Department of Education: Status of Financial Management Weaknesses
Reported in the Fiscal Year 1999 Financial Statement Audit
(Correspondence, 10/16/2000, GAO/GAO-01-104R).

This document discusses financial weaknesses reported in the Department
of Education's Fiscal Year (FY) 1999 financial statement audit. A major
area needing improvement involves internal controls, which provide the
framework for the accomplishment of management objectives, accurate
financial reporting, and compliance with laws and regulations. This lack
of good internal controls puts Education at risk of mismanagement,
waste, fraud, and abuse. Corrective actions undertaken by Education in
response to the identified weaknesses indicate that it is making
progress in working towards financial accountability. These corrective
actions include purchasing a new general ledger system, acquiring a
software tool to help automate the reconciliation process, improving
computer controls, and establishing a process to transfer certain excess
Federal Family Education Loan Program funds to the Treasury. The
effectiveness of the corrective actions will be determined as part of
the FY 2000 financial statement audit.

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

 REPORTNUM:  GAO-01-104R
     TITLE:  Department of Education: Status of Financial Management
	     Weaknesses Reported in the Fiscal Year 1999 Financial
	     Statement Audit
      DATE:  10/16/2000
   SUBJECT:  Financial statement audits
	     Internal controls
	     Federal agency accounting systems
	     Educational grants
	     Computer security
	     Student loans
	     Accounting procedures
	     Financial management
	     Reporting requirements
IDENTIFIER:  Federal Family Education Loan Program

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GAO-01-104R

GAO- 01- 104R Education's FY99 Financial Management Weaknesses

United States General Accounting Office Washington, DC 20548

October 16, 2000 The Honorable John R. Kasich Chairman, Committee on the
Budget House of Representatives

The Honorable Judy Biggert House of Representatives

Subject: Department of Education: Status of Financial Management Weaknesses
Reported in the Fiscal Year 1999 Financial Statement Audit

In response to your request and subsequent discussions with your offices,
this letter analyzes the Department of Education's financial management
weaknesses, which have been identified through the annual audit of
Education's financial statements. You asked that we (1) analyze Education's
financial management weaknesses in the context of possible program and
budgetary implications based on the results of the audit of its fiscal year
1999 financial statements, (2) identify Education's corrective actions to
address reported weaknesses, and (3) explain how Education prepared reliable
fiscal year 1997 cost estimates for its loan programs and resolved the
related reported material weakness in fiscal year 1998.

Education is the primary agency responsible for overseeing the more than $75
billion annual federal investment in support of educational programs for U.
S. citizens and eligible noncitizens. Education is also responsible for
collecting about $175 billion owed by students. In fiscal year 1999, more
than 8.1 million students received over $53 billion in federal student
financial aid through programs administered by Education.

Results in Brief

Education's fiscal year 1999 financial statement audit results disclosed
continuing financial management weaknesses that prevented the agency from
receiving a “clean” audit opinion. Four of the eight reported
financial management weaknesses were classified as material internal control
weaknesses. 1 These weaknesses existed generally because Education lacked an
effective system of internal controls. An effective internal control system
provides the framework for the accomplishment of

1 A material internal control weakness is a reportable condition in which
one or more of the internal controls does not reduce to a relatively low
level the risk that errors, fraud, or noncompliance involving significant
amounts may occur and not be detected in a timely manner by employees in the
normal course of performing their assigned functions.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 2
management objectives, accurate financial reporting, and compliance with
laws and

regulations. In addition, effective internal controls serve as checks and
balances against undesired actions and, as such, provide reasonable
assurance that agencies operate in a sound manner. The lack of good internal
controls puts Education at risk of mismanagement, waste, fraud, and abuse.

The specific material internal control weaknesses cited by the independent
auditors in its fiscal year 1999 audit deal with (1) the inability of the
accounting system to perform a year- end closing process or produce
automated consolidated financial statements, (2) the lack of proper or
timely reconciliations of accounting records, (3) inadequate controls over
information systems, including access to sensitive information, and (4)
failure to transfer certain Federal Family Education Loan Program (FFELP) 2
unobligated balances to Treasury in accordance with the Federal Credit
Reform Act of 1990 (FCRA).

Corrective actions undertaken by Education in response to these financial
management weaknesses indicate that it is making progress in working towards
financial accountability. Key corrective actions initiated in response to
the material financial management weaknesses identified in its fiscal year
1999 financial statement audit include purchasing a new general ledger
system, acquiring a software tool to help automate the reconciliation
process, improving computer controls, and establishing a process to transfer
certain excess FFELP funds to Treasury. Also, although the financial
management weaknesses identified in its fiscal year 1999 audit are serious,
it should nevertheless be recognized that in fiscal year 1999 Education made
progress over fiscal year 1998 in terms of the audit opinion received. In
fiscal year 1999, Education's auditors issued qualified opinions on four of
the agency's five required financial statements and a disclaimer of opinion
on the fifth statement, whereas Education had received a disclaimer on its
fiscal year 1998 financial statements. 3

Education's financial reporting weaknesses can be attributed primarily to
several limitations of a new accounting system that Education implemented
during fiscal year 1998. A significant limitation of the new accounting
system was its general ledger system, 4 which, among other problems, was
unable to perform an automated year- end closing process and directly
produce consolidated financial statements, as required by Office of
Management and Budget (OMB) Circular A- 127 pursuant to the

2 FFELP (formerly known as the Guaranteed Student Loan Program) operates
with state and private nonprofit guaranty agencies to provide loan
guarantees and interest supplements through permanent budget authority on
loans provided by private lenders to eligible students attending
participating postsecondary schools.

3 The auditor issues a disclaimer when a pervasive material uncertainty
exists or there is a significant restriction on the scope of the audit. The
auditor issues a qualified opinion when he/ she concludes that the financial
statements are fairly stated except for one of the following conditions for
one or more major accounts: (1) limitation on audit scope, (2) failure to
follow generally accepted accounting principles, and (3) uncertainty over
whether certain information was fairly presented.

4 A general ledger system provides a standard chart of accounts for
recording financial transactions.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 3
Federal Financial Management Improvement Act of 1996 (FFMIA). 5 Because of
these

weaknesses, Education had to resort to a costly, labor- intensive, and time-
consuming process involving automated and manual procedures to prepare
financial statements for fiscal year 1999.

Education's account reconciliation problems involved its Fund Balance with
Treasury accounts and certain grant accounts. 6 There are many underlying
reasons for these problems, including formal reconciliation procedures not
being performed adequately or promptly throughout fiscal year 1999. For
fiscal year 1999, Education adjusted its Fund Balance with Treasury account
to agree with Treasury's records by a net amount of about $244 million
without determining the causes of the differences. In other words, Education
simply forced its records to agree with Treasury's records. Education had
not been able to identify and resolve differences between its financial
accounting records and cash transactions reported by Treasury. Reconciling
agencies' accounting records with relevant Treasury records is required by
Treasury policy and is analogous to individuals reconciling their checkbooks
to monthly bank statements. Because most assets, liabilities, revenues, and
expenses stem from or result in cash transactions, errors in the receipt or
disbursement data affect the accuracy of the individual agency financial
reports and various U. S. government financial reports, including data
provided by agencies for inclusion in the President's Budget concerning
fiscal year outlays. Further, the lack of effective reconciliations
increases the risk of fraud, waste, and mismanagement of government funds.

Education also did not perform routine reconciliations of its grant payments
system with the general ledger. The auditors noted that reconciliations were
not routinely performed because Education had not developed adequate
policies and procedures for doing so. As a result, there was increased risk
that material errors or irregularities could occur and not be detected on a
timely basis. In addition, while no instances of improper payments were
identified, we reported in August 2000 7 that there was increased risk of
fraud, waste, and mismanagement of Education grant funds as a result of
financial management system deficiencies, inadequate systems of funds
control, internal control weaknesses, and the inappropriate manner in which
the agency used one of its deposit funds. (This deposit fund, called the
grantback account, was established to retain availability of funds needed to
make grantback

5 FFMIA requires auditors for each of the 24 major departments and agencies
named in the Chief Financial Officers Act of 1990 to include in their audit
reports on the agencies' annual financial statements information to indicate
whether the agencies' financial management systems comply with three
requirements: (1) federal financial management systems requirements, (2)
applicable federal accounting standards, and (3) the U. S. Government
Standard General Ledger( SGL) at the transaction level.

6 Education records its budget authority in asset accounts called Fund
Balance with Treasury and increases or decreases these accounts as it
collects or disburses funds. 7 Financial Management: Review of Education's
Grantback Account( GAO/ AIMD- 00- 228, August 18, 2000).

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 4
payments and account for grantback activity. 8 ) For example, we found that
beginning

in 1993, Education inappropriately used the grantback account as a suspense
account 9 for hundreds of millions of dollars of activity related to grant
reconciliation efforts affecting its appropriations that fund grants. We
made a series of recommendations which Education has targeted for
implementation by November 2000.

In fiscal year 1999, Education's auditors also reported that Education had
serious computer security deficiencies in (1) implementing user management
controls, such as procedures for requesting, authorizing, and revalidating
access to computing resources, (2) monitoring and reviewing access to
sensitive computer resources, (3) documenting the approach and methodology
for the design, selection, and maintenance of its information technology
architecture, and (4) developing, documenting, and testing a comprehensive
disaster recovery plan to ensure the continuity of critical information
system operations in the event of disaster. Continued weaknesses in computer
systems controls increase the risk of unauthorized access to or disruption
of services and make Education's sensitive grant and loan data vulnerable to
inadvertent or deliberate misuse, fraudulent use, improper disclosure, or
destruction, which could occur without being detected.

In addition, during fiscal year 1999, Education did not transfer about $2.7
billion in unobligated balances in its liquidating account for FFELP loans
to Treasury's general fund as required by FCRA. Further, Education did not
sufficiently analyze the balances reflected on the financial statements to
ensure that the FFELP balances agreed with relevant balances in the
department's budgetary accounts. The auditors identified an unexplained
difference of about $700 million for the liquidating account between the
FFELP and budgetary accounts as of September 30, 1999. Because it did not
properly account for and analyze its FFELP transactions and properly
reconcile related accounting and budgetary accounts consistent with FCRA,
Education could not be assured that its financial or budgetary reports were
accurate.

Education has taken the need to improve its financial management systems and
practices seriously and initiated various corrective actions in response to
the material financial management weaknesses identified in its fiscal year
1999 financial statement audit. For example:

ï¿½ In response to financial reporting weaknesses, Education is purchasing a
new general ledger system. It plans to fully implement the new general
ledger system

8 If audits of grant recipients identify certain noncompliance, recipients
must repay Education the amount related to the noncompliance. For some grant
programs, if the grant recipient meets certain conditions, including
correcting the noncompliance, Education may return up to 75 percent of the
amounts recovered (referred to as grantback payments).

9 Suspense accounts are used by entities as temporary holding places for
certain transactions until they can be cleared to the proper accounts. Sound
financial management practices entail entities having appropriate controls
over the suspense accounts, including maintaining adequate detailed records
of the transactions in the account, promptly investigating the transactions,
and promptly transferring them to the proper accounts.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 5 by
August 2001 and to eliminate the current general ledger system by January

2002. Also, it is now using a new reporting tool to automatically produce
all of its financial statements.

ï¿½ In response to the auditors' findings on reconciliation weaknesses,
Education has purchased a software tool to help enhance its ability to
reconcile its account balances with the corresponding Treasury account
balances on a monthly basis. In addition, in response to the auditors'
finding of inadequate reconciliation of grant expenditures, Education has
now developed policies and procedures to reconcile grant expenditures to the
general ledger. According to Education officials, Education is in the final
stages of reconciling its payments system to its general ledger system.

ï¿½ In response to the information systems control weaknesses, Education
officials stated that the department has developed and implemented a formal
approach and methodology for designing and maintaining an entitywide
security program technology architecture and has updated its security
policies and procedures for its financial management systems to ensure that
changing system security needs are reflected, access authorizations are
documented, and access rights are revalidated periodically.

ï¿½ In response to inadequate accounting for FFELP guaranteed loans, Education
transferred the $2.7 billion to the Treasury in February 2000. Education
officials stated that they believe the noncompliance with FCRA issue will be
resolved for the fiscal year 2000 audit because they have developed and
implemented detailed policies and procedures for transferring excess funds
to the Treasury.

The effectiveness of these corrective actions will be determined as part of
the fiscal year 2000 financial statement audit.

In fiscal year 1996 and in prior years, auditors had reported a material
weakness relating to the preparation of reliable cost estimates for
Education's loan programs. Federal accounting standards state that actual
and expected costs of federal credit programs should be fully recognized in
both budgetary and financial reporting. The primary deficiency cited by the
auditors was that Education was not able to obtain complete and accurate
student loan data from its systems to support its loan subsidy estimates. To
address this deficiency, Education developed a temporary solution for fiscal
year 1997 by using external loan data obtained from 10 of the larger federal
student loan guaranty agencies. 10 By fiscal year 1998, Education had made
significant progress in improving loan data quality in its National Student
Loan Data System

10 These agencies are state or private nonprofit entities that act as
intermediaries between the government and the lender. They are responsible
for reviewing student applications and approving loans, reviewing and paying
claims to lenders when defaults occur, and collecting on defaulted loans.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 6
(NSLDS) 11 -- the basic source of historical data used to prepare loan
liability estimates-

by, among other things, performing reconciliations with guaranty agency
systems data, improving data edits, ensuring complete data, and requiring
audits of guaranty agency data submissions. Consequently, for fiscal year
1998, the auditors removed the material internal control weakness relating
to the preparation of loan liability estimates from their audit report.

Education needs to be able to generate reliable, useful, and timely
information on an ongoing basis to ensure adequate accountability to
taxpayers, manage for results, and help program and congressional
decisionmakers make timely, well- informed judgments to be used for day- to-
day management and oversight. While Education has planned and begun
implementing many actions to resolve its financial management problems, it
is too early to tell how successful it will be. It is critical that
Education rise to the challenges posed by its financial management
weaknesses because its success in achieving all aspects of its strategic
goals depends in part upon reliable financial management information and
effective internal controls.

In commenting on a draft of this report, Education officials agreed that the
draft accurately described the material internal control weaknesses
discussed in the audit report on Education's fiscal year 1999 financial
statements. However, the officials felt that the draft did not adequately
reflect the extent of corrective actions that they have undertaken to
improve the department's financial management. We have included in the
report additional information on Education's efforts to correct its
financial management weaknesses and recognized that Education has taken a
number of steps to implement corrective actions. Whether these actions have
been successful in addressing the reported weaknesses will be determined
through the fiscal year 2000 financial statement audit, which is expected to
be completed by no later than March 1, 2001.

Education officials also stated that they believed the report would be more
balanced if it included discussion of the findings and conclusions included
in several other GAO reports regarding various grant programs that suggest
that the agency had followed sound financial management practices for those
programs. 12 However, the issues discussed in those reports, and many others
that GAO has issued on Education's various program activities, are beyond
the scope of this audit, which focuses on the status of financial management
weaknesses reported as part of the fiscal year 1999 financial statement
audit.

11 NSLDS is a national database of individual loan- level information and
grant data on aid disbursed under Title IV of the Higher Education Act of
1965, as amended. NSLDS contains data on the FFELP, Federal Direct Loan
Program (FDLP), Perkins Loans, Federal Pell Grant Program, and overpayments
from the Federal Supplemental Educational Opportunity Grant Program. These
data are provided by guaranty agencies, schools, the FDLP servicer, and the
department's Title IV systems.

12 Federal Education Funding Allocation to State and Local Agencies for 10
Programs( GAO/ HEHS- 99- 180, September 30, 1999) and Education
Discretionary Grants: Awards Process Could Benefit from Additional
Improvements( GAO/ HEHS- 00- 55, March 30, 2000).

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 7

Background

Over the past 10 years, dramatic changes have occurred in federal financial
management in response to comprehensive management reform legislation
designed to provide a critical link between budgeting, financial reporting,
and performance measurements. Specifically, the combination of reforms
ushered in by (1) the Chief Financial Officers (CFO) Act of 1990, (2) the
Government Management Reform Act of 1994, (3) FFMIA, (4) the Government
Performance and Results Act of 1993 (GPRA), and (5) the Clinger- Cohen Act
of 1996 will, if successfully implemented, provide the necessary foundation
to run an effective, results- oriented government. Efforts to continue
building the foundation for generating accurate financial information
through lasting financial management reform are essential. Only by
generating reliable and useful information can government agencies such as
Education ensure adequate accountability to taxpayers, manage for results,
and help decisionmakers reach timely, well- informed judgments.

OMB's implementation guidance for audited financial statements requires
Education and other major federal agencies to receive three reports from its
auditors annually: an opinion or report on its financial statements, a
report on its internal controls, and a report on its compliance with laws
and regulations. In understanding Education's financial management
weaknesses and their program and budgetary implications, the independent
auditors' report on internal controls is particularly important because it
highlights the agency's material internal control weaknesses that increase
its risk of mismanagement that can sometimes result in waste, fraud, and
abuse.

Since the first agencywide financial audit for fiscal year 1995, Education's
auditors have each year reported largely the same serious internal control
weaknesses, which have affected its ability to provide reliable financial
information to decisionmakers both inside and outside the agency. In both
fiscal years 1995 and 1996, Education's auditors issued a disclaimer of
opinion on the agency's financial statements- meaning that they were unable
to express an opinion-- due primarily to a material internal control
weakness involving the lack of reliable and complete NSLDS data supporting
the estimates of its loan guarantee liability. In fiscal year 1997,
Education overcame this barrier and received an unqualified opinion.
However, Education's auditors continued to report material internal control
weaknesses. Education received another disclaimer of opinion for fiscal year
1998 due primarily to serious problems with its newly implemented accounting
system. 13 Furthermore, Education issued its fiscal year 1998 financial
statements more than 8 months after the March 1 statutory deadline. In
fiscal year 1999, Education made progress over fiscal year 1998 when its
auditors issued qualified opinions on four of the agency's five required
financial statements and a disclaimer of opinion on the fifth statement.
However, although progress was made, Education's auditors continued to
report material

13 Education operated under a new accounting system, Education's Central
Automated Processing System, in fiscal year 1998.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 8
internal control weaknesses in their audit report on the fiscal year 1999
financial

statements. Education provides grants for various education programs, such
as postsecondary, special education, and vocational programs and has over
16,000 grant recipients. Grant recipients meeting certain thresholds are
required by law to have single audits 14 or other audits (such as those that
Education might perform itself). If these audits identify instances of
noncompliance, grant recipients must repay Education the amount related to
the noncompliance. However, for some grant programs, if the grant recipient
meets certain conditions, including correcting the noncompliance, Education
may return up to 75 percent of the amounts repaid in the form of a
“grantback” payment to the recipient. Any remaining funds are to
be returned to Treasury. Education established a deposit fund to retain
amounts needed to make grantback payments to grant recipients and referred
to it as the grantback account.

Scope and Methodology

To analyze Education's financial management weaknesses, we reviewed
Education's fiscal year 1999 audit reports issued by its independent
auditors and focused on the four material internal control weaknesses cited
in its Report on Internal Controls. In addition, we identified internal
control standards in our Standards for Internal Control in the Federal
Government 15 and audit guidance for CFO agencies' financial statements
issued by OMB. 16 To develop information on possible program and budgetary
implications, we interpreted the results of Education's fiscal year 1999
audit reports, reviewed federal guidance for audited financial statements,
and reviewed the independent auditors' report and workpapers. We also
reviewed numerous reports we issued during the last few years that discuss
governmentwide financial management weaknesses, such as information security
problems, similar to those existing at Education.

To identify Education's corrective actions, we obtained and reviewed
Education's corrective action plan, dated October 2, 2000, and interviewed
Education officials about the current status of these corrective actions to
resolve the reported weaknesses. However, as part of our review, we did not
assess the effectiveness of these corrective actions, which will be assessed
as part of the audit of Education's fiscal year 2000 financial statements.
To assess how Education resolved past reported weaknesses in developing its
loan liability estimates, we reviewed the audit reports from fiscal year
1995 through fiscal year 1999 and related GAO and Inspector General (IG)
reports, and interviewed Education officials.

14 Single audits include tests of grant recipients' compliance with
requirements that have a direct and material effect on a major program. A
major program is a federal program identified in accordance with risk- based
criteria prescribed by OMB. Single audits are performed of states, local
governments, and nonprofit organizations that expend federal grants.

15 GAO/ AIMD- 00- 21.3.1, November 1999. 16 Audit Requirements for Federal
Financial Statements, OMB Bulletin No. 98- 08, as amended, January 25, 1999.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 9 We
performed our review in Washington, D. C., between August 2000 and mid-
October

2000 in accordance with generally accepted government auditing standards.

Reported Material Financial Management Weaknesses Have Potential Program and
Budgetary Implications

Education's fiscal year 1999 financial statement audit results disclosed
continuing financial management weaknesses that prevented the agency from
receiving an unqualified audit opinion. Four of the eight reported financial
management weaknesses were classified as material internal control
weaknesses. A material internal control weakness is a reportable condition
in which one or more of the internal controls does not reduce to a
relatively low level the risk that errors, fraud, or noncompliance involving
significant amounts may occur and not be detected in a timely manner by
employees in the normal course of performing their assigned functions. The
specific material internal control weaknesses cited by the independent
auditors were (1) weaknesses in the financial reporting process, (2)
inadequate reconciliations of financial accounting records, (3) inadequate
controls over information systems, and (4) failure to transfer funds related
to certain loan collections to Treasury in accordance with FCRA. The first
three material weaknesses were also reported in the fiscal year 1998 report
on internal controls. The fourth weakness was new for fiscal year 1999.

These weaknesses existed because Education's financial systems lacked strong
internal controls, including appropriate policies and procedures. The CFO
Act of 1990 calls for financial management systems to comply with internal
control standards issued by GAO. Our Standards for Internal Control in the
Federal Governmentstates that internal control is an integral component of
an agency's management that provides reasonable assurance that the following
objectives are being achieved: (1) effectiveness and efficiency of
operations, (2) reliability of financial reporting, and (3) compliance with
applicable laws and regulations. Furthermore, the Federal Managers'
Financial Integrity Act requires agency managers to conduct regular
evaluations of management controls with special attention to accounting
systems.

Education's financial management system problems and its range of internal
control weaknesses hamper its ability to generate reliable, useful, and
timely information on an ongoing basis to ensure accountability to
taxpayers. Without strong internal controls, Education is also challenged in
carrying out its responsibilities to manage for results and help
congressional and program decisionmakers make timely and well- informed
judgments. Internal control serves as the first line of defense in
safeguarding assets and in helping to detect and prevent waste, fraud, and
abuse. As federal policymakers and program managers continually seek to
better achieve agencies' missions and program results, they seek ways to
improve accountability. A key factor in achieving these outcomes and
minimizing operational problems is the implementation of appropriate
internal control.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 10
Summaries of the material internal control weaknesses reported in fiscal
year 1999

along with our analysis of the program and budgetary implications of these
weaknesses follow. We provided similar information in our testimony before
the Subcommittee on Oversight and Investigations, House Committee on
Education and the Workforce in September 2000. 17

Financial Reporting Weaknesses For fiscal year 1999, as in prior years,
Education did not have adequate internal controls over its financial
reporting process. Education's financial reporting weaknesses can be
attributed primarily to several limitations of a new accounting system that
Education implemented during fiscal year 1998. A significant limitation of
the new accounting system was its general ledger system, which was unable to
perform an automated year- end closing process and directly produce
consolidated financial statements, as required by OMB Circular A- 127 18
pursuant to FFMIA. 19 Because of these weaknesses, Education had to resort
to a costly, labor- intensive, and time- consuming process involving
automated and manual procedures to prepare financial statements for fiscal
year 1999. Specifically, Education used a software package that interfaced
with the general ledger to produce financial reports by reporting group,
transferred these reports to manual spreadsheets, and made numerous year end
adjusting and closing entries to produce its consolidated financial
statements for the department. Education will continue to experience
difficulties in preparing timely, accurate financial statements until it
successfully completes its efforts to improve its financial reporting
process.

In one instance, Education's financial statements included a balance of
approximately $7.5 billion for its cumulative results of operations.
However, the majority of this amount, which pertains to FFELP, should have
been reported as an amount to be transferred to Treasury rather than as
cumulative results of operations. As a result of the independent auditors'
work, the accounting records had to be adjusted to reflect the proper amount
to be transferred to Treasury. However, after adjusting the accounting
records, $800 million still remained in cumulative results of operations for
which Education was unable to provide adequate support. When financial
reporting errors like this occur and are not detected by Education's
controls, there are increased risks that Education could inappropriately
spend or retain funds that should be transferred to Treasury. However, we
are not aware of any instances where Education spent funds that should have
been transferred to Treasury. According to Education officials, the
department has analyzed the

17 Financial Management: Financial Management Challenges Remain at the
Department of Education (GAO/ T- AIMD- 00- 323, September 19, 2000). 18 OMB
Circular A- 127, Financial Management Systems, references the series of
publications, entitled Federal Financial Management Systems Requirements,
issued by the Joint Financial Management Improvement Program as the primary
source of governmentwide requirements for financial management systems.

19 See footnote 5.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 11 $800
million and determined the proper balance for the account. The department's

analysis will be subject to testing during the fiscal year 2000 financial
statement audit. Education's approach of using various automated and manual
tools to work around the accounting system's limitations in order to prepare
annual financial statements is not consistent with the CFO Act's ultimate
goal of federal financial systems that can generate reliable, timely
information.

Inadequate Reconciliations Education did not properly or promptly reconcile
certain of its financial accounting records during fiscal year 1999 and
could not provide sufficient documentation to support some of its financial
transactions. There are many underlying reasons for Education's
reconciliation difficulties, including inadequate reconciliation policies
and procedures.

Weaknesses in Education's internal controls over the reconciliation process
prevented timely detection and correction of errors in its underlying
accounting records. Without reliable and timely data in its accounting
records, the risk of fraud, waste, and mismanagement of funds is increased.

Education's financial statement auditors and we have reported instances in
which Education adjusted its general ledger to reflect the balance in
detailed records, without sufficiently researching the cause for
differences. Examples related to Education's Fund Balance with Treasury
accounts, grant expenditures, and grantback account are discussed below,
along with program and budget implications.

Implications of Inadequate Reconciliations of Fund Balance With Treasury
Accounts

As indicated in prior audits, Education has not been able to identify and
resolve differences between its financial accounting records and cash
transactions reported by Treasury. Reconciling agencies' accounting records
with relevant Treasury records is required by Treasury policy and is
analogous to individuals reconciling their checkbooks to monthly bank
statements. For example, for fiscal year 1999, Education arbitrarily
adjusted its Fund Balance with Treasury accounts, due to a difference
between its general ledger and Treasury records, by a net amount of about
$244 million. Education simply changed its records to agree with Treasury
balances without determining the causes of the differences. Because
Education had not been performing periodic reconciliations and discerning
reasons for differences between its and Treasury's records on an ongoing
basis, it could not determine which records, if any, were correct and relied
only on Treasury's records. Until this problem is corrected, the integrity
of certain of Education's financial data is questionable.

Because most assets, liabilities, revenues, and expenses stem from or result
in cash transactions, errors in the receipt or disbursement data can affect
the accuracy of the individual agency financial reports and various U. S.
government financial reports, including data provided by agencies for
inclusion in the President's Budget

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 12
concerning fiscal year outlays. Further, the lack of effective
reconciliations increases

the risk of fraud, waste, and mismanagement of government funds. Inaccurate
receipt and disbursement data not identified as a result of timely
reconciliations also can limit Education's overall ability to accurately
measure the cost of its programs.

Implications of Inadequate Reconciliation of Grant Expenditures Education
did not perform routine reconciliations of its grant payments system with
the general ledger. In its report on Education's fiscal year 1999 financial
statements, the auditors stated that during their testing of grant
expenditures, they found that Education had not performed this routine
reconciliation process. The auditors noted that reconciliations were not
performed because Education had not developed adequate policies and
procedures for reconciling grant expenditures between its payments system
and its general ledger system. As a result, there is increased risk that
material errors or irregularities could occur and not be detected on a
timely basis. This risk is significant to Education because it processes
over $30 billion in grant transactions annually.

Given the high- dollar volume of grant transactions and the lack of adequate
policies and procedures specific to the reconciliation of grant
expenditures, the risk that material errors or irregularities could occur
and not be detected on a timely basis increases significantly. Without
reliable, useful, and timely information on grant transactions, program
managers run the risk of making duplicate payments to grant recipients, not
becoming aware on a timely basis of these payments, as well as unusual or
questionable grant activity, and not making informed decisions on the best
use of grant funds. Furthermore, the possibility of collecting duplicate
payments declines as time passes and they remain uncollected.

Data on duplicate payments for fiscal years 1998 and 1999, provided to us by
Education's CFO office, showed $47.5 million in duplicate payments in fiscal
year 1998 and $566,403 in fiscal year 1999. These duplicate payments,
including those identified by grant recipients, could have been identified
earlier by Education if it had performed proper reconciliations. In
addition, the department has reported as duplicate payments for fiscal year
2000 about $150.7 million, primarily to grantees. These duplicate payments
were caused by manual and data input processing errors. Until Education
implements an improved reconciliation process, exposure to these types of
errors will continue. The IG stated that all of these duplicate payments
have now been recovered by the department.

Implications of Weaknesses in Controls Over Education's Grantback Account In
our recent review of Education's grantback account, which is one of
Education's Fund Balance with Treasury accounts, we found that Education had
used this account to, among other things, clear unreconciled differences in
other grant appropriation fund balance accounts and adjust certain
appropriation fund balance accounts to ensure that they did not have
negative balances. We reported in August

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 13 2000
20 that there is increased risk of fraud, waste, and mismanagement of grant
funds

as a result of financial management system deficiencies, inadequate systems
of funds control, internal control weaknesses, and the inappropriate manner
in which the grantback account was used.

Although the grantback account was established to account for grantback
activities, we reported that about 95 percent of the activity in the account
for fiscal years 1993 through 1999 was unrelated to such activities. While
no instances of improper payments were identified, we found that beginning
in 1993, Education used the grantback account as a suspense account for
hundreds of millions of dollars of activity related to grant reconciliation
efforts affecting its appropriations that fund grants. We also found that
Education did not maintain adequate detailed records for certain grantback
account activity by the applicable fiscal year and appropriation that would
allow it to promptly investigate the activity so that it could transfer
improperly recorded transactions to the proper accounts. Education's
independent auditors similarly reported in fiscal years 1998 and 1999 that
Education could not readily determine to which appropriations the amounts in
the grantback account belonged. Detailed records are needed to have an
adequate system of funds control and help prevent Anti- Deficiency Act
violations. 21

Education also used the grantback account to (1) clear unreconciled
differences in other grant appropriation fund balance accounts and (2)
adjust certain appropriation fund balance accounts to ensure that they did
not have negative balances. For example, in 1999, Education made a $111
million adjustment, reducing the grantback account balance and increasing
the balance of six appropriations to ensure that projected negative funds
balances did not occur in these appropriation accounts. A negative balance
is an indicator of a potential Anti- Deficiency Act violation. For this
adjustment activity, Education did not provide any documentation to show a
direct correlation between the reductions to the grantback account for the
adjustments and the initial increases made to the grantback account. Such
documentation is needed as part of a funds control system to ensure
compliance with the Anti- Deficiency Act, which requires agencies to prevent
possible overobligations or overexpenditures and to report to the President
and the Congress if overobligations or overexpenditures occur.

In our August 2000, report we made a series of recommendations to improve
accounting for grantback funds. Education stated that it has prepared a
detailed plan to address our recommendations.

Inadequate Information System Controls In fiscal year 1999, Education's
auditors reported that Education had information systems control
deficiencies in (1) implementing user management controls, such as

20 GAO/ AIMD- 00- 228, August 18, 2000. 21 Anti- Deficiency Act violations
include the obligation or expenditure of amounts exceeding the amount
available in an appropriation or fund account.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 14
procedures for requesting, authorizing, and revalidating access to computing

resources, (2) monitoring and reviewing access to sensitive computer
resources, (3) documenting the approach and methodology for the design and
maintenance of its information technology architecture, and (4) developing
and testing a comprehensive disaster recovery plan to ensure the continuity
of critical system operations in the event of disaster.

Education relies significantly on its financial management systems to
perform basic functions, such as making payments to grantees and maintaining
budget controls. Consequently, continued weaknesses in information systems
controls increase the risk of unauthorized access or disruption in services
and make Education's sensitive grant and loan data vulnerable to inadvertent
or deliberate misuse, fraudulent use, improper disclosure, or destruction,
which could occur without being detected.

The information systems weaknesses highlight some of the computer security
vulnerabilities, such as the lack of an effective process to monitor
security violations on all of the Department's critical systems. A report
issued by the department's IG in February 22 emphasizes the need for the
department to focus on addressing its computer security vulnerabilities. In
addition, earlier this year, the White House recognized the importance of
strengthening the nation's defenses against threats to public and private
sector information systems that are critical to the country's economic and
social welfare when it issued its National Plan for Information Systems
Protection. 23 In the aftermath of the attack by the “ILOVEYOU”
virus, which disrupted operations at large corporations, governments, and
media organizations worldwide, we testified 24 about the need for federal
agencies to promptly implement a comprehensive set of security controls. We
also recently reported 25 on the results of information security audits at
federal agencies that show that federal computer systems are riddled with
weaknesses that continue to put critical operations and assets at risk.
These types of concerns led us, in 1997 and 1999 reports to the Congress, to
identify information security as a high- risk issue. 26

22 Review of Security Posture, Policies, and Plans( ED- OIG/ A11- 90013,
February 2000). 23 Defending America's Cyberspace: National Plan for
Information Systems Protection: Version 1. 0: An Invitation to a Dialogue,
released January 7, 2000, the White House. 24 Critical Infrastructure
Protection: “ILOVEYOU” Computer Virus Highlights Need for
Improved Alert and Coordination Capabilities( GAO/ T- AIMD- 00- 181, May 18,
2000) and Information Security: “ILOVE

YOU” Computer Virus Emphasizes Critical Need for Agency and
Governmentwide Improvements (GAO/ T- AIMD- 00- 171, May 10, 2000).

25 Computer Security: Critical Federal Operations and Assets Remain at Risk(
GAO/ T- AIMD- 00- 314, September 11, 2000) and Information Security: Serious
and Widespread Weaknesses Persist at Federal Agencies( GAO/ AIMD- 00- 295,
September 6, 2000).

26 High- Risk Series: Information Management and Technology( GAO/ HR- 97- 9,
February 1, 1997) and High- Risk Series: An Update( GAO/ HR- 99- 1, January
1999).

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 15
Inadequate Accounting for FFELP Loans

During fiscal year 1999, Education did not transfer unobligated balances in
its liquidating account for FFELP loans to Treasury's general fund as
required by FCRA. 27 Specifically, it did not return about $2.7 billion in
net collections specific to its FFELP liquidating account to Treasury until
February 2000. The liquidating account includes transactions for loans that
originated prior to fiscal year 1992. Any unobligated balances in this
account at fiscal year- end are unavailable for obligation in subsequent
fiscal years and must be transferred to the general fund. Further, Education
did not sufficiently analyze the balances reflected on the financial
statements to ensure that the FFELP balances agreed with relevant balances
in the department's budgetary accounts. As a result, the auditors stated
that an unexplained difference of about $700 million existed between the
FFELP liquidating account and the related budgetary accounts as of September
30, 1999. According to Education officials, the department has analyzed the
$700 million unexplained difference and determined the proper balance for
the accounts; however, we have not reviewed the adequacy of the department's
analysis.

Because it did not properly account for and analyze its FFELP transactions
and properly reconcile related accounting and budgetary accounts consistent
with FCRA, Education could not be assured that its financial or budgetary
reports were accurate. This lack of assurance that the financial or
budgetary reports are accurate diminishes the potential that these reports
will help the Congress and others determine how Education spent program
funds.

Education Is Taking Actions to Correct Material Internal Control Weaknesses

Each year, following receipt of the annual auditors' report on the results
of its financial statement audit, Education prepares a corrective action
plan that is updated periodically throughout the year to address each
reported financial management weakness and related recommendation by listing
a proposed action for resolving the weakness. Education then provides its
corrective action plan to the department's IG for review and concurrence. On
October 2, 2000, as we were completing our fieldwork, Education submitted an
updated fiscal year 1999 corrective action plan to the IG. Education told us
that it had carried out the majority of the corrective actions. However,
whether the corrective actions are sufficient to resolve Education's
material internal control weaknesses will not be determined until the
independent auditing firm assesses the effectiveness of these corrective
actions as part of its audit of Education's fiscal year 2000 financial
statements.

The following sections describe Education's planned and completed corrective
actions for resolving the four material internal control weaknesses.

27 The FFELP liquidating account includes collections from borrowers
received by Education on defaulted guaranteed loans made prior to the
effective date of the requirements of FCRA.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 16
Actions to Address Financial Reporting Weaknesses

Education officials told us that they have taken actions to address all of
the auditors' recommendations related to financial reporting weaknesses.
Specifically, the auditors recommended that Education develop an
implementation plan to replace the general ledger, ensure comprehensive
reviews of the financial statements, update policies and procedures for
generating trial balances and financial statements, update policies and
procedures for preparing and reviewing adjustments, provide appropriate
training to those individuals responsible for preparing and reviewing the
adjustments, and ensure that unobligated balances in the liquidating account
for FFELP loans are transferred to the U. S. Treasury in accordance with
FCRA. Education has purchased a new general ledger system that it plans to
fully implement by August 2001 and to eliminate the current general ledger
system by January 2002. To facilitate the fiscal year 2000 consolidated
audit, Education officials told us they prepared, analyzed, and provided to
its auditors interim financial statements as of March 31, 2000, and June 30,
2000, using a new reporting tool that enables it to automatically produce
financial statements from its existing reporting system.

Actions to Address Inadequate Reconciliation of Financial Accounts In
response to the auditors' findings, Education has purchased a software tool
to help enhance its ability to reconcile its account balances with the
corresponding Treasury account balances on a monthly basis. Education has
also developed Web- based policies and procedures for reconciling its
material accounts and programs. Additionally, in response to the auditors'
finding of inadequate reconciliation of grant expenditures, Education has
now developed policies and procedures to reconcile grant expenditures to the
general ledger. According to Education officials, Education is in the final
stages of reconciling its payments system to its general ledger system. With
regard to the grantback account issues, Education advised that it has
developed a detailed plan to address the recommendations made in our August
2000 report and expects to complete implementation of our recommendations by
November 2000.

Actions to Address Inadequate Controls over Information Systems According to
Education officials, the department has developed and implemented a formal
approach and methodology for designing and maintaining an entitywide
security program technology architecture and has updated its security
policies and procedures for its financial management systems to ensure that
changing system security needs are reflected, access authorizations are
documented, and access rights are revalidated periodically. The department
informed us that it is finalizing a disaster recovery plan for Education's
Central Automated Processing System, the accounting system Education
implemented in fiscal year 1998.

Actions to Address Inadequate Accounting for FFELP Guaranteed Loans
Education returned the $2.7 billion to the Treasury in February 2000.
Education officials stated that they believe the noncompliance with FCRA
issue has been resolved because they have developed and implemented detailed
policies and

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 17
procedures for returning excess funds to the Treasury. According to
Education

officials, the department has analyzed the $700 million unexplained
difference and determined the proper balance for the accounts; however, we
have not reviewed the adequacy of the department's analysis. A review of
this analysis will be performed as part of the fiscal year 2000 financial
statement audit.

Education Addressed Previous Material Internal Control Weakness Related to
Cost and Liability Estimates for Its Loan Guarantee Program

One of the largest dollar value line items in Education's financial
statements is its liability estimate resulting from potential losses
associated with its guaranteed loan program. Critical to determining this
liability is a reliable database of historical loan performance information.
Prior to fiscal year 1997, without accurate historical data, Education had
no sound basis for supporting the reasonableness of its cost estimates.
Consequently, when Education's auditors found that Education's NSLDS
database was incomplete and inaccurate, they identified the loan cost
estimation process as a material internal control weakness.

Because Education is a credit agency, it has been required to estimate the
cost of its loan programs in accordance with FCRA and the Federal Accounting
Standards Advisory Board's (FASAB) accounting standard for credit reform,
Statement of Federal Financial Accounting Standards (SFFAS) No. 2,
Accounting for Direct Loans and Loan Guarantees, as amended, since fiscal
years 1992 and 1994, respectively. The

FASAB standard established guidance for estimating the cost of direct and
guaranteed loan programs as well as for recording direct loans and the
liability for loan guarantees for financial reporting purposes. In its
issuance of SFFAS No. 2, FASAB stated that actual and expected costs of
federal credit programs should be fully recognized in both budgetary and
financial reporting.

For fiscal years 1995 and 1996, when independent auditors conducted a
departmentwide audit, data reliability concerns precluded these auditors
from rendering an opinion on Education's financial statements. Education's
chronic data systems deficiencies had hampered its ability to prepare
financial statements that fairly presented the financial condition of its
student financial aid programs. The primary deficiency was that Education
was not able to obtain complete and accurate student loan data from its
systems to support its loan subsidy cost estimates and related liability for
loan guarantees.

Education temporarily overcame this barrier and received an unqualified
opinion on its fiscal year 1997 consolidated financial statements by
obtaining data from 10 of the larger guaranty agencies' systems and using
these data to compute loan cost estimates. Although the data provided by the
guaranty agencies supported the loan cost estimates in the fiscal year 1997
financial statements, the auditors reported that Education's ability to
continue to prepare auditable loan cost estimates depended on establishing a
reliable source of up- to- date historical loan data.

In fiscal year 1998, Education's auditors found that Education had corrected
the longstanding significant internal control weakness related to its FFELP
loan cost

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 18
estimates. Education improved the quality of data in NSLDS by, among other
things,

working with guaranty agencies to reconcile their records with NSLDS and
establishing automatic data edits of data submitted to NSLDS. In addition,
as part of the guaranty agency audit process, its auditors reviewed whether
information submitted to NSLDS was consistent with data from the guaranty
agency's systems. According to an OIG report, Education also has undertaken
other initiatives to improve the quality of data in NSLDS. 28 These
initiatives include: performing on- site support visits to guaranty agencies
and other data providers; working with the National Council of Higher
Education Loan Programs to conduct training workshops for guaranty agencies,
lenders, and servicers; and reviewing data quality issues with data
providers and making systematic improvements in the data provider process.
Fully populating NSLDS with historical data from guaranty agency systems and
performing extensive reconciliations with guaranty agency systems has
improved NSLDS' data quality.

In June 1999, about 5 months before Education issued its fiscal year 1998
financial statements, an Education contractor conducted a data quality
assessment of NSLDS and reported that some data problems existed within
NSLDS. However, the contractor also reported that the data anomalies were
within a statistically tolerable range when the data were used for program
oversight and financial subsidy estimate calculations. The contractor
concluded that NSLDS provides Education with a valuable opportunity to
recognize trends; develop detailed profiles, such as student, loan type,
default, and collection profiles; establish performance benchmarks; and
provide performance feedback to institutions based upon national statistics.

Because Education used improved data from its NSLDS to prepare the fiscal
year 1998 FFELP loan cost estimates, Education's auditors reported this
issue as resolved. Although these auditors qualified Education's opinion on
its fiscal year 1999 financial statements for other reasons mentioned
previously, they concluded that the data within NSLDS were reasonable and
could be relied upon for purposes of estimating the cost of its loan
programs.

According to Education officials, Education continues to focus on its data
quality initiatives to further improve the data integrity of NSLDS. For
example, Education has recently issued final Guaranty Agency Provider
Instructions to agencies that more clearly define data requirements for
NSLDS. Education also continues to provide technical assistance to its
guaranty agencies.

Conclusion

Education needs to be able to generate reliable, useful, and timely
information on an ongoing basis to ensure adequate accountability to
taxpayers, manage for results, and help congressional and program
decisionmakers make timely, well- informed judgments. While Education has
planned and begun implementing many actions to resolve its financial
management problems, the effectiveness of these corrective

28 NSLDS Can Be Enhanced If Loan Principal and Interest Balances and
Statuses Are Updated With Lender Data( OIG Final Audit Report 06- 70001,
September 1998.

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 19
actions will be determined as part of the fiscal year 2000 financial
statement audit. It

is critical that Education rise to the challenges posed by its financial
management weaknesses because its success in achieving all aspects of its
strategic objectives depends in part upon reliable financial management
information and effective internal controls.

We are not making any recommendations at this time beyond those already made
by the financial statement auditors in their fiscal year 1999 audit report
and those made in our August 2000 report on Education's grantback account.
We will continue to monitor the auditors' and the OIG's assessments of
Education's corrective action plan and its implementation.

Agency Comments

On October 13, 2000, we met with cognizant Education officials and obtained
comments on a draft of our report. The officials agreed that the draft
accurately described the material internal control weaknesses discussed in
the audit report on Education's fiscal year 1999 financial statements.
However, the officials felt that the draft did not adequately reflect the
extent of corrective actions that they have undertaken to improve the
department's financial management. Specifically, they stressed that they
have taken corrective actions to address the majority of the weaknesses
identified in the fiscal year 1999 and prior year audits, have implemented a
number of internal controls, strengthened overall financial management, and
are continuing to address the other weaknesses. We have included in the
report additional information on Education's efforts to correct its
financial management weaknesses and recognized that Education has taken a
number of steps to implement corrective actions. Whether these actions have
been successful in addressing the reported weaknesses will be determined
through the fiscal year 2000 financial statement audit, which is expected to
be completed by no later than March 1, 2001.

Education officials also stated that they believed the report would be more
balanced if it included discussion of the findings and conclusions included
in several other GAO reports regarding various grant programs that suggest
that the agency had followed sound financial management practices for those
programs. 29 However, the issues discussed in those reports, and many others
that GAO has issued on Education's various program activities, are beyond
the scope of this audit, which focuses on the status of financial management
weaknesses reported as part of the fiscal year 1999 financial statement
audit.

---- As we arranged with your offices, unless you publicly announce its
contents earlier, we plan no further distributions of this report until one
week from the date of this letter. At that time, we will send copies of this
letter to the Honorable Richard W.

29 Federal Education Funding Allocation to State and Local Agencies for 10
Programs( GAO/ HEHS- 99- 180, September 30, 1999) and Education
Discretionary Grants: Awards Process Could Benefit from Additional
Improvements( GAO/ HEHS- 00- 55, March 30, 2000).

GAO- 01- 104R Education's FY99 Financial Management Weaknesses Page 20
Riley, the Secretary of Education; the Honorable Lorraine Lewis, Inspector
General,

Department of Education; Thomas P. Skelly, Acting Chief Financial Officer;
James Lynch, Chief Financial Officer, Student Financial Assistance; and
other interested parties. We will make copies available to others upon
request.

If you have any questions about this letter, please contact me at (202) 512-
8341 or McCoy Williams, Acting Director, at (202) 512- 6906. Key
contributors to this assignment were Cheryl Driscoll, Louis Schuster, and
Maria Zacharias.

Linda M. Calbom Director Financial Management and Assurance

(916377)
*** End of document. ***