------------------------- Appendix III:1

Robert F.  Dacey, Senior Assistant Director
Dianne D.  Guensberg, Assistant Director
Charles E.  Norfleet, Senior Audit Manager
Cheryl D.  Driscoll, Audit Manager
Miguel A.  Castillo, Senior Auditor
Mazhar Ahson, Auditor
Paul F.  Foderaro, Auditor
Karen M.  Spencer, Auditor

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