U.S. Government Financial Statements: FY 2000 Reporting 	 
Underscores the Need to Accelerate Federal Financial Management  
Reform (30-MAR-01, GAO-01-570T).				 
								 
The Comptroller General discussed GAO's report on the U.S.	 
government's consolidated financial statements for fiscal year	 
2000. This is the fourth consecutive year that GAO has been	 
unable to express an opinion on the U.S. government's		 
consolidated financial statements. Certain material weaknesses in
internal control and accounting and reporting issues resulted in 
conditions that prevented GAO from being able to provide Congress
and the American citizens with an opinion as to whether the	 
government's consolidated financial statements are fairly stated 
in accordance with U.S. generally accepted accounting principles.
These material weaknesses also affected the reliability of	 
certain information contained in the Management's Discussion and 
Analysis included in the financial report and other financial	 
management information--including information used to manage the 
government day to day and budget information reported by	 
agencies--which is taken from the same data sources as the	 
financial statements.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-570T					        
    ACCNO:   A00704						        
    TITLE:   U.S. Government Financial Statements: FY 2000 Reporting  
             Underscores the Need to Accelerate Federal Financial Management  
             Reform                                                           
     DATE:   03/30/2001 
  SUBJECT:   Financial management				 
	     Financial statement audits 			 
	     Reporting requirements				 
	     Accounting standards				 

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GAO-01-570T

Ordering Information

Ordering Information

For Release on Delivery Expected at 10 a. m. Friday, March 30, 2001

GAO- 01- 570T

U. S. GOVERNMENT FINANCIAL STATEMENTS

FY 2000 Reporting Underscores the Need to Accelerate Federal Financial
Management Reform

Statement of David M. Walker Comptroller General of the United States
Testimony

Before the Subcommittee on Government Efficiency, Financial Management, and
Intergovernmental Relations, Committee on Government Reform, House of
Representatives

United States General Accounting Office

GAO

Page 1 GAO- 01- 570T

Mr. Chairman and Members of the Subcommittee: I am pleased to be here today
to discuss our report on the U. S. government's consolidated financial
statements for fiscal year 2000. Both the consolidated financial statements
and our report are included in the Fiscal Year 2000 Financial Report of the
United States Government (Financial Report), which was issued today by the
Department of the Treasury (Treasury) and is attached to this testimony.

In passing the 1990 Chief Financial Officers (CFO) Act and other financial
management reform legislation, such as the Government Management Reform Act
and the Federal Financial Management Improvement Act (FFMIA), the Congress
sought to overcome the historical lack of timely, accurate, and useful
information to assure financial accountability for the federal government.
Without timely, accurate, and useful financial information, the government
cannot adequately ensure accountability, measure and control costs, manage
for results, or make timely and fully informed decisions about allocating
limited resources. A critical financial management reform component
established by the Congress entails requirements for annual audited
financial statements for 24 major federal departments and agencies (CFO Act
agencies), beginning with fiscal year 1996, and consolidated financial
statements for the U. S. government, beginning with fiscal year 1997.

In summary, this is the fourth consecutive year in which we were unable to
express an opinion on the U. S. government's consolidated financial
statements. Certain material weaknesses 1 in internal control and accounting
and reporting issues resulted in conditions that prevented us from being
able to provide the Congress and the American citizens an opinion as to
whether the government's consolidated financial statements are fairly stated
in accordance with U. S. generally accepted accounting principles. These
material weaknesses also affect the reliability of certain information
contained in the Management's Discussion and Analysis included in the
Financial Report and any other financial management information- including
information used to manage the government day to day and budget information
reported by agencies- which is taken from the same data sources as the
financial statements.

1 A material weakness is a condition that precludes the entity's internal
control from providing reasonable assurance that misstatements, losses, or
noncompliance material in relation to the financial statements or to
stewardship information would be prevented or detected on a timely basis.

Page 2 GAO- 01- 570T

While many of the pervasive and generally long- standing material weaknesses
we have reported in past years remain to be fully resolved, progress
continues to be made in addressing the underlying causes of these problems-
significant financial management systems weaknesses, problems with
fundamental recordkeeping and financial reporting, incomplete documentation,
and weak internal controls. Accelerating the pace of completing ongoing and
planned efforts to implement financial management reform is essential, as
reports of Inspectors General and their contract auditors indicated that
only 3 of the 24 CFO Act agencies had neither a material control weakness
nor an issue involving compliance with applicable laws and regulations.

Agencies have made marked strides in obtaining unqualified audit opinions on
their annual financial statements. The number of the 24 CFO Act agencies
that were able to attain an unqualified audit opinion on their financial
statements from their auditors increased to 18 for fiscal year 2000, up from
just 6 agencies 4 years ago. Also, for the first time, the Office of
Management and Budget (OMB) reported that all 24 CFO Act agencies met the
March 1 reporting deadline. But the timeliness of agencies having audited
financial statements should be further improved. For example, auditors for
the Social Security Administration's (SSA) fiscal year 2000 financial
statements issued their report to SSA on November 30, 2000, or 2 months
after the close of the government's fiscal year.

Many agencies undertake tremendous efforts, lasting 5 months or more, to
produce annual financial statements. The need for such time- consuming
procedures, which often represent “heroic efforts” by agency and
contractor personnel, primarily result from inadequate financial management
systems. A number of the unqualified opinions discussed above were obtained
by expending significant resources to use extensive ad hoc procedures and
making billions of dollars in adjustments to derive financial statements
months after the end of a fiscal year. This approach must be combined with
sustained efforts to improve agencies' underlying financial management
systems and controls. If agencies continue year after year to rely on
significant costly and time- intensive manual efforts to achieve or maintain
unqualified opinions without such improvements, it can serve to mislead the
public as to the true status of agencies' financial management capabilities.
In such a case, an unqualified opinion would become an accomplishment
without much substance.

The past 4 years have included extensive cooperative efforts and
considerable attention by agency Chief Financial Officers, Inspectors
General, Treasury and OMB officials, and the General Accounting Office. From
the outset, those involved in these efforts understood that

Page 3 GAO- 01- 570T

formidable challenges were ahead. As we have previously reported, they faced
the need to overcome decades of neglect in addressing serious financial
management and internal control problems across government.

In the past few weeks, I met with Secretary of the Treasury Paul O'Neill and
OMB Director Mitch Daniels to discuss the need for aggressive action to
accelerate progress in financial management reform. I am heartened that they
strongly support these efforts. We have agreed to cooperatively pursue
developing short- and long- term strategies and operational plans for
addressing the problems that prevent us from expressing an opinion on the U.
S. government's consolidated financial statements.

Therefore, at this juncture, with the benefit of several years of experience
by the government in having the required financial statements subjected to
audit, it is appropriate to focus particular attention on the most serious
obstacles to achieving an unqualified opinion on the U. S. government's
consolidated financial statements. These obstacles include (1) financial
management problems at specific agencies that have not yet been able to
produce auditable financial statements, especially the Departments of
Defense (DOD) and Agriculture (USDA), (2) problems in resolving difficulties
in reconciling intragovernmental transactions, (3) information systems
security weaknesses that affect agencies across government, and (4) the need
to modernize agency financial management systems to ensure that they
routinely provide timely, accurate, and useful information for managing
operations day to day.

Irrespective of the unqualified opinions on their financial statements, many
agencies do not have timely, accurate, and useful financial information and
sound controls with which to make informed decisions and to ensure
accountability on an ongoing basis. This is the ultimate goal of financial
management reform legislation such as FFMIA, which requires auditors
performing financial audits to report whether agencies' financial management
systems comply substantially with federal accounting standards, federal
financial management systems requirements, and the government's standard
general ledger at the transaction level, and is essential to meeting the
mandate of the Government Performance and Results Act. For most CFO Act
agencies, the auditors reported that agencies' financial management systems
did not substantially comply with certain FFMIA requirements.

It is especially important for the Congress and other policymakers to have
this kind of financial information in deliberations involving the long-
range fiscal policy challenges facing the Congress and our nation. While
current budget surpluses offer an opportunity to address today's needs and
the

Page 4 GAO- 01- 570T

many pent- up demands held in abeyance during years of fighting deficits,
they do not eliminate our obligation to prepare for the future. Today's
choices must be seen not only in terms of how they respond to today's needs,
but also how they affect the future capacity of the nation and its ability
to meet the very real and significant fiscal challenges associated with the
approaching demographic tidal wave and rising health care costs. The
question before this Congress is how to balance today's wants and needs
against our nation's long- term challenges.

Such challenges involve reforming and strengthening Medicare and Social
Security at the earliest opportunity, as called for by the Trustees of these
programs' trust funds in their March 19, 2001, report on the current and
projected status of these programs over the next 75 years. The Trustees
reported that, while the near- term financial conditions of both Social
Security and Medicare have improved since last year's report, the longterm
outlook for Medicare's financial future has deteriorated substantially. This
has substantial implications for the budget and the economy. This issue must
be dealt with from the standpoint of starting to take incremental steps to
close the Trustees' projected $4.6 trillion Hospital Insurance (Medicare
Part A) 75- year funding gap, which is only part of an overall Medicare
challenge. Also, congressional deliberations on modernizing the Medicare
benefits package to include prescription drug coverage must focus attention
on incremental solutions, concentrating on targeted and legitimate needs
rather than unlimited wants. In addition, any potential benefit expansion
should be coupled with program reforms that will assure that we do not make
the considerable long- range financial imbalance worse.

The government today is moving from balancing the budget to balancing fiscal
risk. Surpluses challenge our nation to move beyond a focus on reducing
annual deficits to a broader agenda. They offer us an opportunity to look
more closely at what government does and how government does business. That
is why it is so essential that efforts continue to build the necessary
fundamental foundation through lasting financial management reform. Only by
generating timely, accurate, and useful information can the government
maximize its economy, efficiency and effectiveness; assure adequate
accountability to taxpayers; manage for results; and help decisionmakers
make timely and well- informed judgments.

Page 5 GAO- 01- 570T

As was the case for fiscal years 1997 through 1999, 2 our report on the U.
S. government's consolidated financial statements for fiscal year 2000
states that certain significant financial systems weaknesses, problems with
fundamental recordkeeping and financial reporting, incomplete documentation,
and weak internal controls continued to hamper the government's ability to
accurately report a significant portion of its assets, liabilities, and
costs.

Major challenges include the federal government's inability to:

properly account for and report (1) material amounts of property, equipment,
inventories, materials, and supplies, and (2) certain stewardship assets,
primarily at DOD;

? properly estimate the cost of certain major federal credit programs and
the related loans receivable and loan guarantee liabilities, primarily at
USDA;

? estimate and reliably report material amounts of environmental and
disposal liabilities and related costs at DOD, and determine the proper
amount of various reported liabilities, including postretirement health
benefits for military employees and accounts payable and other liabilities
for certain agencies;

? accurately report major portions of the net cost of government operations;

? ensure that all disbursements are properly recorded; and

? properly prepare the U. S. government's consolidated financial statements,
including balancing the statements, accounting for substantial amounts of
transactions between governmental entities, fully ensuring that the
information in the consolidated financial statements was consistent with the
underlying agency financial statements, and reconciling operating results
with budget results.

In addition, we found that (1) the government is unable to determine the
full extent of improper payments- estimated to total billions of dollars
annually- and therefore cannot develop effective strategies to reduce them,
(2) serious, long- standing computer security weaknesses expose the
government's financial and other sensitive information to inappropriate
disclosure, destruction, modification, and fraud, and critical operations to

2 See, for example, Financial Audit: 1999 Financial Report of the United
States Government (GAO/ AIMD- 00- 131, March 31, 2000). Highlights of Major

Issues Relating to the U. S. Government's Consolidated Financial Statements
for Fiscal Year 2000

Page 6 GAO- 01- 570T

disruption, and (3) material control weaknesses affect the government's tax
collection activities. Further, the financial management systems of most CFO
Act agencies were again reported by their auditors not to be in substantial
compliance with certain FFMIA requirements.

I would now like to discuss in more detail the major issues identified by
our work.

Because the government lacked complete and reliable information to support
these asset holdings, reported at $484 billion, it could not satisfactorily
determine that all assets were included in the financial statements, verify
that certain reported assets actually exist, or substantiate the amount at
which they were valued. A majority of the property, plant, and equipment and
inventories and related property, which is primarily the responsibility of
DOD, was not adequately supported by financial and/ or logistical records.

Without accurate asset information, the government does not fully know the
assets it owns and their location and condition and cannot effectively (1)
safeguard assets from physical deterioration, theft, or loss, (2) account
for acquisitions and disposals of such assets, (3) prevent unnecessary
storage and maintenance costs or purchase of assets already on hand, (4)
identify and utilize assets when they are needed, and (5) determine the full
costs of programs that use these assets.

Further, national defense asset unit information reported as Stewardship
Information in the Financial Report was incomplete because (1) it did not
include billions of dollars of major national defense support real property
and equipment, such as missile silos and communications equipment, and (2)
amounts were reported in units, rather than in dollars as required by
generally accepted accounting principles.

As of the end of fiscal year 2000, the government reported $208 billion of
loans receivable and $37 billion of liabilities for estimated losses related
to estimated future defaults of guaranteed loans. Certain federal credit
agencies responsible for significant portions of the government's lending
programs, most notably USDA, were unable to properly estimate the cost of
these programs, or estimate the net loan amounts expected to be collected,
in accordance with generally accepted accounting principles and budgeting
requirements. Unreliable information about the cost of credit programs
affects the government's ability to support annual budget requests for these
programs, make future budgetary decisions, manage program costs, and measure
the performance of credit activities. Property, Plant, and Equipment

and Inventories and Related Property

Loans Receivable and Loan Guarantee Liabilities

Page 7 GAO- 01- 570T

The government did not maintain adequate systems or have sufficient
information necessary to:

? develop an accurate estimate of key components of DOD's environmental and
disposal liabilities, which were reported at $63 billion, such as
liabilities related to unexploded ordnance and residual contaminants from
training ranges;

? accurately estimate the reported $192 billion military postretirement
health benefits liability included in federal employees and veterans
benefits payable because, for example, some of the underlying cost,
demographic, and workload data used to develop the estimate were not
reliable;

? ensure that accurate and complete data were used to estimate a reported
$91 billion of accounts payable and $175 billion of other liabilities; and

? determine whether commitments and contingencies were complete and properly
reported.

Problems in accounting for liabilities affect the determination of the full
cost of the government's current operations and the extent of its
liabilities. Also, improperly stated environmental and disposal liabilities
and weak internal control supporting the process for their estimation affect
the government's ability to determine priorities for cleanup and disposal
activities and to allow for appropriate consideration of future budgetary
resources needed to carry out these activities.

The previously discussed material deficiencies in reporting assets and
liabilities and the lack of effective disbursement reconciliations and
material deficiencies in financial statement preparation, as discussed
below, affect reported net costs. Further, the government was unable to
support whether the amounts reported in the individual net cost categories
on the Statement of Net Cost were properly classified. As a result, the
government was unable to support significant portions of the more than $1.9
trillion reported as the total net cost of government operations, most
notably related to DOD's and USDA's net costs. Inaccurate cost information
affects the government's ability to control and reduce costs, assess
performance, evaluate programs, and set fees to recover costs where
required.

Several major agencies did not effectively reconcile disbursements, which is
intended to be a key control to detect and correct errors and other
misstatements in financial records in a timely manner- similar in concept to
individuals reconciling their checkbooks with their bank statements
Liabilities

Cost of Government Operations Disbursement Activity

Page 8 GAO- 01- 570T

each month. Specifically, there were billions of dollars of unreconciled
differences between agencies' and Treasury's records of disbursements as of
September 30, 2000. Improperly recorded disbursements could result in
misstatements in the financial statements and in certain data provided by
agencies for inclusion in the President's budget concerning obligations and
outlays.

The government did not have adequate systems, controls, and procedures to
properly prepare its consolidated financial statements. Such material
deficiencies are described below. Also, certain financial information
required by generally accepted accounting principles was omitted from the
consolidated financial statements. Weaknesses related to the preparation of
the consolidated financial statements impair the government's ability to (1)
account for billions of dollars of transactions between governmental
entities, (2) effectively reconcile operating results reported in the
consolidated financial statements with budget results, and (3) fully ensure
that the consolidated financial statements were consistent with agency
financial statements and were properly balanced.

Intragovernmental Activity and Balances OMB requires the CFO Act agencies to
reconcile selected intragovernmental activity and balances with their
“trading partners.” 3 However, numerous agencies did not fully
perform such reconciliations for fiscal year 2000. Using the detail of
certain intragovernmental accounts by trading partner that was gathered by
the government, we estimated that the amounts reported for agency trading
partners for these specific intragovernmental accounts were out- of- balance
by more than $250 billion. In addition, solutions will be required to
resolve significant differences reported in other intragovernmental
accounts, primarily related to appropriations.

Reconciling Operating Results With Budget Results The government did not yet
have an effective process to obtain information to reconcile fully the
reported $46 billion excess of revenue over net cost and the reported
unified budget surplus of $237 billion. Consequently, it could not identify
all items needed to reconcile these amounts.

3 “Trading partners” are U. S. government agencies, departments,
or other components included in the consolidated financial statements that
do business with each other. Preparation of Consolidated

Financial Statements

Page 9 GAO- 01- 570T

Consolidated Financial Statement Compilation The government could not fully
ensure that the information in the consolidated financial statements was
consistent with the underlying agency financial statements. These problems
are compounded by the need for certain standard general ledger (SGL)
accounts to be split between different financial statement line items due to
limitations in the government's SGL account structure. In addition, to make
the consolidated financial statements balance, Treasury recorded a net $7
billion item on the Statement of Operations and Changes in Net Position,
which it labeled Unreconciled Transactions. An additional net $0.2 billion
of unreconciled transactions was improperly recorded in net cost. Treasury
attributes these net out- of- balance amounts primarily to the government's
inability to properly identify and eliminate transactions between
governmental entities, as discussed above, to agency adjustments that
affected net position, and to other errors. However, Treasury was unable to
adequately identify and explain the gross components of such amounts.
Unreconciled transactions also may exist because the government does not
have effective controls over reconciling net position. The net position
reported in the consolidated financial statements is derived by subtracting
liabilities from assets, rather than through balanced accounting entries.
Further, the process for compiling the financial statements involves
significant adjustments and reclassifications and requires significant human
and financial resources, which lessens the government's ability to perform
effective financial analysis of the information.

In addition to the material weaknesses noted above, we found that (1) most
agencies have not estimated the magnitude of improper payments in their
programs and (2) material internal control weaknesses and systems
deficiencies continue to affect the government's ability to effectively
manage its tax collection activities. We also found that widespread and
serious computer control weaknesses, which are further discussed later in
this testimony, affect virtually all federal agencies.

Across government, improper payments occur in a variety of programs and
activities, including those related to health care, contract management,
federal financial assistance, and tax refunds, and include payments made for
unauthorized purposes and for excessive amounts, such as overpayments to
program recipients or contractors and vendors. The reasons for improper
payments range from program design issues to inadvertent errors to fraud and
abuse. While reported estimates of improper payments totaled approximately
$20 billion for both fiscal years Ineffective Internal Control

Improper Payments

Page 10 GAO- 01- 570T

2000 and 1999, the government did not estimate the full extent of improper
payments.

As part of its annual financial statements, the Department of Health and
Human Services (HHS) has been reporting a national estimate of improper
Medicare Fee- for- Service payments since fiscal year 1996. In fiscal year
2000, HHS reported estimated improper Medicare Fee- for- Service payments of
$11.9 billion, or about 7 percent of such benefits- down from $13.5 billion,
or 8 percent, a year earlier and $23.2 billion, or 14 percent, for fiscal
year 1996. HHS' reporting and analysis of improper Medicare payments has
helped lead to the implementation of several initiatives to identify and
reduce such payments. Annual estimates of improper payments in future
audited financial statements will provide information on the progress of
these initiatives.

However, most agencies have not estimated the magnitude of improper payments
in their programs and comprehensively addressed this issue in their annual
performance plans under the Government Performance and Results Act. 4 For
example, the Earned Income Tax Credit (EITC) program- a refundable tax
credit available to low- income, working taxpayers- has historically been
vulnerable to high rates of invalid claims. During fiscal year 2000, the
Internal Revenue Service (IRS) examined about 257,000 suspicious tax returns
claiming about $587 million in EITCs and found that 173,000 of these returns
claiming $395 million in EITCs (67 percent) were invalid. Additionally,
during fiscal year 2000, IRS released the results of its study of EITC
compliance for tax year 1997. In this study, which is not performed
annually, IRS estimated that taxpayers filed returns claiming about $9.3
billion in invalid EITCs, of which $1.5 billion (16 percent) either was
recovered or was expected to be recovered through compliance efforts.
Although the full extent of refunds resulting from invalid EITCs is unknown,
the IRS has not routinely estimated the potential magnitude of invalid
refunds and has not disclosed an estimate of improper payments in its
financial reports.

Without a systematic measurement of the extent of improper payments, agency
management cannot determine (1) if the problem is significant enough to
require corrective action, (2) how much to invest in preventative internal
control, (3) the success of efforts implemented to reduce improper payments,
or (4) the magnitude or trends of improper

4 Financial Management: Billions in Improper Payments Continue to Require
Attention (GAO- 01- 44, October 27, 2000).

Page 11 GAO- 01- 570T

payments, which limits the ability to pinpoint or target mitigation
strategies.

Material internal control weaknesses and systems deficiencies continue to
affect the government's ability to effectively manage its tax collection
activities. 5 This situation results in the need for extensive, costly, and
timeconsuming ad hoc programming and analyses, as well as material audit
adjustments, to prepare basic financial information. As further discussed
later in this testimony, this approach cannot be used to prepare such
information on a timely, routine basis to assist in ongoing decisionmaking.
Additionally, the severity of the system deficiencies that give rise to the
need to resort to such procedures for financial reporting purposes, as well
as deficient physical safeguards, result in burden on taxpayers and lost
revenue.

The lack of appropriate subsidiary systems to track the status of taxpayer
accounts affects the government's ability to make informed decisions about
collection efforts. Due to errors and delays in recording activity in
taxpayer accounts, (1) taxpayers were not always being credited for payments
made on their tax liabilities and (2) the government lost opportunities to
retain or offset overpayments made by a taxpayer for one period to collect
on outstanding amounts owed for another period. In addition, the government
did not always follow up on potential unreported or underreported taxes and
did not always pursue collection efforts against taxpayers owing taxes to
the federal government. This could result in billions of dollars not being
collected and adversely affect future compliance.

The federal government also continues to be vulnerable to loss of tax
revenue due to weaknesses in preventive and detective controls over
disbursements for tax refunds. Although the government does have detective
controls in place, they are not applied to millions of tax returns estimated
to have billions of dollars in underreported tax liabilities. These
conditions expose the government to potentially billions of dollars in
losses due to inappropriate refund disbursements.

Additionally, the government does not perform sufficient up- front
verification procedures to ensure the validity of amounts claimed by
taxpayers as overpayments prior to making disbursements for refunds.
Finally, continued weaknesses in physical controls over cash, checks, and
sensitive data received from taxpayers increase both the government's and

5 Financial Audit: IRS' Fiscal Year 2000 Financial Statements (GAO- 01- 394,
March 1, 2001). Tax Collection Activities

Page 12 GAO- 01- 570T

the taxpayers' exposure to losses and increases the risk of taxpayers
becoming victims of crimes committed through identity fraud.

IRS senior management continues to be committed to addressing many of these
operational and financial management issues and has made a number of
improvements to address some of these weaknesses. Successful implementation
of long- term efforts to resolve these serious problems will require the
continued commitment of IRS management as well as substantial resources and
expertise.

Our work to determine compliance with selected provisions of laws and
regulations related to financial reporting was limited by the material
weaknesses discussed above. Instances of noncompliance, some of which the
auditors reported were material to individual agency financial statements,
are included in individual agency audit reports. However, none of these
instances were material to the consolidated financial statements.
Additionally, as further discussed later in this testimony, for most CFO Act
agencies, the auditors reported that agencies' financial management systems
did not substantially comply with certain FFMIA requirements.

Across government, we are seeing financial management improvement
initiatives that could ultimately lead to an unqualified opinion on the U.
S. government's consolidated financial statements. However, accelerating the
pace of completing ongoing and planned efforts to implement financial
management reform is essential, as reports of Inspectors General and their
contract auditors indicated that only 3 of the 24 CFO Act agencies had
neither a material control weakness nor an issue involving compliance with
applicable laws and regulations. While many of the pervasive and generally
long- standing material weaknesses we have reported for the past 3 years
remain to be fully resolved, some progress continues to be made in
addressing the underlying causes of these problems- significant financial
systems weaknesses, problems with fundamental recordkeeping and financial
reporting, incomplete documentation, and weak internal controls.

The number of the 24 CFO Act agencies that were able to attain an
unqualified audit opinion on their financial statements has increased. For
fiscal year 2000, 18 of the 24 CFO Act agencies received unqualified
opinions from their auditors, up from 6 agencies four years ago. Also, OMB
has reported that, for the first time, all 24 CFO Act agencies met the March
1 reporting deadline. While the timeliness of agencies' financial statement
submissions has improved, agencies' must work toward having their Compliance
With

Applicable Laws and Regulations and FFMIA Requirements

Need to Accelerate Financial Management Reform Efforts

Page 13 GAO- 01- 570T

financial statements prepared and audited much closer to the end of a fiscal
year, as March 1 is a reporting deadline rather than a benchmark indicating
timely financial reporting. For example, auditors for SSA were able to
report on SSA's fiscal year 2000 financial statements on November 30, 2000,
or 2 months after the close of the government's fiscal year.

While agencies are making some progress in obtaining unqualified audit
opinions on annual financial statements, many of these opinions were
obtained by expending significant resources to use extensive ad hoc
procedures and making billions of dollars in adjustments to derive financial
statements months after the end of a fiscal year. The need for such time-
consuming procedures, which often represent “heroic efforts,”
primarily result from inadequate financial management systems. Also,
irrespective of the unqualified opinions on their financial statements, many
agencies do not have timely, accurate, and useful financial information and
sound controls with which to make informed decisions and to ensure
accountability on an ongoing basis.

For example, IRS' unqualified opinion on its overall financial statements
for the first time in fiscal year 2000 was the culmination of several years
of extraordinary effort on the part of IRS senior management and staff to
develop compensating processes to work around its serious systems and
control weaknesses to derive year- end balances for its financial
statements. While IRS' efforts did address several management issues we
raised in previous audits, its approach to obtaining the unqualified opinion
relied heavily on costly, time- consuming processes; statistical
projections; external contractors; substantial adjustments; and monumental
human efforts that extended well after the fiscal year- end. This was
particularly the case with respect to reporting amounts for both taxes
receivable and property and equipment. Because IRS' systems cannot
accurately track amounts representing taxes receivable, IRS has for the past
4 years employed a complex statistical sampling process to derive the
balance reported on its financial statements; this process takes months to
complete, requires extensive human and financial resources, and results in
tens of billions of dollars in adjustments annually to present a balance
that is good for one day only. Additionally, because IRS does not have an
adequate property management system, it had to use contractors to (1)
perform statistical sampling procedures to derive a reliable balance for
property and equipment in fiscal year 1999 and (2) analyze fiscal year 2000
transactions to derive the September 30, 2000, balance for property and
equipment, a process that extended into February 2001.

Page 14 GAO- 01- 570T

Another case involves the Department of Justice (DOJ). For fiscal year 1999,
auditors expressed a qualified opinion on DOJ's financial statements. DOJ's
Office of Inspector General (OIG) reported this year that removal of the
qualification on DOJ's balance sheet required tremendous efforts and cost.
According to the OIG, because DOJ lacks automated systems to readily support
ongoing accounting operations, financial statement preparation, and the
audit process, many tasks had to be performed manually. For example, in
order to determine deferred revenue at year end, the Immigration and
Naturalization Service manually counted approximately 2 million
applications, which the OIG said involved substantial preparation and
several preliminary counts throughout the fiscal year and caused delays in
the processing of applications. The OIG said also that DOJ incurred
substantial costs and depended heavily on contractors to assist in the
cleanup of accounting transaction backlogs and to provide other accounting
support.

In addition, the Department of Transportation's (DOT) Federal Aviation
Administration (FAA) used alternative procedures and labor- intensive
methods to prepare its fiscal year 1999 financial statements, which received
an unqualified audit opinion from the DOT Inspector General. The need for
these efforts stemmed primarily from FAA's long- standing weaknesses in
accounting for property caused by the lack of an integrated property system.
The DOT Inspector General also reported that, if improvements to address
this issue were not made, the Department would have to continue the same
type of extraordinary, expensive, and laborintensive efforts in the future
and that such efforts are not sustainable for the long term.

In fiscal year 2000, when FAA converted its real property system to a new
property system, the number of real property items unexpectedly increased
from about 14,000 to about 18,000 as of September 30, 1999 and 2000,
respectively. In addition, FAA inappropriately changed property acquisition
dates in its database, which caused depreciation expense for fiscal year
2000 and the net value of property as of September 30, 2000, to be
incorrectly reported. For example, of the 216 FAA property items, having a
total value of $398 million, that were tested as part of the DOT Inspector
General's fiscal year 2000 DOT financial statement audit, 58 items (27
percent) were found to have incorrect acquisition dates, causing the net
value of these tested items to be overstated by $78 million. Because the
Inspector General could not substantiate FAA's property account balances,
both FAA and DOT received a qualified opinion on their fiscal year 2000
financial statements. We initially designated FAA's financial

Page 15 GAO- 01- 570T

management as a high- risk area in 1999 and continued that designation in
2001. 6

Situations such as these demonstrate the tremendous efforts, lasting 5
months or more, many agencies use to produce annual financial statements.
These agencies undertake far more work to prepare financial statements,
beginning at the close of a fiscal year, than would be necessary if they had
basic financial systems in place to routinely provide the data. Information
to compile agency financial statements should flow from their financial
management systems. Agencies will continue to rely on significant costly and
time- intensive manual efforts to achieve or maintain unqualified opinions
until automated, integrated processes and systems are implemented that
readily produce the necessary information. The need for agencies to improve
financial management systems is further discussed later in this testimony.

These efforts prevent financial management staff from doing other financial-
related work such as financial analyses, which could directly support
strategic decision- making and ultimately improve overall business
performance. In our Executive Guide: Creating Value Through World- class
Financial Management (GAO/ AIMD- 00- 134, April 2000), we identified the

success factors, practices, and outcomes associated with world- class
financial management efforts. We found that many leading finance
organizations have a goal to reduce the time spent on routine accounting
activities, such as financial statement preparation, so that financial
management staff can spend more time on activities such as business
performance analysis or cost analysis.

As I mentioned earlier, the federal government has been required to prepare
and have audited consolidated financial statements for the past 4 years.
Successfully meeting this requirement is tightly linked to the requirement
for the 24 CFO Act agencies to also produce auditable financial statements.
This has stimulated extensive cooperative efforts and considerable attention
by agency Chief Financial Officers, Inspectors General, Department of the
Treasury and OMB officials, and the General Accounting Office. Those
involved in these efforts understood that formidable challenges were ahead,
as we had previously reported the need to overcome decades of neglect in
addressing serious financial management and internal control problems across
government. With the benefit of several years' experience by the government
in having the

6 See, for example, High- Risk Series: An Update (GAO- 01- 263, January
2001). Major Obstacles to

Unqualified Opinion on Consolidated Financial Statements

Page 16 GAO- 01- 570T

required financial statements subjected to audit, the time has come to focus
even more intensified attention on the most serious obstacles to achieving
an unqualified opinion on the U. S. government's consolidated financial
statements.

The largest impediment to an opinion on the U. S. government's consolidated
financial statements is DOD's serious financial management problems, which
we have designated as high risk since 1995. 7 To date, none of the military
services, or the Department as a whole, have passed the test of an
independent financial audit because of pervasive weaknesses in DOD's
financial management systems, operations, and internal control, including an
inability to compile financial statements that comply with generally
accepted accounting principles. The Department has made progress in a number
of areas, but is far from solving a range of serious financial management
problems. Their resolution, however, is key to having auditable consolidated
financial statements because DOD has annual budget authority of about $310
billion, or about 16 percent of the entire federal budget, and is
accountable for vast government assets worldwide.

Despite progress, ineffective asset accountability and lack of effective
internal controls continue to adversely affect visibility over DOD's
estimated $1 trillion investment in weapon systems and inventories. These
weaknesses can affect the Department's ability to ensure that materials are
on hand when needed and prevent the purchase of assets already on hand.
Further, unreliable cost and budget information related to a reported nearly
$1 trillion of liabilities and about $347 billion 8 of net costs negatively
affects DOD's ability to effectively measure performance, reduce costs, and
maintain adequate fund control. In addition, we are concerned that many of
the planned financial management improvement initiatives are designed to
result in a one- time, year- end number for financial statement purposes. As
such, they will not result in the production of timely and reliable
financial and performance information for ongoing use by management.

7 See, for example, GAO- 01- 263, January 2001. 8 This amount was reported
on the Department's fiscal year 2000 financial report, whereas the $310
billion discussed in the preceding paragraph represents an estimate of the
amount of budget authority shown in the documents accompanying the
President's budget submission. Differences between these amounts are the
result of (1) timing differences in the receipt of budgetary resources and
recording associated expenses and (2) unknown errors in the amounts shown in
the financial statements, which were unauditable. Reforming Financial

Management at the Department of Defense (DOD)

Page 17 GAO- 01- 570T

A visible, substantive, and sustained commitment from the Secretary of
Defense and the Deputy Secretary of Defense, as well as from the military
and civilian leadership, will be needed to overhaul DOD's financial
operations. Personnel throughout the Department must share a common goal of
establishing modern and integrated financial management systems, processes,
and controls that not only produce financial statements that can withstand
the test of an audit, but more importantly routinely generate timely,
reliable, and useful financial information for day- to- day management and
operations purposes. The Secretary of Defense has indicated that he intends
to include financial management reform among his top priorities. The
Secretary of Defense's personal commitment and involvement will be critical
to the success of efforts to overhaul DOD's financial management.

As we testified before you in May 2000 9 and the House Task Force on Defense
and International Relations in July 2000, 10 both short- and longterm
actions will be needed to improve the Department's financial management
operations. In the short term, it will be essential to continue efforts to
standardize, streamline, and simplify processes; to strengthen and enforce
existing controls; to ensure basic transaction processing, which today is a
major impediment, as well as a cost that can be greatly reduced; to develop
more reliable estimates of future liabilities; to enhance human capital; and
to oversee performance. At the heart of the Department's long- term
financial management challenge is hundreds of outdated and free- standing
information systems. These systems are not integrated and have a range of
individual weaknesses, some very serious, and collectively simply do not get
the job done.

Thus, the ultimate resolution of DOD's financial management problems- which
are pervasive, deeply rooted, and complex in nature- must be closely tied to
addressing its interrelated problems in the logistics, contract management,
acquisition, strategic planning, support infrastructure, human capital, and
information technology areas, including information security. As detailed in
a January 2001 report on DOD's performance and accountability, 11 we have
identified DOD financial management and these additional interrelated areas
as the Department's

9 Department of Defense: Progress in Financial Management Reform (GAO/ T-
AIMD/ NSIAD- 00- 163, May 9, 2000). 10 Department of Defense: Implications
of Financial Management Issues (GAO/ T- AIMD/ NSIAD- 00- 264, July 20,
2000). 11 Major Management Challenges and Program Risks: Department of
Defense (GAO- 01- 244, January 2001) .

Page 18 GAO- 01- 570T

greatest challenges to developing world- class operations and activities to
support its forces. To its credit, the Department has initiated a number of
department- wide reform initiatives and other actions to improve its key
business processes, not only in the financial area, but also in such areas
as information management, weapon system acquisitions, and logistics
reengineering. These initiatives have produced some positive results, but
four key underlying causes of these problems within DOD have not yet been
effectively addressed: (1) a lack of top- level management attention to and
accountability for correcting problems, (2) cultural resistance to change,
including service parochialism and stovepiped operations, (3) a lack of
results- oriented goals and performance measures and monitoring, and (4)
inadequate incentives for seeking change.

In this regard, DOD's experience in addressing the Year 2000 (Y2K) computing
challenge can serve as a guidepost to overhaul the Department's financial
management systems.

? First, DOD recognized that Y2K was a Chief Executive Officer issue, not
just a Chief Information Officer issue. The Deputy Secretary took direct
control and exerted strong overall leadership. DOD's financial management
challenges cut across its operations, similar to Y2K. Given DOD's corporate
culture, strong, direct, and sustained financial management reform
leadership must come from the top.

? Second, Y2K had a date certain. But it also had a series of milestone
dates, together with periodic self- reporting to gauge progress, to enable
midcourse corrections, and to hold people accountable. To overhaul DOD's
financial management system, a clear plan with an end date and enforced
interim milestones will be essential.

? Third, for Y2K, DOD followed a standard, disciplined approach. Given the
complexity of DOD's financial management improvement challenge, it will be
particularly important that DOD fully adhere to the information technology
investment controls of the Clinger- Cohen Act.

? Finally, for Y2K, DOD had extensive validation and verification by the
Inspector General, as well as end- to- end testing. Meaningful testing and
reporting by DOD must be critical components of a successful financial
management system overhaul at DOD.

As discussed earlier in this testimony, another major impediment that must
be overcome is the government's inability to properly account for billions
of dollars of transactions between federal government entities; that is,
intragovernmental transactions. Agencies' accounts can be out of Focusing on

Intragovernmental Transactions

Page 19 GAO- 01- 570T

balance with each other, for example, when one or the other of the affected
agencies does not properly record a transaction with another agency or the
agencies record the transactions in different accounting periods. These out-
of- balance conditions can be detected and corrected by instituting
procedures for reconciling transactions between agencies on a regular basis
and in a timely manner.

To help address this problem, for fiscal year 2000, OMB required CFO Act
agencies to reconcile selected intragovernmental activity and balances with
their trading partners. With full and proper implementation, the trading
partner concept can begin to provide the government critical information
with which to analyze the nature of intragovernmental account differences
and develop effective solutions. However, numerous agencies did not complete
reconciliations of intragovernmental activity and balances with their
trading partners for fiscal year 2000. Using the detail of certain
intragovernmental accounts by trading partner that was gathered by the
government, we estimated that the amounts reported for agency trading
partners for these specific intragovernmental accounts were out- of- balance
by more than $250 billion.

The control weaknesses relating to unreconciled intragovernmental
transactions, combined with the significant volume of transactions and
number of reporting entities, can result in misstatements in the financial
statements, hinder the ability of the government to identify misstatements
that may exist, and may contribute to the amount of reported unreconciled
transactions. The Joint Financial Management Improvement Program has
initiated a study to further focus on identifying the causes of and
solutions to the government's intragovernmental transaction problem.

USDA is another major agency that continues to face challenges in correcting
severe and long- standing financial management problems and achieving
financial accountability over the billions of dollars of assets required to
carry out its diverse missions. 12 Since 1991, USDA's Office of Inspector
General has issued a series of unfavorable financial audit reports on USDA's
consolidated financial statements.

USDA Inspector General financial statement audits have, for example,
determined that USDA continues to be unable to provide documentation to
support numerous material financial statement line items. Also, the

12 Major Management Challenges and Program Risks: Department of Agriculture
(GAO- 01- 242, January 2001). Resolving Financial

Management Issues at the Department of Agriculture (USDA)

Page 20 GAO- 01- 570T

Inspector General has identified persistent internal control weaknesses over
USDA's financial management systems, food stamp receipt claims, and security
controls for information technology.

In addition, since fiscal year 1994, the Inspector General has reported
material weaknesses in the processes and procedures used by USDA's lending
agencies to estimate and reestimate loan subsidy costs for the Department's
net credit program receivables, which totaled a reported $73.8 billion as of
September 30, 2000. As a result, USDA has been unable to implement the
Federal Credit Reform Act of 1990 and related accounting standards. In
addition, these problems materially affect USDA's budget submissions because
the same cost estimates are generally used for both budget preparation and
financial reporting. Because the Inspector General can not provide assurance
on USDA's credit reform financial data, the Congress does not know whether
the costs of USDA's loan programs, estimated in excess of $24.1 billion, as
of September 30, 2000, can be relied upon to base its decisions about
whether to expand or scale back the agency's loan programs.

Further, the Inspector General identified internal control and accounting
problems involving $5.4 billion in general property, plant, and equipment
reported by USDA in its fiscal year 2000 consolidated financial statements.
For instance, the Inspector General reported material internal control
weaknesses relating to personal property valued at a reported $597 million.
Also, the Inspector General could not substantiate over $5.3 billion of real
property reported by USDA on its fiscal year 2000 consolidated financial
statements, most of which relates to assets that are the responsibility of
the Forest Service.

The inability to substantiate USDA's real property, and thus contributing to
the Inspector General's disclaimer of opinion, occurred because the Forest
Service was unable to produce auditable fiscal year 2000 financial
statements within established timeframes. 13 Since 1999, we have designated
the Forest Service financial management as a high- risk area due to its
serious financial management systems weaknesses and the major hurdles it
faces in achieving financial accountability. 14

13 The Commodity Credit Corporation, an agency component of USDA, was also
unable to provide the Inspector General with auditable financial statements
within established timeframes and also contributed to the Inspector
General's disclaimer of opinion on the USDA's consolidated financial
statements.

14 See, for example, GAO- 01- 263, January 2001.

Page 21 GAO- 01- 570T

USDA has completed several actions and begun others that, if successfully
implemented, represent important steps toward first achieving an unqualified
opinion on its financial statements and ultimately obtaining overall
financial accountability. With the commitment of the Secretary and senior
management across the Department, attaining an unqualified opinion on USDA's
financial statements is achievable if USDA successfully implements an
integrated financial management system; fundamentally improves its
underlying internal controls, financial management systems, and operations
to provide the capability for routine production of timely, accurate, and
useful data; and continues to have additional resources devoted to
addressing its financial management deficiencies.

Evaluations of computer security continue to show that federal computer
security is fraught with serious and widespread weaknesses. 15 As a result,
federal assets continue to be at risk of inadvertent or deliberate misuse,
financial information at risk of unauthorized modification or destruction,
sensitive information at risk of inappropriate disclosure, and critical
operations at risk of disruption. Significant computer security weaknesses
in systems that handle the government's unclassified information continue to
be reported in each of the major federal agencies.

The computer security weaknesses covered the full range of computer security
controls. For example, physical and logical access controls were not
effective in preventing and detecting system intrusions and misuse. In
addition, software change controls were ineffective in ensuring that only
properly authorized and tested software programs were implemented. Further,
duties were not adequately segregated to reduce the risk that one individual
could execute unauthorized transactions or software changes without
detection. Finally, sensitive operating system software was not adequately
controlled, and adequate steps had not been taken to ensure continuity of
operations. The risks associated with these weaknesses are heightened
because of the increasing interconnectivity of today's computerized systems
and use of the Internet that further exposes them to outside hackers.

The government is not in a position to estimate the full magnitude of actual
damage and loss resulting from federal computer security weaknesses because
it is likely that many such incidents are either not

15 Information Security: Serious and Widespread Weaknesses Persist at
Federal Agencies (GAO/ AIMD00- 295, September 6, 2000). Addressing Computer

Security Weaknesses

Page 22 GAO- 01- 570T

detected or not reported. However, GAO and IG reports on agency computer
security weaknesses highlight the potential for negative impacts.

For example, computer control weaknesses at DOD increased the vulnerability
of its interconnected systems to unauthorized access to modify, steal, and
destroy DOD data, including financial, procurement, and logistics data.
Also, weaknesses identified at HHS's Health Care Financing Administration,
IRS, and the Department of Veterans Affairs place medical, tax, and other
sensitive records at risk of unauthorized disclosure, modification, and
destruction. Unauthorized disclosure of sensitive information has led to
instances of identity theft, in which individuals use such information to
commit financial crimes, such as fraudulently establishing credit and
running up debts. In addition, pervasive computer security weaknesses at the
Department of the Treasury placed billions of dollars of payments and
collections at significant risk of loss or fraud in its role as the
government's central financial manager, disburser, and collection agency.
Further, the vulnerability of mission- related systems, such as those at the
Environmental Protection Agency and the Department of Energy, to tampering,
disruption, and misuse increase the vulnerability of the agencies' financial
systems.

We and the Inspectors General have issued numerous reports that identify
computer security weaknesses in the federal government and have made scores
of recommendations to agencies regarding specific steps they should take to
make their security programs more effective. Also, in 2001, we again
reported information security as a high- risk area across government, as we
did in our 1997 and 1999 high- risk series. 16

As we have reported in the past, information security problems continue to
persist, in large part, because agency managers have not yet established
comprehensive security management programs. An effective program would
include guidance and procedures for assessing risks, establishing
appropriate policies and related controls, raising awareness of prevailing
risks and mitigating controls, and evaluating the effectiveness of
established controls. While some agencies have taken steps to develop and
implement security policies and have established security awareness
programs, the other key elements of an effective security management program
have not been implemented. The implementation of a comprehensive security
management program at all agencies would

16 See, for example, GAO- 01- 263, January 2001.

Page 23 GAO- 01- 570T

provide the government with a framework for resolving computer security
problems and managing computer security risks on an ongoing basis.

The Congress has expressed concern about the serious and pervasive nature of
computer security weaknesses and the resulting risks to federal government
systems. Most recently, government information security reform provisions in
the fiscal year 2001 National Defense Authorization Act are intended to
strengthen information security practices throughout the government.
Specifically, this new legislation requires annual agency and Inspectors
General evaluations of agency security programs. Further, it requires each
agency to develop and implement an agencywide information security program
to provide information security for all operations and assets of the agency.

In addition, other efforts have been initiated at the governmentwide level
to improve information security. For example, the federal Chief Information
Officers Council has taken steps to raise awareness, promote best practices,
and provide agencies tools for improving their security program. During
2000, the Council sponsored development of a selfassessment guide for
agencies to serve as a means of measuring progress in improving information
security. Also, the Federal Computer Incident Response Capability (FedCIRC)
at the General Services Administration and the National Infrastructure
Protection Center located in the Federal Bureau of Investigation have both
expanded their efforts to issue warnings of potential computer intrusions or
misuse and to assist in responding to computer security incidents. It is
important to maintain the momentum of these governmentwide efforts and
ensure that the activities currently under way are coordinated under a
comprehensive strategy and that the roles and responsibilities of the
numerous organizations with central responsibilities are clearly defined.

As I stated earlier, and it bears repeating because it represents the
ultimate goal of the CFO Act, a central challenge is the need for agencies
to generate timely, accurate, and useful data throughout the year by
overhauling financial and related management information systems. The CFO
Act calls for the modernization of financial management systems, including
the systematic measurement of performance, the development of cost
information, and the integration of systems- program, budget, and financial.

To help stimulate attention to this challenge, the Congress passed the
Federal Financial Management Improvement Act (FFMIA) of 1996, which requires
auditors performing financial audits to report whether agencies' Improving
Financial

Management Systems

Page 24 GAO- 01- 570T

financial management systems comply substantially with federal accounting
standards, federal financial management systems requirements, and the
government's standard general ledger at the transaction level. For fiscal
year 2000, reports of Inspectors General and their contract auditors
indicated that only 5 of the 24 CFO Act agencies' financial management
systems were in substantial compliance with the three federal financial
management systems requirements of FFMIA.

Noncompliance with FFMIA, which we further discuss in our report, Financial
Management: Federal Financial Management Improvement Act Results for Fiscal
Year 1999 (GAO/ AIMD- 00- 307, September 29, 2000), is indicative of the
overall continuing poor condition of many financial systems across
government. We reported that the reasons for systems' noncompliance included
nonintegrated systems, inadequate reconciliation procedures, noncompliance
with the government's standard general ledger, lack of adherence to
accounting standards, and weak security over information systems. We have
also reported that agency remediation plans, required by FFMIA, may not
adequately address the system deficiencies. As required by FFMIA, GAO will
report to the Congress by October 1, 2001, on agencies' FFMIA implementation
for fiscal year 2000.

Bringing financial management systems into compliance with the requirements
of FFMIA is a complex and difficult challenge. Through the rigors of the
financial statement audit process and the requirements of FFMIA, agencies
have gained a better understanding of their financial management weaknesses
and the impetus to resolve problems caused by those weaknesses. At the same
time, agencies are slowly making progress in addressing their problems.

Facing the Year 2000 (Y2K) challenge of ensuring that systems functioned
properly at the turn of the century understandably took priority for federal
agencies and resulted in some agencies delaying financial systems changes.
Now that the federal government has made the successful conversion to Year
2000, it can apply those valuable lessons to financial systems
modernization. As I mentioned earlier, among the lessons learned were the
importance of (1) providing high- level congressional and executive branch
leadership, (2) understanding the importance of computer- supported
operations, (3) providing standard guidance, (4) establishing partnerships,
(5) facilitating progress and monitoring performance, and (6) implementing
fundamental information technology improvements and disciplined processes.

Significant time and wise investments are needed for agencies to address and
correct long- standing financial management systems problems. Over

Page 25 GAO- 01- 570T

the longer term, agencies must address their serious systems problems by
applying the framework outlined in the Clinger- Cohen Act and implementing
guidance. This includes (1) adopting sound information technology investment
and control processes, (2) designing welldeveloped architectures to guide
information flows for financial and other related management information,
and (3) establishing disciplined approaches for developing and acquiring
computer software. Strong partnerships between Chief Financial Officers,
Chief Information Officers, and program managers are essential to achieve
these goals.

Ultimately, to fully meet the goals of financial management reform
legislation, agencies will need to be able to generate timely, accurate, and
useful financial and management information, including reporting performance
results, to make decisions and monitor government performance every day.
Agencies will also need to have effective internal control in place and must
ensure compliance with applicable laws and regulations.

Meeting legislative financial management reforms and modernizing financial
management systems will be especially important to provide the Congress and
other policymakers timely, accurate, and useful information in deliberations
involving the long- range fiscal policy challenges facing our nation. As I
recently testified before the Senate Committee on the Budget, the government
today is moving from balancing the budget to balancing fiscal risk. 17

This Congress and the President face a very different set of budget choices
than did their predecessors. For over 15 years, fiscal policy has been seen
in the context of the need to reduce the deficit. The policies and
procedures put in place to achieve a balanced budget do not provide guidance
for fiscal policy in a time of surplus.

While considerable uncertainty surrounds both short- and long- term budget
projections, we know two things for certain: the population is aging and the
baby boom generation is approaching retirement age. Although the 10- year
horizon looks better in the Congressional Budget Office's (CBO) January 31,
2001, projections than it did in July 2000, the long- term fiscal outlook
looks worse. In the longer term- beyond the 10year budget window of CBO's
projections- the share of the population

17 Long- term Budget Issues: Moving From Balancing the Budget to Balancing
Fiscal Risk (GAO- 01385T, February 6, 2001). Moving From

Balancing the Budget to Balancing Fiscal Risk

Page 26 GAO- 01- 570T

over 65 will begin to climb, and the federal budget will increasingly be
driven by demographic trends and rising health care costs.

In this regard, I have consistently stressed that without meaningful reform,
demographic and cost trends will drive Medicare spending to unsustainable
levels but that today's projected surpluses provide an opportunity to act
before these trends make needed changes more painful and disruptive. On
March 19, 2001, the Trustees of the Social Security and Medicare trust funds
reported on the current and projected status of these programs over the next
75 years. The near- term financial conditions of both Social Security and
Medicare have improved since last year's report. This should not distract
from focusing on the more important long- term perspective. The Medicare
Trustees' latest projections incorporate more realistic assumptions about
long- term health care spending and, as a result, the long- term outlook for
Medicare's financial future has deteriorated substantially since the last
Trustees' Annual Report.

Last week, I testified before the Senate Committee on Finance that we must
capitalize on momentum gathering in the Congress and elsewhere to take
action to adopt effective cost containment reforms alongside potential
benefit expansions. 18 The new consensus that Medicare is likely to cost
more than previously estimated serves to reinforce the need to take prompt
action. This issue, in part, must be dealt with from the standpoint of
starting to take incremental steps to close the Trustees' projected $4.6
trillion Hospital Insurance (Medicare Part A) 75- year funding gap. Also, it
is important that any benefit expansion efforts be coupled with adequate
program reforms so as not to worsen Medicare's long- range financial
condition. Congressional deliberations on modernizing the Medicare benefits
package to include prescription drug coverage must focus attention on
incremental solutions, concentrating on meeting targeted and legitimate
needs rather than on unlimited wants.

While current budget surpluses offer an opportunity to address today's needs
and the many pent- up demands held in abeyance during years of fighting
deficits, they do not eliminate our obligation to prepare for the future.
Today's choices must be seen not only in terms of how they respond to
today's needs, but also how they affect the future capacity of the nation
and its ability to meet the very real and significant fiscal challenges
associated with the approaching demographic tidal wave. Without a change in
entitlement programs, demographics will overwhelm

18 Medicare: Higher Expected Spending and Call for New Benefit Underscore
Need for Meaningful Reform (GAO- 01- 539T, March 22, 2001).

Page 27 GAO- 01- 570T

the surplus and drive us back into escalating deficits and debt. In this
regard, for entitlement programs, the key question is not trust fund
solvency but overall program sustainability.

The question before this Congress is how to balance today's wants and needs
against our nation's long- term challenges. Surpluses challenge our nation
to move beyond a focus on reducing annual deficits to a broader agenda. They
offer us an opportunity to look more closely at what government does and how
government does business. The budget surpluses before us offer policymakers
the opportunity to strike a balance between addressing today's needs and the
obligation to hand a strong economy and sustainable fiscal policies on to
our children, our grandchildren, and future generations.

As we look ahead, it will be essential for the government to begin
strengthening its financial reporting to make more meaningful information
available to the Congress, other policymakers, and the American public.
Financial reports must continue to strive to further report on long- range
financial commitments and contingencies, which will be useful in
highlighting the long- range fiscal policy challenges facing the nation.
Also, enhanced reporting in certain key areas, including performance
information (i. e., results and outcomes), will be central to managing
government operations more efficiently, effectively, and economically and in
supporting the Government Performance and Results Act. In addition, enhanced
disclosures on the government's most valuable assets, its own employees- or
human capital, is needed to draw further attention to the need to revamp
federal strategic human capital management and assess the government's
capability to perform its missions in the future.

In closing Mr. Chairman, I want to underscore the importance of the
President and the new Administration emphasizing and giving priority to (1)
addressing the problems preventing us from being able to express an opinion
on the government's consolidated financial statements, (2) having effective
internal control, and (3) modernizing financial management systems. As I
stated at the outset of my testimony today, my recent meetings with the
Treasury Secretary and the OMB Director have been most encouraging. I look
forward to working closely and cooperatively with them in developing the
short- and long- term strategies and plans necessary to address the problems
I have discussed this morning.

Finally, I want to reiterate the value of sustained congressional interest
in these issues, as demonstrated by this hearing and those held to oversee
financial management reform at particular agencies. Your work and that of

Page 28 GAO- 01- 570T

the committee over the past years to facilitate government management reform
have been a catalyst to the progress we have seen to date and will be
critical to ultimately restoring the confidence of citizens in the federal
government as a financial steward that is accountable for its finances. It
will be key that the appropriations, budget, authorizing, and oversight
committees hold agency top leadership accountable for resolving these
previously intractable problems and support improvement efforts.

I thank you for the opportunity to testify before you today, and I would be
pleased to answer questions you or the members of the Subcommittee may have
at this time.

For future contacts regarding this testimony, please call Jeffrey C.
Steinhoff, Managing Director, or Gary T. Engel, Director, Financial
Management and Assurance, on (202) 512- 2600.

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