Financial Audit: Restatements to the Department of Agriculture's 
Fiscal Year 2003 Consolidated Financial Statements (25-JAN-06,	 
GAO-06-254R).							 
                                                                 
The Secretary of the Treasury, in coordination with the Director 
of the Office of Management and Budget (OMB), is required to	 
annually prepare and submit audited financial statements of the  
U.S. government to the President and Congress. We are required to
audit these consolidated financial statements (CFS) and report on
the results of our work. An issue meriting concern and close	 
scrutiny that emerged during our fiscal year 2004 CFS audit was  
the growing number of Chief Financial Officers (CFO) Act agencies
that restated certain of their financial statements for fiscal	 
year 2003 to correct errors. Errors in financial statements can  
result from mathematical mistakes, mistakes in the application of
accounting principles, or oversight or misuse of facts that	 
existed at the time the financial statements were prepared.	 
Frequent restatements to correct errors can undermine public	 
trust and confidence in both the entity and all responsible	 
parties. Further, when restatements do occur, it is important	 
that financial statements clearly communicate, and readers of the
restated financial statements understand, that the financial	 
statements originally issued by management in the previous year  
and the opinion thereon should no longer be relied on and instead
the restated financial statements and related auditor's opinion  
should be used. Because of the varying nature and circumstances  
surrounding the restatements, we are issuing a number of separate
reports on the matter. This report communicates our observations 
regarding the Department of Agriculture's (USDA) fiscal year 2003
restatements. Going forward, we hope that the lessons learned	 
from the fiscal year 2003 restatements, together with our	 
recommendations, will help (1) USDA avoid the need for		 
restatements to its future financial statements and ensure the	 
adequacy of the disclosure and presentation of audit results and 
any restatements and (2) ensure that USDA's Office of Inspector  
General (OIG) and other auditors apply appropriate audit	 
procedures in future audits so that similar errors, which caused 
the original fiscal year 2003 financial statements to be	 
misstated, as noted in this report, are identified before the	 
financial statements are issued. We reviewed four key areas with 
respect to the restatements of USDA's fiscal year 2003 financial 
statements: (1) the nature and cause of the errors that 	 
necessitated the restatements, including planned corrective	 
actions by the agency and its auditors; (2) the timing of	 
communicating the material misstatement to users of the financial
statements; (3) the extent of transparency exhibited in 	 
disclosing the nature and impact of the material misstatement in 
the financial statements and the reissued auditor's report; and  
(4) audit issues that contributed to the failure to detect the	 
errors that necessitated the restatements during the audit of the
agency's fiscal year 2003 financial statements. 		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-254R					        
    ACCNO:   A45697						        
  TITLE:     Financial Audit: Restatements to the Department of       
Agriculture's Fiscal Year 2003 Consolidated Financial Statements 
     DATE:   01/25/2006 
  SUBJECT:   Accounting errors					 
	     Accounting standards				 
	     Auditing procedures				 
	     Auditing standards 				 
	     Financial statement audits 			 
	     Financial statements				 
	     Internal controls					 
	     Reporting requirements				 
	     Transparency					 

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GAO-06-254R

     

     * Material Error Was Not Detected Due to a Lack of Key Interna
     * Audit Procedures Were Not Adequately Designed to Detect the
     * Material Error Resulted from a Lack of Key Internal Control
     * Audit Procedures Did Not Detect the Material Error on FCIC's
     * Material Error Resulted from Ineffective Internal Control Pr
     * Audit Procedures Were Not Effectively Implemented to Detect
     * PDF6-Ordering Information.pdf
          * Order by Mail or Phone

January 26, 2006

Mr. Charles R. Christopherson, Jr.

Chief Financial Officer

Department of Agriculture

The Honorable Phyllis K. Fong

Inspector General

Department of Agriculture

Subject: Financial Audit: Restatements to the Department of Agriculture's
Fiscal Year 2003 Consolidated Financial Statements

As you know, the Secretary of the Treasury, in coordination with the
Director of the Office of Management and Budget (OMB), is required to
annually prepare and submit audited financial statements of the U.S.
government to the President and Congress. We are required to audit these
consolidated financial statements (CFS) and report on the results of our
work.1 An issue meriting concern and close scrutiny that emerged during
our fiscal year 2004 CFS audit was the growing number of Chief Financial
Officers (CFO) Act agencies that restated2 certain of their financial
statements for fiscal year 2003 to correct errors.3 Errors in financial
statements can result from mathematical mistakes, mistakes in the
application of accounting principles, or oversight or misuse of facts that
existed at the time the financial statements were prepared. Frequent
restatements to correct errors can undermine public trust and confidence
in both the entity and all responsible parties. Further, when restatements
do occur, it is important that financial statements clearly communicate,
and readers of the restated financial statements understand, that the
financial statements originally issued by management in the previous year
and the opinion thereon should no longer be relied on and instead the
restated financial statements and related auditor's opinion should be
used.

1The Government Management Reform Act of 1994 has required such reporting,
covering the executive branch of government, beginning with financial
statements prepared for fiscal year 1997. 31 U.S.C. S: 331 (e). The
federal government has elected to include certain financial information on
the legislative and judicial branches in the CFS as well.

2A financial statement restatement occurs when an entity either
voluntarily or prompted by its auditors or regulators revises public
financial information that has previously been reported.

3According to Federal Accounting Standards Advisory Board, Statement of
Federal Financial Accounting Standards (SFFAS) No. 21, Reporting
Corrections of Errors and Changes in Accounting Principles, prior period
financial statements presented should be restated only to correct errors
that caused such statements to be materially misstated.

Eleven of the 23 CFO Act agencies4 restated certain of their financial
statements for fiscal year 2003. Five CFO Act agencies had restatements in
fiscal year 2003 covering their fiscal year 2002 financial statements.
Three CFO Act agencies had restatements covering both years. We noted that
the extent of the restatements to CFO Act agencies' fiscal year 2003
financial statements varied from agency to agency, ranging from correcting
two line items on one agency's balance sheet to correcting numerous line
items on several of another agency's financial statements. In some cases,
the net operating results of an agency were affected by the restatement.
The amounts of the agencies' restatements ranged from several million
dollars to more than $91 billion.

Nine of the 11 agencies that had restatements for fiscal year 2003
received unqualified opinions on their originally issued fiscal year 2003
financial statements. The auditors for 6 of these 9 agencies issued
unqualified opinions on the restated financial statements, replacing the
previous unqualified opinions on the respective agencies' original fiscal
year 2003 financial statements. The auditors for 2 of these 9 withdrew
their unqualified opinions on the fiscal year 2003 financial statements
and issued other than unqualified opinions on the respective agencies'
restated fiscal year 2003 financial statements because they could not
determine whether there were any additional misstatements and the effect
of any such misstatements on the restated fiscal year 2003 financial
statements. For the remaining agency, the principal auditor of the
agency's fiscal year 2004 financial statements was not the principal
auditor of the agency's fiscal year 2003 financial statements, and an
audit opinion on the agency's restated fiscal year 2003 financial
statements was not issued.

Our review focused on the nine agencies with restatements for fiscal year
2003 that received unqualified opinions on their originally issued fiscal
year 2003 financial statements.5 These were the Department of Agriculture
(USDA), Department of State, Department of Justice, Department of
Transportation, Department of Health and Human Services, General Services
Administration, National Science Foundation, Nuclear Regulatory
Commission, and Office of Personnel Management.

Because of the varying nature and circumstances surrounding the
restatements, we are issuing a number of separate reports on the matter.
This report communicates our observations regarding USDA's fiscal year
2003 restatements. Going forward, we hope that the lessons learned from
the fiscal year 2003 restatements, together with our recommendations, will
help (1) USDA avoid the need for restatements to its future financial
statements and ensure the adequacy of the disclosure and presentation of
audit results and any restatements and (2) ensure that USDA's Office of
Inspector General (OIG) and other auditors apply appropriate audit
procedures in future audits so that similar errors, which caused the
original fiscal year 2003 financial statements to be misstated, as noted
in this report, are identified before the financial statements are issued.

4The Federal Emergency Management Agency (FEMA) was transferred to the
Department of Homeland Security (DHS) effective March 1, 2003. With this
transfer, FEMA was no longer required to prepare and have audited
stand-alone financial statements under the CFO Act, leaving 23 CFO Act
agencies for the remainder of fiscal year 2003 and for fiscal year 2004.
The DHS Financial Accountability Act, Pub. L. No. 108-330, 118 Stat. 1275
(Oct. 16, 2004), added DHS to the list of CFO Act agencies, increasing the
number of CFO Act agencies again to 24 beginning in fiscal year 2005.

5The two agencies that had restatements for fiscal year 2003 but did not
receive unqualified opinions on their originally issued fiscal year 2003
financial statements were the Department of Defense and the Small Business
Administration.

We reviewed four key areas with respect to the restatements of USDA's
fiscal year 2003 financial statements: (1) the nature and cause of the
errors that necessitated the restatements, including planned corrective
actions by the agency and its auditors; (2) the timing of communicating
the material misstatement to users of the financial statements; (3) the
extent of transparency6 exhibited in disclosing the nature and impact of
the material misstatement in the financial statements and the reissued
auditor's report; and (4) audit issues that contributed to the failure to
detect the errors that necessitated the restatements during the audit of
the agency's fiscal year 2003 financial statements.

Results in Brief

Material errors identified at three of USDA's component agencies led to
the restatement of four of the five statements in USDA's originally issued
fiscal year 2003 consolidated financial statements.7 The material errors
resulted from the lack of or ineffective implementation of several key
internal control procedures related to (1) recording appropriations, (2)
the proper reporting of material items on the Statement of Financing, and
(3) processing nonroutine journal vouchers. We believe that more effective
audit procedures applied by USDA's auditors could have detected the
material errors noted in this report.

In addition, certain aspects of the footnote disclosure and financial
statement presentation relating to the restatements could be
misinterpreted. Specifically, the footnote disclosure related to the
restatements was titled Prior Period Adjustments, which could be
misinterpreted since most of the corrections discussed in the note were
not prior period adjustments.8 USDA's presentation of its fiscal year 2004
Consolidated Statement of Changes in Net Position may also be
misinterpreted because the fiscal year 2004 beginning balances did not
agree with the restated fiscal year 2003 ending balances. Further, USDA
asserted in its fiscal year 2004 Management Discussion and Analysis (MD&A)
that the agency has sustained

6Transparency is the full, accurate, and timely disclosure of information.

7USDA restated certain of its originally issued fiscal year 2003
consolidated financial statements to correct for material errors
identified at its Food and Nutrition Service, Forest Service, and Risk
Management Agency's Federal Crop Insurance Corporation. According to USDA
officials, since USDA was already restating the fiscal year 2003 financial
statements for material errors, it also decided to correct for less
significant errors that had been identified. Specifically, certain less
significant errors identified at Animal and Plant Health Inspection
Service, Credit Commodity Corporation, Forest Service, Natural Resources
Conservation Service, and the departmentwide level were also included in
the restatement note disclosure.

8SFFAS No. 21 defines a prior period adjustment as a correction for an
error that occurred in and whose cumulative effect is attributable to
periods not presented in the current financial statements.

unqualified or "clean" opinions on its financial statements since fiscal
year 2002 but did not specifically acknowledge in its MD&A that it
restated both originally issued fiscal years 2003 and 2002 financial
statements for material errors. In addition, USDA did not completely
disclose in the MD&A the nature and extent of the restatements to its
originally issued fiscal year 2003 financial statements. We believe that
not including this information in the MD&A could be misleading. Although
the OIG told us that it believed disclosure of such information in its
audit report was not necessary, in our view, such disclosure could have
reduced the potential for a reader to be misled.

We are making three recommendations on this matter, including two
recommendations to USDA's CFO. We recommend that USDA's CFO ensure (1)
that procedures to prevent any similar errors from occurring and going
undetected in future years are effectively implemented and (2) for future
years, the adequacy of the disclosure and presentation of audit results
and any restatements. We are also making a recommendation to USDA's
Inspector General to ensure, in conjunction with the contracted
independent public accountant (IPA) if one is used, that audit procedures
are effectively implemented to test for any (1) improperly recorded
appropriations transactions in the general ledger, (2) improperly reported
material items on the Statement of Financing, and (3) incorrect nonroutine
journal vouchers.

In commenting on a draft of this report, USDA's CFO expressed confidence
that his office's current plans and efforts would ensure that its
consolidated financial statements are accurate and timely and contain
adequate disclosure. In a separate letter, the Inspector General concurred
with our recommendations.

Background

In conducting the fiscal year 2004 audit of the CFS, we reviewed the 23
CFO Act agencies' performance and accountability reports for possible
restatements and identified 11 agencies that had restated certain of their
audited fiscal year 2003 financial statements.

The primary intended users of federal agencies' financial reports are
citizens, Congress, federal executives, and federal program managers.9
Each of these groups may use federal agencies' financial statements to
satisfy their specific needs. Citizens are interested in many aspects of
the federal government, particularly federal programs that affect their
financial well-being. Congress is interested in monitoring and assessing
the efficiency and effectiveness of federal programs. Federal executives,
such as central agency officials at OMB and the Department of the Treasury
(Treasury), are interested in federal financial statements to assist the
President of the United States. OMB assists the President in overseeing
the preparation of the federal budget by formulating the President's
spending plans, evaluating the effectiveness of agency programs, assessing
competing funding demands among agencies, and setting funding priorities.
Treasury assists the President in managing the finances of the federal
government and prepares the CFS, which are based on audited financial
statements prepared by federal agencies. We audit the CFS and report on
the results of our audit. Finally, federal program managers use agency
financial statements as tools for managing their operations within the
limits of the spending authority granted by Congress.

9Federal Accounting Standards Advisory Board, Statement of Federal
Financial Accounting Concepts No. 1, Objectives of Federal Financial
Reporting.

The primary accounting and auditing standards that apply to restatement
disclosures by federal entities are Federal Accounting Standards Advisory
Board's Statement of Federal Financial Accounting Standards (SFFAS) No.
21, and the American Institute of Certified Public Accountants' (AICPA)
Codification of Auditing Standards, AU section 561, Subsequent Discovery
of Facts Existing at the Date of the Auditor's Report.10

Objective, Scope, and Methodology

The objective of our review of restatements of USDA's fiscal year 2003
consolidated financial statements was to determine the nature and cause of
the errors, the transparency and timing of communicating the material
misstatements, any audit issues relating to such misstatements, and any
actions being taken to help preclude similar errors from occurring in the
future.

We reviewed the nature and causes of the restatements, and we also
examined corrective actions taken by USDA to help preclude similar errors
from occurring in the future. We interviewed the preparers and auditors of
USDA's fiscal year 2003 consolidated and certain component agencies'
financial statements, including staff from the agency's OIG, and we
obtained and reviewed relevant audit documentation. Because USDA's OIG
contracted with various IPAs for the audits of certain USDA component
agencies' financial statements, such as the Forest Service and Risk
Management Agency's Federal Crop Insurance Corporation, we also had to
expand our contacts to include such IPAs. Our work was not designed to and
we did not test the accuracy or appropriateness of the restatements.

In our review, we considered certain accounting and auditing standards,
including SFFAS No. 21; OMB Bulletin 01-09, Form and Content of Agency
Financial Statements;11 the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 16, Prior Period
Adjustments; and the AICPA Codification of Auditing Standards, AU section
329, Analytical Procedures, AU section 420, Consistency of Application of
Generally Accepted Accounting Principles, AU section 508, Reports on
Audited Financial Statements, and AU section 561.

10Generally accepted government auditing standards incorporate AICPA
reporting standards and Statements on Auditing Standards unless the
Comptroller General of the United States excludes them by formal
announcement.

11Office of Management and Budget, Bulletin 01-09, Form and Content of
Agency Financial Statements (Washington, D.C.: Sept. 25, 2001).

We performed our review of the restatements of USDA's fiscal year 2003
consolidated financial statements from December 2004 to October 2005 in
accordance with U.S. generally accepted government auditing standards.

We requested comments on a draft of this report from USDA's CFO and
Inspector General or their designees. Written comments from USDA's CFO and
Inspector General are reprinted in enclosures I and II, respectively, and
are discussed in the Agency Comments section.

Issues Related to Restatements of USDA's Fiscal Year 2003 Consolidated
Financial Statements

USDA restated four of the five statements in its originally issued fiscal
year 2003 consolidated financial statements to reflect material errors
detected at three of its component agencies. These errors affected USDA's
originally issued fiscal year 2003 Consolidated Statement of Changes in
Net Position, Consolidated Balance Sheet, Combined Statement of Budgetary
Resources, and Consolidated Statement of Financing.

During our review of the restatements, we identified the following areas
that need improvement:

           o  internal control procedures over recording appropriations,
           o  internal control procedures related to the proper reporting of
           material items on the Statement of Financing,
           o  internal control procedures over processing nonroutine journal
           vouchers,
           o  audit procedures for detecting errors similar to those
           discussed throughout this report, and
           o  disclosure and presentation of the restatements.

These issues are discussed in detail below.

Material Error in Recording Certain Appropriations  General Ledger
Accounts

USDA restated its originally issued fiscal year 2003 Consolidated
Statement of Changes in Net Position and its Consolidated Balance Sheet
for an incorrect recording of Appropriations Used in fiscal year 2003 by
its Food and Nutrition Service (FNS). In our view, the approximately $4.7
billion error was not detected by FNS due to a lack of key internal
control procedures over recording appropriations.

USDA and USDA's OIG officials provided us the following perspectives on
the events that led to the needed restatements. FNS incorrectly recorded a
transfer of intragovernmental funds as Unexpended Appropriations -
Transfers - In during fiscal year 2003, expended those moneys during the
fiscal year, and incorrectly recorded the expenditures as Unexpended
Appropriations - Used in its general ledger. FNS recorded the transfer of
intragovernmental funds in such a manner because FNS's general ledger at
that time did not have the standard general ledger account Nonexpenditure
Financing Sources - Transfers - In. Later in fiscal year 2003, the Office
of the Chief Financial Officer (OCFO) implemented this standard general
ledger account to account for transfers of intragovernmental funds. In
late October 2003, FNS discovered and corrected the transfer recording
error by reclassifying the transfer of intragovernmental funds from
Unexpended Appropriations - Transfers - In to Nonexpenditure Financing
Sources - Transfers - In.12 However, FNS did not correct the accounting
entries related to expending those funds, which led to the need to restate
USDA's originally issued fiscal year 2003 Consolidated Statement of
Changes in Net Position and Consolidated Balance Sheet. It was not until
October 2004, during FNS's year-end analysis of its fiscal year 2004
financial statements that FNS determined that the fiscal year 2003
recording errors were not fully corrected.

A USDA OIG official told us that it was first notified of the material
error by FNS at the end of fiscal year 2004 and subsequently informed
USDA's OCFO that USDA would need to restate its originally issued fiscal
year 2003 Consolidated Statement of Changes in Net Position and
Consolidated Balance Sheet for the material error detected at FNS.13 The
error caused the ending balances for Cumulative Results of Operations and
Unexpended Appropriations on the fiscal year 2003 Consolidated Statement
of Changes in Net Position and Consolidated Balance Sheet to be materially
overstated and understated by approximately $4.7 billion, respectively.14
Although Total Net Position was unchanged, these two accounts represent
distinct components of net position. Specifically, according to Statements
of Federal Financial Accounting Concepts No. 2, Cumulative Results of
Operations generally includes the amounts accumulated over the years by an
entity from its financing sources less its expenses and losses, while
Unexpended Appropriations represents appropriations not yet obligated or
expended, including undelivered orders.

12According to Treasury's U.S. Standard General Ledger (USSGL) Supplement
No. S2 Treasury Financial Manual (Hyattsville, Md.: September 2002), the
Unexpended Appropriations - Transfers - In represents the amount of
unexpended appropriations from current or prior years that were
transferred in during the fiscal year, while Nonexpenditure Financing
Sources - Transfers - In represents funds transferred in, or to be
transferred in, that occur as a result of a nonexchange nonexpenditure
transaction. According to Federal Accounting Standards Advisory Board,
Original Pronouncements, a nonexchange transaction occurs when one party
involved in a transaction (1) receives value without giving or promising
value in return or (2) gives or promises value without receiving value in
return. GAO's Glossary of Terms Used in the Federal Budget Process,
GAO-05-734SP, states that for accounting and reporting purposes, a
nonexpenditure transfer includes transactions between appropriation and
fund accounts that do not represent payments for goods and services
received or to be received but rather serves only to adjust the amounts
available in the accounts for making payments.

13USDA officials stated that once notified of the error, they researched
whether other USDA component agencies had similar errors. According to the
officials, their research identified that USDA's Animal and Plant Health
Inspection Service and Natural Resources Conservation Service had similar
situations where they had improperly recognized Appropriations Used in the
approximate amounts of $311 million and $478 million, respectively.

14This is because the material error caused the Appropriations Used
component of Cumulative Results of Operations and the Appropriations Used
component of Unexpended Appropriations on USDA's originally issued fiscal
year 2003 Consolidated Statement of Changes in Net Position to be
materially overstated and understated by approximately $4.7 billion,
respectively.

  Material Error Was Not Detected Due to a Lack of Key Internal Control
  Procedures over Recording Appropriations

USDA officials told us that the FNS error was not detected during fiscal
year 2003 because the department did not have internal control procedures
requiring (1) a reconciliation of current year appropriations reported in
USDA's general ledger with Treasury's record of USDA's appropriations
accounts and (2) that any exceptions identified during the reconciliation
be adequately researched and resolved. According to the Treasury Financial
Manual (TFM),15  agencies (1) must compare their Fund Balance with
Treasury account16 in their internal ledgers with reports furnished by
Treasury17 and (2) should use guidelines in the TFM supplement, Fund
Balance with Treasury Reconciliation Procedures,18 as a basis for
tailoring procedures for their own operations. Specifically, this
supplement outlines generic operating procedures for reconciling the Fund
Balance with Treasury account, including performing a reconciliation that
involves comparing an agency's current year appropriations reported in the
agency's general ledger to Treasury's record of the agency's
appropriations accounts. Such a reconciliation and effective research
would have identified Nonexpenditure Financing Sources - Transfers - In
that were inappropriately classified as Unexpended Appropriations -
Transfers - In, which in turn, could have led to the identification of the
recording error in Unexpended Appropriations - Used. According to the TFM,
failure to implement effective and timely reconciliation procedures could
(1) increase the risks of fraud, waste, and mismanagement of funds; (2)
affect the federal government's ability to effectively monitor budget
execution; and (3) affect the federal government's ability to accurately
measure the full cost of its programs.

According to USDA officials, USDA formally established procedures in June
2005 requiring monthly reconciliations of certain19 current year
appropriations reported in USDA's general ledger with Treasury's record of
USDA's appropriations accounts and resolution of any identified
differences. This procedure is intended to provide reasonable assurance,
on a timely basis, that USDA's appropriations transactions are properly
recorded in its general ledger, by detecting and correcting errors similar
to those that led to the fiscal year 2003 restatement.

15Department of the Treasury, Treasury Financial Manual, vol. 1, pt. 2,
ch. 5100, I TFM 2-5100 (Hyattsville, Md.: Oct. 18, 1999).

16The Fund Balance with Treasury account is an asset account representing
the future economic benefits of moneys that agencies can spend for future
authorized transactions. Transactions, such as nonexpenditure transfers,
affect the Fund Balance with Treasury account.

17Treasury's Financial Management Service maintains a summary account for
each appropriation and fund showing transactions relating to
appropriations. For example, at the close of each month, agencies are
furnished FMS 6653, a ledger for each appropriation and fund account. The
ledger shows the opening balance, classified transactions for the month,
and the resultant closing balance as well as appropriation warrants
issued.

18Department of the Treasury, Fund Balance with Treasury Reconciliation
Procedures A Supplement to the Treasury Financial Manual, I TFM 2-5100
(November 1999).

19According to a USDA official, USDA's Controller Operations Division
Financial Reporting Branch performs the reconciliation for all of the USDA
component agencies it services.

  Audit Procedures Were Not Adequately Designed to Detect the Material Error in
  Certain Recorded Appropriations

USDA's OIG officials stated that the OIG's fiscal year 2003 audit
procedures did not detect the material error in Appropriations Used. In
addition, according to an OIG official, FNS did not timely notify the OIG
that the OCFO had implemented the above-noted standard general ledger
account. The OIG official stated that FNS informed the OIG that no changes
in accounting operations were made and that the OIG's various audit
procedures did not identify any information that contradicted what FNS had
told the OIG.

According to the Financial Audit Manual (FAM),20 the auditor should
perform audit procedures to test for all significant assertions21 in
significant financial statement line items and accounts. An OIG official
stated that the OIG performed audit procedures on funds FNS received
during its fiscal year 2003 audit, which included tracing funds to source
documents, but its procedures did not detect the material error.

The official stated that if an appropriate analytical procedure had been
performed during fiscal year 2003, then the material error would have been
detected. The FAM states that as required by AU 329, Analytical
Procedures, auditors must perform overall analytical procedures in order
to determine if the auditor has obtained an adequate understanding of all
fluctuations and relationships in the financial statements. According to
AU 329, analytical procedures involve comparisons of recorded amounts, or
ratios developed from recorded amounts, to expectations developed by the
auditor. The OIG official stated that the analytical procedure that could
have detected this material error was not performed during fiscal year
2003, but that the OIG included such an analytical procedure during its
fiscal year 2004 and fiscal year 2005 audits. Specifically, according to
an OIG official, the OIG performed an analytical procedure to calculate
the cumulative results of operations independently and then compared the
expected results with amounts reported in the financial statements.

Material Error Due to Improperly Reported Material Items on the Statement
of Financing

In fiscal year 2004, USDA restated its originally issued fiscal year 2003
Combined Statement of Budgetary Resources and Consolidated Statement of
Financing to address a material error that occurred at USDA's Risk
Management Agency's Federal Crop Insurance Corporation (FCIC) when FCIC
tried to correct, per OMB's advisement, the way it recorded Obligations
Incurred.

20GAO/President's Council on Integrity and Efficiency, Financial Audit
Manual, GAO-01-765G (Washington, D.C.: July 2001), updated by GAO-04-1015G
and GAO-04-942G (July 2004).

21Financial statement assertions are management representations that are
embodied in financial statement components. The assertions can be either
explicit or implicit and can be classified into the following categories:
(1) existence or occurrence, (2) completeness, (3) rights and obligations,
(4) valuation or allocation, and (5) presentation and disclosure.

According to an FCIC official, FCIC received a letter from OMB, dated
December 19, 2002, requesting that FCIC properly record insurance fund
program obligations incurred during the fiscal year when individual claims
are approved to be paid for insured events. According to OMB's letter,
FCIC instead was recording estimated obligations during the fiscal year in
which the insured event occurred, which potentially placed FCIC in the
untenable position of violating the Anti-Deficiency Act22 should actual
claims exceed estimates. The FCIC official stated that as a result of
OMB's letter, FCIC modified the way it recorded Obligations Incurred
before the fiscal year 2002 financial statements were issued; however,
FCIC failed to remove all of its estimated accrued obligations (i.e.,
claims not yet approved to be paid for insured events) from the fiscal
year 2002 beginning obligated balance. The FCIC official told us that as a
result, an incorrect fiscal year 2002 ending obligated balance was carried
forward to become the fiscal year 2003 beginning balance. This material
error caused the Beginning of Period Obligated Balance, Net and Beginning
of Period Unobligated Balance on FCIC's originally issued fiscal year 2003
Statement of Budgetary Resources to be materially overstated and
understated by approximately $1.2 billion, respectively. In addition, due
to the same error, Obligations Incurred on FCIC's originally issued fiscal
year 2003 Statement of Budgetary Resources and Statement of Financing were
materially understated by approximately $1.2 billion.23

According to OMB Bulletin 01-09, the Statement of Financing (1) is the
bridge between an entity's budgetary and proprietary24 accounting25 and
(2) articulates the relationships between net obligations derived from an
entity's budgetary accounts and net cost of operations derived from the
entity's proprietary accounts by identifying and explaining key
differences between the two numbers. As stated in

SFFAS No. 7, the Statement of Financing reconciles the budgetary resources
obligated for a federal entity's programs and operations (i.e.,
Obligations Incurred) to the net cost of operating that entity (i.e., Net
Cost of Operations). As a result, because Obligations Incurred was
materially understated, the Net Cost of Operations reported on FCIC's
draft of its fiscal year 2003 Statement of Financing did not match the Net
Cost of Operations reported on FCIC's draft of its fiscal year 2003
Statement of Net Cost. According to an FCIC official, in fiscal year 2003,
FCIC was aware that the Net Cost of Operations as reported on both draft
statements did not match but did not research the issue to determine the
exact accounting entries necessary to correct the error. The official
stated that instead of researching the issue, FCIC made an unsupported
adjustment to Other Components Requiring or Generating Resources in Future
Periods on the Statement of Financing in order to force the Net Cost of
Operations reported on FCIC's draft of its fiscal year 2003 Statement of
Financing to match Net Cost of Operations reported on FCIC's draft of its
fiscal year 2003 Statement of Net Cost. While this adjustment eliminated
the imbalance between Net Cost of Operations reported on the two
statements, it also caused Other Components Requiring or Generating
Resources in Future Periods to be overstated by approximately $1.2
billion.

2231 U.S.C. S: 1341.

23This is because there is a relationship between Beginning of Period
Obligated Balance, Net and Obligations Incurred such that if there is an
overstatement of the Beginning of Period Obligated Balance, Net, then,
provided no other errors have occurred on the Statement of Budgetary
Resources, Obligations Incurred would be understated.

24Proprietary accounts provide the information for the financial
statements based on Federal Accounting Standards Advisory Board standards
and are intended to provide an economic, rather than a budgetary, measure
of operations and resources.

25Certain transactions affect both proprietary and budgetary accounts.
Although budgetary and proprietary accounting information are
complementary, both the types of information and the timing of their
recognition are different, which is caused by differences in the basis of
accounting. For example, under budgetary accounting, a federal entity
records an obligation when it places a purchase order or signs a contract.
Under proprietary accounting, liabilities are recognized when goods and
services are received or are recognized based on an estimate of work
completed under a contract or agreement.

The material error at FCIC also affected USDA's consolidated financial
statements. Specifically, the material error caused the same line items,
as noted above, to be materially misstated on USDA's originally issued
fiscal year 2003 Combined Statement of Budgetary Resources and
Consolidated Statement of Financing. This material error resulted in
USDA's originally issued fiscal year 2003 Combined Statement of Budgetary
Resources showing that USDA had fewer budgetary resources than it actually
did.

  Material Error Resulted from a Lack of Key Internal Control Procedures Related
  to the Proper Reporting of Material Items on FCIC's Statement of Financing

FCIC's IPA's audit report, dated November 4, 2004, found that FCIC's
preparation of its Statement of Financing needed improvements.
Specifically, the IPA found that FCIC made unsupported adjustments to its
originally issued fiscal year 2003 Statement of Financing instead of
performing research and taking corrective action. In this case, the fiscal
year 2003 year-end unsupported adjustment, which was made in order to
force the Net Cost of Operations reported on FCIC's draft of its fiscal
year 2003 Statement of Financing to match Net Cost of Operations reported
on FCIC's draft of its fiscal year 2003 Statement of Net Cost, was
incorrect.

FCIC's IPA noted in its independent auditor's report that this material
error resulted from FCIC's lack of key internal control procedures related
to the proper reporting of material items on the Statement of Financing.
Specifically, the IPA noted that FCIC did not have procedures requiring
its accounting staff to research and identify why Net Cost of Operations
as reported on FCIC's draft of its fiscal year 2003 Statement of Financing
did not match Net Cost of Operations as reported on FCIC's draft of its
fiscal year 2003 Statement of Net Cost. As a result, FCIC made the
unsupported manual adjustment to  force the Net Cost of Operations
reported on the two draft statements to match. If such above-noted
research procedures had been performed, we believe that FCIC could have
identified and corrected the error in Beginning of Period Obligated
Balance, Net and Beginning of Period Unobligated Balances,  which caused
Obligations Incurred to be materially understated and, in turn, could have
prevented the need to make an unsupported adjustment to Other Components
Requiring or Generating Resources in Future Periods on the Statement of
Financing, which created an additional error.

According to our Internal Control Management and Evaluation Tool,26 when
assessing whether necessary control activities are in place and being
applied, agencies should consider if timely action is taken on exceptions,
implementation problems, or information that requires follow-up. Such
consideration may have identified that FCIC lacked key internal control
procedures requiring timely action be taken to investigate and resolve
identified exceptions, such as the above-noted exception that led to
FCIC's fiscal year 2003 material error. Failure to timely investigate and
resolve exceptions, implementation problems, or information that requires
follow-up could, among other things, (1) increase the risks of fraud,
waste, and mismanagement of funds and (2) result in materially inaccurate
reporting of financial information.

In April 2005, FCIC established internal control procedures related to
reporting of material items on FCIC's Statement of Financing. These
procedures require FCIC's financial management staff to (1) prepare
supporting documentation for manual adjustments to FCIC's Statement of
Financing; (2) increase their review of the financial statements,
including incorporating analytical analyses of the relationships among
balances into the review process; and (3) attend additional training on
budgetary accounting and the related statements. In addition, the newly
established procedures require an accountant to review FCIC's Statement of
Financing for consistency and accuracy with other financial statements,
such as FCIC's Statement of Net Cost and Statement of Budgetary Resources.
These procedures are intended to support the proper reporting of material
line items on FCIC's Statement of Financing  so that errors, similar to
those noted above, are identified and corrected before the financial
statements are issued.

  Audit Procedures Did Not Detect the Material Error on FCIC's Statement of
  Financing

FCIC's IPA for fiscal year 2003 stated that its audit procedures did not
detect the material error in FCIC's fiscal year 2003 reported unobligated
and obligated beginning account balances. FCIC's IPA for fiscal year 2003
stated that it was not the IPA for fiscal year 2002. Accordingly, FCIC's
IPA for fiscal year 2003 told us that it reviewed the predecessor
auditor's working papers to determine the nature, timing, and extent of
the fiscal year 2003 audit procedures that the IPA would perform over
opening balances. FCIC's IPA for fiscal year 2003 told us that it relied
upon the work of the previous auditor with respect to the fiscal year 2002
ending obligated and unobligated balances that were, in turn, the
beginning balances for fiscal year 2003, which were subsequently
determined to be materially overstated and understated, respectively.

In addition, FCIC's IPA for fiscal year 2003 stated that it had designed
and applied audit procedures in fiscal year 2003 to analyze differences
between budgetary and proprietary accounts. However, FCIC's IPA for fiscal
year 2003 stated that such audit procedures did not identify the material
error in Obligations Incurred, which resulted from improperly recorded
obligations in fiscal year 2002. Although we requested FCIC's IPA's audit
documentation related to its review of FCIC's fiscal year 2003 Statement
of Financing, we were not provided with such information. Without
documentation of the IPA's audit procedures in this area, we are unable to
determine whether the lack of detection of the material error was a result
of inadequate design or implementation of audit procedures.

26GAO, Internal Control Management and Evaluation Tool, GAO-01-1008G
(Washington, D.C.: August 2001).

We believe that analytical procedures could also have detected the error.
Specifically, as previously mentioned, the FAM states that as required by
AU 329, the auditor must perform overall analytical procedures in order to
determine if the auditor has obtained an adequate understanding of all
fluctuations and relationships in the financial statements. The FAM states
that the auditor should understand the causes of fluctuations and
determine if its understanding is consistent with other audit evidence; if
the auditor is unable to do so, the auditor should perform appropriate
procedures to obtain an understanding or to resolve any inconsistencies.
According to the FAM, one such analytical procedure involves comparing
current year amounts in the financial statements with comparative
financial information (i.e., amounts reported in prior years). We believe
that this type of analytical procedure could have identified the
significant increase in Other Components Requiring or Generating Resources
in Future Periods, which resulted from the above-noted unsupported
adjustment. Specifically, the reported balance for Other Components
Requiring or Generating Resources in Future Periods on the Statement of
Financing increased from $148 million for fiscal year 2002 to $1,520
million for fiscal year 2003. In our view, an investigation of the cause
of this increase could have detected the above-noted material error.

Both FCIC's IPA and USDA's OIG stated that they plan to dedicate more
resources to ensure the proper reporting of material items on the
Statement of Financing. However, it is going to be important that in
future years, audit procedures are performed to identify and investigate
any material unsupported adjustments made to FCIC's as well as USDA's
consolidated financial statements.

USDA Restated Its Combined Statement of Budgetary Resources Due to an
Incorrect Nonroutine Journal Voucher

In fiscal year 2004, USDA restated its originally issued fiscal year 2003
Combined Statement of Budgetary Resources to correct for a material
accounting error made by

USDA's Forest Service (FS).27 According to an FS official, the restatement
to USDA's fiscal year 2003 Combined Statement of Budgetary Resources
corrected an approximately $178 million overstatement of the ending
unobligated balance, an approximately $16 million overstatement of Net
Transfers, and an approximately $193 million understatement of Total
Obligated Balance, Net, End of Period. The FS official stated that the
error was caused by an incorrect, nonroutine journal voucher28 processed
by FS in October 2003 and recorded in the general ledger activity for
fiscal year 2003.

27USDA's consolidated financial statements were also corrected for less
significant errors identified at FS. According to the OIG's audit report,
FS corrected errors for alignment of budgetary and proprietary account
relationships and posting errors, unsupported balances in various suspense
and deposit clearing funds, Fund Balance with Treasury and associated
custodial liability, and certain revenue transactions. According to FS,
the IPA, and the OIG, of the errors that were corrected, only the
nonroutine journal voucher, noted above, was material.

  Material Error Resulted from Ineffective Internal Control Procedures over
  Processing Nonroutine Journal Vouchers

FS's IPA stated that as a result of FS's fiscal year-end 2003 account
analyses, FS processed several nonroutine journal vouchers, including one
that incorrectly adjusted three budgetary accounts and led to the
restatement of USDA's originally issued fiscal year 2003 Combined
Statement of Budgetary Resources. According to an

FS official, inexperienced FS personnel used a nonroutine journal voucher
to adjust an out-of-balance condition between FS's budgetary accounts and
the corresponding financial information submitted to Treasury without
identifying the underlying cause of the out-of-balance condition and
without sufficient approval. In an FS memo to its IPA dated November 12,
2004, FS noted that it did not have properly designed and/or effective
internal control procedures to prevent and/or detect errors in the
processing of its financial transactions, primarily related to the
processing and approval of nonroutine transactions through the use of
journal vouchers.

According to our Standards for Internal Control in the Federal
Government,29 control activities, such as internal control procedures,
help to ensure that transactions are completely and accurately recorded.
Properly designed and effectively implemented internal control procedures
over processing nonroutine journal vouchers, which according to FS's IPA
is an inherently high-risk area, could have prevented or detected the
material error that led to the restatement of USDA's originally issued
fiscal year 2003 Combined Statement of Budgetary Resources. Failure to
have properly designed and effective internal control procedures over
processing nonroutine journal vouchers could, among other things, (1)
increase the risks of fraud, waste, and mismanagement of funds and (2)
result in materially inaccurate reporting of financial information.

An FS official stated that during fiscal year 2004, FS established new
internal control procedures requiring multiple supervisory reviews of
nonroutine journal vouchers with final approval by FS's CFO. These
procedures, if effectively implemented, should help ensure that nonroutine
journal vouchers are appropriate. According to FS's IPA, as of October 30,
2005, FS had not processed any nonroutine journal vouchers during fiscal
year 2005.

28According to an FS official, FS's nonroutine journal vouchers do not
follow the USSGL posting model logic, since nonroutine journal vouchers
allow for posting increases and decreases to any account in the general
ledger. The USSGL provides basic standard posting logic for financial
events across the federal government and illustrates both proprietary and
budgetary entries for each accounting event.

29GAO, Standards for Internal Control in the Federal Government,
GAO/AIMD-00-21.3.1 (Washington, D.C.: November 1999).

  Audit Procedures Were Not Effectively Implemented to Detect FS's Material
  Error

According to FS's IPA, its staff selected and reviewed the nonroutine
journal voucher that resulted in the material error, but did not identify
the above-noted problems related to the material error. According to the
FAM, there are many aspects of an audit that require technical judgments,
and the auditor should ensure that persons with adequate technical
expertise are available to make such decisions. FS's IPA stated that
starting in fiscal year 2004, it has staffed the audit with personnel more
experienced in budgetary accounting and reporting and plans to continue
staffing the

FS audit with similarly experienced personnel.

In addition, FS's IPA noted in its fiscal year 2004 audit documentation
that throughout fiscal year 2004, it tested FS's new internal control
procedures for processing nonroutine journal vouchers by sampling
nonroutine journal vouchers to determine whether they were accurately
prepared, properly supported, correctly posted, and properly reviewed and
approved.  As a result of its internal control testing, FS's IPA found
that (1) some journal vouchers were not accurately prepared, properly
supported, and correctly posted and (2) in some instances, FS personnel
had already identified the errors and made corrections. FS's IPA also
noted that it discussed all errors disclosed by its test work with FS, and
FS made appropriate corrections.

Disclosure and Presentation of USDA's Restatements Could Be Misinterpreted

Certain aspects of the footnote disclosure and financial statement
presentation relating to the restatements could be misinterpreted.
Specifically, the notes to USDA's comparative fiscal years 2004 and 2003
consolidated financial statements included a note disclosure titled Prior
Period Adjustments, which could be misinterpreted since most of the
corrections discussed in the note were not prior period adjustments as
defined by SFFAS No. 21. In addition, we found that USDA's presentation of
the restatements in its comparative fiscal years 2004 and 2003
consolidated financial statements could also be misinterpreted.
Specifically, on USDA's fiscal years 2004 and 2003 comparative
Consolidated Statement of Changes in Net Position, the fiscal year 2004
beginning balances did not agree with the restated fiscal year 2003 ending
balances, and amounts were reported in the fiscal year 2004 column as
prior period adjustments to the fiscal year 2004 beginning balances to
reflect the restated fiscal year 2003 ending balances. We believe that a
clearer presentation on USDA's fiscal years 2004 and 2003 comparative
Consolidated Statement of Changes in Net Position would have been to carry
forward the restated fiscal year 2003 ending balances and present them as
the fiscal year 2004 beginning balances instead of presenting prior period
adjustments in the fiscal year 2004 column.

Other Matters Related to the Disclosure of the Restatements

According to SFFAS No. 15, Management's Discussions and Analysis,
management should have great discretion regarding what to say in its MD&A,
but the pervasive requirement is that the MD&A not be misleading. USDA
asserted in its fiscal year 2004 MD&A that an unqualified financial
statement audit opinion indicates that a department's financial statements
are free of significant errors or misstatements. USDA also stated in its
MD&A that "in fiscal year 2002, USDA-and all its agencies-achieved their
first unqualified consolidated financial audit opinion in the Department's
140-year history ... USDA's clean audit opinion was sustained in fiscal
years 2003 and 2004." However, USDA did not specifically acknowledge in
the MD&A that its fiscal year 2003 and its fiscal year 2002 consolidated
financial statements, as originally issued, were both materially misstated
and subsequently restated. Furthermore, in its MD&A, USDA did not
completely disclose the nature and extent of the restatements to its
originally issued fiscal year 2003 financial statements. Specifically,
USDA disclosed in the MD&A only one of the three restatements discussed in
this report. We believe not including the above-noted information in the
MD&A could be misleading. Although the OIG told us that it believed
disclosure of such information in its audit report was not necessary, in
our view, such disclosure could have reduced the potential for a reader to
be misled.

Conclusions

The material errors in USDA's originally issued fiscal year 2003
consolidated financial statements could have been detected by more
effective internal controls and audit procedures. USDA corrected the
errors and issued restated financial statements. Going forward, it will be
important for USDA to ensure that corrective actions are taken to prevent
any similar errors from going undetected. In addition, for future years,
USDA should ensure the adequacy of the disclosure and presentation of
audit results and any restatements. Further, it will be important that
USDA's OIG and other auditors effectively implement audit procedures to
detect any similar errors in the future.

Recommendations for Executive Action

We are making three recommendations on this matter, including two
recommendations to USDA's CFO. We recommend that USDA's CFO ensure (1)
that procedures to prevent any errors similar to those that resulted in
the need to restate USDA's originally issued fiscal year 2003 financial
statements are effectively implemented and (2) for future years, the
adequacy of the disclosure and presentation of audit results and any
restatements.

We also recommend that USDA's Inspector General, in conjunction with the
IPA if one is used, ensure that audit procedures are effectively
implemented to test for any (1) improperly recorded appropriations
transactions in the general ledger, (2) improperly reported material items
on the Statement of Financing, and (3) incorrect nonroutine journal
vouchers.

Agency Comments

USDA's CFO and Inspector General provided written comments on a draft of
this report. (See encs. I and II.) The CFO expressed confidence that his
office's current plans and efforts would ensure that the financial
statements are accurate and timely and contain adequate disclosures. The
Inspector General agreed with our recommendations and stated that her
office has instituted, in conjunction with the IPAs, strengthened quality
control measures over its audit procedures.

                                   - - - - -

Within 60 days of the date of this report, we would appreciate receiving a
written statement on actions taken to address these recommendations.

We are sending copies of this report to the Chairmen and Ranking Minority
Members of the Senate Committee on Homeland Security and Governmental
Affairs; the Subcommittee on Federal Financial Management, Government
Information, and International Security, Senate Committee on Homeland
Security and Governmental Affairs; the House Committee on Government
Reform; and the Subcommittee on Government Management, Finance and
Accountability, House Committee on Government Reform. In addition, we are
sending copies to the Fiscal Assistant Secretary of the Treasury and the
Controller of OMB. This report is also available at no charge on GAO's Web
site at www.gao.gov .

We appreciate the courtesy and cooperation extended to us by your staff
throughout our work. We look forward to continuing to work with your
offices to help improve financial management in the federal government. If
you have any questions about the contents of this report, please contact
me at (202) 512-3406 or [email protected] . Contact points for our Offices of
Congressional Relations and Public Affairs may be found on the last page
of this report.

Gary T. Engel

Director

Financial Management and Assurance

Enclosure I: Comments from the Chief Financial Officer, Department of
Agriculture

Enclosure II: Comments from the Inspector General, Department of
Agriculture

(198397)

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