Fiscal Year 2005 U.S. Government Financial Statements: Sustained 
Improvement in Federal Financial Management Is Crucial to	 
Addressing Our Nation's Financial Condition and Long-term Fiscal 
Imbalance (01-MAR-06, GAO-06-406T).				 
                                                                 
GAO is required by law to annually audit the consolidated	 
financial statements of the U.S. government. The Congress and the
President need to have timely, reliable, and useful financial and
performance information. Sound decisions on the current results  
and future direction of vital federal government programs and	 
policies are made more difficult without such 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 reliably report a significant portion of 
its assets, liabilities, costs, and other information; (2) affect
the federal government's ability to reliably measure the full	 
cost as well as the financial and nonfinancial performance of	 
certain programs and activities; (3) impair the federal 	 
government's ability to adequately safeguard significant assets  
and properly record various transactions; and (4) hinder the	 
federal government from having reliable financial information to 
operate in an economical, efficient, and effective manner.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-406T					        
    ACCNO:   A48021						        
  TITLE:     Fiscal Year 2005 U.S. Government Financial Statements:   
Sustained Improvement in Federal Financial Management Is Crucial 
to Addressing Our Nation's Financial Condition and Long-term	 
Fiscal Imbalance						 
     DATE:   03/01/2006 
  SUBJECT:   Accountability					 
	     Accounting procedures				 
	     Accounting standards				 
	     Audit reports					 
	     Federal agency accounting systems			 
	     Financial management				 
	     Financial management systems			 
	     Financial statement audits 			 
	     Financial statements				 
	     Internal controls					 
	     Performance measures				 
	     Reporting requirements				 
	     Projections					 

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GAO-06-406T

     

     * Appendix I: Material Deficiencies
     * Appendix II: Other Material Weaknesses
     * Appendix III: Fiscal Year 2005 Audit Results

Testimony

Before the Subcommittee on Government Management, Finance, and
Accountability, Committee on Government Reform, House of Representatives

United States Government Accountability Office

GAO

For Release on Delivery Expected at 2:00 p.m. EST

Wednesday, March 1, 2006

FISCAL YEAR 2005 U.S. GOVERNMENT FINANCIAL STATEMENTS

Sustained Improvement in Federal Financial Management Is Crucial to
Addressing Our Nation's Financial Condition and Long-term Fiscal Imbalance

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

GAO-06-406T

Mr. Chairman and Members of the Subcommittee:

I am most pleased to be here today and commend your subcommittee's
tradition of oversight hearings on this and other financial management
issues throughout the year. Such hearings continue to play a vital role in
ensuring that the federal government is held accountable to the American
people. Today I will discuss our report on the U.S. government's
consolidated financial statements for fiscal years 2005 and 2004. Our work
was conducted in accordance with U.S. generally accepted government
auditing standards.

Both the consolidated financial statements and our report on them are
included in the fiscal year 2005 Financial Report of the United States
Government. This most recent report was issued by the Department of the
Treasury (Treasury) on December 15, 2005, and is available through GAO's
Internet site, at www.gao.gov/financial/fy2005financialreport.html , and
Treasury's Internet site, at www.fms.treas.gov/fr/index.html . I also
would like to highlight a guide we issued in September 2005 titled
Understanding the Primary Components of the Annual Financial Report of the
United States Government,1 which was prepared to help those who seek to
obtain a better understanding of the Financial Report. This guide can also
be found on GAO's Internet site at
www.gao.gov/financial/fy2005/guidetofrofusg.pdf.

For the ninth consecutive year, certain material weaknesses2 in internal
control and in selected accounting and financial reporting practices
resulted in conditions that continued to prevent us from being able to
provide the Congress and American people an opinion as to whether the
consolidated financial statements of the U.S. government were fairly
stated in conformity with U.S. generally accepted accounting principles
(GAAP). Further, we also reported that the federal government did not
maintain effective internal control over financial reporting (including
safeguarding assets) and compliance with significant laws and regulations
as of September 30, 2005. Until the problems that I will discuss today and
that are discussed in our audit report are adequately addressed, they will
continue to have adverse implications for the federal government and the
taxpayers.

1GAO, Understanding the Primary Components of the Annual Financial Report
of the United States Government, GAO-05-958SP (Washington, D.C.: September
2005).

2A 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.

More troubling still is the federal government's overall financial
condition and long-term fiscal imbalance. While the fiscal year 2005
budget deficit was lower than 2004, it was still very high, especially
given the impending retirement of the "baby boom" generation and rising
health care costs. Importantly, as reported in the fiscal year 2005
Financial Report of the United States Government, the federal government's
accrual-based net operating cost-that is, the cost to operate the federal
government-increased to $760 billion in fiscal year 2005 from $616 billion
in fiscal year 2004. This represents an increase of about $144 billion or
23 percent. To make matters worse, the federal government's liabilities
and unfunded commitments, which include military and civilian retirement
benefits and promised Social Security and Medicare payments, are growing
rapidly. Simply put, our nation's financial condition and long-term fiscal
imbalance is on an imprudent and unsustainable course.

In this testimony, I will discuss (1) the federal government's long-term
fiscal imbalance, (2) our continued concerns about the identification of
misstatements in federal agencies' prior year financial statements, and
(3) the major issues relating to the consolidated financial statements for
fiscal years 2005 and 2004. I will also 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.

                         The Nation's Fiscal Imbalance

The Financial Report of the United States Government provides useful
information on the government's financial position at the end of the
fiscal year and changes that have occurred over the course of the year.
However, in evaluating the nation's fiscal condition, it is critical to
look beyond the short-term results and consider the overall long-term
financial condition and long-term fiscal imbalance of the government-that
is, the sustainability of the federal government's programs, commitments,
and responsibilities in relation to the resources expected to be
available. More important than the large increase in the government's net
operating cost in fiscal year 2005 and persistent short-term budget
deficits, fiscal simulations by GAO and others show that over the long
term, we face large and growing structural deficits due primarily to known
demographic trends, rising health care costs, and lower federal revenues
relative to the economy.

As I have testified before, the current financial reporting model does not
clearly, comprehensively, 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. Thus, it provides a potentially unrealistic and misleading
picture of the federal government's overall performance, financial
condition, and future fiscal outlook. The federal government's gross debt3
in the U.S. government's consolidated financial statements was about $8
trillion as of September 30, 2005.4 This number excludes such items as the
current gap between the present value of future promised and funded Social
Security and Medicare benefits, veterans' health care, and a range of
other liabilities (e.g., federal employee and veteran benefits payable),
commitments, and contingencies that the federal government has pledged to
support.5 Including these items, the federal government's fiscal exposures
now total more than $46 trillion, representing close to four times gross
domestic product (GDP) in fiscal year 2005 and up from about $20 trillion
or two times GDP in 2000. About one third of the approximately $26
trillion increase resulted from enactment of the Medicare prescription
drug benefit in fiscal year 2004. (See table 1.) The federal government's
current fiscal exposures translate into a burden of about $156,000 per
American or approximately $375,000 per full-time worker, up from $72,000
and $165,000 respectively, in 2000. Furthermore, these amounts do not
include future costs resulting from Hurricane Katrina or the conflicts in
Iraq and Afghanistan.

3The federal government's gross debt consists of debt held by the public
and intragovernmental debt holdings.

4On December 29, 2005, the Secretary of the Treasury (Secretary) notified
the Congress that the statutory debt limit will be reached in mid-February
2006. On February 16, 2006, to avoid exceeding the debt limit, the
Secretary began suspending investments in the Government Securities
Investment Fund of the Federal Employees' Retirement System (G-Fund) and
also suspended the sales of State and Local Government Series securities
(SLGS).

5A broader discussion of fiscal exposures can be found in GAO, Fiscal
Exposures: Improving the Budgetary Focus on Long-Term Costs and
Uncertainties, GAO-03-213 (Washington, D.C.: Jan. 24, 2003).

Table 1: Estimated Fiscal Exposures

Dollars in trillions                                                 
                                                                   2000  2005 
Explicit liabilities                                            $6.9  $9.9 
      o  Publicly held debt                                             
      o  Military & civilian pensions & retiree health                  
      o  Other                                                          
Commitments & contingencies                                      0.5   0.9 
      o  E.g., Pension Benefit Guarantee Corporation, undelivered       
      orders                                                            
Implicit exposures                                              13.0  35.6 
      o  Future Social Security benefits                            3.8   5.7 
      o  Future Medicare Part A benefits                            2.7   8.8 
      o  Future Medicare Part B benefits                            6.5  12.4 
      o  Future Medicare Part D benefits                             --   8.7 
Total                                                          $20.4 $46.4 

Source: U.S. government's consolidated financial statements (CFS).

Note: Estimates for Social Security and Medicare are at present value as
of January 1 of each year as reported in the CFS and all other data are as
of September 30.

In addition to the approximately $46 trillion of estimated fiscal
exposures discussed above, there are exposures that are not included in
those figures because the amounts of the exposures are not currently
estimable. For example, the Department of Energy, in the footnotes to its
fiscal year 2005 financial statements, disclosed that its environmental
liability estimates do not include cleanup costs at sites for which there
is no current feasible remediation approach, such as the nuclear explosion
test area at the Nevada Test Site. It is important to understand the
nature and extent of these types of additional exposures in the long-term
fiscal planning for the federal government.6

6For information on how agencies could better recognize, in the budget,
the full costs of environmental cleanup and disposal associated with asset
acquisitions, see GAO, Long-Term Commitments: Improving the Budgetary
Focus on Environmental Liabilities, GAO-03-219 (Washington, D.C.: Jan. 24,
2003). Also, at the request of this subcommittee and the House
Subcommittee on Energy and Resources, Committee on Government Reform, GAO
has ongoing work assessing the adequacy of agency processes and controls
for estimating environmental liabilities and the nature and type of
uncertainties that could impact the ultimate cost of cleanup. Our report
on this study is expected to be issued by the end of this month.

Additionally, tax expenditure amounts are not required to be disclosed,
nor are they disclosed, in agency or the U.S. government's consolidated
financial statements. Tax expenditures are reductions in tax revenues that
result from preferential provisions, such as tax exclusions, credits, and
deductions. These revenue losses reduce the resources available to fund
other programs or they require higher tax rates to raise a given amount of
revenue. As we reported in September 2005, the number of tax expenditures
more than doubled since 1974, and the sum of tax expenditure revenue loss
estimates tripled in real terms to nearly $730 billion in 2004.7 Under the
most recent estimates, this has risen to more than $775 billion in 2005.
Enhanced reporting on tax expenditures would ensure greater transparency
and accountability for revenue forgone by the federal government and
provide a more comprehensive picture of the federal government's policies
and fiscal position.

Further, additional changes are needed to communicate important
information to users about current operating results and the long-term
financial condition of the U.S. government and annual changes therein. In
particular, the government's financial statements should clearly
communicate to the user:

           o  the on-budget or operating results versus unified budget
           results for the year;

           o  the long-term sustainability of federal government
           programs-areas to consider include

                        o  the relationship of the federal government's
                        existing commitments/responsibilities, including
                        social insurance, to appropriate measures, such as
                        GDP and per capita amounts,
                        o  the government's long-term fiscal imbalance in
                        relation to appropriate measures, such as GDP, and
                        o  the magnitude of the potential alternatives for
                        resolving the long term deficits, such as the rate of
                        tax increases or spending reductions necessary to
                        balance the government's long-term finances;

           o  inter-generational equity issues, e.g., assessing the extent to
           which different age groups may be required to assume financial
           burdens for commitments already made; and

           o  a liability at the governmentwide level for funds held by
           Social Insurance trust funds.

           Another tool that would serve to more effectively communicate the
           federal government's finances to the public would be a Summary
           Annual Report. Such a report would summarize, in a clear, concise,
           and transparent manner, key financial and performance information
           included in the Financial Report of the United States Government.

           The federal government's financial condition and long-term fiscal
           imbalance present enormous challenges to the nation's ability to
           respond to emerging forces reshaping American society, the United
           States' place in the world, and the future role of the federal
           government. GAO's long-term simulations illustrate the magnitude
           of the fiscal challenges associated with an aging society and the
           significance of the related challenges the government will be
           called upon to address. Figures 1 and 2 present these simulations
           under two different sets of assumptions. In figure 1, we start
           with the Congressional Budget Office's (CBO) 10-year
           baseline-constructed according to the statutory requirements for
           that baseline.8 Consistent with these requirements, discretionary
           spending is assumed to grow with inflation for the first 10 years
           and all tax cuts currently scheduled to expire are assumed to
           expire. After 2016, discretionary spending is assumed to grow at
           the same rate as the economy, and revenue is held constant as a
           share of GDP at the 2016 level. In figure 2, two assumptions are
           changed: (1) discretionary spending is assumed to grow at the same
           rate as the economy after 2006 rather than merely with inflation,
           and (2) all expiring tax provisions are extended. For both
           simulations, Social Security and Medicare spending is based on the
           2005 Trustees' intermediate cost projections, and we assume that
           benefits continue to be paid in full after the trust funds are
           exhausted. Medicaid spending is based on CBO's December 2005
           long-term projections under midrange assumptions.

           Figure 1: Composition of Spending as a Share of GDP under Baseline
           Extended

           Note: In addition to the expiration of tax cuts, revenue as a
           share of GDP increases through 2016 due to (1) real bracket creep,
           (2) more taxpayers becoming subject to the alternative minimum tax
           (AMT), and (3) increased revenue from tax-deferred retirement
           accounts. After 2016, revenue as a share of GDP is held constant.

           Figure 2: Composition of Spending as a Share of GDP Assuming
           Discretionary Spending Grows with GDP after 2006 and All Expiring
           Tax Provisions Are Extended

           Note: This includes certain tax provisions that expired at the end
           of 2005, such as the increased AMT exemption amount.

           As these simulations illustrate, absent policy changes on the
           spending or revenue side of the budget, the growth in spending on
           federal retirement and health entitlements will encumber an
           escalating share of the government's resources. Indeed, when we
           assume that all the temporary tax reductions are made permanent
           and discretionary spending keeps pace with the economy, our
           long-term simulations suggest that by 2040 federal revenues would
           be adequate to pay only some Social Security benefits and interest
           on the federal debt. Neither slowing the growth in discretionary
           spending nor allowing the tax provisions to expire-nor both
           together-would eliminate the imbalance.

           Although revenues will be part of the debate about our fiscal
           future, assuming no changes to Social Security, Medicare,
           Medicaid, and other drivers of the long-term fiscal gap would
           require at least a doubling of taxes-and that seems to be highly
           implausible. Accordingly, substantive reform of Social Security
           and our major health programs is critical to recapturing our
           future fiscal flexibility. Ultimately, the nation will have to
           decide what level of federal benefits and spending it wants and
           how it will pay for these benefits. Our current path also will
           increasingly constrain our ability to address emerging and
           unexpected budgetary needs and increase the burdens that will be
           faced by future generations. Continuing on this fiscal path will
           mean escalating and ultimately unsustainable federal deficits and
           debt that will serve to threaten the standard of living for the
           American people and ultimately our national security.

           As these simulations illustrate, regardless of the assumptions
           used, the problem is too big to be solved by economic growth alone
           or by making modest changes to existing spending and tax policies.
           Rather, a fundamental reexamination, reprioritization, and
           reengineering of major spending programs, tax policies, and
           government priorities will be important to recapture our fiscal
           flexibility and update our programs and priorities to respond to
           emerging social, economic, and security changes. Ultimately, this
           will likely require a national discussion about what Americans
           want from their government and how much they are willing to pay
           for those things.

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

           We continue to have concerns about the identification of
           misstatements in federal agencies' prior year financial
           statements. At least 79 of the 24 CFO Act agencies restated
           certain of their fiscal year 2004 financial statements to correct
           errors. During fiscal year 2005, we reviewed the causes and nature
           of the restatements made by several Chief Financial Officers (CFO)
           Act agencies in fiscal year 2004 to their fiscal year 2003
           financial statements and recommended improvements in internal
           controls and audit procedures to prevent or detect future similar
           errors.10 Generally, the reasons for the restatements we reviewed
           were agencies' lack of effective internal controls over the
           processing and reporting of certain transactions and the failure
           of the auditors to design and/or perform adequate audit procedures
           to detect such errors. During our review, we noted that the extent
           of the restatements to the agencies' fiscal year 2003 financial
           statements varied from agency to agency, ranging from correcting
           two line items on an 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 the agency were affected
           by the restatement. The amounts of the agencies' restatements
           ranged from several million dollars to more than $91 billion.

           Frequent restatements to correct errors can undermine public trust
           and confidence in both the entity and all responsible parties.
           Material internal control weaknesses discussed in our fiscal year
           2005 audit report serve to increase the risk that additional
           errors may occur and not be identified on a timely basis by agency
           management or their auditors, resulting in further restatements.

           As has been the case for the previous eight fiscal years, the
           federal government did not maintain adequate systems or have
           sufficient reliable evidence to support certain material
           information reported in the U.S. government's consolidated
           financial statements. These material deficiencies, which generally
           have existed for years, contributed to our disclaimer of opinion
           on the U.S. government's consolidated financial statements for the
           fiscal years ended September 30, 2005, and 2004 and also
           constitute material weaknesses in internal control.11 Appendix I
           describes the material deficiencies in more detail and highlights
           the primary effects of these material weaknesses on the
           consolidated financial statements and on the management of federal
           government operations. These material deficiencies were the
           federal government's inability to

           o  satisfactorily determine that property, plant, and equipment
           and inventories and related property, primarily held by the
           Department of Defense (DOD), were properly reported in the
           consolidated financial statements;

           o  reasonably estimate or adequately support amounts reported for
           certain liabilities, such as environmental and disposal
           liabilities, or determine whether commitments and contingencies
           were complete and properly reported;

           o  support significant portions of the total net cost of
           operations, most notably related to DOD, and adequately reconcile
           disbursement activity at certain federal agencies;

           o  adequately account for and reconcile intragovernmental activity
           and balances between federal agencies;

           o  ensure that the federal government's consolidated financial
           statements were consistent with the underlying audited agency
           financial statements, balanced, and in conformity with GAAP; and

           o  resolve material differences that exist between the total net
           outlays reported in federal agencies' Statements of Budgetary
           Resources and the records used by Treasury to prepare the
           Statements of Changes in Cash Balance from Unified Budget and
           Other Activities.

           Due to the material deficiencies and additional limitations on the
           scope of our work, as discussed in our audit report, there may
           also be additional issues that could affect the consolidated
           financial statements that have not been identified.

           In addition to the material weaknesses that represented material
           deficiencies, which were discussed above, we found the following
           four other material weaknesses in internal control as of September
           30, 2005. These weaknesses are discussed in more detail in
           appendix II, including the primary effects of the material
           weaknesses on the consolidated financial statements and on the
           management of federal government operations. These material
           weaknesses were the federal government's inability to

           o  implement effective processes and procedures for properly
           estimating the cost of certain lending programs, related loan
           guarantee liabilities, and value of direct loans;

           o  determine the extent to which improper payments exist;

           o  identify and resolve information security control weaknesses
           and manage information security risks on an ongoing basis; and

           o  effectively manage its tax collection activities.

           For fiscal year 2005, 18 of 24 CFO Act agencies were able to
           attain unqualified opinions on their financial statements by the
           November 15, 2005, reporting deadline established by the Office of
           Management and Budget (OMB) (see app. III). The independent
           auditor of the Department of State subsequently withdrew its
           qualified opinion on the department's fiscal year 2005 financial
           statements and reissued an unqualified opinion on such financial
           statements dated December 14, 2005. As a result, 19 CFO Act
           agencies received unqualified opinions on their fiscal year 2005
           financial statements. However, irrespective of these unqualified
           opinions, many agencies do not have timely, reliable, and useful
           financial information and effective controls with which to make
           informed decisions and ensure accountability on an ongoing basis.
           The ability to produce the data needed for efficient and effective
           management of day-to-day operations in the federal government and
           provide the necessary accountability to taxpayers and the Congress
           has been a long-standing challenge at most federal agencies.

           The results of the fiscal year 2005 Federal Financial Managers
           Integrity Act of 1996 (FFMIA) assessments performed by agency
           inspectors general or their contract auditors show that certain
           problems continue to affect financial management systems at most
           CFO Act agencies. 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).12
           While the problems are much more severe at some agencies than at
           others, the nature and severity of the problems indicate that
           overall, management at most CFO Act agencies lack the complete
           range of information needed for accountability, performance
           reporting, and decision making.

           FFMIA requires auditors, as part of the CFO Act agencies'
           financial statement audits, to report 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. The major
           barrier to achieving compliance with FFMIA continues to be the
           inability of agencies to meet federal financial management systems
           requirements, which involve not only core financial systems, but
           also administrative and programmatic systems.

           For fiscal year 2005, auditors for 18 of the 24 CFO Act agencies
           reported that the agencies' financial management systems did not
           substantially comply with one or more of the FFMIA requirements
           noted above. For 5 of 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 5 agencies did not definitively state whether
           the agencies' systems substantially complied with FFMIA
           requirements, as is required under the statute. In contrast,
           auditors for the Department of Labor provided positive assurance
           by stating that, in their opinion, the department's financial
           management systems substantially complied with the requirements of
           FFMIA. Further, auditors for the Department of Energy and the
           General Services Administration reported that those agencies'
           financial management systems did not substantially comply with
           FFMIA requirements in fiscal year 2005 due to recently identified
           internal control weaknesses over financial reporting. The auditors
           had not reported any FFMIA compliance issues at those 2 federal
           agencies in fiscal year 2004.

           As individual agencies move forward with various initiatives to
           address FFMIA-related problems, it is important that consideration
           be given to the numerous governmentwide initiatives under way to
           address long-standing financial management weaknesses. OMB
           continues to move forward on new initiatives to enhance financial
           management and provide results-oriented information in the federal
           government. Two ongoing developments in this area in fiscal year
           2005 were the realignment of responsibilities formerly performed
           by the Joint Financial Management Improvement Program and its
           Program Management Office and the development of financial
           management lines of business. The overall vision of these
           initiatives is to eliminate duplicative roles, streamline
           financial management improvement efforts, and improve the cost,
           quality, and performance of financial management systems by
           leveraging shared services13 solutions.

           Three major impediments to our ability to render an opinion on the
           U.S. government's consolidated financial statements continued to
           be: (1) serious financial management problems at DOD, (2) the
           federal government's inability to adequately account for and
           reconcile intragovernmental activity and balances between federal
           agencies, and (3) the federal government's ineffective process for
           preparing the consolidated financial statements. Extensive
           cooperative efforts between agency chief financial officers,
           inspectors general, Treasury officials, and OMB officials will be
           needed to resolve these serious obstacles to achieving an opinion
           on the U.S. government's consolidated financial statements.

           Essential to improving financial management governmentwide and
           ultimately to achieving an opinion on the U.S. government's
           consolidated financial statements is the resolution of serious
           weaknesses in DOD's business operations. DOD's financial
           management weaknesses 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 audit14
           because of pervasive weaknesses in business management systems,
           processes, and internal control. Of the 25 areas on GAO's
           governmentwide high-risk list, 8 are DOD programs or operations,
           and the department shares responsibility for 6 other high-risk
           areas that are governmentwide in scope.15 These weaknesses
           adversely affect the department's (and the federal government's)
           ability to control costs; ensure basic accountability; anticipate
           future costs and claims on the budget; measure performance;
           maintain funds control; prevent fraud, waste, and abuse; and
           address pressing management issues.

           Effective management, reporting, and decision making depend upon
           information that is timely, reliable, and useful. Recent actions
           taken by the department to develop an integrated strategy to
           better understand and initiate efforts to systematically transform
           and address weaknesses in its business operations are encouraging.
           On September 28, 2005, DOD approved two key components of its
           transformation strategy: the Business Enterprise Architecture and
           the Business Transition Plan.16 An enterprise architecture should
           provide a clear and comprehensive picture of an entity, whether it
           is an organization (e.g., a federal department) or a functional or
           mission area that cuts across more than one organization (e.g.,
           financial management). This picture consists of snapshots of both
           the enterprise's current "As Is" operational and technological
           environment and its target or "To Be" environment. A transition
           plan should provide the capital investment roadmap for
           transitioning from the current to the target environment by
           describing how and when new business systems will be developed and
           implemented. In November 2005, we reported17 that while DOD had
           made important progress toward building a foundation upon which to
           improve its business operations, it did not fully satisfy the
           requirements of the Ronald W. Reagan National Defense
           Authorization Act for 2005.18 For example, we reported that the
           architecture did not address how DOD would comply with federal
           accounting, financial, and reporting requirements, such as the
           United States Government Standard General Ledger.

           In late December 2005, DOD issued its Financial Improvement and
           Audit Readiness (FIAR) Plan, a third major component of its
           business transformation strategy. According to DOD briefings, the
           "purpose of the FIAR Plan is to provide a roadmap to guide the
           department in improving financial management and achieving a clean
           audit opinion." Similar to an earlier DOD improvement effort, the
           Financial Improvement Initiative, the FIAR Plan utilizes an
           incremental approach to structure its process for examining its
           operations, diagnosing problems, planning corrective actions, and
           preparing for audit. However, unlike the previous plan, the FIAR
           Plan does not establish an overall goal of achieving a clean audit
           opinion on its departmentwide financial statements by a specific
           date. Rather, the FIAR Plan appears to recognize that it will take
           several years before DOD is able to implement the systems,
           processes, and other changes necessary to fully address its
           financial management weaknesses. In the interim, DOD plans to
           focus its initial efforts on four areas: (1) military equipment,
           (2) real property, (3) military retiree eligible health care fund
           liabilities, and (4) environmental liabilities. The FIAR Plan also
           focuses on the U.S. Marine Corps and the U.S. Army Corps of
           Engineers, Civil Works because these organizations intend to be
           ready for audit in fiscal years 2007 and 2008, respectively. As
           the FIAR Plan evolves, DOD intends to refine or include additional
           goals to improve processes and systems related to other balance
           sheet line items and financial statements.

           There will need to be ongoing and sustained top management
           attention to business transformation at DOD to address what are
           some of the most difficult financial management challenges in the
           federal government. As we noted in our November 2005 testimony,19
           we continue to believe that the implementation of a new Chief
           Management Officer position at DOD will be needed in order for the
           department to succeed in its overall business transformation
           strategy. We will continue to monitor DOD's efforts to transform
           its business operations and address its financial management
           deficiencies as part of our continuing DOD business enterprise
           architecture work and our oversight of DOD's financial statement
           audit.

           Federal agencies are unable to adequately account for and
           reconcile intragovernmental activity and balances. OMB and
           Treasury require the CFOs of 35 executive departments and agencies
           to reconcile, on a quarterly basis, selected intragovernmental
           activity and balances with their trading partners.20 In addition,
           these agencies are required to report to Treasury, the agency's
           inspector general, and GAO on the extent and results of
           intragovernmental activity and balances reconciliation efforts as
           of the end of the fiscal year.

           A substantial number of the agencies did not fully perform the
           required reconciliations for fiscal years 2005 and 2004. For
           fiscal year 2005, based on trading partner information provided in
           the Governmentwide Financial Reporting System discussed below,
           Treasury produced a "Material Difference Report" for each agency
           showing amounts for certain intragovernmental activity and
           balances that significantly differed from those of its
           corresponding trading partners. After analysis of the fiscal year
           2005 "Material Difference Reports", we noted a significant number
           of CFOs were still unable to explain their material differences
           with their trading partners. For both fiscal years 2005 and 2004,
           amounts reported by federal agency trading partners for certain
           intragovernmental accounts were significantly out of balance. As a
           result, the federal government's ability to determine the impact
           of these differences on the amounts reported in the consolidated
           financial statements is impaired. Resolving the intragovernmental
           transactions problem remains a difficult challenge and will
           require a commitment by federal agencies and strong leadership and
           oversight by OMB.

           The federal government continued to have inadequate systems,
           controls, and procedures to ensure that the consolidated financial
           statements are consistent with the underlying audited agency
           financial statements, balanced, and in conformity with GAAP.
           During fiscal year 2005, Treasury continued the ongoing
           development of a new system, the Governmentwide Financial
           Reporting System (GFRS), to collect agency financial statement
           information directly from federal agencies' audited financial
           statements. The goal of GFRS is to be able to directly link
           information from federal agencies' audited financial statements to
           amounts reported in the consolidated financial statements, a
           concept that we strongly support, and to resolve many of the
           weaknesses we have identified in the process for preparing the
           consolidated financial statements. For the fiscal year 2005
           reporting process, Treasury's GFRS was able to capture certain
           agency financial information from agencies' audited financial
           statements, but GFRS was still not at the stage that it could be
           used to fully compile the consolidated financial statements from
           the information captured. Treasury did, however, make progress in
           demonstrating that amounts in the consolidated Balance Sheet and
           Statement of Net Cost were consistent with federal agencies'
           audited financial statements prior to eliminating
           intragovernmental activity and balances.

           In closing, given the federal government's overall financial
           condition and long-term fiscal imbalance, the need for the
           Congress and the President to have timely, reliable, and useful
           financial and performance information is greater than ever. Sound
           decisions on the current results and future direction of vital
           federal government programs and policies are made more difficult
           without such information. Until the problems discussed in our
           audit report are adequately addressed, they will continue to have
           adverse implications for the federal government and the taxpayers.
           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.

           Addressing the nation's long-term fiscal imbalance constitutes a
           major transformational challenge that may take a generation or
           more to resolve. Given the size of the projected deficit, the U.S.
           government will not be able to grow its way out of this
           problem-tough choices will be required.

           Traditional incremental approaches to budgeting will need to give
           way to more fundamental and periodic reexaminations of the base of
           government. Our report, 21st Century Challenges: Reexamining the
           Base of the Federal Government,21 is intended to support the
           Congress in identifying issues and options that could help address
           these fiscal pressures.

           Further, the Congress needs to have access to the long-term cost
           of selected spending and tax proposals before they enact related
           laws. The fiscal risks previously mentioned can be managed only if
           they are properly accounted for and publicly disclosed, including
           the many existing commitments facing the federal government. New
           reporting approaches, as well as enhanced budget processes and
           control mechanisms, are needed to better understand, monitor, and
           manage the impact of spending and tax policies over the long term.
           In addition, a set of key national, outcome-based performance
           metrics would inform strategic planning, enhance performance and
           accountability reporting, and help to assess the impact of various
           spending programs and tax policies.

           Mr. Chairman, this concludes my prepared statement. I would be
           pleased to respond to any questions that you or other members of
           the subcommittee may have at this time.

           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.

           The continuing material deficiencies discussed below contributed
           to our disclaimer of opinion on the federal government's
           consolidated financial statements for fiscal years 2005 and 2004.
           The federal government did not maintain adequate systems or have
           sufficient, reliable evidence to support information reported in
           the consolidated financial statements, as described below.

           The federal government could not satisfactorily determine that
           property, plant, and equipment (PP&E) and inventories and related
           property were properly reported in the consolidated financial
           statements. Most of the PP&E and inventories and related property
           are the responsibility of the Department of Defense (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.

           Without reliable asset information, the federal government does
           not fully know the assets it owns and their location and condition
           and cannot effectively (1) safeguard assets from physical
           deterioration, theft, or loss; (2) account for acquisitions and
           disposals of such assets; (3) ensure that 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.

           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.

           Problems in accounting for liabilities affect the determination of
           the full cost of the federal 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 appropriately consider 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.

           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 reported continued weaknesses in reconciling disbursement
           activity. For fiscal years 2005 and 2004, there was unreconciled
           disbursement activity, including unreconciled differences between
           federal agencies' and the Department of the Treasury's records of
           disbursements and unsupported federal agency adjustments, totaling
           billions of dollars, which could also affect the balance sheet.

           Unreliable cost information affects the federal government's
           ability to control and reduce 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.

           Federal agencies are unable to adequately account for and
           reconcile intragovernmental activity and balances. The Office of
           Management and Budget (OMB) and Treasury require the Chief
           Financial Officers (CFO) of 35 executive departments and agencies
           to reconcile, on a quarterly basis, selected intragovernmental
           activity and balances with their trading partners.1 In addition,
           these agencies are required to report to Treasury, the agency's
           inspector general, and GAO on the extent and results of
           intragovernmental activity and balances reconciliation efforts as
           of the end of the fiscal year.

           A substantial number of the agencies did not fully perform the
           required reconciliations for fiscal years 2005 and 2004. For these
           fiscal years, based on trading partner information provided in the
           Governmentwide Financial Reporting System (GFRS), Treasury
           produced a "Material Difference Report" for each agency showing
           amounts for certain intragovernmental activity and balances that
           significantly differed from those of its corresponding trading
           partners. After analysis of the "Material Difference Reports" for
           fiscal year 2005, we noted a significant number of CFOs were still
           unable to explain the differences with their trading partners. For
           both fiscal years 2005 and 2004, amounts reported by federal
           agency trading partners for certain intragovernmental accounts
           were significantly out of balance. In addition, about 25 percent
           of the significant federal agencies reported internal control
           weaknesses regarding reconciliations of intragovernmental activity
           and balances. As a result, the federal government's ability to
           determine the impact of these differences on the amounts reported
           in the consolidated financial statements is impaired.

           Fiscal year 2005 was the second year that Treasury used its GFRS
           to collect agency financial statement information taken directly
           from federal agencies' audited financial statements. The goal of
           GFRS is to be able to directly link information from federal
           agencies' audited financial statements to amounts reported in the
           U.S. government's consolidated financial statements and resolve
           many of the weaknesses we previously identified in the process for
           preparing the consolidated financial statements. For both the
           fiscal year 2005 and 2004 reporting processes, GFRS was able to
           capture agency financial information, but GFRS was still not at
           the stage that it could be used to fully compile the consolidated
           financial statements from the information captured. Therefore, for
           fiscal year 2005 Treasury continued to primarily use manual
           procedures to prepare the consolidated financial statements. As
           discussed in the scope limitations section of our audit report,
           Treasury could not produce the fiscal year 2005 consolidated
           financial statements and supporting documentation in time for us
           to complete all of our planned auditing procedures. In addition,
           the federal government continued to have inadequate systems,
           controls, and procedures 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 (GAAP). Specifically,
           during our fiscal year 2005 audit, we found the following2

           o  Treasury's process for compiling the consolidated financial
           statements did not ensure that the information in all of the five
           principal financial statements and notes was fully consistent with
           the underlying information in federal agencies' audited financial
           statements and other financial data. Treasury made progress in
           demonstrating amounts in the Balance Sheet and the Statement of
           Net Cost were consistent with federal agencies' audited financial
           statements prior to eliminating intragovernmental activity and
           balances. However, about 25 percent of the significant federal
           agencies' auditors reported internal control weaknesses related to
           the processes the agencies perform to provide financial statement
           information to Treasury for preparing the consolidated financial
           statements.

           o  To make the fiscal years 2005 and 2004 consolidated financial
           statements balance, Treasury recorded a net $4.3 billion decrease
           and a net $3.4 billion increase, 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."3 An additional net $3.2 billion and $1.2 billion
           of unreconciled transactions were recorded in the Statement of Net
           Cost for fiscal years 2005 and 2004, respectively. Treasury is
           unable to fully identify and quantify all components of these
           unreconciled activities.

           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 2005 showed a net operating cost of
           $760 billion, to the budget results, which for the same period
           showed a unified budget deficit of $318.5 billion. In addition, a
           net $13.2 billion "net amount of all other differences" was needed
           to force this statement into balance.

           o  Treasury's ability to eliminate certain intragovernmental
           activity and balances continues to be impaired by the federal
           agencies' problems in handling their intragovernmental
           transactions. As discussed above, amounts reported for federal
           agency trading partners for certain intragovernmental accounts
           were significantly out of balance, resulting in the need for
           unsupported intragovernmental elimination entries in order to
           force the Statement of Operations and Changes in Net Position into
           balance. In addition, significant differences in other
           intragovernmental accounts, primarily related to transactions with
           the General Fund, have not been reconciled and still remain
           unresolved. Therefore, the federal government continues to be
           unable to determine the impact of unreconciled intragovernmental
           activity and balances on the consolidated financial statements.

           o  Treasury lacked a process to ensure that fiscal years 2005 and
           2004 consolidated financial statements and notes were comparable.
           Certain information reported for fiscal 2004 may require
           reclassification to be comparable to the fiscal year 2005 amounts.
           However, Treasury did not analyze this information or reclassify
           amounts within various financial statement line items and notes to
           enhance comparability. For example, the Reconciliations of Net
           Operating Cost and Unified Budget Deficit showed $47.8 billion and
           $.2 billion for property, plant, and equipment disposals and
           revaluations for fiscal years 2005 and 2004, respectively.
           However, based on the financial information provided by agencies
           to Treasury in GFRS, the fiscal year 2004 amount would be $25.4
           billion. The difference would be reclassified from the net amount
           of all other differences line item on the Reconciliations of Net
           Operating Cost and Unified Budget Deficit.

           o  Treasury did not have an adequate process to ensure that the
           financial statements, related notes, Stewardship Information, and
           Supplemental Information are presented in conformity with GAAP.
           For example, we found that certain financial information required
           by GAAP was not disclosed in the consolidated financial
           statements. Treasury submitted a proposal to the Federal
           Accounting Standards Advisory Board (FASAB) seeking to amend
           previously issued standards and eliminate or lessen the disclosure
           requirements for the consolidated financial statements so that
           GAAP would no longer require certain of the information that
           Treasury has not been reporting. Comments are due to the FASAB
           today, on an exposure draft of a proposed FASAB standard, based on
           the Treasury proposal. Treasury stated that it is waiting for
           FASAB approval and issuance of this proposed standard to determine
           the disclosures that will be required in future consolidated
           financial statements. As a result of Treasury not providing us
           with adequate documentation of its rationale for excluding the
           currently required information and certain of the material
           deficiencies noted above, we were unable again to determine if the
           missing information was material to the consolidated financial
           statements.

           o  Information system weaknesses existed within the segments of
           GFRS that were used during the fiscal years 2005 and 2004
           reporting processes. We found that the GFRS database (1) was not
           configured to prevent the alteration of data submitted by federal
           agencies and (2) was used for both production and testing during
           the reporting processes. Therefore, information submitted by
           federal agencies within GFRS is not adequately protected against
           unauthorized modification or loss. In addition, Treasury was
           unable to explain why numerous GFRS users appeared to have
           inappropriate access to GFRS agency information or demonstrate the
           appropriate segregation of duties exist.

           o  Although Treasury made progress in addressing them, certain
           other internal control weaknesses in its process for preparing the
           consolidated financial statements continued to exist and involved
           a lack of (1) appropriate documentation of certain policies and
           procedures for preparing the consolidated financial statements,
           (2) adequate supporting documentation for certain adjustments made
           to the consolidated financial statements, and (3) necessary
           management reviews.

           o  The consolidated financial statements include 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
           the excluded financial information was immaterial.

           o  Treasury did not have the infrastructure to address the
           magnitude of the fiscal year 2005 financial reporting challenges
           it was faced with, such as an incomplete financial reporting
           system, compressed time frames for compiling the financial
           information, and lack of adequate internal control over the
           financial statement preparation process. We found that personnel
           at Treasury's Financial Management Service had excessive workloads
           that required an extraordinary amount of effort and dedication to
           compile the consolidated financial statements; however, there were
           not enough personnel with specialized financial reporting
           experience to ensure reliable financial reporting by the reporting
           date.

           o  Treasury, in coordination with OMB, had not provided us with
           adequate documentation evidencing an executable plan of action and
           milestones for short-term and long-range solutions for certain
           internal control weaknesses we have previously reported regarding
           the process for preparing the consolidated financial statements.

           OMB Circular A-136, Financial Reporting Requirements, which
           incorporated and updated OMB Bulletin No. 01-09, Form and Content
           of Agency Financial Statements, states that outlays in federal
           agencies' Statement of Budgetary Resources (SBR) should agree with
           the net outlays reported in the Budget of the United States
           Government. In addition, Statement of Federal Financial Accounting
           Standards 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) in the financial statements and the amounts described as
           "actual" in the Budget of the United States Government.

           The federal government reported in the Statement of Changes in
           Cash Balance from Unified Budget and Other Activities (Statement
           of Changes in Cash Balance) and the Reconciliations of Net
           Operating Cost and Unified Budget Deficit (Reconciliation
           Statement) budget deficits for fiscal years 2005 and 2004 of
           $318.5 billion and $412.3 billion, respectively. The budget
           deficit is calculated by subtracting actual budget outlays from
           actual budget receipts.4 As we have reported since fiscal year
           2003, we found material unreconciled differences between the total
           net outlays reported in selected federal agencies' SBRs and
           Treasury's central accounting records, which it uses to prepare
           the Statement of Changes in Cash Balance. Treasury's processes for
           preparing the Statement of Changes in Cash Balance do not include
           procedures for identifying and resolving differences between its
           central accounting records and net outlay amounts reported in
           agencies' SBRs.

           In fiscal year 2004, we noted reported internal control weaknesses
           regarding certain agencies' SBRs. In fiscal year 2005, several
           agencies' auditors reported internal control weaknesses (1)
           affecting the agencies' SBRs, and (2) relating to monitoring,
           accounting, and reporting of budgetary transactions. These
           weaknesses could affect the reporting and calculation of the net
           outlay amounts in the agencies' SBRs. In addition, such weaknesses
           transcend to agencies' ability to also report reliable budgetary
           information to Treasury and OMB and may affect the unified budget
           outlays reported by Treasury in its Combined Statement of
           Receipts, Outlays, and Balances,5 and certain amounts reported in
           the Budget of the United States Government.

           OMB has been working with agencies to reduce the differences
           between the total net outlays reported in the federal agencies'
           SBRs and the Statement of Changes in Cash Balance. In June 2005,
           OMB issued its Differences Between FY 2004 Budget Execution
           Reports and Financial Statements for CFO Act Agencies report which
           discusses various types of differences in federal agency financial
           statements and budget execution reports, including net outlays,
           and makes recommendations for OMB and federal agencies to consider
           in improving both sets of reports in the future.

           Until the material 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 timely
           reconciled, the effect of these differences on the U.S.
           government's consolidated financial statements will be unknown.

           The federal government did not maintain effective internal control
           over financial reporting (including safeguarding assets) and
           compliance with significant laws and regulations as of September
           30, 2005. In addition to the material deficiencies discussed in
           appendix I, we found the following four other material weaknesses
           in internal control.

           Federal agencies continue to have material weaknesses and
           reportable conditions related to their lending activities. The
           Department of Housing and Urban Development lacked adequate
           management reviews of underlying data and cost estimation
           methodologies that resulted in material errors being undetected,
           and significant adjustments were needed. In addition, the
           Department of Education's processes do not provide for a robust
           budget-to-actual cost comparison or facilitate assessments of the
           validity of its lending program cost estimates. While the Small
           Business Administration made substantial progress to improve its
           cost-estimation processes, additional improvements are still
           needed to ensure that year-end reporting is accurate. These
           deficiencies plus others at the Department of Agriculture relating
           to the processes and procedures for estimating program costs
           continue to adversely affect the federal 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. Further, these weaknesses and
           the complexities associated with estimating the costs of lending
           activities greatly increase the risk that significant errors in
           agency and governmentwide financial statements could occur and go
           undetected.

           While agencies have made progress in implementing processes and
           controls to identify, estimate, and reduce improper payments,1
           such improper payments are a long-standing, widespread, and
           significant problem in the federal government. The Congress
           acknowledged this problem by passing the Improper Payment
           Information Act of 2002 (IPIA).2 The IPIA requires agencies to
           review all programs and activities, identify those that may be
           susceptible to significant improper payments,3 estimate and report
           the annual amount of improper payments for those programs, and
           implement actions to cost-effectively reduce improper payments.
           Further, in fiscal year 2005, the Office of Management and Budget
           (OMB) began to separately track the elimination of improper
           payments under the President's Management Agenda.

           Significant challenges remain to effectively achieve the goals of
           the IPIA. From our review of agencies' fiscal year 2005
           Performance and Accountability Reports (PARs), we noted that some
           agencies still have not instituted a systematic method of
           reviewing all programs and activities, have not identified all
           programs susceptible to significant improper payments, and/or have
           not annually estimated improper payments for their high-risk
           programs. For example, seven major agency programs with outlays
           totaling about $280 billion, including Medicaid and the Temporary
           Assistance For Needy Families programs, still cannot annually
           estimate improper payments, even though they were required by OMB
           to report such information beginning with their fiscal year 2003
           budget submissions. In addition, two agency auditors that tested
           compliance with IPIA cited agency noncompliance with the act in
           their annual audit reports.

           Federal agencies' estimates of improper payments, based on
           available information, for fiscal year 2005 exceeded $38 billion,
           a net decrease of about $7 billion, or 16 percent, from the prior
           year improper payment estimate of $45 billion.4 This decrease was
           attributable to the following factors. In fiscal year 2005, the
           Department of Health and Human Services reported a $9.6 billion
           decrease in its Medicare program improper payment estimate,
           principally due to improvements in its due diligence with
           providers to ensure the necessary documentation is in place to
           support payment claims. However, in fiscal year 2005, this
           decrease was partially offset as a result of more programs
           reporting estimates of improper payments.

           Although progress has been made, serious and widespread
           information security control 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 control 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 control 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 with hearings on
           Federal Information Security Management Act of 20025
           implementation and information security. In addition, the
           administration has taken important actions to improve information
           security, such as revising agency internal control requirements in
           OMB Circular A-1236 and issuing extensive guidance on information
           security.

           Material internal control weaknesses and systems deficiencies
           continue to affect the federal government's ability to effectively
           manage its tax collection activities,7 an issue that has been
           reported in our financial statement audit reports for the past 8
           years. Due to errors and delays in recording taxpayer information,
           payments, and other activities, 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.

           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 of revenues 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.

7The sum of individual tax expenditure estimates is useful for gauging the
general magnitude of the revenue involved, but does not take into account
possible interactions between individual provisions. For additional
information, see GAO, Government Performance and Accountability: Tax
Expenditures Represent a Substantial Federal Commitment and Need to Be
Reexamined, GAO-05-690 (Washington, D.C.: September 2005).

8The Congressional Budget Office, The Budget and Economic Outlook: Fiscal
Years 2007 to 2016 (Washington, D.C.: January 2006).

                 Restatements of Agencies' Financial Statements

9Three of these agencies had received an unqualified opinion on their
originally issued fiscal year 2004 financial statements while the
remaining four had received a disclaimer of opinion on their financial
statements. The auditor for one of the agencies withdrew the unqualified
opinion that had been previously rendered on the agency's fiscal year 2004
financial statements and issued a qualified opinion on the restated
financial statements.

10GAO, Financial Audit: Restatements to the Department of State's Fiscal
Year 2003 Financial Statements, GAO-05-814R (Washington, D.C.: Sep. 20,
2005); GAO, Financial Audit: Restatements to the Nuclear Regulatory
Commission's Fiscal Year 2003 Financial Statements, GAO-06-30R
(Washington, D.C.: Oct. 27, 2005); GAO, Financial Audit: Restatements to
the General Services Administration's Fiscal Year 2003 Financial
Statements, GAO-06-70R (Washington, D.C.: Dec. 6, 2005); GAO Financial
Audit: Restatements to the National Science Foundation's Fiscal Year 2003
Financial Statements, GAO-06-229R (Washington, D.C.: Dec. 22, 2005); and
GAO, Financial Audit: Restatements to the Department of Agriculture's
Fiscal Year 2003 Financial Statements, GAO-06-254R (Washington, D.C.: Jan.
26, 2006).

    Highlights of Major Issues Related to the U.S. Government's Consolidated
              Financial Statements for Fiscal Years 2005 and 2004

11We previously reported that material deficiencies prevented us from
expressing an opinion on the consolidated financial statements of the U.S.
government for fiscal years 1997 through 2004.

         Systems Problems at Agencies Continue to Hinder Accountability

12The United States Standard General Ledger provides a uniform Chart of
Accounts and technical guidance to be used in standardizing federal agency
accounting.

Addressing Major Impediments to an Opinion on Consolidated Financial Statements

Financial Management at DOD

13As defined by the Association of Government Accountants (AGA), shared
services represent "financial and administrative services provided by a
single organization established to provide such services efficiently and
effectively for the benefit of multiple organizations or entities". See
AGA Corporate Partner Advisory Group Research, Financial Management Shared
Services: A Guide for Federal Users, AGA CPAG Research Series: Report No.
2, July 2005.

14Although not major DOD components, the Military Retirement Fund received
an unqualified audit opinion on its fiscal year 2005 financial statements,
and the DOD Medicare Eligible Retiree Health Care Fund received a
qualified audit opinion on its fiscal year 2005 financial statements.

15 GAO, High-Risk Series: An Update, GAO-05-207 (Washington, D.C.: January
2005). The eight specific DOD high-risk areas are: (1) approach to
business transformation, (2) business systems modernization, (3) contract
management, (4) financial management, (5) personnel security clearance
program, (6) supply chain management, (7) support infrastructure
management, and (8) weapon systems acquisition. The six governmentwide
high-risk areas are (1) disability programs, (2) interagency contracting,
(3) information systems and critical infrastructure, (4) information
sharing for homeland security, (5) human capital, and (6) real property.

16The Ronald W. Reagan National Defense Authorization Act for Fiscal Year
2005, Pub. L. No. 108-375, S:332, 118 Stat. 1811, 1851-1856 (Oct. 28,
2004) (codified, in part, at 10 U.S.C. S:2222) required DOD to develop a
Business Enterprise Architecture and Transition Plan.

17GAO, DOD Business Systems Modernization: Important Progress Made in
Establishing Foundational Architecture Products and Investment Management
Practices, but Much Work Remains, GAO-06-219 (Washington, D.C.: Nov. 23,
2005).

18Pub. L. No. 108-375, S:332, 118 Stat. 1811, 1851 (Oct. 28, 2004).

Intragovernmental Activity and Balances

19GAO, Defense Management: Foundational Steps Being Taken to Manage DOD
Business Systems Modernization, but Much Remains to be Accomplished to
Effect True Business Transformation, GAO-06-234T (Washington, D.C.: Nov.
9, 2005).

20Trading partners are U.S. government agencies, departments, or other
components included in the consolidated financial statements that do
business with each other.

Preparing the Consolidated Financial Statements

                                Closing Comments

                                  GAO Contacts

21GAO, 21st Century Challenges: Reexamining the Base of the Federal
Government, GAO-05-325SP (Washington, D.C.: February 2005).

Appendix I: Material Deficiencies

Material Deficiencies

Property, Plant, and Equipment and Inventories and Related Property

Liabilities and Commitments and Contingencies

Cost of Government Operations and Disbursement Activity

Accounting for and Reconciliation of Intragovernmental Activity and Balances

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

Preparation of Consolidated Financial Statements

2Most of the issues we identified in fiscal year 2005 existed in fiscal
year 2004, and many have existed for a number of years. In May 2005, we
reported in greater detail on the issues we identified in GAO, Financial
Audit: Process for Preparing the Consolidated Financial Statements of the
U.S. Government Continues to Need Improvement, GAO-05-407 (Washington,
D.C.: May 4, 2005). This report includes numerous recommendations to
Treasury and OMB.

3Although 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.

Net Outlays-A Component of the Budget Deficit

4In previous years, the Statement of Changes in Cash Balance reported
actual budget outlays and actual budget receipts; however, beginning in
fiscal year 2004, the federal government chose not to disclose budget
outlays and budget receipts in this financial statement and only included
the budget deficit. Receipts and net outlays (unified budget amounts) are
also reported in governmentwide reports--specifically, in the President's
Budget (annually); Treasury's Final Monthly Treasury Statement, as part of
leading economic indicators on federal finances (quarterly); and
Treasury's annual Combined Statement of Receipts, Outlays, and Balances of
the United States Government.

5Treasury's Combined Statement of Receipts, Outlays, and Balances presents
budget results and cash-related assets and liabilities of the federal
government with supporting details. Treasury represents this report as the
recognized official publication of receipts and outlays of the federal
government based on agency reporting.

Appendix II: Other Material Weaknesses

Other Material Weaknesses

Loans Receivable and Loan Guarantee Liabilities

Improper Payments

1Improper 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.

2Pub. L. No. 107-300, 116 Stat. 2350 (Nov. 26, 2002).

3OMB defines the term "significant improper payments" as "annual erroneous
payments in the program exceeding both 2.5 percent of program payments and
$10 million."

4In their fiscal year 2005 PARs, selected agencies updated their fiscal
year 2004 improper payment estimates to reflect changes since issuance of
their fiscal year 2004 PARs. These updates increased the governmentwide
improper payment estimate for fiscal year 2004 from $45 billion to $46
billion.

Information Security

Tax Collection Activities

5Title III of the E-Government Act of 2002, Pub. L. No. 107-347, 116 Stat.
2899, 2946 (Dec. 17, 2002).

6OMB Circular No. A-123, Management's Responsibility for Internal Control
(Revised December 21, 2004).

7GAO, Financial Audit: IRS's Fiscal Years 2005 and 2004 Financial
Statements, GAO-06-137 (Washington, D.C.: Nov. 10, 2005).

Appendix III: Fiscal Year 2005 Audit Results

Table 2: CFO Act Agencies: Fiscal Year 2005 Audit Results, Principal
Auditors, and Number of Other Audit Contractors

                           Agencies'                                        
                           auditors                                         
               Opinion     reported                                         Agency for    Unqualified SQRT OIG 2 
               rendered by material                               Number of International                      
CFO Act        agency      weaknesses or                        other audit Development                        
agencies       auditor     noncompliance Principal auditor      contractors                                    
Agriculture    Unqualified     SQRT      OIG                              3 
Commerce       Unqualified     SQRT      KPMG LLP                         0 
Defense        Disclaimer      SQRT      OIG                              1 
Education      Unqualified     SQRT      Ernst & Young, LLP               0 
Energy         Disclaimer      SQRT      KPMG LLP                         0 
Environmental  Unqualified     SQRT      OIG                              0 
Protection                                                                  
Agency                                                                      
General        (a)             SQRT      PricewaterhouseCoopers           0 
Services                                 LLP                                
Administration                                                              
Health and     Unqualified     SQRT      Ernst & Young, LLP               2 
Human Services                                                              
Homeland       Disclaimer      SQRT      KPMG LLP                         0 
Security                                                                    
Housing and    Unqualified     SQRT      OIG                              1 
Urban                                                                       
Development                                                                 
Interior       Unqualified     SQRT      KPMG LLP                         0 
Justice        Unqualified     SQRT      KPMG LLP                         2 
Labor          Unqualified               R. Navarro &                     1 
                                         Associates, Inc.                   
National       Disclaimer      SQRT      Ernst & Young, LLP               0 
Aeronautics                                                                 
and Space                                                                   
Administration                                                              
National       Unqualified               KPMG LLP                         0 
Science                                                                     
Foundation                                                                  
Nuclear        Unqualified     SQRT      R. Navarro &                     0 
Regulatory                               Associates, Inc.                   
Commission                                                                  
Office of      Unqualified     SQRT      KPMG LLP                         0 
Personnel                                                                   
Management                                                                  
Small Business Unqualified     SQRT      Cotton and Company LLP           0 
Administration                                                              
Social         Unqualified               PricewaterhouseCoopers           2 
Security                                 LLP                                
Administration                                                              
State          (b)             SQRT      Leonard G. Birnbaum              4 
                                         and Company, LLP                   
Transportation Unqualified     SQRT      OIG                              3 
Treasury       Unqualified     SQRT      KPMG LLP                         5 
Veterans       Unqualified     SQRT      Deloitte & Touche LLP            0 
Affairs                                                                     

Source: GAO.

aIn 2005, GSA received an unqualified opinion on its Balance Sheet,
Statement of Changes in Net Position, and Statement of Net Cost, and a
disclaimer of opinion on its Statement of Budgetary Resources and
Statement of Financing.

bThe independent auditors of the Department of State's fiscal year 2005
financial statements issued a qualified opinion because they were not able
to examine evidence regarding personal property in time to meet the
November 15, 2005, reporting deadline. In late December, GAO was informed
by the Acting Chief Financial Officer for the Department of State that
subsequent to the issuance of the qualified opinion, the independent
auditors satisfied themselves about the amounts presented as personal
property. As a result, the auditors issued an unqualified opinion on the
Department of State's fiscal year 2005 financial statements dated December
14, 2005.

(198413)

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www.gao.gov/cgi-bin/getrpt? GAO-06-406T .

To view the full product, including the scope

and methodology, click on the link above.

For more information, contact Jeffrey C. Steinhoff or Gary T. Engel at
(202) 512-2600.

Highlights of GAO-06-406T , testimony before the Subcommittee on
Government Management, Finance, and Accountability, Committee on
Government Reform, House of Representatives

March 1, 2006

FISCAL YEAR 2005 U.S. GOVERNMENT FINANCIAL STATEMENTS

Sustained Improvement in Federal Financial Management Is Crucial to
Addressing Our Nation's Financial Condition and Long-term Fiscal Imbalance

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

The Congress and the President need to have timely, reliable, and useful
financial and performance information. Sound decisions on the current
results and future direction of vital federal government programs and
policies are made more difficult without such 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
reliably report a significant portion of its assets, liabilities, costs,
and other information; (2) affect the federal government's ability to
reliably measure the full cost as well as the financial and nonfinancial
performance of certain programs and activities; (3) impair the federal
government's ability to adequately safeguard significant assets and
properly record various transactions; and (4) hinder the federal
government from having reliable financial information to operate in an
economical, efficient, and effective manner.

For the ninth consecutive year, certain material weaknesses in internal
control and in selected accounting and financial reporting practices
resulted in conditions that continued to prevent GAO from being able to
provide the Congress and American people 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
continued to be (1) serious financial management problems at the
Department of Defense, (2) the federal government's inability to
adequately account for and reconcile intragovernmental activity and
balances between federal agencies, and (3) the federal government's
ineffective process for preparing the consolidated financial statements.
Further, in our opinion, as of September 30, 2005, the federal government
did not maintain effective internal control over financial reporting and
compliance with significant laws and regulations due to numerous material
weaknesses.

More troubling still is the federal government's overall financial
condition and long-term fiscal imbalance. While the fiscal year 2005
budget deficit was lower than 2004, it was still very high, especially
given the impending retirement of the "baby boom" generation and rising
health care costs. Importantly, as reported in the fiscal year 2005
Financial Report of the United States Government, the federal government's
accrual-based net operating cost-the cost to operate the federal
government-increased to $760 billion in fiscal year 2005 from $616 billion
in fiscal year 2004. This represents an increase of about $144 billion or
23 percent. The federal government's gross debt was about $8 trillion as
of September 30, 2005. This number excludes such items as the gap between
the present value of future promised and funded Social Security and
Medicare benefits, veterans' health care, and a range of other
liabilities, commitments, and contingencies that the federal government
has pledged to support. Including these items, the federal government's
fiscal exposures now total more than $46 trillion, representing close to
four times gross domestic product (GDP) in fiscal year 2005 and up from
about $20 trillion or two times GDP in 2000. Given these and other
factors, a fundamental reexamination of major spending programs, tax
policies, and government priorities will be important and necessary to put
us on a prudent and sustainable fiscal path. This will likely require a
national discussion about what Americans want from their government and
how much they are willing to pay for those things.

We continue to have concerns about the identification of misstatements in
federal agencies' prior year financial statements. Frequent restatements
to correct errors can undermine public trust and confidence in both the
entity and all responsible parties. The material internal control
weaknesses discussed in this testimony serve to increase the risk that
additional errors may occur and not be identified on a timely basis by
agency management or their auditors, resulting in further restatements.
*** End of document. ***