Financial Audit: Examination of IRS' Fiscal Year 1995 Financial
Statements (Letter Report, 07/11/96, GAO/AIMD-96-101).
As in earlier years, GAO found it impossible to provide an affirmative
opinion on IRS' principal financial statements for 1995, internal
controls, and IRS' compliance with laws and regulations. The following
financial management problems prevented GAO from rendering an opinion:
(1) the amounts of total revenue ($1.4 trillion) and tax refunds ($122
billion) cannot be verified or reconciled to accounting records
maintained for individual taxpayers in the aggregate; (2) the amounts
reported for taxes collected (social security, income, and excise taxes,
for example) cannot be substantiated; (3) the reliability of reported
estimates of $113 billion for valid accounts receivable and $46 billion
for collectible accounts receivable cannot be determined; (4) a
significant portion of the agency's reported $3 billion in nonpayroll
operating expenses cannot be verified; (5) the amounts IRS reported as
appropriations available for expenditure for operations cannot be
reconciled fully with Treasury's central accounting records showing
these amounts, and hundreds of millions of dollars in differences have
been found.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: AIMD-96-101
TITLE: Financial Audit: Examination of IRS' Fiscal Year 1995
Financial Statements
DATE: 07/11/96
SUBJECT: Financial statement audits
Internal controls
Tax administration systems
Accounts receivable
Accounting procedures
Financial records
Federal agency accounting systems
Auditing standards
Financial management
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Cover
================================================================ COVER
Report to the Congress
July 1996
FINANCIAL AUDIT - EXAMINATION OF
IRS' FISCAL YEAR 1995 FINANCIAL
STATEMENTS
GAO/AIMD-96-101
IRS Financial Audit
(901671)
Abbreviations
=============================================================== ABBREV
ADP - automated data processing
BMF - Business Master File
CFO - Chief Financial Officer
FMFIA - Federal Managers' Financial Integrity Act
FMS - Financial Management Service
FTD - federal tax deposit
IMF - Individual Master File
IRC - Internal Revenue Code
IRS - Internal Revenue Service
NMF - nonmaster file
OMB - Office of Management and Budget
RACS - Revenue Accounting Control System
SSA - Social Security Administration
TSM - Tax Systems Modernization
Letter
=============================================================== LETTER
B-261816
July 11, 1996
To the President of the Senate and the
Speaker of the House of Representatives
In accordance with the Chief Financial Officers Act of 1990, this
report presents the results of our efforts to audit the Principal
Financial Statements of the Internal Revenue Service (IRS) for fiscal
years 1995 and 1994.
As in prior years, limitations on the scope of our audit and the
problems that we found made it impossible to provide an affirmative
opinion on:
-- The Principal Financial Statements for 1995. Thus, the
accompanying statements may be unreliable.
-- Internal controls. Management did not assert that IRS controls
were effective and we noted major weaknesses in recordkeeping
and systems.
-- Compliance with laws and regulations. We were unable to test
the laws we considered necessary; accordingly, we are unable to
report on the Internal Revenue Service's compliance with laws
and regulations.
The report discusses IRS' continuing financial management problems
and certain related matters. It also contains our formal opinions
and reports on IRS' financial statements, internal controls, and
compliance with laws and regulations and our audit objectives, scope,
and methodology. We make no new recommendations in this report.
Appendix I describes the status of IRS' efforts to implement the 59
recommendations we made in prior years.
We are sending copies of this report to the Commissioner of Internal
Revenue, the Secretary of the Treasury, the Director of the Office of
Management and Budget, the Chairmen and Ranking Minority Members of
the Senate Committee on Governmental Affairs and the House Committee
on Government Reform and Oversight, and other interested
congressional committees. Copies will be made available to others
upon request.
This report was prepared under the direction of Gregory M. Holloway,
Director, Governmentwide Audits, with the support of IRS' Internal
Audit staff and staff from the Accounting and Information Management
Division's Governmentwide Audits Group and Audit Support and Quality
Assurance Group. Mr. Holloway may be reached at (202) 512-9510.
Charles A. Bowsher
Comptroller General
of the United States
Letter
=============================================================== LETTER
B-261816
To the Commissioner of Internal Revenue
In accordance with the Chief Financial Officers (CFO) Act of 1990,
the Internal Revenue Service (IRS) prepared the accompanying
Principal Financial Statements for the fiscal years ended September
30, 1995 and 1994. In our attempt to audit these principal financial
statements for fiscal year 1995, we found the following.
-- We are unable to give an opinion on the fiscal year 1995
Principal Financial Statements of the IRS because of the
limitations on the scope of our work, which are discussed below.
Thus, the Principal Financial Statements may be unreliable.
-- Material weaknesses in internal controls resulted in ineffective
controls over safeguarding assets from material loss, assuring
material compliance with laws governing the use of budget
authority and with other relevant laws and regulations, and
assuring that there were no material misstatements in the
Principal Financial Statements.
-- We are unable to report on compliance with laws and regulations
because of limitations on the scope of our work.
The following five financial management problems, which have
undermined our ability to attest to the reliability of IRS' financial
statements for the past 4 fiscal years, provide the basis for these
conclusions.\1
-- One, the amounts of total revenue ($1.4 trillion) and tax
refunds ($122 billion) cannot be verified or reconciled to
accounting records maintained for individual taxpayers in the
aggregate.
-- Two, the amounts reported for various types of taxes collected
(social security, income, and excise taxes, for example) cannot
be substantiated.
-- Three, the reliability of reported estimates of $113 billion for
valid accounts receivable and $46 billion for collectible
accounts receivable cannot be determined.
-- Four, a significant portion of IRS' reported $3 billion in
nonpayroll operating expenses cannot be verified.
-- Five, the amounts IRS reported as appropriations available for
expenditure for operations cannot be reconciled fully with
Treasury's central accounting records showing these amounts, and
hundreds of millions of dollars in differences have been
identified.
IRS worked toward the goal of resolving these issues in time for our
fiscal year 1995 financial statement audit. Progress was made, but
many of IRS' efforts were not yet completed at the conclusion of the
audit. IRS has continued its efforts to correct these problems with
a goal of having these matters resolved in time for the fiscal year
1996 financial statement audit. Some of the corrective actions,
particularly where they involve reprogramming software for IRS'
antiquated systems and developing new systems, will require longer
term solutions. Therefore, the focus of key IRS efforts are on
interim solutions to facilitate reliable reporting while IRS works to
put longer term corrective actions in place.
IRS advised us that, as of the end of May 1996, its status in
correcting the problems our audit identified was as follows:
-- IRS stated that it had developed software programs to capture,
from its revenue financial management system, the detailed
revenue and refund transactions that, in the short term, would
support reported amounts in its future financial statements
until longer term system fixes could be made to achieve more
reliable reporting of these amounts. In addition, IRS is
attempting to complete documentation of its revenue financial
management system to (1) aid in identifying better interim
reporting solutions for reporting revenues and refunds, (2)
provide better insights on the longer term systems fixes needed
to enable IRS to readily and reliably provide the underlying
support for its reported revenue and refund amounts, and (3)
demonstrate that the level of misstatement related to its
inability to reconcile the detailed transactions it identifies
in its interim reporting efforts to its summary account records
would not be material.
-- IRS asserted that it would continue its efforts to determine a
means of using its current revenue financial management system's
coding to identify its accounts receivable. IRS' efforts are
focused on correcting known current coding errors through
reviewing 100 percent of all receivables over a certain dollar
threshold. In addition, through intensified training efforts
and better internal control policies and procedures, it said it
would seek to ensure more accurate input and processing of
transactions that underpin accounts receivable.
-- IRS stated that it had completed the reconciliation of its Fund
Balance with Treasury accounts except for IRS' suspense accounts
that contained reconciling items that were more than 6 months
old. However, IRS said it was still in the process of making
the necessary adjustments required to its general ledger and the
related Department of the Treasury records to complete this
effort.
-- IRS stated that it believed the core issue for correcting its
receipt and acceptance problems related to properly accounting
for transactions with other federal agencies. IRS stated that
it was performing a study of transactions with other federal
agencies to determine and correct the problems in this process
that are due to IRS policies and procedures and to identify
those that need to be corrected governmentwide.
We could not verify the results of IRS' efforts as of the close of
our fiscal year 1995 audit since they were not yet complete.
However, we will continue to monitor IRS' progress and advise IRS as
it attempts to identify and implement solutions for correcting its
underlying financial management problems.
These financial management problems and certain other related matters
are discussed further in the Significant Matters section of this
report. Our conclusions on IRS' financial statements, internal
controls, and compliance with laws and regulations are also included
in the following sections.
--------------------
\1 See Financial Audit: Examination of IRS' Fiscal Year 1994
Financial Statements (GAO/AIMD-95-141, August 4, 1995); Financial
Audit: Examination of IRS' Fiscal Year 1993 Financial Statements
(GAO/AIMD-94-120, June 15, 1994); and Financial Audit: Examination
of IRS' Fiscal Year 1992 Financial Statements (GAO/AIMD-93-2, June
30, 1993).
SIGNIFICANT MATTERS
------------------------------------------------------------ Letter :1
The overriding problem in providing an opinion on IRS' financial
statements, reporting on its internal controls, and reporting on its
compliance with laws and regulations is that IRS has not yet been
able to provide support for major portions of the information
presented in its financial statements and, in some cases where it was
able to do so, the information was found to be in error. The
principal purpose of our financial audits is to attest to the
reliability of information presented in the financial statements and
to independently verify management's assertions about the
effectiveness of internal controls and whether the agency complied
with laws and regulations. When information that underpins the
reported financial statements is not available for audit, it
sometimes results in the auditor being unable to render an opinion on
the financial statements as a whole. This is because the auditor
cannot evaluate sufficient evidence as a basis for forming an opinion
on whether the information presented in the financial statements is
correct, determining whether all significant internal controls
through which the information was managed and processed were
effective, and testing whether or not the agency, in this case IRS,
complied with laws and regulations. This situation was the case for
IRS for fiscal year 1995.
The following discusses the five material weaknesses\2 we found.
Each weakness was identified in IRS' Federal Managers' Financial
Integrity Act (FMFIA) report for fiscal year 1995.
--------------------
\2 A material weakness is a condition in which the design or
operation of one or more of the internal control structure elements
does not reduce to a relatively low level the risk that errors or
irregularities in amounts that would be material to the financial
statements may occur and not be detected promptly by employees in the
normal course of performing their duties.
REVENUES AND ACCOUNTS
RECEIVABLE REMAIN
UNSUBSTANTIATED
---------------------------------------------------------- Letter :1.1
Revenues, including the related refunds and accounts receivable, are
the two key areas in IRS' efforts to report Custodial financial
statements. IRS collects tax receipts, receives tax returns, makes
tax refunds to, and corresponds with hundreds of millions of
taxpayers each year. IRS also tries to obtain compliance by
enforcing the tax laws through its monitoring of accounts receivable.
These activities involve processing and tracking billions of paper
documents and, in fiscal year 1995, handling a reported $1.4 trillion
in tax receipts and a reported $122 billion in tax refunds.
Processing this volume of money and paperwork requires substantive
coordination among IRS' more than 600 offices worldwide,
approximately 12,000 financial institutions, and 12 Federal Reserve
Banks throughout the country.
REVENUE
-------------------------------------------------------- Letter :1.1.1
For fiscal year 1995, IRS made several attempts at extracting
taxpayer information from its masterfiles--the only detailed record
of taxpayer information IRS maintains--to support the amounts it
reported for revenues in its financial statements. However, IRS has
not been able to make these amounts agree to the amounts included in
its financial management systems and Treasury records. Further, IRS
is unable to determine that the correct amounts are transferred to
the ultimate recipient of the collected taxes. For fiscal year 1995,
the detailed transactions from its masterfile accounts were not
provided to us in a timely manner to substantiate the reported
amounts and thus we could not determine the amount of the
differences.
The core financial management control weaknesses that contribute
greatly to these problems are that IRS does not have comprehensive
documentation on how its financial management system works. It has
not yet put into place the necessary procedures to routinely
reconcile activity in its summary account records with that
maintained in its detailed masterfile records of taxpayer accounts.
This problem is further exacerbated by IRS' financial management
system, which was not designed to support financial statement
presentation, and thus significantly hinders IRS' ability to identify
the ultimate recipient of collected taxes.
This occurs because the system requires that corporate and individual
taxpayers pay multiple taxes at the same time without readily
identifying the application of the payments to the various taxes
paid.\3 As a result, IRS is forced to make the allocation of
collections to the recipient based on the total tax owed as
identified on the related tax return. The tax return is filed at a
later date and may not contain sufficient information if the amount
of taxes owed on the return does not agree with the amount paid, as
is sometimes the case.
IRS has developed computer programs to extract the detailed
masterfile data from its records but continues to be unable to
reconcile the detailed extracted data to the summary accounts. In an
interim effort to prepare reliable financial statement information,
IRS is attempting to demonstrate the maximum exposure likely
attributable to the unexplained differences and provide the necessary
information to fix the identified system flaws. This interim plan
involves IRS continuing its efforts to develop detailed comprehensive
documentation of its current financial management system. We are
monitoring IRS' efforts closely, providing guidance and
recommendations, and reporting at regular intervals to IRS' senior
management on the agency's progress and actions needed to correct
these problems in the short and long term.
As reported since our audit of IRS' fiscal year 1992 financial
statements, IRS cannot ensure that it distributes excise taxes based
on collections, as required by law, because it bases these
distributions on the amount reported on the tax return, that is, the
assessed amount. However, during fiscal year 1995, IRS analyzed
excise taxes by specific trust funds to determine if there were
significant differences between taxes paid and amounts reported as
owed on the return and found that these differences were
insignificant. Because IRS completed this analysis after our audit
was completed, we were unable to examine and determine the
reliability of this information.
--------------------
\3 For an explanation of how IRS processes tax returns, tax
information, and payments, see Financial Audit: Actions Needed to
Improve IRS Financial Management (GAO/T-AIMD 96-96, June 6, 1996).
ACCOUNTS RECEIVABLE
-------------------------------------------------------- Letter :1.1.2
For fiscal year 1995, IRS attempted to test a statistical sample of
its inventory of open assessments to categorize them between
financial accounts receivable and compliance assessments.\4 For all
the 4 fiscal years we have audited\5
IRS' financial statements, IRS has had difficulty separating, in its
masterfile records of taxpayer accounts, its financial accounts
receivable, from the amounts it has assessed only for compliance
purposes because the design of IRS' masterfiles commingles these
amounts.
In fiscal year 1995, IRS expanded its previous years' efforts by
trying to first separate the inventory of assessments into accounts
receivable and compliance assessments based on its coding of these
assessments in its financial management system and then testing the
accuracy of this coding to separate accounts receivable from
compliance assessments on a taxpayer account basis. However, these
efforts were unsuccessful because of mistakes made in performing the
statistical tests and errors found in the coding of the assessments
in IRS' financial management systems which made the sample results
unreliable for projecting to the total inventory of outstanding
assessments. Our tests of the fiscal year 1995 data found
significant errors at levels that made the result of any projections
from the samples taken unreliable.
The actions needed to resolve the key financial management control
weaknesses in accounts receivable are consistent with recommendations
from our prior reports and are as follows: (1) better review and
approval procedures are needed before assessment information is
entered into IRS' masterfile system, (2) clearer lines of authority
and responsibility are needed between IRS' taxpayer service and the
Chief Financial Officer's operations to ensure that internal control
procedures are properly identified and strictly adhered to, (3)
procedures need to be developed for processing in-process accounts
and properly applying them to the respective taxpayer accounts, and
(4) periodic detailed taxpayer account reviews should be performed as
a quality review measure to ensure that the proper coding is taking
place for taxpayer accounts. In addition, IRS needs to (1) continue
its efforts to review taxpayer accounts with amounts owed to ensure
that they are properly coded and accounted for and (2) perform more
macro analysis of its inventory of assessments to identify
aberrations and other systemic problems that will need to be
corrected to accurately report on accounts receivable. We will
continue to monitor IRS' progress in this area and provide guidance
and recommendations as it proceeds.
--------------------
\4 Compliance assessments occur when IRS records an assessment to a
taxpayer's account, but neither the taxpayer nor a court has agreed
that the assessment is appropriate. IRS makes these assessments to
encourage compliance with the tax laws. Financial accounts
receivable arise when taxpayers agree to assessments or a court
determines that an amount is owed.
\5 For a discussion of the problems with IRS' accounts receivable in
our fiscal years 1992 through 1994 audits, see Financial Audit:
Actions Needed to Improve IRS Financial Management (GAO/T-AIMD-96-96,
June 6, 1996).
ADMINISTRATIVE OPERATIONS
HAVE IMPROVED BUT MORE
IMPROVEMENT IS NEEDED
---------------------------------------------------------- Letter :1.2
For fiscal year 1995, IRS had a reported $8.1 billion in operating
expenses and related assets and liabilities used and incurred in its
administrative operations. The key asset in its administrative
operations is its Fund Balance with Treasury accounts and the related
Unexpended Appropriations accounts. Its operating expenses can be
readily separated between its efforts to account for and report, in
fiscal year 1995, its $5.3 billion in payroll costs and $2.8 billion
in nonpayroll costs.
IRS has made progress in accounting for and reporting its
administrative operations. In fiscal year 1992, for the most part,
we were unsuccessful in our attempts to audit IRS' records for its
administrative operations. IRS' accounting records were in total
disarray, and it could not substantiate large portions of the
reported amounts. In addition, internal control policies and
procedures were either nonexistent, inappropriately focused, or not
followed. For fiscal year 1995, IRS had a core accounting system in
place that tracked its financial management activity. Two critical
problems, however, have continued to persist that were identified in
our fiscal year 1992 audit: (1) IRS' Fund Balance with Treasury
accounts remain unreconciled, though some progress has been made
toward that end and (2) IRS has not been able to provide support as
to whether and when certain nonpayroll goods and services paid for
were received and, in instances where support existed, we found that
the cost associated with the purchase was often recorded and reported
in the wrong fiscal year.
FUND BALANCE WITH
TREASURY
-------------------------------------------------------- Letter :1.2.1
IRS' Fund Balance with Treasury accounts historically were not being
reconciled. For the most part, IRS' personnel were only tracking the
gross differences between their accounting records and what Treasury
(the equivalent of their bank) reported to them for their
administrative receipts and disbursements. This resulted in years of
unreconciled amounts accumulating that were never researched and
resolved and that were made difficult to research and resolve when
the amounts were required to be audited.
These accounts have been unreconciled in each of the years of our
prior audits--1992 through 1994--with net reconciling differences in
the millions of dollars that were made up of gross reconciling
differences in the hundreds of millions of dollars. We were not
provided the information to fully determine the gross amount of the
differences for fiscal year 1995 and, thus, while we do know the
accounts remain unreconciled, we do not know by how much.
Over the last 2 fiscal years, IRS has made adjustments to its
accounting records to write off large portions of the gross
unreconciled amounts where it could not determine what the correct
disposition of the difference should be after several efforts at
researching the items. In addition, it hired a contractor to
identify the differences\6 between its accounting records and what it
had reported to Treasury as its activity in its Fund Balance with
Treasury accounts. IRS, though, has still not fully reconciled its
differences between its records and Treasury's records that are
reported to IRS through its budget clearing accounts\7 --for items
that are more than 6 months old that remain unreconciled--and that
are identified on its statement of differences--for similar items
that are less than 6 months old.
Similarly, IRS still needs to investigate and resolve amounts in its
suspense accounts, many of which have been in suspense for 1 year or
more. In addition, IRS has not disposed of some of the reconciling
items between its accounting records and what it reported to Treasury
that were identified by the contractor. Through further contractor
assistance or more intensified internal efforts, IRS must get these
accounts fully reconciled. In addition, IRS needs to look more
closely at the skill mix of its staff assigned with the
responsibility of completing this reconciliation process.
If these accounts remain unreconciled, it will continue to be
difficult to provide an opinion on either IRS' administrative
financial statements or management's assertion about the
effectiveness of internal controls. It will also continue to be
impossible to determine whether IRS has complied with all of the
appropriate laws and regulations to which it is subject.
Notwithstanding the problems these unreconciled accounts present for
rendering an opinion, these accounts make it impossible, or at best
difficult, for IRS or anyone else to know whether its operating funds
have been improperly spent and calls into question the accuracy of
its reported operating expenses, assets, and liabilities.
--------------------
\6 Much like what occurs with a checking account, differences between
accounting records and bank records can occur because of timing
differences or errors in recording transactions. However, the
differences identified by the contractor were those between IRS'
accounting records and the reports of receipts and disbursements IRS
sends to Treasury.
\7 Budget clearing accounts are accounts that serve as suspense
accounts for unidentified transactions.
RECEIPT AND ACCEPTANCE
-------------------------------------------------------- Letter :1.2.2
IRS did not provide support as to whether and when it received goods
and services for significant portions of its nonpayroll operating
expenses and, in several instances where the support was provided, we
found that the cost should have been included in another period.
Simply stated, this situation is much like when IRS audits a
taxpayer. If the taxpayer cannot show independent evidence that an
expense that was deducted on the tax return was incurred in the year
under audit, the expense would be disallowed and the taxpayer's tax
liability increased. Likewise, when IRS cannot provide support for
its reported expenses or the support shows that the expenses should
be properly included in a different fiscal year, the auditor cannot
provide an opinion on the amounts. Simply put, we cannot determine
whether this expense was an expense of the current period--when no
support exists--or whether it must be adjusted from the current
year's expenses--when the support shows it is in the wrong period.
Our interim testing of IRS' accounting records covering the first 10
months of fiscal year 1995 showed significant amounts of nonpayroll
costs that were either unsupported or recorded in the wrong period.
IRS' nonpayroll expenses that we reviewed included purchases from
other federal agencies as well as from commercial vendors for
printing services, postage, computer equipment, and many other costs.
IRS' lack of control over receipt and acceptance of goods and
services, combined with its problems in linking the controls over
goods and services purchased to the payment for these goods and
services, makes it especially vulnerable to vendors, both federal and
commercial, billing IRS for goods and services not provided or for
amounts in excess of what was provided. This would be comparable to
an individual or business receiving an invoice and paying it without
verifying that the purchased item had been received and accepted,
based on an assumption that someone else in the household or business
received it. For example, IRS has an inventory management system
that tracks when printed tax forms are received and used. However,
the information tracked in this system is not used or integrated with
the payment system for making vendor payments nor with any other
system used to account for and report IRS' operating expense for
printing these forms.
COMPUTER SECURITY
---------------------------------------------------------- Letter :1.3
In our prior year reports,\8 we stated that IRS' computer security
environment was inadequate. Our review of controls over IRS'
computerized information systems, done to support our fiscal year
1995 audit, found that IRS has made some progress in addressing and
initiating actions to resolve prior years' computer security issues;
however, some of the fundamental security weaknesses we previously
identified continued to exist in this fiscal year. We will be
studying these issues further and reporting on them in greater detail
in a future report.
--------------------
\8 Financial Audit: Examination of IRS' Fiscal Year 1992 Financial
Statements (GAO/AIMD-93-2, June 30, 1993); IRS Information Systems:
Weaknesses Increase Risk of Fraud and Impair Reliability of
Management Information (GAO/AIMD-93-34, September 22, 1993);
Financial Audit: Examination of IRS' Fiscal Year 1993 Financial
Statements (GAO/AIMD-94-120, June 15, 1994); and Financial Audit:
Examination of IRS' Fiscal Year 1994 Financial Statements
(GAO/AIMD-95-141, August 4, 1995).
---------------------------------------------------------- Letter :1.4
These deficiencies in internal controls may adversely affect any
decision by management which is based, in whole or in part, on
information that is inaccurate because of the deficiencies.
Unaudited financial information reported by the Internal Revenue
Service, including budget information, also may contain misstatements
resulting from these deficiencies.
DISCLAIMER OF OPINION ON
PRINCIPAL STATEMENTS
------------------------------------------------------------ Letter :2
As described above, we are unable to give an opinion on the Principal
Financial Statements for fiscal year 1995. In addition, we were
unable to give an opinion on the Principal Financial Statements for
fiscal year 1994.\9
--------------------
\9 See our fiscal year 1994 audit report Financial Audit:
Examination of IRS' Fiscal Year 1994 Financial Statements
(GAO/AIMD-95-141, August 4, 1995). See appendixes I and III of that
report for a detailed explanation of our findings and
recommendations, along with the status of IRS' corrective actions to
respond to the problems we identified in our financial statement
audits for fiscal years 1992, 1993, and 1994. At the completion of
our audit for fiscal year 1994--which was substantively completed on
May 1, 1995--IRS had completed 13 of the 59 recommendations that had
been made.
STATEMENT ON INTERNAL CONTROLS
------------------------------------------------------------ Letter :3
We gained an understanding of internal controls designed to
-- safeguard assets against loss from unauthorized acquisition,
use, or disposition;
-- assure the execution of transactions in accordance with laws
governing the use of budget authority and with other laws and
regulations that have a direct and material effect on the
Principal Financial Statements or that are listed in Office of
Management and Budget (OMB) audit guidance and could have a
material effect on the Principal Financial Statements; and
-- properly record, process, and summarize transactions to permit
the preparation of reliable financial statements and to maintain
accountability for assets.
For fiscal years 1995 and 1994, we do not express an opinion on
internal controls because the scope of our work was limited to
determining our procedures for auditing the financial statements, not
to express an opinion on internal controls. However, we found that
the material weaknesses, described in the Significant Matters section
of this report, resulted in ineffective controls that could lead to
losses, noncompliance, or misstatements that are material in relation
to the financial statements. Our internal control work would not
necessarily disclose all material weaknesses.
COMPLIANCE WITH LAWS AND
REGULATIONS
------------------------------------------------------------ Letter :4
Because of the limitations on the scope of our work as discussed
above, we were unable to test the laws we considered necessary;\10
accordingly, we are unable to report on IRS' compliance with laws and
regulations.
--------------------
\10 These are laws governing the use of budget authority and other
laws and regulations that have a direct and material effect on the
Principal Financial Statements or that are listed in OMB audit
guidance and could have a material effect on the Principal Financial
Statements.
STATUS OF RECOMMENDATIONS AND
FUTURE STEPS NEEDED
------------------------------------------------------------ Letter :5
In our prior year reports (see footnote 1), we made 59
recommendations aimed at resolving IRS' financial management
problems. In our assessment this year, we determined that IRS had
completed 17 of these recommendations. See appendix I for the status
of IRS' implementation efforts on the 59 recommendations from our
prior year reports. IRS has stated its intention to commit the
necessary resources and management oversight to resolve its financial
management weaknesses and receive its first opinion on the fiscal
year 1996 financial statements. In this regard, we are providing
advice to IRS on how to resolve its long-standing and pervasive
financial management problems.
OBJECTIVES, SCOPE, AND
METHODOLOGY
------------------------------------------------------------ Letter :6
Management is responsible for
-- preparing the annual financial statements in conformity with the
basis of accounting described in note 1 of the Administrative
and Custodial financial statements;
-- establishing, maintaining, and assessing the internal control
structure to provide reasonable assurance that the broad control
objectives of the Federal Managers' Financial Integrity Act
(FMFIA) are met; and
-- complying with applicable laws and regulations.
We attempted to perform audit procedures on the limited information
IRS was able to provide; however, for the reasons stated above, we
were unable to perform the necessary audit procedures to opine on
IRS' Principal Financial Statements.
Except for the limitations on the scope of our work on (1) the
Principal Financial Statements, (2) internal controls, and (3)
compliance with laws and regulations described above, we did our work
in accordance with generally accepted government auditing standards
and OMB Bulletin 93-06, "Audit Requirements for Federal Financial
Statements."
We requested written comments on a draft of this report from you or
your designee. Your office provided us with written comments which
are discussed in the following section and reprinted in appendix II.
AGENCY COMMENTS AND OUR
EVALUATION
------------------------------------------------------------ Letter :7
In commenting (see appendix II) on a draft of this report, IRS
generally agreed with the facts as stated in our report. In
addition, IRS reaffirmed its commitment to ensuring the integrity of
its financial data.
Charles A. Bowsher
Comptroller General
of the United States
May 17, 1996
PRINCIPAL FINANCIAL STATEMENTS
=========================================================== Appendix 0
(See figure in printed
edition.)
Overview to the Financial
Statements
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
Statement of Financial Position
(Administrative)
(See figure in printed
edition.)
Statement of Operations
(Administrative)
(See figure in printed
edition.)
Notes to Principal Financial
Statements (Administrative)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
Statement of Financial Position
(Custodial)
(See figure in printed
edition.)
Statement of Activity
(Custodial)
(See figure in printed
edition.)
Notes to Financial Statements
(Custodial)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
Statement of Financial Position
(Revolving Fund)
(See figure in printed
edition.)
Statement of Activity
(Revolving Fund)
(See figure in printed
edition.)
Note to Financial Statements
(Revolving Fund)
(See figure in printed
edition.)
Supplemental Management
Information
(See figure in printed
edition.)
(See figure in printed
edition.)
Supplemental Financial
Information
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
(See figure in printed
edition.)
REPORTS ISSUED AS A RESULT OF
GAO'S AUDIT OF IRS' FISCAL YEAR
1992, 1993, AND 1994 FINANCIAL
STATEMENTS AND STATUS OF
RECOMMENDATIONS
=========================================================== Appendix I
The results of our efforts to audit IRS' fiscal year 1992, 1993, and
1994 Principal Financial Statements were presented in our reports
entitled Financial Audit: Examination of IRS' Fiscal Year 1992
Financial Statements (GAO/AIMD-93-2, June 30, 1993), Financial Audit:
Examination of IRS' Fiscal Year 1993 Financial Statements
(GAO/AIMD-94-120, June 15, 1994), and Financial Audit: Examination
of IRS' Fiscal Year 1994 Financial Statements (GAO/AIMD-95-141,
August 4, 1995). The system and internal control weaknesses
identified in the 1992 report and recommendations to correct them
were discussed in more detail in six reports. In fiscal year 1993,
we issued one report that included the system and internal control
weaknesses and recommendations. For fiscal year 1994, we issued one
report that contained no new recommendations.
We determined the status of the following recommendations based on
our audit work at IRS during fiscal year 1995 and on our discussions
with IRS officials. Our assessments of IRS' actions for the most
significant recommendations are discussed in the report. However, we
have not fully assessed the appropriateness or effectiveness of all
of the responses identified in the following table. We plan to
update our assessment of IRS' responses as part of our fiscal year
1996 audit.
Action
in
planni No
ng or specif
Action planni ic
Action in ng action
comple progre comple planne
Reports/recommendations te ss te d
---------------------------------- -- ------ ------ ------ ------
Financial Audit: IRS Significantly
Overstated Its Accounts Receivable
(GAO/AFMD-93-42, May 6, 1993)
Provide the IRS Chief Financial
Officer authority to ensure that
IRS accounting system development
efforts meet its financial X
reporting needs. At a minimum, the
Chief Financial Officer's approval
of related system designs should
be required.
Take steps to ensure the accuracy
of the balances reported in IRS
financial statements. In the long
term, this will require modifying
IRS systems so that they are
capable of (1) identifying which X
assessments currently recorded in
the Master File System represent
valid receivables and (2)
designating new assessments that
should be included in the
receivables balance as they are
recorded. Until these capabilities
are implemented, IRS should rely
on statistical sampling to
determine what portion of its
assessments represent valid
receivables.
Clearly designate the Chief
Financial Officer as the official X
responsible for coordinating the
development of performance
measures related to receivables
and for ensuring that IRS
financial reports conform with
applicable accounting standards.
Modify the IRS methodology for
assessing the collectibility of
its receivables by
--including only valid accounts X
receivable in the analysis;
--eliminating, from the gross
receivables balance, assessments
determined to have no chance of
being collected;
--including an analysis of
individual taxpayer accounts to
assess their ability to pay;
--basing group analyses on
categories of assessments with
similar collection risk
characteristics; and
--considering current and forecast
economic conditions, as well as
historical collection data, in
analyses of groups of
assessments.
Once the appropriate data are
accumulated, IRS may use modeling
to analyze collectibility of
accounts on a group basis, in
addition to separately analyzing
individual accounts. Such modeling
should consider factors that are
essential for estimating the level
of losses, such as historical loss
experience, recent economic
events, and current and forecast
economic conditions. In the
meantime, statistical sampling
should be used as the basis for
both individual and group
analyses.
IRS Information Systems:
Weaknesses Increase Risk of Fraud
and Impair Reliability of
Management Information (GAO/AIMD-
93-34, September 22, 1993)
Limit access authorizations for
individual employees to only those
computer programs and data needed X
to perform their duties and
periodically review these
authorizations to ensure that they
remain appropriate.
Monitor efforts to develop a
computerized capability for
reviewing user access activity to X
ensure that it is effectively
implemented.
Establish procedures for reviewing
the access activity of unit
security representatives. X
Use the security features
available in IRS' operating X
systems software to enhance system
and data integrity.
Require that programs developed
and modified at IRS headquarters
be controlled by a program X
librarian responsible for (1)
protecting such programs from
unauthorized changes including
recording the time, date, and
programmer for all software
changes, and (2) archiving
previous versions of programs.
Establish procedures requiring
that all computer program
modifications be considered for X
independent quality assurance
review.
Formally analyze Martinsburg
Computing Center's computer
applications to ensure that X
critical applications have been
properly identified for purposes
of disaster recovery.
Test the disaster recovery plan. X
Monitor service center practices
regarding the development,
documentation, and modification of X
locally developed software to
ensure that such software use is
adequately controlled.
Review the current card key access
system in the Philadelphia Service
Center to ensure that only users X
who need access to the facilities
protected by the system have
access and that authorized users
each have only one unique card
key.
Establish physical controls in the
Philadelphia Service Center to
protect computers with access to X
sensitive data that are not
protected by software access
controls.
Financial Management: IRS' Self-
Assessment of Its Internal Control
and Accounting Systems Is
Inadequate (GAO/AIMD-94-2, October
13, 1993)
The Senior Management Council
should coordinate, monitor, or
oversee activities to (1)
establish and implement proper
written procedures that provide X
for the identification,
documentation, and correction of
material weaknesses, (2) provide
classroom training and guidance
materials to all review staff, (3)
develop effective corrective
action plans that address the
fundamental causes of the
weaknesses, and (4) verify the
effectiveness of corrective
actions before removing reported
weaknesses from IRS' records.
Financial Management: Important
IRS Revenue Information Is
Unavailable or Unreliable (GAO/
AIMD-94-22, December 21, 1993)
Develop a method to determine
specific taxes collected by trust
fund so that the difference
between amounts assessed and
amounts collected is readily X
determinable and excise tax
receipts can be distributed as
required by law. This could be
done by obtaining specific payment
detail from the taxpayer,
consistent with our April 1993 FTD
report. Alternatively, IRS might
consider whether allocating
payments to specific taxes based
on the related taxpayer returns is
a preferable method.
Determine the trust fund revenue
information needs of other
agencies and provide such X
information, as appropriate. If
IRS is precluded by law from
providing needed information, IRS
should consider proposing
legislative changes.
Identify reporting information
needs, develop related sources of
reliable information, and
establish and implement policies X
and procedures for compiling this
information. These procedures
should describe any (1)
adjustments that may be needed to
available information and (2)
analyses that must be performed to
determine the ultimate disposition
and classification of amounts
associated with in-process
transactions and amounts pending
investigation and resolution.
Establish detailed procedures for
(1) reviewing manual entries to
the general ledger to ensure that
they have been entered accurately X
and (2) subjecting adjusting
entries to supervisory review to
ensure that they are appropriate
and authorized.
Monitor implementation of actions
to reduce the errors in
calculating and reporting manual X
interest, and test the
effectiveness of these actions.
Give a priority to the IRS efforts
that will allow for earlier
matching of income and withholding X
information submitted by
individuals and third parties.
Financial Management: IRS Does Not
Adequately Manage Its Operating
Funds (GAO/AIMD-94-33, February 9,
1994)
Monitor whether IRS' new
administrative accounting system
effectively provides managers up- X
to-date information on available
budget authority.
Promptly resolve differences
between IRS and Treasury records X
of IRS' cash balances and adjust
accounts accordingly.
Promptly investigate and record
suspense account items to X
appropriate appropriation
accounts.
Perform periodic reviews of
obligations, adjusting the records
for obligations to amounts X
expected to be paid, and removing
expired appropriation balances
from IRS records as stipulated by
the National Defense Authorization
Act for Fiscal Year 1991.
Monitor compliance with IRS
policies requiring approval of
journal vouchers and enforcing X
controls intended to preclude data
entry errors.
Review procurement transactions to
ensure that accounting information
assigned to these transactions
accurately reflects the X
appropriate fiscal year,
appropriation, activity, and sub-
object class.
Provide (1) detailed written
guidance for all payment
transactions, including unusual
items such as vendor credits, and X
(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 X
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 X
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 X
promptly forward receiving reports
to payment offices so that
payments can be promptly
processed.
Monitor manually computed interest
on late payments to determine X
whether interest is accurately
computed and paid.
Enforce existing requirements that
early payments be approved in X
accordance with OMB Circular A-
125.
Require payment and procurement
personnel, until the integration
of AFS and the procurement system X
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 X
responsible for processing
payments, and enhance the edit and
validity checks in AFS to help
prevent and detect improper
payments.
Establish procedures, based on
budget categories approved by OMB,
to develop reliable data on budget X
and actual costs.
Use AFS' enhanced cost
accumulation capabilities to X
monitor and report costs by
project in all appropriations.
Financial Management: IRS Lacks
Accountability Over Its ADP
Resources (GAO/AIMD-93-24, August
5, 1993)
Provide the agency's CFO with the
authority to ensure that data
maintained by IRS' ADP inventory X
system meet its management and
reporting needs.
Provide that any software
purchases, development, or
modifications related to this X
system are subject to the CFO's
review and approval.
Develop and implement standard
operating procedures that
incorporate controls to ensure
that inventory records are
accurately maintained. Such X
controls should include
--establishing specific procedures
to ensure the prompt and accurate
recording of acquisitions and
disposals in IRS' ADP fixed asset
system, including guidance
addressing the valuation of
previously leased assets;
--reconciling accounting and
inventory records monthly as an
interim measure until the
successful integration of
inventory and accounting systems
is completed as planned; and
--implementing mechanisms for
ensuring that annual physical
inventories at field locations are
effectively performed, that
discrepancies are properly
resolved, and that inventory
records are appropriately
adjusted.
Oversee IRS efforts for ensuring
that property and equipment X
inventory data, including
telecommunications and electronic
filing equipment, is complete and
accurate.
Determine what information related
to ADP resources, such as
equipment condition and remaining X
useful life, would be most useful
to IRS managers for financial
management purposes and develop a
means for accounting for these
data.
Develop an interim means to
capture relevant costs related to
in-house software development. X
Financial Audit: Examination of
IRS' Fiscal Year 1993 Financial
Statements (GAO/AIMD-94-120, June
15,1994)
Tax Collection Activities
Ensure that system development
efforts provide reliable,
complete, timely, and
comprehensive information with X
which to evaluate the
effectiveness of its enforcement
and collection programs;
Establish and implement procedures
to analyze the impact of
abatements on the effectiveness of X
assessments from IRS' various
collection programs; and
Reconcile detailed revenue
transactions for individual
taxpayers to the master file and X
general ledger.
Establish and implement procedures
to proactively identify errors
that occur during processing of X
data, and design and implement
improved systems and controls to
prevent or detect such errors in
the future.
Management of Operating Funds
Monitor its systems and controls
to regularly identify problems as
they occur by establishing clear X
lines of responsibility and
communication from top management
to the lowest staff levels,
Develop action plans that are
agreed upon by all affected groups
and individuals to correct X
problems identified, and
Continuously monitor corrective
actions to ensure that progress is X
achieved.
Periodically compare information
in payroll records to supporting X
personnel information,
Use current information to
periodically update estimated X
future TSM costs, and
Develop reliable detailed
information supporting its X
reported accounts payable
balances.
Seized Assets
Develop and implement systems and
standard operating procedures that
incorporate controls to ensure X
that seized asset inventory
records are accurately maintained,
which include
Establishing specific procedures
to ensure the prompt and accurate
recording of seizures and X
disposals, including guidance
addressing the valuation of seized
assets;
Reconciling accounting and
inventory records monthly as an
interim measure until the X
successful integration of
inventory and accounting systems
is completed; and
Implementing mechanisms for
ensuring that annual physical
inventories at field locations are
effectively performed, that X
discrepancies are properly
resolved, and that inventory
records are appropriately
adjusted.
Determine what information related
to seized assets, such as proceeds
and liens and other encumbrances,
would be most useful to IRS X
managers for financial management
purposes and develop a means for
accounting for these data.
----------------------------------------------------------------------
(See figure in printed edition.)Appendix II
COMMENTS FROM THE INTERNAL REVENUE
SERVICE
=========================================================== Appendix I
*** End of document. ***