Fiscal Year 2003 U.S. Government Financial Statements: Sustained 
Improvement in Federal Financial Management Is Crucial to	 
Addressing Our Nation's Future Fiscal Challenges (03-MAR-04,	 
GAO-04-477T).							 
                                                                 
GAO is required to audit the consolidated financial statements of
the U.S. government. Proper accounting and reporting practices	 
are essential in the public sector. The U.S. government is the	 
largest, most diverse, most complex, and arguably the most	 
important entity on earth today. Its services--homeland security,
national defense, Social Security, mail delivery, and food	 
inspection, to name a few--directly affect the well-being of	 
almost every American. But sound decisions on the future	 
direction of vital federal government programs and policies are  
made more difficult without timely, accurate, and useful	 
financial and performance information. Until the problems	 
discussed in GAO's audit report on the U.S. government's	 
consolidated financial statements are adequately addressed, they 
will continue to (1) hamper the federal government's ability to  
accurately report a significant portion of its assets,		 
liabilities, and costs; (2) affect the federal government's	 
ability to accurately measure the full cost as well as the	 
financial and nonfinancial performance of certain programs while 
effectively managing related operations; and (3) significantly	 
impair the federal government's ability to adequately safeguard  
certain significant assets and properly record various		 
transactions.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-477T					        
    ACCNO:   A09418						        
  TITLE:     Fiscal Year 2003 U.S. Government Financial Statements:   
Sustained Improvement in Federal Financial Management Is Crucial 
to Addressing Our Nation's Future Fiscal Challenges		 
     DATE:   03/03/2004 
  SUBJECT:   Accountability					 
	     Accounting procedures				 
	     Federal agencies					 
	     Financial disclosure				 
	     Financial management				 
	     Financial management systems			 
	     Financial records					 
	     Financial statement audits 			 
	     Financial statements				 
	     Information disclosure				 
	     Internal controls					 
	     Performance measures				 
	     Audit reports					 
	     Reporting requirements				 
	     General management reviews 			 

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GAO-04-477T

United States General Accounting Office

GAO Testimony

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

Wednesday, March 3, 2004 FISCAL YEAR 2003

U.S. GOVERNMENT

FINANCIAL STATEMENTS

 Sustained Improvement in Federal Financial Management Is Crucial to Addressing
                     Our Nation's Future Fiscal Challenges

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

GAO-04-477T

Highlights of GAO-04-477T, testimony before the Subcommittee on Government
Efficiency and Financial Management, Committee on Government Reform, House
of Representatives

GAO is required to audit the consolidated financial statements of the U.S.
government.

Proper accounting and reporting practices are essential in the public
sector. The U.S. government is the largest, most diverse, most complex,
and arguably the most important entity on earth today. Its
services-homeland security, national defense, Social Security, mail
delivery, and food inspection, to name a few-directly affect the
well-being of almost every American. But sound decisions on the future
direction of vital federal government programs and policies are made more
difficult without timely, accurate, and useful financial and performance
information.

Until the problems discussed in GAO's audit report on the U.S.
government's consolidated financial statements are adequately addressed,
they will continue to (1) hamper the federal government's ability to
accurately report a significant portion of its assets, liabilities, and
costs; (2) affect the federal government's ability to accurately measure
the full cost as well as the financial and nonfinancial performance of
certain programs while effectively managing related operations; and (3)
significantly impair the federal government's ability to adequately
safeguard certain significant assets and properly record various
transactions.

www.gao.gov/cgi-bin/getrpt?GAO-04-477T.

To view the full testimony, click on the link above. For more information,
contact Jeffrey Steinhoff or Gary Engel at (202) 512-2600.

March 3, 2004

FISCAL YEAR 2003 U.S. GOVERNMENT FINANCIAL STATEMENTS

Sustained Improvement in Federal Financial Management Is Crucial to Addressing
Our Nation's Future Fiscal Challenges

As in the 6 previous fiscal years, certain material weaknesses in internal
control and in selected accounting and reporting practices resulted in
conditions that continued to prevent GAO from being able to provide the
Congress and American citizens an opinion as to whether the consolidated
financial statements of the U.S. government are fairly stated in
conformity with U.S. generally accepted accounting principles. Three major
impediments to an opinion on the consolidated financial statements
continue to be (1) serious financial management problems at DOD, (2) the
federal government's inability to fully account for and reconcile
transactions between federal government entities, and (3) the federal
government's ineffective process for preparing the consolidated financial
statements.

For fiscal year 2003, 20 of 23 Chief Financial Officers (CFO) Act agencies
received unqualified opinions, the same number received by these agencies
for fiscal year 2002, up from 6 for fiscal year 1996. However, only 3 of
the CFO Act agencies had neither a material weakness in internal control,
an issue involving compliance with applicable laws and regulations, nor an
instance of lack of substantial compliance with Federal Financial
Management Improvement Act requirements.

The requirement for timely, accurate, and useful financial and performance
management information is greater than ever as the nation faces major
longterm fiscal challenges that will require tough choices in setting
priorities and linking resources to results. Given the nation's large and
growing long-term fiscal imbalance, which is driven largely by known
demographic trends and health care costs, coupled with new homeland
security and defense commitments, the status quo is unsustainable. Current
financial reporting does not clearly and transparently show the wide range
of responsibilities, programs, and activities that may either obligate the
federal government to future spending or create an expectation for such
spending and provides an unrealistic and even misleading picture of the
federal government's overall performance and financial condition. In
addition, too many significant federal government commitments and
obligations, such as Social Security and Medicare, are not fully and
consistently disclosed in the federal government's financial statements
and budget, and current federal financial reporting standards do not
require such disclosure.

A top-to-bottom review of government activities to ensure their relevance
and fit for the 21st century and their relative priority is long overdue.
The federal government needs a three-pronged approach to (1) restructure
existing entitlement programs, (2) reexamine the base of discretionary and
other spending, and (3) review and revise the federal government's tax
policy and enforcement programs. New accounting and reporting approaches,
budget control mechanisms, and metrics are needed for considering and
measuring the impact of spending and tax policies and decisions over the
long term.

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 years 2003 and
2002. Both the consolidated financial statements and our report are
included in the fiscal year 2003 Financial Report of the United States
Government, which was issued by the Department of the Treasury (Treasury)
on February 27, 2004, and is available through GAO's Internet site, at
www.gao.gov, and Treasury's Internet site, at
www.fms.treas.gov/fr/index.html.

At the outset, I would like to thank the subcommittee for continuing an
annual tradition of oversight hearings on this important subject. The work
of the Subcommittee on Government Efficiency and Financial Management and
its predecessor has for years been a catalyst to facilitate government
management reform. The involvement of this subcommittee remains critical
to ultimately assuring public confidence in the federal government as a
financial steward that is accountable for its finances.

As in the 6 previous fiscal years, certain material weaknesses1 in
internal control and in selected accounting and reporting practices
resulted in conditions that continued to prevent us from being able to
provide the Congress and American citizens an opinion as to whether the
consolidated financial statements of the U.S. government are fairly stated
in conformity with U.S. generally accepted accounting principles (GAAP).
Until the problems discussed in our report are adequately addressed, they
will continue to (1) hamper the federal government's ability to accurately
report a significant portion of its assets, liabilities, and costs; (2)
affect the federal government's ability to accurately measure the full
cost as well as the financial and nonfinancial performance of certain
programs while effectively managing related operations; and (3)
significantly impair the federal government's ability to adequately
safeguard certain significant assets and properly record various
transactions.

While the federal government has not yet been able to prepare auditable
financial statements, the requirement to do so at the consolidated level
as well as at the agency level has already yielded important results. We
see

1A 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.

continuous movement toward the ultimate goals of annual accountability
and, more importantly, of development of the day-to-day financial
information that the federal government will need to best address today's
budgetary challenges and the looming longer-term fiscal imbalance driven
by demographic trends, rising health care costs, and new homeland security
and defense commitments. Across government, financial management
improvement initiatives are under way that, if effectively implemented,
have the potential to appreciably improve the quality of the federal
government's financial management and reporting. Federal agencies continue
to make progress in their efforts to modernize their financial management
systems and improve financial management performance as called for in the
President's Management Agenda.2

The Principals of the Joint Financial Management Improvement Program
(JFMIP)3 agreed with the Office of Management and Budget's (OMB)
initiative to accelerate the agency financial statements reporting date to
November 15 for fiscal year 2004. For fiscal year 2003, OMB required the
Chief Financial Officers (CFO) Act agencies4 to deliver their Performance
and Accountability Reports, including their audited financial statements,
to OMB by January 30, 2004. However, to prepare for meeting the required
November 15 accelerated reporting date for fiscal year 2004, OMB
encouraged the CFO Act agencies to accelerate the issuance of their fiscal
year 2003 audited financial statements to November 15, 2003, or as close
to that date as possible. OMB reported that 8 CFO Act agencies-the
Department of Education, the Environmental Protection Agency, the

2The President's Management Agenda is the Bush administration's strategy
for improving the management and performance of the federal government.
Its purpose is to identify and address the most significant problems
facing the federal government. It contains five governmentwide and nine
agency-specific goals to improve federal management and deliver results to
the American people.

3JFMIP is a joint and cooperative undertaking of the Department of the
Treasury, GAO, the Office of Management and Budget (OMB), and the Office
of Personnel Management working in cooperation with each other and other
federal agencies to improve financial management practices in the federal
government. Leadership and program guidance are provided by the four
Principals of the JFMIP-the Comptroller General of the United States, the
Secretary of the Treasury, and the Directors of OMB and the Office of
Personnel Management.

431 U.S.C. 901(b). One of the 24 CFO Act agencies, the Federal Emergency
Management Agency, was transferred to the new Department of Homeland
Security effective March 1, 2003. With this transfer, the Federal
Emergency Management Agency will no longer be required to prepare and have
audited stand-alone financial statements under the CFO Act, leaving 23 CFO
Act agencies.

Department of Health and Human Services, the National Science Foundation,
the Social Security Administration, the Department of the Treasury, the
Agency for International Development, and the Department of Veterans
Affairs-were able to issue their fiscal year 2003 financial statements
with unqualified audit opinions by mid-November 2003. Another 10 CFO Act
agencies issued their financial statements by December 31, 2003, and the
remaining 5 CFO Act agencies issued by the end of January 2004. A 24th
major agency, the Department of Homeland Security (DHS),5 issued its
financial statements on February 13, 2004. DHS faced a herculean challenge
with respect to issuing audited financial statements, since the department
had been in operation only for the last 7 months of the fiscal year and
involved a transfer of operations from a number of diverse entities, some
with known financial management problems.

While these results represent a significant improvement over previous
years in the timeliness of CFO Act agencies' issuance of audited financial
statements, they also demonstrate the significant challenges that the
federal government will face in meeting the November 15 accelerated
reporting date for fiscal year 2004. Auditors at several of the CFO Act
agencies reported that the agencies may not be able to produce auditable
financial statements within the accelerated time frame for fiscal year
2004 without making fundamental changes to improve a number of their
financial management practices. For example, certain federal agency
auditors reported that major improvements are needed in (1) management
controls to monitor established policies and procedures for conducting
financial analyses and reconciliations throughout the year, (2) fully
integrating financial management systems, and (3) providing adequate and
skilled staff to support efficient, effective preparation of federal
agency consolidated financial statements. Our experience as the auditor of
the financial statements of the Internal Revenue Service, which
successfully accelerated its reporting to November 15 beginning with its
fiscal year 2002 financial statements, showed that significant changes had
to be made

5DHS is not a CFO Act agency and is therefore not subject to CFO Act
requirements. However, along with most other executive branch agencies not
covered by the CFO Act, DHS is required to prepare and have audited
financial statements under the Accountability of Tax Dollars Act of 2002,
Pub. L. No. 107-289, 116 Stat. 2049. For fiscal year 2003, the act
provided that OMB could grant executive branch agencies' requests for
waivers from having audited financial statements for fiscal year 2003.
However, DHS and certain other agencies chose to prepare and have their
fiscal year 2003 financial statements audited.

to improve routine financial management procedures in order to be able to
accelerate reporting.

For fiscal year 2003, as in fiscal year 2002, 20 of 23 CFO Act agencies
were able to attain unqualified audit opinions on their financial
statements (see app. I),6 up from 6 agencies for fiscal year 1996. This is
the same number of unqualified opinions received by these CFO Act agencies
for fiscal year 2002. However, 2 agencies' fiscal year 2003 opinions were
different from those they received for fiscal year 2002. The Agency for
International Development received an unqualified opinion on all of its
fiscal year 2003 financial statements for the first time, while the
National Aeronautics and Space Administration, which for fiscal year 2002
received an unqualified opinion on its financial statements, received a
disclaimer of opinion for fiscal year 2003. DHS, which as I mentioned
before prepared consolidated financial statements for fiscal year 2003
covering its first 7 months of operations, received a qualified opinion on
two of the six required financial statements.7

In identifying improved financial performance as one of its five
governmentwide initiatives, the President's Management Agenda recognized
that a clean (unqualified) financial audit opinion is a basic prescription
for any well-managed organization. At the same time, it recognized that
"most federal agencies that obtain clean audits only do so after making
extraordinary, labor-intensive assaults on financial records" at or after
year-end. The President's Management Agenda further recognized that
without sound internal control and accurate and timely financial
information, it is not possible to accomplish the agenda and secure the
best performance and highest measure of accountability for the

6At least 4 CFO Act agencies restated certain of their audited fiscal year
2002 financial statements to correct misstatements in such financial
statements. All 4 of the agencies had received unqualified opinions on
their fiscal year 2002 financial statements. These restatements were not
material to the consolidated financial statements.

7DHS began operations as an agency 5 months after the start of the fiscal
year, on March 1, 2003. Transfers of funds, assets, liabilities, and
obligations from 22 existing federal agencies to DHS began on March 1,
2003. DHS's auditors issued a qualified opinion on the consolidated
balance sheet and statement of custodial activity as of September 30,
2003, and disclaimed on the consolidated statement of net cost,
consolidated statement of changes in net position, combined statement of
budgetary resources, and consolidated statement of financing for the 7
months ended September 30, 2003. In accordance with Federal Accounting
Standards Advisory Board Technical Bulletin 2003-1, Certain Questions and
Answers Related to the Homeland Security Act of 2002, the fiscal year 2003
activities that occurred prior to the transfer of operations to DHS were
to be reflected in the transferring agencies' financial statements.

American people. The JFMIP Principals have defined certain measures, in
addition to receiving an unqualified financial statement opinion, for
achieving financial management success. These additional measures include
being able to routinely provide timely, accurate, and useful financial and
performance information and having no material internal control weaknesses
or material noncompliance with laws and regulations and the requirements
of the Federal Financial Management Improvement Act of 1996 (FFMIA). As
shown in figure 1, while the severity and magnitude of the problems
identified vary greatly, reports of inspectors general and their contract
auditors indicated that for fiscal year 2003 only 3 of the 23 CFO Act
agencies had neither a material weakness in internal control, an issue
involving compliance with applicable laws and regulations, nor an instance
of lack of substantial compliance with the requirements of FFMIA.

Figure 1: Fiscal Year 2003 CFO Act Agency Results Reported by Auditors

                                       Agencies with unqualified opinions and
                                                    no material weaknesses or
                            Agencies with unqualified opinions noncompliances

b

20a

Source: GAO.

aAgriculture, Commerce, Education, Energy, Health and Human Services,
Housing and Urban Development, Interior, Justice, Labor, State,
Transportation, Treasury, Veterans Affairs, Agency for International
Development, Environmental Protection Agency, General Services
Administration, National Science Foundation, Nuclear Regulatory
Commission, Office of Personnel Management, and Social Security
Administration.

bEnergy, National Science Foundation, and Social Security Administration.

In this testimony, I will highlight the major issues relating to the
consolidated financial statements for fiscal years 2003 and 2002, discuss
systems problems that continue to hinder federal agency accountability,
and describe progress that has been made toward addressing major
impediments to an opinion on the consolidated financial statements. I will
then discuss why sound financial management today and in the future is
critical to meeting tomorrow's fiscal needs and the need for "truth and
transparency" in connection with our nation's financial condition and
fiscal outlook.

  Highlights of Major Issues Related to the U.S. Government's Consolidated
  Financial Statements for Fiscal Years 2003 and 2002

As I mentioned earlier, as has been the case for the previous 6 fiscal
years, the federal government continues to have a significant number of
material weaknesses related to financial systems, fundamental
recordkeeping and financial reporting, and incomplete documentation.
Several of these material weaknesses (referred to hereafter as material
deficiencies) resulted in conditions that continued to prevent us from
forming and expressing an opinion on the U.S. government's consolidated
financial statements for the fiscal years ended September 30, 2003 and
2002.8 There may also be additional issues that could affect the
consolidated financial statements that have not been identified.

Major challenges include the federal government's inability to

o  	properly account for and report property, plant, and equipment and
inventories and related property, primarily at the Department of Defense
(DOD);

o  	reasonably estimate or adequately support amounts reported for certain
liabilities, such as environmental and disposal liabilities and related
costs at DOD, and ensure complete and proper reporting for commitments and
contingencies;

o  	support major portions of the total net cost of government operations,
most notably related to DOD, and ensure that all disbursements are
properly recorded;

o  fully account for and reconcile intragovernmental activity and
balances;

o  	demonstrate how net outlay amounts reported in the consolidated
financial statements were related to net outlay amounts reported in the
underlying federal agencies' financial statements; and

o  	effectively prepare the federal government's financial statements,
including ensuring that the consolidated financial statements are
consistent with the underlying audited agency financial statements,
balanced, and in conformity with GAAP.

In addition to these material deficiencies, we identified four other
material weaknesses in internal control related to loans receivable and
loan guarantee liabilities, improper payments, information security, and
tax collection activities.

8We previously reported that material deficiencies prevented us from
expressing an opinion on the fiscal years 1997, 1998, 1999, 2000, 2001,
and 2002 consolidated financial statements of the U.S. government.

  Recurring Systems Problems Hinder Accountability

The material weaknesses identified by our work are discussed in more
detail in appendix III.

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 and the Congress has been a long-standing
challenge at most federal agencies. The results of the fiscal year 2003
assessments performed by agency inspectors general or their contract
auditors under FFMIA9 show that these problems continue to plague the
financial management systems used by most of the CFO Act agencies. While
the problems are much more severe at some agencies than at others, their
nature and severity indicate that overall, management at most CFO Act
agencies lacks the full range of information needed for accountability,
performance reporting, and decision making. These problems include
nonintegrated financial systems, lack of accurate and timely recording of
data, inadequate reconciliation procedures, and noncompliance with
accounting standards and the U.S. Government Standard General Ledger
(SGL).

Agencies' inability to meet the federal financial management systems
requirements continues to be the major barrier to achieving compliance
with FFMIA. Under FFMIA, CFO Act agency auditors are required to report,
as part of the agencies' financial statement audits, whether agencies'
financial management systems substantially comply with (1) federal
financial management systems requirements, (2) applicable federal
accounting standards, and (3) the SGL at the transaction level. As shown
in figure 2, auditors most frequently reported instances of noncompliance
with federal financial management systems requirements. These instances of
noncompliance involved not only core financial systems, but also
administrative and programmatic systems.

9Pub. L. No. 104-208, S: 101(f)(title VIII), 110 Stat. 3009-389.

  Figure 2: Auditors' FFMIA Assessments for Fiscal Years 2000, 2001, 2002, and
                                      2003

For fiscal year 2003, auditors for 17 of the 23 CFO Act agencies reported
that the agencies' financial management systems did not comply
substantially with one or more of FFMIA's three requirements. For the
remaining 6 CFO Act agencies, auditors provided negative assurance,
meaning that nothing came to their attention indicating that the agencies'
financial management systems did not substantially meet FFMIA
requirements. The auditors for these 6 agencies did not definitively state
whether the agencies' systems substantially complied with FFMIA
requirements, as is required under the statute. DHS is not subject to the
requirements of the CFO Act and, consequently, is not required to comply
with FFMIA. Accordingly, DHS's auditors did not report on DHS's compliance
with FFMIA. However, the auditors identified and reported deficiencies
that related to the aforementioned three requirements of FFMIA.

Federal agencies have recognized the seriousness of their financial
systems weaknesses and have efforts under way to implement or upgrade
their financial systems to alleviate long-standing problems. We recognize

  Addressing Major Impediments to an Opinion on Consolidated Financial
  Statements

that it will take time, investment, and sustained emphasis to improve
agencies' underlying financial management systems.

As I mentioned earlier, for the past 7 fiscal years, the federal
government has been required to prepare, and have audited, consolidated
financial statements. Successfully meeting this requirement is tightly
linked to the requirements for the CFO Act agencies to also have audited
financial statements. This has stimulated extensive cooperative efforts
and considerable attention by agency chief financial officers, inspectors
general, Treasury and OMB officials, and GAO. With the benefit of the past
7 years' experience by the federal government in having the required
financial statements subjected to audit, more intensified attention will
be needed on the most serious obstacles to achieving an opinion on the
U.S. government's consolidated financial statements. Three major
impediments to an opinion on the consolidated financial statements are (1)
serious financial management problems at DOD, (2) the federal government's
inability to fully account for and reconcile transactions between federal
government entities, and (3) the federal government's ineffective process
for preparing the consolidated financial statements.

Financial Management at DOD

Essential to achieving an opinion on the consolidated financial statements
is resolution of the serious financial management problems at DOD, which
we have designated as high risk10 since 1995. In accordance with section
1008 of the National Defense Authorization Act for Fiscal Year 2002,11 DOD
reported that for fiscal year 2003, it was not able to provide adequate
evidence supporting material amounts in its financial statements. DOD
stated that it is unable to comply with applicable financial reporting
requirements for (1) property, plant, and equipment (PP&E); (2) inventory
and operating materials and supplies; (3) environmental liabilities; (4)
intragovernmental eliminations and related accounting adjustments; (5)
disbursement activity; and (6) cost accounting by responsibility segment.
Although DOD represented that the military retirement health care
liability data had improved for fiscal year 2003, the cost of direct
health care provided by DOD-managed military treatment facilities was a
significant

10GAO identifies areas at high risk due to either their greater
vulnerabilities to waste, fraud, abuse, and mismanagement or major
challenges associated with their economy, efficiency, or effectiveness.

11Pub. L. No. 107-107, 115 Stat. 1012, 1204 (2001).

amount of DOD's total recorded health care liability and was based on
estimates for which adequate support was not available.

Overhauling DOD's financial management operations represents a challenge
that goes far beyond financial accounting to the very fiber of DOD's range
of business operations, management information systems, and culture. As I
have reported in past years, DOD's financial management problems are
pervasive, complex, long-standing, and deeply rooted in virtually all
business operations throughout the department. To date, none of the
military services or major DOD components has passed the test of an
independent financial audit12 because of pervasive weaknesses in financial
management systems, operations, and controls. DOD has been up front about
the seriousness of these problems and the need to transform the way it
does business. To address these problems, DOD has taken several positive
steps in many key areas. For example, the Secretary of Defense has
included improving DOD's financial management as one of his top 10
priorities, and the department has taken a number of actions under its
Business Management Modernization Program, including development in April
2003 of an initial business enterprise architecture to guide operational
and technological changes.13 DOD is currently working to refine and
implement that architecture and expects to issue new versions of it during
2004. DOD reports that it is also developing detailed financial
improvement plans intended to provide disciplined leadership, identify
corrective actions, implement solutions, and result in a favorable audit
opinion on the fiscal year 2007 DOD-wide financial statements. But DOD
still has a long way to go, and top leadership must continue to stress the
importance of achieving lasting improvement that truly transforms the
department's business systems and operations. Only through major
transformation, which will take time and sustained leadership from top
management, will DOD be able to meet the mandate of the CFO Act and
achieve the President's Management Agenda goal of improved financial
performance.

12Although not major DOD components, the Military Retirement Fund received
an unqualified opinion on its fiscal year 2003 financial statements, and
the DOD Medicare-Eligible Retiree Health Care Fund received a qualified
opinion on its fiscal year 2003 financial statements.

13See U.S. General Accounting Office, Business Systems Modernization:
Summary of GAO's Assessment of the Department of Defense's Initial
Business Enterprise Architecture, GAO-03-877R (Washington, D.C.: July 7,
2003).

Intragovernmental Transactions

OMB and Treasury require the CFOs of 35 executive departments and
agencies, including the 23 CFO Act agencies, to reconcile selected
intragovernmental activity and balances with their "trading partners"14
and to report to Treasury, the agency's inspector general, and GAO on the
extent and results of intragovernmental activity and balances
reconciliation efforts. A substantial number of the agencies continue to
be unable to fully perform reconciliations of intragovernmental activity
and balances with their trading partners, citing reasons such as (1)
trading partners not providing needed data; (2) limitations and
incompatibility of agency and trading partner information systems; and (3)
lack of human resources. Amounts reported for federal agency trading
partners for certain intragovernmental accounts were significantly out of
balance in the aggregate for both fiscal years 2003 and 2002.

We reported in previous years that the heart of the intragovernmental
transactions issue was that the federal government lacked clearly
articulated business rules for these transactions so that they would be
handled consistently by agencies. In this regard, at the start of fiscal
year 2003, OMB issued business rules to transform and standardize
intragovernmental ordering and billing. To address long-standing problems
with intragovernmental exchange transactions between federal agencies,
Treasury provided federal agencies with quarterly detailed trading partner
information during fiscal year 2003 to help them better perform their
trading partner reconciliations. In addition, the federal government began
a three-phase Intragovernmental Transactions e-gov project to define a
governmentwide data architecture and provide a single source of detailed
trading partner data. Resolving the intragovernmental transactions
problem, though, still remains a difficult challenge and will require a
commitment by the CFO Act agencies and continued strong leadership by OMB.

Preparing the The federal government did not have adequate systems,
controls, and Consolidated Financial procedures to ensure that the
consolidated financial statements are Statements consistent with the
underlying audited agency financial statements,

balanced, and in conformity with GAAP. In this regard, Treasury is
developing a new system and procedures to prepare the consolidated
financial statements beginning with the statements for fiscal year 2004.

14Trading partners are U.S. government agencies, departments, or other
components included in the consolidated financial statements that do
business with each other.

  Truth and Transparency in the Fiscal Outlook

Treasury officials have stated that these actions are intended to, among
other things, directly link information from federal agencies' audited
financial statements to amounts reported in the consolidated financial
statements and resolve many of the issues we identified in the process for
preparing the consolidated financial statements. Resolving issues
surrounding preparing the consolidated financial statements will require
continued strong leadership by Treasury management.

Our nation's large and growing long-term fiscal imbalance, which is driven
largely by known demographic trends and rising health care costs- coupled
with new homeland security and defense commitments-serves to sharpen the
need to fundamentally review and re-examine basic federal entitlements, as
well as other mandatory and discretionary spending, and tax policies. As
we look ahead, our nation faces an unprecedented demographic challenge
with significant implications, among them budgetary and economic. Between
now and 2035, the number of people who are 65 years old or over will
double, driving federal spending on the elderly to a larger and ultimately
unsustainable share of the federal budget. As a result, tough choices will
be required to address the resulting structural imbalance.

GAO prepares long-term budget simulations that seek to illustrate the
likely fiscal consequences of the coming demographics and rising health
care costs. Our latest long-term budget simulations reinforce the need for
change in the major cost drivers-Social Security and health care programs.
As shown in figure 3, by 2040, absent reform of these entitlement
programs, projected federal revenues may be adequate to pay little beyond
interest on the debt.

Figure 3: Composition of Spending as a Share of GDP Assuming Discretionary
Spending Grows with GDP after 2004 and All Expiring Tax Provisions Are
Extended

Note: Although expiring tax provisions are extended, revenue as a share of
gross domestic product (GDP) increases through 2014 due to (1) real
bracket creep, (2) more taxpayers becoming subject to the alternative
minimum tax, and (3) increased revenue from tax-deferred retirement
accounts. After 2014, revenue as a share of GDP is held constant.

Current financial reporting does not clearly and transparently show the
wide range of responsibilities, programs, and activities that may either
obligate the federal government to future spending or create an
expectation for such spending and provides an unrealistic and even
misleading picture of the federal government's overall performance and
financial condition. Few agencies adequately show the results they are
getting with the taxpayer dollars they spend. In addition, too many
significant federal government commitments and obligations, such as Social
Security and Medicare, are not fully and consistently disclosed in the
federal government's consolidated financial statements and budget, and
current federal financial reporting standards do not require such

disclosure.15 Figure 4 shows some selected fiscal exposures. The spectrum
of these exposures ranges from covering only the explicit liabilities that
are shown on the consolidated financial statements to implicit promises
embedded in current policy or public expectations. These liabilities,
commitments, and promises have created a fiscal imbalance that will put
unprecedented strains on the nation's spending and tax policies. Although
economic growth can help, the projected fiscal gap is now so large that
the federal government will not be able to simply grow its way out of the
problem. Tough choices are inevitable.

                      Figure 4: Selected Fiscal Exposures

                       Type Example (dollars in billions)

Explicit liabilities	Publicly held debt ($3,913) Military and civilian
pension and post-retirement health ($2,857) Veterans benefits payable
($955) Environmental and disposal liabilities ($250) Loan guarantees ($35)
Explicit financial Undelivered orders ($596) commitments Long-term leases
($47)

Explicit financial Unadjudicated claims ($9)

contingencies	Pension Benefit Guaranty Corporation ($86) Other national
insurance programs ($7) Government corporations e.g., Ginnie Mae

Implicit exposures implied by Debt held by government accounts ($2,859)a
current policies or the public's Future Social Security benefit payments
($3,550)b expectations about the role of Future Medicare Part A benefit
payments ($5,931)b government Future Medicare Part B benefit payments
($9,619)b

Life cycle cost including deferred and future maintenance and operating
costs (amount unknown) Government Sponsored Enterprises e.g., Fannie Mae
and Freddie Mac

Source: GAO analysis.

aThis amount includes $774 billion in securities held by military and
civilian pension funds that would offset the explicit liabilities reported
by those funds.

bFigures for Social Security and Medicare are as of January 1, 2003, and
are estimated over a 75year period. These amounts represent net present
value and are net of debt held by the trust funds ($1,378 billion for
Social Security, $235 billion for Medicare Part A, and $34 billion for
Medicare Part B). The estimate for Social Security over an infinite
horizon would be $10.5 trillion according to the Social Security Trustees'
2003 annual report. There is no infinite horizon estimate for Medicare
included in the Medicare Trustees' 2003 annual report. Medicare Part D was
enacted after the end of fiscal year 2003.

15The Federal Accounting Standards Advisory Board has a project under way
to consider recognition, measurement, and display of social insurance
obligations.

Particularly troubling are the many big-ticket items that taxpayers will
eventually have to deal with. The federal government has pledged its
support to a long list of programs and activities, including pension and
health care benefits for senior citizens, medical care for veterans, and
contingencies associated with various government-sponsored entities, whose
claims on future spending total trillions of dollars. Despite their
serious implications for future budgets, tax burdens, and spending
flexibilities, these unfunded commitments get short shrift in the federal
government's current financial statements and in budgetary deliberations.

The federal government's gross debt as of September 2003 was about $7
trillion, or about $24,000 for every man, woman, and child in this country
today. But that number excludes items such as the gap between promised and
funded Social Security and Medicare commitments and veterans health care
benefit commitments provided through the Department of Veterans Affairs.
If these items are factored in, the burden for every American rises to
well over $100,000. In addition, the new Medicare prescription drug
benefit will add thousands more to that tab.

The new drug benefit is one of the largest unfunded commitments ever
undertaken by the federal government. The Trustees of the Social Security
and Medicare trust funds will include an official estimate of the
discounted present value cost of this new benefit over the next 75 years
in their annual report,16 which is scheduled for issuance later this
month. Preliminary estimates of its long-term cost range up to $7 trillion
in discounted present value terms over a 75-year period. To put that
number into perspective, it is as much as the total amount of the federal
government's gross debt outstanding as of September 30, 2003. Even before
the prescription drug benefit was enacted, our long-term budget
simulations showed that by 2040, the federal government may have to cut
federal spending in half or double taxes to pay for the mounting cost of
the government's current unfunded commitments. Either would be
devastating.

Proper accounting and reporting practices are essential in the public
sector. After all, the U.S. government is the largest, most diverse, most
complex, and arguably the most important entity on earth today. Its
services-homeland security, national defense, Social Security, mail

16The Trustees of the Social Security and Medicare trust funds report
annually on the current and projected status of these programs over the
next 75 years.

delivery, and food inspection, to name a few-directly affect the wellbeing
of almost every American. But sound decisions on the future direction of
vital federal government programs and policies are made more difficult
without timely, accurate, and useful financial and performance
information.

Fortunately, we are starting to see efforts to address the shortcomings in
federal financial reporting. The President's Management Agenda, which
closely reflects GAO's list of high-risk government programs, is bringing
attention to troubled areas across the federal government and is taking
steps to better assess the results that programs are getting with the
resources they are given. The Federal Accounting Standards Advisory Board
is also making progress on many key financial reporting issues.

In addition to these efforts, we have published a framework for analyzing
various Social Security reform proposals17 and will soon publish a
framework for analyzing health care reform proposals. We have also helped
to create a consortium of "good government" organizations to stimulate the
development of a set of key national indicators to assess the United
States' overall position and progress over time and in comparison to those
of other industrialized nations.

Budget experts at the Congressional Budget Office (CBO) and GAO continue
to encourage reforms to the federal budget process to better reflect the
federal government's commitments and signal emerging problems. Among other
things, we have recommended that the federal government issue an annual
report on major fiscal exposures. The President's fiscal year 2005 budget
also proposes that future President's budgets report on any enacted
legislation in the past year that worsens the unfunded obligations of
programs with long-term actuarial projections, with CBO to make a similar
report. Such reporting could be a good starting point.

Although these are positive initial steps, much more must be done given
the magnitude of the federal government's fiscal challenge. A top-tobottom
review of government activities to ensure their relevance and fit for the
21st century and their relative priority is long overdue. As I have

17U.S. General Accounting Office, Social Security Reform: Analysis of
Reform Models Developed by the President's Commission to Strengthen Social
Security, GAO-03-310 (Washington, D.C.: Jan. 15, 2003).

  Closing Comments

spoken about in the past, the federal government needs a three-pronged
approach to (1) restructure existing entitlement programs, (2) reexamine
the base of discretionary and other spending, and (3) review and revise
the federal government's tax policy and enforcement programs. New
accounting and reporting approaches, budget control mechanisms, and
metrics are needed for considering and measuring the impact of spending
and tax policies and decisions over the long term.

Our report on the U.S. government's consolidated financial statements for
fiscal years 2003 and 2002 highlights the need to continue addressing the
federal government's serious financial management weaknesses. With the
significantly accelerated financial reporting time frame for fiscal year
2004 and beyond, it is essential that the federal government move away
from the extraordinary efforts many federal agencies continue to make to
prepare financial statements and toward giving prominence to strengthening
the federal government's financial systems, reporting, and controls. This
is the only way the federal government can meet the end goal of making
timely, accurate, and useful financial and performance information
routinely available to the Congress, other policymakers, and the American
public. The requirement for timely, accurate, and useful financial and
performance management information is greater than ever as our nation
faces major long-term fiscal challenges that will require tough choices in
setting priorities and linking resources to results.

The Congress and the President face the challenge of sorting out the many
claims on the federal budget without the budget enforcement mechanisms or
fiscal benchmarks that guided the federal government through the previous
years of deficit reduction into the brief period of surplus. While a
number of steps will be necessary to address this challenge, truth and
transparency in federal government reporting are essential elements of any
attempt to address the nation's long-term fiscal challenges. The fiscal
risks I mentioned earlier can be managed only if they are properly
accounted for and publicly disclosed. A crucial first step will be to face
facts and identify the significant commitments facing the federal
government. If citizens and federal government officials come to
understand various fiscal exposures and their potential claims on future
budgets, they are more likely to insist on prudent policy choices today
and sensible levels of fiscal risk in the future. In addition, new budget
control mechanisms will be required, along with effective approaches to
successfully engage in a fundamental review, reassessment, and
reprioritization of the base of federal government programs and policies
that I have recommended previously.

Public officials will have more incentive to make difficult but necessary
choices if the public has the facts and comes to support serious and
sustained action to address the nation's fiscal challenges. Without
meaningful public debate, however, real and lasting change is unlikely.
Clearly, the sooner action is taken, the easier it will be to turn things
around.

I believe a national education campaign and outreach effort is needed to
help the public understand the nature and magnitude of the long-term
financial challenge facing this nation. An informed electorate is
essential for a sound democracy. Members of Generation X and Y especially
need to become active in this discussion because they and their children
will bear the heaviest burden if policymakers fail to act in a timely and
responsible manner.

We at GAO are committed to doing our part, but others also need to step up
to the plate. By working together, I believe we can make a meaningful
difference for our nation, fellow citizens, and future generations of
Americans.

In closing Mr. Chairman, I want to reiterate the value of sustained
congressional interest in these issues, as demonstrated by this
subcommittee's hearings and those the former Subcommittee on Government
Efficiency, Financial Management, and Intergovernmental Relations held
over the past several years to oversee financial management reform. It
will also be key that the appropriations, budget, authorizing, and
oversight committees hold agency top leadership accountable for resolving
these problems and that they support improvement efforts.

Contacts 	For further information regarding this testimony, please contact
Jeffrey C. Steinhoff, Managing Director, and Gary T. Engel, Director,
Financial Management and Assurance, at (202) 512-2600.

    Appendix I: Selected Major Federal Departments and Agencies: Fiscal Year
       2003 Audit Results, Principal Auditors, and Number of Other Audit
                                  Contractors
Number  23 CFO                                 Agency for                                                                                                                                            Ernst                           Environmental                           General                                          Health                         Housing and                                                                                                                 R. Navarro      National                                        National                     Nuclear               R. Navarro                               
       of   Act     Audit  Principal       audit International Unqualified Inspector  Agriculture Unqualified Inspector  Commerce Unqualified KPMG  Defense Disclaimer Inspector  Education Unqualified   &    Energy Unqualified KPMG   Protection   Unqualified Inspector     Services    Unqualified PricewaterhouseCoopers    and    Unqualified Inspector     Urban    Unqualified Inspector  Interior Unqualified KPMG  Justice Unqualified PricewaterhouseCoopers  Labor Unqualified      &        Aeronautics   Disclaimer PricewaterhouseCoopers   Science   Unqualified KPMG  Regulatory Unqualified      &       Office of              KPMG 
    other agencies results  auditor  contractors  Development               General                            General                        LLP                       General                         Young                     LLP      Agency                  General   Administration                      LLP             Human                General   Development              General                        LLP                                LLP                              Associates,    and Space                        LLP            Foundation             LLP   Commission             Associates,  Personnel              LLP  
                                                                                                                                                                                                         LLP                                                                                                                    Services                                                                                                                                                       Inc.      Administration                                                                                           Inc.      Management Unqualified      

        Small Business       Disclaimer         Cotton & Company LLP        0 
        Administration                                                      
        Social Security      Unqualified     PricewaterhouseCoopers LLP     0 
        Administration                                                      
             State           Unqualified  Leonard G. Birnbaum and Company,  2 
                                                        LLP                 
        Transportation       Unqualified         Inspector General          2 

a

Treasury Unqualified Inspector General Veterans Affairs Unqualified
Deloitte & Touche LLP 0

Other major agency

Homeland Security Disclaimerb KPMG LLP 0

Source: GAO.

aIn addition, GAO audited the Internal Revenue Service's financial
statements and the Schedules of Federal Debt Managed by the Bureau of the
Public Debt.

bDHS began operations as an agency 5 months after the start of the fiscal
year, on March 1, 2003. Transfers of funds, assets, liabilities, and
obligations from 22 existing federal agencies to DHS began on March 1,
2003. DHS's auditors issued a qualified opinion on the consolidated
balance sheet and statement of custodial activity as of September 30,
2003, and disclaimed on the consolidated statement of net cost,
consolidated statement of changes in net position, combined statement of
budgetary resources, and consolidated statement of financing for the 7
months ended September 30, 2003.

Appendix II: Primary Effects of the Material Weaknesses Described in This
Report

Areas Involving Material Weaknesses Statements and the Management of
Government Operations

Property, plant, and equipment and Without accurate asset information, the
federal government does not fully know the assets

inventories and related property	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) ensure the assets are available for use when needed, (4) prevent
unnecessary storage and maintenance costs or purchase of assets already on
hand, and (5) determine the full costs of programs that use these assets.

Liabilities and commitments and Problems in accounting for liabilities
affect the determination of the full cost of the federal

contingencies 	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 federal 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. In addition, when disclosures of commitments and contingencies
are incomplete or incorrect, reliable information is not available about
the extent of the federal government's obligations.

Cost of government operations and Inaccurate cost information affects the
federal government's ability to control and reduce

disbursement activity 	costs, assess performance, evaluate programs, and
set fees to recover costs where required. Improperly recorded
disbursements could result in misstatements in the financial statements
and in certain data provided by federal agencies for inclusion in the
President's budget concerning obligations and outlays.

Accounting for and reconciliation of Problems in accounting for and
reconciling intragovernmental activity and balances impair
intragovernmental activity and balances the government's ability to
account for billions of dollars of transactions between

Primary Effects on the Fiscal Years 2003 and 2002 Consolidated Financial

governmental entities.

Net outlays 	Until the differences between the total net outlays reported
in federal agencies' Statements of Budgetary Resources and the records
used by the Department of the Treasury to prepare the Statement of Changes
in Cash Balance from Unified Budget and Other Activities are reconciled,
the effect that these differences may have on the U.S. government's
consolidated financial statements will be unknown.

Preparation of consolidated financial Because the federal government did
not have adequate systems, controls, and procedures statements to prepare
its consolidated financial statements, the federal government's ability to
ensure that the consolidated financial statements are consistent with the
underlying audited agency financial statements, balanced, and in
conformity with U.S. generally accepted accounting principles was
impaired.

Improper payments 	Without a systematic measurement of the extent of
improper payments, federal agency management cannot determine (1) if
improper payment problems exist that require corrective action, (2)
mitigation strategies and the appropriate amount of investments to reduce
them, and (3) the success of efforts implemented to reduce improper
payments.

Loans receivable and loan guarantee Weaknesses in the processes and
procedures for estimating credit program costs affect liabilities the
government's ability to support annual budget requests for these programs,
make future budgetary decisions, manage program costs, and measure the
performance of lending activities.

Information security weaknesses 	Information security weaknesses over
computerized operations are placing enormous amounts of federal assets 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.

Primary Effects on the Fiscal Years 2003 and 2002 Consolidated Financial
Areas Involving Material Weaknesses Statements and the Management of
Government Operations

Tax collection activities 	Weaknesses in controls over tax collection
activities continue to affect the federal government's ability to
efficiently and effectively account for and collect revenue. Additionally,
weaknesses in financial reporting affect the federal government's ability
to make informed decisions about collection efforts. As a result, the
federal government is vulnerable to loss of tax revenue and exposed to
potentially billions of dollars in losses due to inappropriate refund
disbursements.

Source: GAO.

                      Appendix III: Material Deficiencies

The federal government did not maintain adequate systems or have
sufficient, reliable evidence to support information reported in the
consolidated financial statements of the U.S. government, as described
below. These material deficiencies contributed to our disclaimer of
opinion on the consolidated financial statements and also constitute
material weaknesses in internal control.

Property, Plant, and Equipment and Inventories and Related Property

The federal government could not satisfactorily determine that all PP&E
and inventories and related property were included in the consolidated
financial statements, verify that certain reported assets actually exist,
or substantiate the amounts at which they were valued. Most of the PP&E
and inventories and related property are the responsibility of DOD. As in
past years, DOD did not maintain adequate systems or have sufficient
records to provide reliable information on these assets. Other agencies,
most notably the National Aeronautics and Space Administration, reported
continued weaknesses in internal control procedures and processes related
to PP&E.

Liabilities and Commitments and Contingencies

The federal government could not reasonably estimate or adequately support
amounts reported for certain liabilities. For example, DOD was not able to
estimate with assurance key components of its environmental and disposal
liabilities. In addition, DOD could not support a significant amount of
its estimated military postretirement health benefits liabilities included
in federal employee and veteran benefits payable. These unsupported
amounts related to the cost of direct health care provided by DOD-managed
military treatment facilities. Further, the federal government could not
determine whether commitments and contingencies, including those related
to treaties and other international agreements entered into to further the
U.S. government's interests, were complete and properly reported.

Cost of Government Operations and Disbursement Activity

The previously discussed material deficiencies in reporting assets and
liabilities, material deficiencies in financial statement preparation, as
discussed below, and the lack of adequate disbursement reconciliations at
certain federal agencies affect reported net costs. As a result, the
federal government was unable to support significant portions of the total
net cost of operations, most notably related to DOD.

With respect to disbursements, DOD and certain other federal agencies did
not adequately reconcile disbursement activity. For fiscal years 2003 and

2002 there were unsupported adjustments to federal agencies' records and
unreconciled disbursement activity, including unreconciled differences
between federal agencies' and Treasury's records of disbursements,
totaling billions of dollars, which could also affect the balance sheet.

Accounting for and Reconciliation of Intragovernmental Activity and
Balances

OMB and Treasury require the CFOs of 35 executive departments and
agencies, including the 23 CFO Act agencies, to reconcile selected
intragovernmental activity and balances with their "trading partners"1 and
to report to Treasury, the agency's inspector general, and GAO on the
extent and results of intragovernmental activity and balances
reconciliation efforts. A substantial number of the agencies did not fully
perform the required reconciliations for fiscal years 2003 and 2002,
citing reasons such as (1) trading partners not providing needed data, (2)
limitations and incompatibility of agency and trading partner information
systems, and (3) lack of human resources. For both of these years, amounts
reported for federal agency trading partners for certain intragovernmental
accounts were significantly out of balance. Treasury's ability to
eliminate certain intragovernmental activity and balances is impaired by
these federal agencies' problems in handling their intragovernmental
transactions.

                                  Net Outlays

OMB Bulletin 01-09, Form and Content of Agency Financial Statements,2
states that outlays in federal agencies' Statements of Budgetary Resources
(SBR) should agree with the respective agency's net outlays reported in
the budget of the U.S. government. In addition, SFFAS No. 7, Accounting
for Revenue and Other Financing Sources and Concepts for Reconciling
Budgetary and Financial Accounting, requires explanation of any material
differences between the information required to be disclosed (including
net outlays) and the amounts described as "actual" in the budget of the
U.S. government.

We found material differences between the total net outlays reported in
selected federal agencies' audited SBRs and the records used to prepare

1Trading partners are U.S. government agencies, departments, or other
components included in the consolidated financial statements that do
business with each other.

2Office of Management and Budget Bulletin No. 01-09, Form and Content of
Agency Financial Statements (Washington, D.C.: Sept. 25, 2001). This
bulletin is OMB's official guidance for the form and content of federal
agencies' financial statements.

the Statement of Changes in Cash Balance from Unified Budget and Other
Activities (Statement of Changes in Cash Balance),3 totaling about $140
billion and $186 billion for fiscal years 2003 and 2002, respectively.4
Two agencies (Treasury and the Department of Health and Human Services
(HHS)) accounted for about 83 percent and 75 percent of the differences
identified in fiscal years 2003 and 2002, respectively. We found that the
major cause of the differences for the two agencies was the treatment of
offsetting receipts.5 Some offsetting receipts for these two agencies had
not been included in the agencies' SBRs, which would have reduced the
agencies' net outlays and made the amounts more consistent with the
records used to prepare the Statement of Changes in Cash Balance.6 For
example, we found that HHS reported net outlays for fiscal year 2003 as
$596 billion on its audited SBR, while the records that Treasury uses to
prepare the Statement of Changes in Cash Balance showed $505 billion for
fiscal year 2003 for this agency. Until these differences between the
total net outlays reported in the federal agencies' SBRs and the records
used to prepare the Statement of Changes in Cash Balance are reconciled,
the effect that these differences may have on the U.S. government's
consolidated financial statements will be unknown. OMB has stated that it
plans to work with the agencies to address this issue.

Preparation of Consolidated Financial Statements

The federal government did not have adequate systems, controls, and
procedures to ensure that the consolidated financial statements are
consistent with the underlying audited agency financial statements,

3OMB and U.S. generally accepted accounting principles (GAAP) require
agencies to report net outlays in the SBR. The Statement of Changes in
Cash Balance also reports unified budget outlays-actual. Both are intended
to represent the same amount and be consistent with the information
presented in the budget of the U.S. government.

4In some agencies' fiscal year 2003 financial statements, the comparable
fiscal year 2002 amounts were restated.

5Offsetting receipts are collections that are credited to general fund,
special fund, or trust fund receipt accounts and that offset gross outlays
at the agency or governmentwide level.

6These two agencies did not adequately explain their fiscal year 2002
differences between the net outlays reported on the SBR and the budget of
the U.S. government in their notes to the fiscal year 2003 financial
statements.

balanced, and in conformity with generally accepted accounting principles
(GAAP). During our fiscal year 2003 audit, we found the following:7

o  	The process for compiling the consolidated financial statements does
not directly link information from federal agencies' audited financial
statements to amounts reported in the consolidated financial statements,
and therefore does not ensure that the information in the consolidated
financial statements is consistent with the underlying information in
federal agencies' audited financial statements and other financial data.

o  	Internal control weaknesses exist in Treasury's process for preparing
the consolidated financial statements, such as a lack of (1) segregation
of duties and (2) appropriate documentation of certain policies and
procedures for preparing the consolidated financial statements.

o  	The net position reported in the consolidated financial statements is
derived by subtracting liabilities from assets, rather than through
balanced accounting entries. To make the fiscal years 2003 and 2002
consolidated financial statements balance, Treasury recorded a net $24.5
billion and a net $17.1 billion decrease, respectively, to net operating
cost on the Statements of Operations and Changes in Net Position, which it
labeled "Unreconciled Transactions Affecting the Change in Net Position."8
An additional net $11.3 billion and $12.5 billion of unreconciled
transactions were recorded in the Statements of Net Cost for fiscal years
2003 and 2002, respectively. Treasury does not identify and quantify all
components of these unreconciled activities, nor does Treasury perform
reconciliation procedures, which would aid in understanding and
controlling the net position balance as well as eliminating the
unreconciled transactions associated with compiling the consolidated
financial statements.

o  	Significant differences in other intragovernmental accounts, primarily
related to appropriations, still remain unresolved. Intragovernmental
activity and balances are "dropped" or "offset" in the preparation of the
consolidated financial statements rather than eliminated through balanced

7The same issues we identified in fiscal year 2003 existed in fiscal year
2002, and some have existed for a number of years. In October 2003, we
reported in greater detail on the issues we identified, in U.S. General
Accounting Office, Financial Audit: Process for Preparing the Consolidated
Financial Statements of the U.S. Government Needs Improvement, GAO-04-45
(Washington, D.C.: Oct. 30, 2003). This report included 44 recommendations
to address weaknesses we identified. It also included recommendations
related to 16 disclosure areas that are required by GAAP. We recommended
that the 16 disclosures that are not included in the consolidated
financial statements either be included or that the rationale for their
exclusion be documented.

8Although Treasury was unable to determine how much of the unreconciled
transactions, if any, relate to operations, it reported unreconciled
transactions as a component of net operating cost in the consolidated
financial statements.

accounting entries. This contributes to the federal government's inability
to determine the impact of these differences on amounts reported in the
consolidated financial statements.

o  	The federal government did not have an adequate process to identify
and report items needed to reconcile the operating results, which for
fiscal year 2003 showed a net operating cost of $665 billion, to the
budget results, which for the same period showed a unified budget deficit
of $374.8 billion.

o  	The consolidated financial statements include certain financial
information for the executive, legislative, and judicial branches, to the
extent that federal agencies within those branches have provided Treasury
such information. However, there are undetermined amounts of assets,
liabilities, costs, and revenues that are not included, and the federal
government did not provide evidence or disclose in the consolidated
financial statements that such excluded financial information was
immaterial.

o  	Treasury lacks an adequate process to ensure that the financial
statements, related notes, Stewardship Information, and Supplemental
Information are presented in conformity with GAAP. We found that certain
financial information required by GAAP was not disclosed in the
consolidated financial statements. Treasury did not provide us with
documentation of its rationale for excluding this information. As a result
of this and certain material deficiencies noted above, we were unable to
determine if the missing information was material to the consolidated
financial statements.

                           Other Material Weaknesses

In addition to the material deficiencies noted above, we found four other
material weaknesses in internal control as of September 30, 2003: (1)
several federal agencies continue to have deficiencies in the processes
and procedures used to estimate the costs of their lending programs and
value their related loans receivable; (2) most federal agencies have not
reported the magnitude of improper payments in their programs and
activities; (3) federal agencies have not yet fully institutionalized
comprehensive security management programs; and (4) material internal
control weaknesses and systems deficiencies continue to affect the federal
government's ability to effectively manage its tax collection activities.

Loans Receivable and Loan Guarantee Liabilities

Improper Payments

In general, federal agencies continue to make progress in reducing the
number of material weaknesses and reportable conditions9 related to their
lending activities. However, significant deficiencies in the processes and
procedures used to estimate the costs of certain lending programs and
value the related loans receivable still remain. The most notable
deficiencies existed at the Small Business Administration (SBA), which,
while improved from last year, continues to have a material weakness
related to this area. For example, SBA did not adequately document its
estimation methodologies, lacked the management controls necessary to
ensure that appropriate estimates were prepared and reported based on
complete and accurate data, and could not fully support the reasonableness
of the costs of its lending programs and valuations of its loan portfolio.
SBA's material weakness plus deficiencies at other federal credit agencies
relating to the processes and procedures for estimating credit program
costs continue to adversely affect the government's ability to support
annual budget requests for these programs, make future budgetary
decisions, manage program costs, and measure the performance of lending
activities.

Across the federal 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.10 While
complete information on the magnitude of improper payments is not yet
available, based on available data, OMB has estimated that improper
payments exceed $35 billion annually. Many improper payments occur in
federal programs that are administered by entities other than the federal
government, such as states. Improper payments often result from a lack of
or an inadequate system of internal controls. Although the President's
Management Agenda includes an initiative to reduce improper payments, most
federal agencies have not reported the magnitude of improper payments in
their programs and activities.

9Reportable conditions are matters coming to our attention that, in our
judgment, should be communicated because they represent significant
deficiencies in the design or operation of internal control that could
adversely affect the federal government's ability to meet the internal
control objectives relating to financial reporting and compliance with
laws and regulations.

10Improper payments include inadvertent errors, such as duplicate payments
and miscalculations, payments for unsupported or inadequately supported
claims, payments for services not rendered, payments to ineligible
beneficiaries, and payments resulting from fraud and abuse by program
participants and/or federal employees.

                              Information Security

The Improper Payments Information Act of 2002 provides for federal
agencies to estimate and report on their improper payments.11 It requires
federal agencies to (1) annually review programs and activities that they
administer to identify those that may be susceptible to significant
improper payments, (2) estimate improper payments in susceptible programs
and activities, and (3) provide reports to the Congress that discuss the
causes of improper payments identified and the status of actions to reduce
them. In accordance with the legislation, OMB issued guidance for federal
agencies' use in implementing the act. Among other things, the guidance
requires federal agencies to report on their improper payment-related
activities in the Management Discussion and Analysis section of their
annual Performance and Accountability Reports (PAR). While the act does
not require such reporting by all federal agencies until fiscal year 2004,
OMB required 44 programs and 14 CFO Act agencies to report improper
payment information in their fiscal year 2003 PARs. Our preliminary review
of the PARs found that 12 of the 14 agencies reported improper payment
amounts for 27 of the 44 programs identified in the guidance. We also
found that, for the programs where improper payments were identified, the
reports often contained information on the causes of the payments but
little information that addressed the other reporting requirements cited
in the legislation.

Although progress has been made, serious and widespread information
security weaknesses continue to place federal assets 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.
GAO has reported information security as a high-risk area across
government since February 1997. Such information security weaknesses could
result in compromising the reliability and availability of data that are
recorded in or transmitted by federal financial management systems. A
primary reason for these weaknesses is that federal agencies have not yet
fully institutionalized comprehensive security management programs, which
are critical to identifying information security weaknesses, resolving
information security problems, and managing information security risks on
an ongoing basis. The Congress has shown continuing interest in addressing
these risks, as evidenced by recent hearings on information security and

11Pub. L. No. 107-300, 116 Stat. 2350. The act's reporting requirement
applies only to an agency program or activity with estimated improper
payments exceeding $10 million.

                           Tax Collection Activities

enactment of the Federal Information Security Management Act of 200212 and
the Cyber Security Research and Development Act.13 In addition, the
administration has taken important actions to improve information
security, such as integrating information security into the Executive
Branch Management Scorecard.14

Material internal control weaknesses and systems deficiencies continue to
affect the federal government's ability to effectively manage its tax
collection activities.15 Due to errors and delays in recording activity in
taxpayer accounts, taxpayers were not always credited for payments made on
their taxes owed, which could result in undue taxpayer burden. In
addition, the federal 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.

12Title III of the E-Government Act of 2002, Pub. L. No. 107-347, 116
Stat. 2899.

13Pub. L. No. 107-305, 116 Stat. 2367 (2002).

14The Executive Branch Management Scorecard highlights agencies' progress
in achieving management and performance improvements embodied in the
President's Management Agenda.

15U.S. General Accounting Office, Financial Audit: IRS's Fiscal Years 2003
and 2002 Financial Statements, GAO-04-126 (Washington, D.C.: Nov. 13,
2003).

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