Department of Homeland Security: Challenges and Steps in	 
Establishing Sound Financial Management (10-SEP-03,		 
GAO-03-1134T).							 
                                                                 
Based on its budget, the Department of Homeland Security (DHS) is
the largest entity in the federal government that is not subject 
to the Chief Financial Officers (CFO) Act of 1990. The		 
department, with an estimated $39 billion in assets, an almost	 
$40 billion fiscal year 2004 budget request, and more than	 
170,000 employees, does not have a presidentially appointed CFO  
subject to Senate confirmation and is not required to comply with
the Federal Financial Management Improvement Act (FFMIA) of 1996.
In addition, we designated implementation and transformation of  
DHS as high risk based on three factors: (1) the implementation  
and transformation of DHS is an enormous undertaking that will	 
take time to achieve in an effective and efficient manner, (2)	 
components to be merged into DHS already face a wide array of	 
existing challenges, and (3) failure to effectively carry out its
mission would expose the nation to potentially very serious	 
consequences. In light of these conditions, Congress asked GAO to
testify on the financial management challenges facing DHS, steps 
for establishing sound financial management and business	 
processes at DHS, and GAO's comments on H.R. 2886, The Department
of Homeland Security Financial Accountability Act.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-1134T					        
    ACCNO:   A08394						        
  TITLE:     Department of Homeland Security: Challenges and Steps in 
Establishing Sound Financial Management 			 
     DATE:   09/10/2003 
  SUBJECT:   Federal agency reorganization			 
	     Federal law					 
	     Financial management				 
	     Internal controls					 
	     Strategic planning 				 
	     Agency missions					 
	     Performance measures				 

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GAO-03-1134T

                                       A

Appendi x I

CFO Act Agencies 24 CFO Act Agencies The Department of Agriculture The
Department of Commerce The Department of Defense The Department of
Education The Department of Energy The Department of Health and Human
Services The Department of Housing and Urban Development The Department of
Interior The Department of Justice The Department of Labor The Department
of State The Department of Transportation The Department of the Treasury
The Department of Veterans Affairs The Environmental Protection Agency The
National Aeronautics and Space Administration The Agency for International
Development The Federal Emergency Management Agency 1 The General Services
Administration The National Science Foundation The Nuclear Regulatory
Commission The Office of Personnel Management The Small Business
Administration The Social Security Administration 1 Under the Homeland
Security Act of 2002, FEMA transferred to DHS and under H. R. 2886 would
no longer be considered a CFO Act agency.

Related GAO Products

Fiscal Year 2002 U. S. Government Financial Statements: Sustained
Leadership and Oversight Needed for Effective Implementation of Financial
Management Reform. GAO- 03- 572T. Washington, D. C.: April 8, 2003.

Transportation Security Administration: Actions and Plans to Build a
Results- Oriented Culture. GAO- 03- 190. Washington, D. C.: January 2003.

High- Risk Series: An Update. GAO- 03- 119. Washington, D. C.: January
2003.

Major Management Challenges and Program Risks: Federal Emergency
Management Agency. GAO- 03- 113. Washington, D. C.: January 2003.

Major Management Challenges and Program Risks: Department of the Treasury.
GAO- 03- 109. Washington, D. C.: January 2003.

Major Management Challenges and Program Risks: Department of Justice. GAO-
03- 105. Washington, D. C.: January 2003.

Major Management Challenges and Program Risks: Department of Homeland
Security. GAO- 03- 102. Washington, D. C.: January 2003.

Financial Management: FFMIA Implementation Necessary to Achieve
Accountability. GAO- 03- 31. Washington, D. C.: October 1, 2002.

Homeland Security: Critical Design and Implementation Issues. GAO- 02-
957T. Washington, D. C.: July 17, 2002.

A Model of Strategic Human Capital Management. GAO- 02- 373SP. Washington,
D. C.: March 2002.

Executive Guide: Creating Value Through World- class Financial Management.
GAO/ AMID- 00- 134. Washington, D. C.: April 2000.

(195024)

Test i mony Before the Subcommittee on Government Efficiency and Financial
Management, Committee on Government Reform, House of Representatives

For Release on Delivery Expected at 2: 00 p. m. EST DEPARTMENT OF
Wednesday, September 10, 2003 HOMELAND SECURITY

Challenges and Steps in Establishing Sound Financial Management

Statement of McCoy Williams, Director Financial Management and Assurance

GAO- 03- 1134T

                                       A

Mr. Chairman and Members of the Subcommittee: I am pleased to be here
today to discuss the major financial management challenges facing the
Department of Homeland Security (DHS), steps for establishing sound
financial management and business processes, and our comments on H. R.
2886, The Department of Homeland Security Financial Accountability Act.
The perspective we offer in this testimony is derived from an extensive
body of work on these topics completed by inspector generals, independent
auditors, as well as from GAO reports; executive guidance; and testimony
related to financial management and DHS.

The Homeland Security Act of 2002 brought together 22 diverse agencies and
created a new cabinet- level department to help prevent terrorist attacks
in the United States, reduce the vulnerability of the United States to
terrorist attacks, and minimize the damage and assist in recovery from
attacks that do occur. Efforts to improve homeland security will require a
results- oriented approach to ensure mission accountability and
sustainability over time, and DHS must have a strong financial management
infrastructure to support these goals. As stated in the President*s
Management Agenda, accurate and timely financial information is needed to
secure the best performance and highest measure of accountability for the
American people. DHS has stated its commitment to becoming a model of
efficiency and

effectiveness for the federal government. To achieve this goal, it must
first overcome significant challenges in integrating 22 separate agencies
and their systems into a single, effective department, as well as correct
the wide array of existing management challenges in the inherited
components.

Developing a financial management architecture with integrated systems and
business processes is one of the many difficult challenges the new
department faces. We designated implementation and transformation of DHS
as high risk based on three factors: (1) the implementation and
transformation of DHS is an enormous undertaking that will take time to
achieve in an effective and efficient manner, (2) components to be merged
into DHS already face a wide array of existing challenges, and (3) failure
to

effectively carry out its mission would expose the nation to potentially
very serious consequences. 1 Our high- risk program has helped the
executive branch and the Congress to galvanize efforts to seek lasting
solutions to high- risk problems and challenges.

1 High- Risk Series: An Update, GAO- 03- 119 (Washington, D. C.: January
2003).

Complicating DHS*s efforts to develop a strong financial management
infrastructure are the many known financial management weaknesses and
vulnerabilities in the agencies DHS inherited. For example, for four of
the seven major agencies 2 that transferred to DHS on March 1, 2003* the
Immigration and Naturalization Service (INS), the Transportation Security
Administration (TSA), the Customs Service, and the Federal Emergency
Management Agency (FEMA)* auditors reported 18 material weaknesses 3 in
internal control for fiscal year 2002. Further, for five of the seven
major

agencies, auditors reported that the agencies* financial management
systems were not in substantial compliance with the Federal Financial
Management Improvement Act (FFMIA) of 1996. 4 Building an effective
financial management infrastructure will require

sustained leadership from top management. Currently, based on its budget,
DHS is the largest entity in the federal government that is not subject to
the Chief Financial Officers (CFO) Act of 1990. 5 As such, this
department, with a fiscal year 2004 budget request of nearly $40 billion
and currently more than 170,000 employees, does not have a presidentially
appointed CFO subject to Senate confirmation and is not required to comply
with FFMIA. The goals of the CFO Act and related financial reform
legislation, such as FFMIA, are to provide the Congress and agency
management with reliable financial information for managing and making
day- to- day decisions and to improve financial management systems and
controls to properly safeguard the government*s assets. DHS should not be
the only cabinet- level

department not covered by what is the cornerstone for pursuing and
achieving the requisite financial management systems and capabilities in
the federal government.

2 The seven major agencies that were transferred to DHS are: Immigration
and Naturalization Service, Federal Emergency Management Agency, Customs
Service, Transportation Security Administration, the Office of Domestic
Preparedness, the U. S. Coast Guard, and the Secret Service.

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

4 FFMIA requires auditors, as part of CFO Act agencies* financial
statements, to report whether agencies* financial management systems
substantially comply with (1) federal financial management systems
requirements, (2) applicable federal accounting standards, and (3) the
federal government*s standard general ledger at the transaction level.

5 Pub. L. No. 101- 576, 104 Stat. 2838 (1990).

The creation of DHS presents an opportunity for the federal government to
ensure that it designs and implements a world- class organization with a
first- rate financial management systems architecture. Providing DHS with
the necessary tools, which would be facilitated by the passage of H. R.
2886, and setting high expectations are of paramount importance to its
success. First, however, DHS must overcome many financial management
challenges, which I will now discuss.

DHS Faces Significant Although many of the larger agencies that
transferred to DHS have been Financial Management

able to obtain unqualified or *clean* audit opinions on their annual
financial statements, most employed significant effort and manual
workarounds Challenges

to do so in order to overcome a history of poor financial management
systems and significant internal control weaknesses. Furthermore, some of
the entities that transferred may also have weaknesses not yet identified
or reported on merely because the problems were considered small or
immaterial in relation to their large parent departments, such as the
Department of Defense or the U. S. Department of Agriculture. Such
weaknesses may become evident now that these smaller

agencies are proportionately larger as a part of DHS, add to the known
extensive existing challenges, and may therefore be subjected to increased
levels of audit scrutiny. Cumulatively, these weaknesses and the efforts
needed to resolve them to achieve sound financial management and business
processes are an important reason for amending the CFO Act to include DHS
and measuring DHS*s financial management systems and internal control
against the same important financial reform legislation and

performance expectations as other federal departments and agencies. DHS,
like other federal agencies, has a stewardship obligation to prevent
fraud, waste, and abuse, to use tax dollars appropriately, and to ensure
financial accountability to the President, the Congress, and the American
people. For the most part, DHS*s component entities are using legacy
financial management systems that have a myriad of problems, such as

disparate, nonintegrated, outdated, and inefficient systems and processes.
DHS will need to focus on building future systems as part of its
enterprise architecture approach to ensure an overarching framework for
the agency*s integrated financial management processes. Plans and standard
accounting

policies and procedures must be developed and implemented to bridge the
many financial environments in which inherited agencies currently operate
to an integrated DHS system.

Another significant challenge for DHS is fixing the previously identified
weaknesses that the agencies bring with them to DHS, a number of which I
will now discuss.

Immigration and While receiving unqualified audit opinions on its fiscal
year 2001 and 2002 Naturalization Service

financial statements, 6 the former INS under the Department of Justice
(DOJ) faces numerous challenges in achieving a sound financial management
environment. Although INS was abolished and split into multiple bureaus
within DHS, its prior financial management weaknesses will still need to
be addressed and could be further complicated by this realignment.

For fiscal year 2002, INS*s financial statement auditors reported three
material internal control weaknesses and that its systems were not in
substantial compliance with FFMIA. Specifically, auditors noted
limitations

in the design and operation of INS*s financial accounting system, thereby
requiring it to use stand- alone systems or obtain the required financial
information via manual processes and nonroutine adjustments as part of the
financial statement preparation process. Having systems that can

routinely produce information for financial reporting on demand for day-
today decision making is one of the expected results of the President*s
Management Agenda, as well as one of the goals of FFMIA. In addition, for
both fiscal years 2001 and 2002, auditors reported that INS did not have a
reliable system for providing regular, timely data on the

numbers of completed and pending immigration applications, and the
associated collections of fees valued at nearly $1 billion for fiscal year
2002. Accordingly, INS was not able to accurately and regularly determine
fees it earns without relying on an extensive servicewide, year- end
physical count of over 5.4 million pending applications, as was the case
in fiscal year 2002. INS has been developing a new tracking system to
facilitate its inventory process. However, until the new system is
implemented, INS must rely on inefficient manual processes that
significantly disrupt its operations. These

and other inherent weaknesses in INS*s financial management process limit
its ability to produce useful, accurate, and timely financial information.

6 U. S. Department of Justice, Office of Inspector General, Immigration
and Naturalization Service Financial Statements, Fiscal Year 2002, Audit
Report No. 03- 22 (Washington, D. C.: May 2003).

Despite the importance and prevalence of information technology (IT)
systems in accomplishing its core missions, INS has not yet established
and implemented effective controls for managing its IT resources. 7 The
root cause of INS*s systems problems has been an absence of effective
enterprise architecture management and an IT investment management
process. To address such weaknesses, INS has been developing an enterprise
architecture, including a current and target architecture, as well

as a transition plan. Similarly, INS has taken steps to implement rigorous
and disciplined investment management controls. However, with the transfer
to DHS and the splitting of INS, these plans will have to be reanalyzed,
further delaying implementation of effective systems and complicating
DHS*s ability to produce reliable, timely, and accurate financial
statements and information.

Federal Emergency FEMA, the only CFO Act agency to transfer in its
entirety to DHS, faces

Management Agency several major financial management challenges, in spite
of receiving an unqualified opinion on its fiscal year 2002 financial
statements. 8 In fiscal

year 2002 FEMA*s auditors reported six material internal control
weaknesses and that FEMA*s financial management systems were not in
substantial compliance with the requirements of FFMIA. One major weakness
was FEMA*s inability to efficiently prepare accurate financial statements
as called for in the President*s Management Agenda. For example, auditors
reported that for fiscal year 2002, FEMA did not have an integrated
financial reporting process that could generate financial

statements as a byproduct of already existing processes, and that its
financial statements were prepared late and required significant
revisions.

In addition, auditors reported in fiscal year 2001 and again in fiscal
year 2002 that FEMA did not have adequate accounting systems and processes
to ensure that all property, plant, and equipment were properly recorded,
accurately depreciated, and tracked in accordance with its polices and
applicable federal accounting standards. As a result, FEMA*s property
management system cannot track items to supporting documentation or to a
current location. Furthermore, FEMA lacks procedures to ensure that 7 U.
S. General Accounting Office, Major Management Challenges and Program
Risks: Department of Justice, GAO- 03- 105 (Washington, D. C.: January
2003).

8 Federal Emergency Management Agency, Annual Performance and
Accountability Report Fiscal Year 2002 (Washington, D. C.: Jan. 24, 2003).

(1) equipment is consistently recorded on either a system or a component
basis, (2) procedures are in place to ensure that property inventories are
performed properly, and (3) all equipment is entered into its personal
property management system. As a result, there is an increased risk that
equipment and other property could be lost, stolen, or improperly recorded
in its accounting records.

Since FEMA was the only agency to transfer to DHS in its entirety, it,
unlike all of the other agencies, is left without a legacy department to
prepare financial statements for the first 5 months of activity for fiscal
year 2003 or an Office of Inspector General (OIG) to audit them, leaving
FEMA*s financial management information for the first 5 months of this
fiscal year

vulnerable to omissions, errors, and ultimately material misstatements.
Given the weaknesses in, among other things, FEMA*s property controls, we
are initiating a review of FEMA*s disbursement activity and property
management controls covering this 5- month period. We will keep this
Subcommittee informed of our progress in this review. Until corrective
actions are implemented to address weaknesses, FEMA will not be able to

achieve effective financial accountability or ensure that property is
properly accounted for. U. S. Customs Service In fiscal year 2002, Customs
under Treasury received a qualified opinion on a limited scope review 9 of
its internal controls. This qualified opinion was

due to the identification of four material weaknesses in Customs* internal
controls by its independent auditors. 10 For example, auditors reported
that Customs* financial systems did not capture all transactions as they
occurred during the year; did not record all transactions properly; were
not fully integrated; and did not always provide for essential controls
with respect to override capabilities. As a result, extensive manual
procedures

and analysis were required to process certain routine transactions and
prepare year- end financial statements. 9 A limited scope review was
performed in lieu of a financial statement audit due to security clearance
procedures and other matters related to the access and handling of
sensitive information, which delayed the start of the IT evaluation and
thus prevented the auditors from completing test work on IT general and
application controls.

10 U. S. Department of the Treasury, Office of Inspector General,
Financial Management: Report on Internal Control Over Financial Reporting
of the U. S. Customs Service for Fiscal Year 2002, OIG- 03- 033
(Washington, D. C.: Dec. 16, 2002).

Customs, which typically collects and processes over $23 billion in fees
annually, was found to have poor collection procedures throughout the
agency. Ongoing weaknesses in the design and operation of Customs*
controls over trade activities and financial management and information
systems continue to inhibit the effective management of these activities
and protection of trade revenue. For example, auditors reported that
Customs* Automated Commercial System could not provide summary

information on the total unpaid assessments for duties, taxes, and fees by
individual importer. The system also could not generate periodic
management information on outstanding receivables, the age of receivables,
or other data necessary for managers to effectively monitor collection
procedures. Such a capability would allow Customs to give managers timely
access to program revenue information and more effectively present
performance measures, which is critical for implementation of the
President*s Management Agenda.

Despite Customs* progress in implementing recommendations GAO and others
have made over the years, numerous weaknesses continue to hinder progress
toward developing Customs* planned import system, the Automated Commercial
Environment (ACE). 11 ACE is intended to replace the current system used
for collecting import- related data and ensuring, among other things, that
trade- related revenue is properly collected and

allocated. To ensure proper implementation of these initiatives, DHS*s
management must continue to provide a sustained level of commitment to its
successful implementation. Until this system is fully implemented,

billions in trade- related revenue will continue to be tracked by systems
with inadequate controls. In addition, like INS, Customs faces additional
financial management challenges because it was split into various
components.

Transportation Security TSA was created by the Aviation and Transportation
Security Act 12 under

Administration the Department of Transportation (DOT) in November 2001, to
develop transportation security policies and programs that contribute to
providing

secure transportation for the American public. Despite its short history,
the 11 U. S. General Accounting Office, Customs Service Modernization:
Automated Commercial Environment Progressing, but Further Acquisition
Management Improvements Needed, GAO- 03- 406 (Washington, D. C.: February
2003).

12 Pub. L. No. 107- 71, 115 Stat. 597 (2001).

former TSA brings to DHS numerous financial management issues. In fiscal
year 2002, auditors reported five material weaknesses and that TSA*s
systems were not in substantial compliance with FFMIA. 13 Specifically,
auditors found that TSA management had not established written accounting
policies and procedures to properly perform TSA*s financial management and
budgeting functions during fiscal year 2002. This is an example of what
can happen when a newly created entity does not thoroughly develop and
implement standard accounting policies and procedures. DHS should
carefully review TSA*s weaknesses to avoid experiencing them on a
departmentwide basis.

Auditors also reported that TSA did not maintain complete and accurate
records of its passenger and baggage screening equipment, most notably its
Explosive Detection System (EDS) equipment. For example, a significant
amount of fixed assets were found to not be recorded in the financial
statements and an adjustment of approximately $149 million was made after
year- end to properly record construction in progress for the manufacture
of EDS equipment. Until such weaknesses are resolved, millions of dollars
spent on new equipment and other fixed assets could go unaccounted for or
be improperly recorded, leaving TSA and DHS vulnerable to fraud, waste,
and abuse.

Another weakness reported by DOT*s OIG was TSA*s inadequate controls over
security screener contracts. Policies and procedures were not established
to provide an effective span of control to monitor contractor costs and
performance. This lack of oversight enabled contractors to charge TSA up
to 97 percent more than the contractors charged air carriers prior to the
federalization of the screener workforce. This weakness provides further
evidence of the importance of carefully documenting policies and
procedures early in the implementation of a new organization.

Office of Domestic Established in 1998, the former Office of Domestic
Preparedness (ODP) Preparedness

under DOJ*s Office of Justice Programs provides grant funds and direct
support to, among other things, help address the equipment, training, and
technical assistance needs of state and local jurisdictions for responding
to terrorism and terrorist- related activities.

13 U. S. Department of Transportation, Office of Inspector General,
Quality Control Review of Audited Financial Statements for Fiscal Year
2002, TSA, QC- 2003- 016 (Washington, D. C.: Jan. 27, 2003).

Since its inception, auditors have reported deficiencies in ODP*s ability
to administer grant funds. 14 In fiscal year 2002, we reported grant
management as one of DOJ*s major performance and accountability
challenges. 15 DOJ*s OIG has found that while millions of dollars had been
awarded, the funds were not awarded expeditiously, and grantees were very
slow to spend the requested monies. 16 According to the OIG, more than
half of the monies requested and granted over the past few years

remained unspent and some of the equipment purchased by state and local
jurisdictions was unavailable for use because grantees did not properly
distribute the equipment, could not locate it, or were inadequately
trained to use it.

Since the DOJ OIG reported on this issue in fiscal year 2002, DHS has
released more than $4.4 billion in grants to state and local governments
and private sector organizations. This increased level of grants will only
exacerbate these problems unless DHS works with grantees to improve the
accountability over these funds.

Coast Guard Unlike many of the larger agencies that transferred to DHS,
the Coast Guard did not have a stand- alone financial statement audit, but
was audited

as part of DOT*s consolidated audit. Although the auditors for DOT have
not reported significant financial management weaknesses at the Coast
Guard in recent years, the Coast Guard still uses DOT*s Departmental
Accounting and Financial Information System, which, among other things,
was unable to produce auditable financial statements based on the
information within the system. In addition, we have listed the Coast Guard
as part of DHS*s major management challenges due to its dual missions of
maritime safety and homeland security. 17

14 U. S. Department of Justice, Office of Inspector General, Office of
Justice Programs: State and Local Domestic Preparedness Grant Programs,
02- 15 (Washington, D. C.: March 2002). 15 U. S. General Accounting
Office, Major Management Challenges and Program Risks: Department of
Justice, GAO- 03- 105 (Washington, D. C.: January 2003).

16 U. S. Department of Justice, Fiscal Year 2002 Performance and
Accountability Report

(Washington, D. C.: Jan. 31, 2003). 17 U. S. General Accounting Office,
Major Management Challenges and Program Risks: Department of Homeland
Security, GAO- 03- 102 (Washington, D. C.: January 2003).

Concerns have also been reported regarding the Coast Guard*s Deepwater
Procurement Project, which currently has an estimated cost of $17 billion
over 20 years. It is intended to replace or modernize by 2022 all assets
used in missions that generally occur offshore. However, due to the events
of September 11 th and the Coast Guard*s expanded role in homeland
security, additional project requirements have been identified, including
accelerating the project to be completed in 10 years. These changes may
result in increased annual funding needs for the project, thus increasing
the

vulnerability to ineffective and inefficient use of funds. Secret Service
The Secret Service, formerly under the Department of the Treasury

(Treasury), has also not had a stand- alone financial statement audit, but
was audited as part of Treasury*s consolidated audit. Although from an
audit perspective the Secret Service was relatively small in relation to
the Internal Revenue Service and Bureau of the Public Debt at Treasury,
its missions of protecting the President and investigating financial
crimes are sensitive. Auditors for Secret Service may identify internal
control weaknesses that were not previously known, but may now be
identified since the Secret Service is proportionately a larger component
of DHS than

it was under Treasury, and may therefore be subjected to increased levels
of audit scrutiny.

Other Entities Aside from the known weaknesses at the 7 larger component
agencies comprising DHS, some of the 15 smaller entities that transferred
to DHS

may also have weaknesses not previously identified. As with the Secret
Service, these entities may be proportionately more significant at DHS
than they were at their legacy departments. In addition, once combined,
certain areas may be cumulatively subject to more audit scrutiny than when
they were dispersed throughout other departments. Any such weaknesses will
only exacerbate the extensive existing challenges.

Financial Reporting DHS plans to prepare financial statements for the 7
months ending Challenges

September 30, 2003. We support DHS*s decision to do so, but recognize that
it will be very challenging given the problems DHS inherited, compounded
by the additional complexity of merging a number of diverse entities,
which literally has had to hit the ground running from day one. Obtaining
a consolidated DHS financial statement audit for that same period will be
equally challenging, but also worthwhile.

Since DHS is a new entity, its auditors have already begun performing
audit procedures on beginning balances (i. e., transferred balances) as of
March 1, 2003, the activity for the 7 months ending September 30, 2003,
and ending balances. The transfer date of March 1 represents a unique
challenge because it does not fall on the end of a typical accounting
period, such as the end of the fiscal year or reporting quarter. In
addition, legacy departments* goals of reaching accelerated reporting
dates 18 for fiscal year 2003 may be impaired if DHS cannot provide
intragovernmental information needed by these departments on time. OMB and
Treasury require agencies to reconcile selected intragovernmental activity
and balances with their *trading partners* (i. e., other agencies) and to
report on the extent and results of intragovernmental activity and balance

reconciliation efforts. This information is necessary, not only for the
agencies* financial statements and reports, but also for the U. S.
Consolidated Financial Statements.

These are unique challenges that must be addressed to ensure that accounts
and amounts transferred to DHS are complete and accurate and that legacy
departments* reporting is not negatively impacted. Any

significant problems encountered could also negatively impact the
preparation and audit of the U. S. government*s fiscal year 2003 financial
statements.

In the longer term, DHS can only overcome its many challenges if it
establishes systems, processes, and controls that help to ensure effective
financial management and insists on the adherence to strong financial
practices. In addition to addressing the many ongoing challenges existing
in the programs of incoming agencies, DHS will need to focus on building
future systems as part of its enterprise architecture approach to ensure
an overarching framework for the agency*s integrated financial management
processes. Plans and standard accounting policies and procedures must be

developed and implemented to bridge these financial environments into an
integrated DHS system. 18 The Office of Management and Budget (OMB) has
issued accelerated reporting requirements that require agencies to prepare
financial statements close to the end of the reporting period. Under these
requirements, agency performance and accountability reports for fiscal
year 2002 were due to OMB by February 1, 2003, and by fiscal year 2004
agencies will be required to submit these reports by November 15, 2004. In
addition, in fiscal year 2003, agencies are required to prepare and submit
quarterly financial statements no later than 45 days after the end of the
reporting period.

Mr. Chairman, I would now like to discuss steps DHS should take to
establish sound financial management and business processes.

Steps for Establishing Successful financial management of DHS will depend
on the department

Sound Financial producing financial information that provides useful
information for

executive decision making. In April 2000, we issued an executive guide
that Management and

provided guidance in creating value through financial management. 19 After
Business Processes

studying the financial management practices and improvement efforts of
nine leading private and public sector finance organizations, we
identified several success factors, practices, and outcomes associated
with worldclass financial management. The organizations we studied include
The Boeing Company, Chase Manhattan Bank, General Electric Company,
Hewlett- Packard, Owens Corning, Pfizer Inc., and the states of

Massachusetts, Texas, and Virginia. First and foremost, establishing the
following goals is key to developing a world- class finance organization
with sound financial management and business processes: (1) make financial
management an entitywide priority, (2) redefine the role of the finance
organization, (3) provide meaningful information to decision makers, and
(4) build a team that delivers results. I

will discuss each of these goals in more detail below, including several
best practices that are critical in meeting these goals. These practices
lead to finance organizations that provide timely information that is
relevant to management, useful in the decision- making process, and adds
value to the organization. Since it is a newly created entity, DHS has a
unique opportunity to implement the identified practices when developing
financial policies and activities to establish sound financial management
and business processes.

Establish Financial Based on our study of world- class financial
organizations, making financial

Management as an management an entitywide priority is encouraged through
the following

Entitywide Priority best practices: (1) providing clear, strong, executive
leadership, (2)

building a foundation of control and accountability, and (3) using
training to change the culture and engage line managers.

19 U. S. General Accounting Office, Executive Guide: Creating Value
Through World- class Financial Management, GAO/ AIMD- 00- 134 (Washington,
D. C.: April 2000).

Top leadership involvement is essential for a successful realignment of
this magnitude. Top leadership is responsible for allocating the resources
needed to improve financial management and for building and maintaining
the organization*s commitment to doing business in a new way. The CFO Act
established the position of CFO in 24 agencies (app. I lists the original
24 CFO Act agencies* FEMA has transferred to DHS since the act was
enacted) in the federal government. These CFOs are given oversight
authority regarding financial management matters and are responsible for
ensuring that sound financial management is in place. As you know, DHS is
not currently subject to the provisions of the CFO Act, and thus has no
legal requirement to comply with its provisions. Although Secretary Ridge
pledged financial management as a priority in his May 1, 2003, testimony,
passage of H. R. 2886, which would amend the CFO Act to include DHS, is

important to ensure the department*s long- term commitment to establishing
sound financial management and business processes. Further, as DHS
continues to integrate its 22 entities, it must build a strong overall
foundation of control and accountability. Management should begin by
considering any significant control issues with agencies that are being
integrated to form DHS, many of which I have already highlighted. These
issues must be addressed within the specific agencies, as well as
departmentwide to ensure they do not continue to be control issues within
the newly formed department. Additionally, increases in accountability

should be encouraged through the production of financial and performance
reports for major programs on a regular and frequent basis to help in the
decision- making process and strategic planning. Ultimately, the
foundation for regular and frequent reporting will be through development
of an integrated financial management system* one capable of capturing
data at an appropriate level of detail and producing relevant and reliable
information for users based on their needs. In the case of DHS, the
challenge of combining, integrating, modernizing, and in some cases
replacing the systems of many disparate agencies will require careful
planning if the conversion is to be successful. Redefine the Role of the

As discussed earlier, many of the larger agencies that transferred to DHS
Finance Organization

have a history of poor systems and inadequate financial management. In
order to establish sound financial management and business processes, we
found that world- class finance organizations redefined the role of the
finance organization and implemented an integrated financial management
structure that: (1) assessed the finance organization*s role in meeting
the department*s mission, (2) maximized the efficiency of day- to- day

accounting activities, and (3) organized the finance organization to add
value.

The ever- increasing competition for resources requires careful allocation
of funds. Without the support of an effective finance organization,
program managers may not be able to determine costs associated with
government activities, defend those costs, or identify the benefits
derived from them. The finance organization must understand the
department*s mission and be able to provide information in support of that
mission. Of key importance is the ability of the finance organization to
efficiently complete routine accounting activities, thus freeing resources
to focus on other financerelated priorities that are in support of the
department*s mission. As I previously discussed, many of the larger
agencies that transferred into DHS spend significant time preparing
financial statements using manual workarounds and have a history of poor
financial management systems and significant internal control weaknesses.
Such a time- consuming method of

routine financial statement preparation does not allow for efficient use
of finance staff. As DHS develops its financial management and businesses
processes, it should focus on developing the abilities to (1) efficiently
and effectively complete routine processing activities and (2) compile the
data needed to measure performance so that information is available to
management on a day- to- day basis.

Provide Meaningful The overarching goal of the President*s Management
Agenda is the

Information for Decision improvement of government performance. The
finance organization must Makers

play a pivotal role in providing decision makers with the information they
need to measure performance. To efficiently and effectively provide
reliable information to decision makers, we identified three best
practices in our study of world- class finance organizations: (1) develop
systems that support the partnership between finance and operations, (2)
reengineer processes in conjunction with new technology, and (3) translate
financial data into meaningful information.

To help agencies set goals and measure performance, the Congress enacted
the Government Performance and Results Act (GPRA) in 1993. As part of
GPRA, agencies, including DHS, are required to prepare a 5- year
performance plan and annual performance reports. These required reports

provide a strategic planning and management framework intended to improve
federal performance and hold agencies accountable for achieving results.
GPRA was intended, in part, to improve congressional decision making by
giving the Congress comprehensive and reliable information on

the extent to which federal programs are fulfilling their statutory
intent. Additionally, the President*s Management Agenda includes improved
financial management performance as one of the five governmentwide
management goals. This initiative is aimed at ensuring that federal
financial systems produce accurate and timely information to support
operating, budget, and policy decisions. The finance organization is a key
component of a department*s ability to meet its requirements under GPRA
and the

objectives of the President*s Management Agenda. Build an Effective
Finance Over the years, the federal government has had difficulty
attracting and Team retaining talented financial management officials.
Improving financial performance is difficult without experienced
leadership and staff who are committed to success. Our study of several
world- class finance organizations indicated the following as best
practices to build a team that can deliver results: (1) develop a finance
team with the right mix of skills and competencies, and (2) attract and
retain talent.

Given the current demand on resources and the competition for qualified
employees, developing and retaining a talented finance team that is
capable of meeting the changing demands of the federal financial workplace
is an important goal. The lack of highly qualified financial management
professionals can hamper effective federal financial management
operations. The CFO Act requires OMB*s Deputy Director for Management to
develop and maintain qualification standards for agency CFOs and their

deputies; provide advice to agencies on the qualification, recruitment,
performance, and retention of financial management personnel; and assess
the adequacy of financial management staffs throughout the government.
Additionally, the CFO Act places responsibility with the CFO to recruit,
select, and train finance personnel.

To help department leaders manage their people and integrate human capital
considerations into daily decision making and the program results they
seek to achieve, we developed a strategic human capital model. 20 This
model is applicable to department leadership as a whole but is also
applicable to finance organization leadership as they seek to attract,
develop, and retain talent. The two critical success factors identified in
our

model to assist organizations in creating results- oriented cultures are
20 U. S. General Accounting Office, A Model of Strategic Human Capital
Management, GAO02- 373SP (Washington, D. C.: Mar. 15, 2002).

(1) linking unit and individual performance to organizational goals and
(2) involving employees in the decision- making process. Agency leaders
have other opportunities for displaying their commitment to human capital.
Continuous learning efforts, employee- friendly workplace policies,

competency- based performance appraisal systems, and retention and reward
programs are all ways in which agencies can value and invest in their
human capital. The sustained provision of resources for such programs can
show employees and potential employees the commitment agency leaders have
to strategic human capital management. DHS should adopt these success
factors in building a financial management team that delivers results. It
is well recognized that mergers of the magnitude of DHS carry significant

risks, including lost productivity and inefficiencies. Successful
transformations of large organizations generally can take from 5 to 7
years to achieve. Necessary management capacity, communication and
information systems, as well as sound financial management and business

processes must be established. Though creating and maintaining these
structures will be demanding and time consuming, it is necessary to
effectively implement the national homeland security strategy. 21 Over the
past several months, we have met with DHS*s CFO, Acting

Inspector General and Assistant Inspector General for Audits, and its
independent auditors performing its financial statement audit for 2003. We
are committed to working in a coordinated effort with the Congress, DHS,
and its auditors to provide advice to DHS on developing a sound financial
management structure that will facilitate, and not hamper, its mission of

securing the homeland. We believe that passage of H. R. 2886 will further
assist DHS in meeting this goal.

Comments on H. R. Mr. Chairman, as you know, H. R. 2886 as introduced on
July 24, 2003 would

2886 amend the CFO Act to (1) add DHS as a CFO Act agency and remove FEMA

as a CFO Act agency, (2) require DHS to obtain an audit opinion on its
internal controls, and (3) require DHS to include program performance

21 GAO convened a forum on September 24, 2002, to identify and discuss
useful practices and lessons learned from major private and public sector
organizational mergers, acquisitions, and transformations. U. S. General
Accounting Office, Highlights of a GAO Forum: Mergers and Transformation:
Lessons Learned for a Department of Homeland Security and Other Federal
Agencies, GAO- 03- 293SP (Washington, D. C.: November 2002).

information in its performance and accountability reports. In addition, H.
R. 2886 as introduced would have provided a waiver allowing DHS to forego
a financial statement audit for fiscal year 2003. We understand an
agreement

has been reached to remove this waiver from the proposed legislation.
DHS*s 2003 audit is already underway and the department has stated it is
committed to obtaining this audit. The waiver option is, therefore, no
longer needed, and we support dropping the provision from H. R. 2886.

Inclusion of DHS as a CFO We supported passage of the CFO Act in 1990 and
continue to strongly

Act Agency support its objectives of (1) giving the Congress and agency
decision makers reliable financial, cost, and performance information both
annually

and, most important, as needed throughout the year to assist in managing
programs and making difficult spending decisions, (2) dramatically
improving financial management systems, controls, and operations to
eliminate fraud, waste, abuse, and mismanagement and properly safeguard
and manage the government*s assets, and (3) establishing effective
financial organizational structures to provide strong leadership.
Achieving these goals is critical for establishing effective financial
management, and we fully support amending the CFO Act to include DHS.

In developing the CFO Act, the Congress viewed the CFO as being a critical
player in the management of an agency. At the time, financial management
was not a priority in most federal agencies and was all too often an
afterthought. All too often, the top financial management official wore
many hats, which left little time for financial management; did not
necessarily have any background in financial management; and focused
primarily on the budget. By establishing statutorily the position of CFO,

requiring that the person in the position have strong qualifications and a
proven track record in financial management, and giving this person status
as a presidential appointee, the Congress sought to change the then
existing paradigm. Of the 24 agencies named in the 1990 CFO Act, 16 were
designated as Level IV, Presidential appointee Senate confirmation

positions and eight were career positions. Today, CFOs have become
influential across government and the quality of the appointees has borne
out the wisdom of the Congress*s insistence that this position be elevated
(meaning it reported to the top and had standing with other top
officials). We have seen an evolution of the CFO position and a quantum
change in the expertise and abilities of CFOs and the attractiveness of
this position to someone having the type of proven track record in
financial management that is needed in the federal government. In the end,
the key attribute is the quality of the person in the position to affect
change and carry out the role

of CFO and whether the head of the agency supports the CFO and empowers
that person to do the job needed. Appointment of the CFO by the President,
subject to Senate confirmation, is one way to help ensure that the goals
of the CFO Act are met and that has proven itself over time.

The CFO Act, as expanded by the Government Management Reform Act of 1994,
also requires agencies to prepare and have audited financial statements.
The Congress added further emphasis to the importance of sound financial
management when it enacted FFMIA. Under the Accountability of Tax Dollars
Act of 2002, 22 DHS, as an executive branch agency with budget authority
greater than $25 million, would be required to obtain annual financial
statement audits; however, its auditors would not have to report on
compliance with FFMIA. Although DHS has appropriately contracted with
independent auditors to report on its systems compliance with FFMIA for
fiscal year 2003, it is not legally required to do so. FFMIA requires that
agencies implement and maintain financial management systems that
substantially comply with (1) federal systems requirements, (2) federal
accounting standards, and (3) the U. S. Government Standard General
Ledger. The ability to produce the data needed to efficiently and
effectively manage the day- to- day operations of the federal government
and provide accountability to taxpayers has been a long- standing
challenge at most federal agencies. As we discussed earlier, auditors
reported that many of the larger agencies that transferred to DHS were not
in substantial compliance with FFMIA prior to their transfer to DHS. Given
these preexisting compliance issues, in addition to issues that may arise
with system integration initiatives, it is critical that DHS be legally
required to comply with these important financial management reforms.

Opinion on Internal Current OMB guidance for audits of government agencies
and programs 23 Controls

requires auditor reporting on internal control, but not at the level of
providing an opinion on internal control effectiveness. However, we have
long believed and the Comptroller General has gone on record in

22 Pub. L. No. 107- 289, 116 Stat. 2049 (2002). 23 Office of Management
and Budget, Audit Requirements for Federal Financial Statements, Bulletin
01- 02 (Washington, D. C.: Oct. 16, 2000).

congressional testimony 24 that auditors have an important role in
providing an opinion on the effectiveness of internal control over
financial reporting and compliance with laws and regulations in connection
with major federal departments and agencies. For a number of years, we
have provided separate opinions on internal control effectiveness for the
federal entities that we audit because of the importance of internal
control to protecting the public*s interest. Specifically, we provide
separate opinions on internal controls and compliance with laws and
regulations for our audits of the U. S. government*s consolidated
financial statements, the financial statements of the Internal Revenue
Service and Federal Deposit Insurance Corporation, the Schedules of
Federal Debt managed by the Bureau of the Public Debt, and numerous small
entities* operations and funds. Our reports and related efforts have
engendered major improvements in internal control.

As part of the annual audit of our own financial statements, we practice
what we recommend to others and contract with an independent public
accounting firm for both an opinion on our financial statements and an
opinion on the effectiveness of our internal control over financial
reporting and compliance with laws and regulations. Our goal is to lead
the way in establishing the appropriate level of auditor reporting on
internal control

for federal agencies, programs, and entities receiving significant amounts
of federal funding. Additionally, three agencies, Social Security
Administration (SSA), General Services Administration (GSA), and the

Nuclear Regulatory Commission (NRC) voluntarily obtain separate opinions
on internal control effectiveness from their auditors, which is
commendable.

Another consideration as the Congress decides whether to enact new
requirements is that an opinion on internal controls is what has been
prescribed by the Congress for publicly traded corporations. A final rule

issued by the Securities and Exchange Commission in June 2003 and
effective in August 2003 provides guidance for implementation of Section
404 of the Sarbanes- Oxley Act of 2002, 25 which requires publicly traded
companies to establish and maintain an adequate internal control structure
and procedures for financial reporting and include in its annual report a
24 U. S. General Accounting Office, Fiscal Year 2002 U. S. Government
Financial Statements: Sustained Leadership and Oversight Needed for
Effective Implementation of Financial Management Reforms, GAO- 03- 572T.

25 Pub. L. No. 107- 204, 116 Stat. 745 (2002).

statement of management*s responsibility for and management*s assessment
of the effectiveness of those controls and procedures in accordance with
standards adopted by the Securities and Exchange Commission. The final
rule defines this requirement and requires applicable companies to obtain
a report in which a registered public accounting firm expresses an
opinion, or states that an opinion cannot be expressed, concerning
management*s assessment of the effectiveness of

internal controls over financial reporting. Auditor reporting on internal
control is a critical component of monitoring the effectiveness of an
organization*s accountability. GAO strongly believes that this is
especially important for very large, complex, or challenged entities. By
giving assurance about internal control, auditors can better serve their
clients and other financial statement users and better protect the public
interest by having a greater role in providing assurances of the
effectiveness of internal control in deterring fraudulent financial
reporting, protecting assets, and providing an early warning of internal
control weaknesses. We believe auditor reporting on internal control is
appropriate and necessary for publicly traded companies and major public
entities alike. We also believe that such reporting is appropriate in
other cases where management assessment and auditor examination and
reporting on the effectiveness of internal control add value and mitigate
risk in a costbeneficial manner. We know that some will point to increased
costs as a reason to remove this

provision from the legislation. We believe that auditors who follow the

Financial Audit Manual* which was jointly developed by GAO and the
President*s Council on Integrity and Efficiency (PCIE) 26 *should
ordinarily have little to no incremental costs associated with such
reporting.

We fully support having DHS, as well as all CFO Act agencies, obtain an
opinion on its internal control. If DHS is truly committed to becoming a
model federal agency, it should begin obtaining opinions on internal
control as soon as practical and set an example for other agencies to
follow and in keeping with the actions already taken by SSA, GSA, NRC, and
GAO. 26 Generally referred to as the GAO/ PCIE Financial Audit Manual.

Inclusion of We also support agencies including program performance
information in

Performance agency performance and accountability reports, so that
relevant

performance and financial information is presented in a consolidated and
Information in

useful manner. Agencies currently have the discretion to include this
Accountability Reports

information in a consolidated format. We strongly encourage DHS to
consolidate this information in its accountability report beginning with
fiscal year 2003.

In closing, the American people have increasingly demanded accountability
from government and the private sector. The Congress has recognized,
through legislation such as the CFO Act, that the federal government must
be held to the highest standards. We already know that many of the larger
agencies transferred to DHS have a history of poor financial management
systems and significant internal control weaknesses. These known
weaknesses provide further evidence that DHS*s systems and financial
controls should be subject to provisions of the CFO Act and thus FFMIA. We
also strongly encourage DHS to become a model agency and, as soon as
practical, obtain an opinion on its internal controls and report
performance information in its accountability reports.

Mr. Chairman, this concludes my statement. I would be happy to answer any
questions you or other Members of the Subcommittee may have at this time.

Contacts and For information about this statement, please contact McCoy
Williams,

Acknowledgments Director, Financial Management and Assurance, at (202)
512- 6906, or Casey Keplinger, Assistant Director, at (202) 512- 9323. You
may also reach them by e- mail at williamsm1@ gao. gov or keplingerc@ gao.
gov. Individuals who

made key contributions to this testimony include Cary Chappell and Heather
Dunahoo.

a

GAO United States General Accounting Office

The Homeland Security Act of 2002 brought together 22 agencies to create a
new cabinet- level department focusing on reducing U. S. vulnerability to
terrorist attacks, and minimizing damages and assisting in recovery from
attacks that do occur. Meeting this mission will require a results-
oriented environment with a strong financial management infrastructure.

Creating strong financial management at DHS is particularly challenging
because most of the entities brought together to form the department have
their own financial management systems, processes, and in some cases,

deficiencies. Four of the seven major agencies that transferred to DHS
reported 18 material weaknesses in internal control for fiscal year 2002
and five of the seven major agencies had financial management systems that
were not in substantial compliance with FFMIA. For DHS to develop a strong
financial management infrastructure, it will need to address these and
many other financial management issues.

Through the study of several leading private and public sector finance
organizations (Creating Value Through World- class Financial Management,
GAO/ AIMD- 00- 134), GAO has identified success factors,

practices, and outcomes associated with world- class financial management.
Four steps DHS can take to begin developing sound financial management and
business processes are to: (1) make financial management an entitywide
priority, (2) redefine the role of the finance organization, (3) provide

meaningful information to decision makers; and (4) build a team that
delivers results.

H. R. 2886 can help facilitate the creation of a first- rate financial
management architecture at DHS by providing the necessary tools and
setting high expectations. The bill would (1) make DHS a CFO Act agency,
(2) require DHS to obtain an opinion on its internal controls, and (3)
require DHS to include program performance information in its performance
and accountability reports. GAO fully supports the objectives of the CFO
Act to provide reliable financial information and improve financial
management systems and controls and believes DHS should be included under
the act and therefore also subject to FFMIA. Further, GAO strongly
believes that auditor reporting on internal control can be a critical
component of monitoring the effectiveness and accountability of an
organization and supports DHS, as well as other CFO Act agencies,
obtaining such opinions. In addition, GAO supports agencies including
program performance information in their performance and accountability
reports and strongly encourages DHS to report this information
voluntarily. Finally, as introduced, H. R. 2886 provided a waiver allowing
DHS to forego a financial statement audit for

fiscal year 2003. We understand an agreement has been reached to remove
this waiver from the proposed legislation. DHS has committed to a 2003
financial statement audit, which is already underway. GAO supports
dropping this provision from H. R. 2886. Based on its budget, the

Department of Homeland Security (DHS) is the largest entity in the federal
government that is not subject to the Chief Financial Officers (CFO) Act
of 1990. The department, with an estimated $39 billion in assets, an
almost $40 billion fiscal year 2004 budget request, and more than 170,000

employees, does not have a presidentially appointed CFO subject to Senate
confirmation and is not required to comply with the Federal Financial
Management Improvement Act (FFMIA) of 1996. In addition, we designated

implementation and transformation of DHS as high risk based on three
factors: (1) the implementation and transformation of DHS is an enormous
undertaking that will

take time to achieve in an effective and efficient manner, (2) components
to be merged into DHS already face a wide array of existing challenges,
and (3) failure

to effectively carry out its mission would expose the nation to
potentially very serious consequences.

In light of these conditions, the Subcommittee asked GAO to testify on the
financial management challenges facing DHS, steps for

establishing sound financial management and business processes at DHS, and
GAO*s comments on H. R. 2886, The Department of Homeland Security
Financial Accountability Act. www. gao. gov/ cgi- bin/ getrpt? GAO- 03-
1134T. To view the full product, including the scope

and methodology, click on the link above. For more information, contact
McCoy Williams at 202- 512- 6906 or williamsm1@ gao. gov. Highlights of
GAO- 03- 1134T, a testimony

before the Subcommittee on Government Efficiency and Financial Management,
House Committee on Government Reform, House of Representatives September
10, 2003

FINANCIAL MANAGEMENT Department of Homeland Security: Challenges and Steps
in Establishing Sound Financial Management

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Appendix I

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