Fiscal Year 2006 U.S. Government Financial Statements: Sustained
Improvement in Federal Financial Management Is Crucial to
Addressing Our Nation's Accountability and Fiscal Stewardship
Challenges (20-MAR-07, GAO-07-607T).
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 related 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-07-607T
ACCNO: A67024
TITLE: Fiscal Year 2006 U.S. Government Financial Statements:
Sustained Improvement in Federal Financial Management Is Crucial
to Addressing Our Nation's Accountability and Fiscal Stewardship
Challenges
DATE: 03/20/2007
SUBJECT: Accountability
Audit reports
Budget deficit
Financial management
Financial management systems
Financial statement audits
Financial statements
Fiscal policies
Future budget projections
Internal controls
Policy evaluation
Reporting requirements
Fiscal imbalance
Policies and procedures
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GAO-07-607T
* [1]The Nation's Fiscal Imbalance
* [2]The Reported Long-Term Fiscal Outlook
* [3]Statement of Social Insurance
* [4]Major Reported Long-Term Fiscal Exposures
* [5]Long-Term Fiscal Simulations
* [6]A Possible Way Forward
* [7]Restatements to Financial Statements
* [8]Highlights of Major Issues Related to the U.S. Government's
* [9]System Problems at Agencies Continue to Hinder Accountabilit
* [10]Addressing Major Impediments to an Opinion on the Consolidat
* [11]Financial Management at DOD
* [12]Intragovernmental Activity and Balances
* [http]Preparing the Consolidated Financial Statements
* [14]The Need for an Improved Federal Financial Reporting Model
* [15]Closing Comments
* [16]GAO Contacts and Acknowledgments
* [17]Appendix I: Material Weaknesses Contributing to Our Disclaim
* [18]Property, Plant, and Equipment and Inventories and Related P
* [19]Liabilities and Commitments and Contingencies
* [20]Cost of Government Operations and Disbursement Activity
* [21]Accounting for and Reconciliation of Intragovernmental Activ
* [22]Preparation of Consolidated Financial Statements
* [23]Outlays and Receipts--Components of the Budget Deficit
* [24]Appendix II: Other Material Weaknesses
* [25]Loans Receivable and Loan Guarantee Liabilities
* [26]Improper Payments
* [27]Information Security
* [28]Tax Collection Activities
* [29]Appendix III: Fiscal Year 2006 Audit Results
* [30]Order by Mail or Phone
Testimony
Before the Subcommittee on Government Management, Organization, and
Procurement, Committee on Oversight and Government Reform, House of
Representatives
United States Government Accountability Office
GAO
For Release on Delivery Expected at 2:00 p.m. EDT
Tuesday, March 20, 2007
FISCAL YEAR 2006 U.S. GOVERNMENT FINANCIAL STATEMENTS
Sustained Improvement in Federal Financial Management Is Crucial to
Addressing Our Nation's Accountability and Fiscal Stewardship Challenges
Statement of David M. Walker
Comptroller General of the United States
GAO-07-607T
Mr. Chairman and Members of the Subcommittee:
I am most pleased to be here today to discuss our report on the U.S.
government's consolidated financial statements for fiscal years 2006 and
2005. I would like to thank you for continuing the annual tradition of
oversight hearings on this important subject. The involvement of your
subcommittee remains critical to ultimately assuring the continued
progress in the financial management area while enhancing public
confidence in the federal government as a financial steward that is
accountable for its finances. Such hearings play a vital role in ensuring
that the federal government is held accountable to the American people.
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 2006 Financial Report of the United States
Government (Financial Report). The most recent report was issued by the
Department of the Treasury (Treasury) on December 15, 2006, and is
available through GAO's Internet site, at
http://www.gao.gov/financial/fy2006financialreport.html , and
Treasury's Internet site, at
http://www.fms.treas.gov/fr/06frusg/06frusg.pdf . 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 http://www.gao.gov/new.items/d05958sp.pdf .
Since the enactment of key financial management reforms, the federal
government has made substantial progress in improving financial management
activities and practices. Federal financial systems requirements have been
developed and internal control has been strengthened. Nonetheless, as I
recently testified before the Senate Subcommittee on Federal Financial
Management, Government Information, Federal Services, and International
Security, Committee on Homeland Security and Governmental Affairs, the
federal government still has a long way to go to address several principal
challenges to fully realizing strong federal financial management.^2 For
the 10th consecutive year, certain material weaknesses^3 in financial
reporting and other limitations on the scope of our work resulted in
conditions that continued to prevent us from being able to provide the
Congress and the 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, 2006. 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, [34]GAO-05-958SP (Washington, D.C.:
September 2005).
GAO's audit report also included an emphasis paragraph for the 3rd
consecutive year noting that the nation's current fiscal path is
unsustainable and that tough choices by the President and the Congress are
necessary to address the nation's large and growing long-term fiscal
imbalance. In fact, the federal government's financial condition and
fiscal outlook are worse than many may understand. The value of the
federal government's net social insurance commitments, liabilities, and
other fiscal exposures is now reported at over $50 trillion, representing
close to four times Gross Domestic Product (GDP) in fiscal year 2006 and
up from about $20 trillion or two times GDP in 2000. One way to think
about it is: if we wanted to put aside today enough to cover these
promises, it would take about $440,000 per American household, up from
$190,000 in 2000. As these numbers indicate, the federal government faces
large and growing structural deficits primarily related to Medicare and
other social insurance commitments. These structural deficits--which are
virtually certain given the design of our current programs and
policies--will mean escalating and ultimately unsustainable federal
deficits and debt levels. Simply put, despite an almost 12 percent
increase in federal revenues this year, our nation's financial condition
and long-term fiscal imbalance continue to deteriorate and are on an
imprudent and unsustainable course.
^2GAO, Critical Accountability and Fiscal Stewardship Challenges Facing
Our Nation, [35]GAO-07-542T (Washington, D.C.: March 2007).
^3A 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.
In this testimony, I will discuss (1) the challenges posed by the federal
government's fiscal condition and my views on a possible way forward,
including ideas for consideration to improve the transparency of long-term
costs; (2) our continued concerns about restatements to prior year
financial statements; (3) the major issues relating to the consolidated
financial statements for fiscal years 2006 and 2005, including systems
problems that continue to hinder federal agency accountability; and (4)
the need for an improved federal financial reporting model. I will also
describe progress that has been made toward addressing major impediments
to an opinion on the consolidated financial statements.
The Nation's Fiscal Imbalance
From a broad financial management perspective, the federal government's
deteriorating long-range financial condition and long-term fiscal
imbalance are matters of increasing concern. We face large and growing
structural deficits due primarily to known demographic trends and rising
health care costs. There is a need to engage in a fundamental review,
repriorization, and reengineering of the base of the government.
Understanding and addressing the federal government's financial condition
and long-term fiscal imbalance are critical to maintain fiscal flexibility
so that we can respond to current and emerging social, economic, and
security challenges.
The Reported Long-Term Fiscal Outlook
The fiscal year 2006 Financial Report disclosed that, despite a reported
increase in revenues in fiscal year 2006 of about $255 billion, the
federal government's costs exceeded its revenues by $450 billion (i.e.,
net operating cost). Further, as of September 30, 2006, the U.S.
government reported in the 2006 Financial Report that it owed (i.e.,
liabilities) more than it owned (i.e., assets) by almost $9 trillion. In
addition, the Statement of Social Insurance in the Financial Report
disclosed an additional $39 trillion of the government's social insurance
responsibilities, including Medicare and Social Security. The total of the
reported liabilities (e.g., debt), contingencies (e.g., insurance), and
social insurance and other commitments and promises (e.g., Social
Security, Medicare)--rose from $20 trillion to about $50 trillion in the
last 6 years.
Over the next few decades, the nation's fiscal outlook will be shaped
largely by known demographic trends and rising health care costs. As the
baby-boom generation retires, federal spending on current retirement and
health care programs--Social Security, Medicare, and Medicaid--will grow
dramatically. These programs represent $39 trillion of the $50 trillion
long-term fiscal exposure. A range of other federal fiscal commitments,
some explicit and some representing implicit public expectations, also
bind the nation's fiscal future. Absent policy changes, a growing
imbalance between expected federal spending and tax revenues will mean
escalating and ultimately unsustainable federal deficits and debt levels.
There are various ways to consider and assess the long-term fiscal
outlook. In this regard, information included in the Financial Report, and
other information and analyses, can be used to more fully understand the
nation's long-term fiscal outlook, including:
o the Statement of Social Insurance,
o major reported long-term fiscal exposures, and
o long-term fiscal simulations.
Statement of Social Insurance
The Statement of Social Insurance in the Financial Report displays
the present value^4 of projected revenues and expenditures for
scheduled benefits of certain benefit programs that are referred
to as social insurance (e.g., Social Security, Medicare). For
Social Security and Medicare alone, projected expenditures for
scheduled benefits for the next 75 years exceed earmarked revenues
(e.g., dedicated payroll taxes, premiums, and existing government
bonds in the trust funds) for the same period by approximately $39
trillion in present value terms. Stated differently, one would
need approximately $39 trillion invested today to deliver on the
currently promised benefits not covered by earmarked revenues for
the next 75 years. Table 1 shows a simplified version of the
Statement of Social Insurance by its primary components.
^4Present value is the discounted value of a payment or stream of payments
to be received or paid in the future, taking into consideration a specific
interest or discount rate.
Table 1: Simplified Statement of Social Insurance as of January 1, 2006
aThese amounts include administrative expenses for the programs.
bUnder current law, Social Security and Federal Hospital Insurance
(Medicare Part A) payments are limited to amounts available to the
respective trust funds.
Note: Data are from the fiscal year 2006 Financial Report.
Major Reported Long-Term Fiscal Exposures
GAO developed the concept of "fiscal exposures" to provide a framework for
considering the wide range of responsibilities, programs, and activities
that explicitly or implicitly expose the federal government to future
spending.
The concept of fiscal exposures is meant to provide a broader perspective
on long-term costs. Major reported long-term fiscal exposures in fiscal
year 2006 with a present value totaling over $50 trillion consisted of
about $10 trillion of liabilities reported on the Balance Sheet, $1
trillion of other commitments and contingencies, and the $39 trillion of
social insurance responsibilities, the last two of which are reported
elsewhere in the Financial Report. This $50 trillion compares to about $20
trillion in fiscal year 2000.
These large numbers are difficult to comprehend. Table 2 seeks to
translate them into several figures and ratios that are more
understandable.
Table 2: Understanding the Size of Major Reported Fiscal Exposures
Note: Percentage increases reflect actual data and may differ from
calculation of rounded numbers presented in table.
Long-Term Fiscal Simulations
Another way to assess the U.S. government's long-term fiscal outlook and
the sustainability of federal programs is to run simulations of future
revenues and costs for all federal programs, based on a continuation of
current or proposed policy. The simulations GAO has published since 1992
are designed to do that. As shown in figure 1, GAO's long-term
simulations--which are neither forecasts nor predictions--continue to show
ever-increasing long-term deficits resulting in a federal debt level that
ultimately spirals out of control. The timing of deficits and the
resulting debt buildup varies depending on the assumptions used; one
alternative (baseline extended) takes the legislatively-mandated baseline
from the Congressional Budget Office (CBO) for the first 10 years and then
keeps discretionary spending and revenues constant as a share of GDP while
letting Social Security, Medicare, and Medicaid grow as projected by the
Trustees and CBO under midrange assumptions. The other, perhaps more
realistic, scenario based on the administration's announced policy
preferences changes only two things in the first 10 years: discretionary
spending grows with the economy and all expiring tax provisions are
extended. Like the "baseline extended" scenario, after 10 years both
revenues and discretionary spending remain constant as a share of the
economy. Under either optimistic set of assumptions, the federal
government's current fiscal policy is unsustainable.
Figure 1: Unified Surpluses and Deficits as a Share of Gross Domestic
Product (GDP) under Alternative Fiscal Policy Simulations
Note: The simulation assumes currently scheduled Social Security benefits
are paid in full throughout the simulation period.
Over the long term, the nation's growing fiscal imbalance stems primarily
from the aging of the population and rising health care costs. Absent
significant changes on the spending or revenue sides of the budget or
both, these long-term deficits will encumber a growing share of federal
resources and test the capacity of current and future generations to
afford both today's and tomorrow's commitments. Continuing on this
unsustainable path will gradually erode, if not suddenly damage our
economy, our standard of living, and ultimately our domestic tranquility
and national security.
If, for example, as shown in figure 2, it is assumed that recent tax
reductions are made permanent and discretionary spending keeps pace with
the growth of our economy, our long-term simulations suggest that by 2040
federal revenues may be adequate to pay little more than interest on debt
held by the public and some Social Security benefits. Neither slowing the
growth in discretionary spending nor allowing the tax provisions,
including the tax cuts enacted in 2001 and 2003, to expire--nor both
together--would eliminate the imbalance. As figures 1 and 2 illustrate,
regardless of the assumptions used, the problem is too big to be solved by
economic growth alone.
Figure 2: Potential Fiscal Outcomes under Alternative Simulation:
Discretionary Spending Grows with GDP after 2007 and All Expiring Tax
Provisions Are Extended
Note: Alternative Minimum Tax (AMT) exemption amount is retained at the
2006 level through 2017 and expiring tax provisions are extended. After
2017, revenue as a share of GDP is held constant--implicitly assuming that
action is taken to offset increased revenue from real bracket creep, the
AMT, and tax-deferred retirement accounts.
At some point, action will need to be taken to change the nation's fiscal
course. The sooner appropriate actions are taken, the sooner the miracle
of compounding will begin to work for the federal budget rather than
against it. Conversely, the longer that action to deal with the nation's
long-term fiscal outlook is delayed, the greater the risk that the
eventual changes will be disruptive and destabilizing. Acting sooner
rather than later will give us more time to phase in gradual changes,
while also providing more time for those likely to be most affected to
make compensatory changes.
The "fiscal gap" is a quantitative measure of long-term fiscal imbalance.
Under GAO's more realistic simulation, assuming debt held by the public
remains at the current share of the economy (i.e., GDP), closing the
fiscal gap would require spending cuts or tax increases equal to 8 percent
of the entire economy each year over the next 75 years, or a total of
about $61 trillion in present value terms. To put this in perspective,
closing the gap would require an immediate and permanent increase in
federal tax revenues of more than 40 percent or an equivalent reduction in
federal program spending (i.e., in all spending except for interest on the
debt held by the public, which cannot be directly controlled).
A Possible Way Forward
Although the long-term fiscal outlook is driven primarily by rising health
care costs and known demographics, we cannot ignore other government
programs and activities. There is a need to engage in a fundamental
review, reprioritization, and reengineering of the base of government.
Aligning the federal government to meet the challenges and capitalize on
the opportunities of the 21st century will require a fundamental review of
what the federal government does, how it does it, and how it is financed.
Many of the federal government's current policies, programs, functions,
and activities are based on conditions that existed decades ago, are not
results-based, and are not well aligned with 21st century realities. We
need to address the growing costs of the major entitlement programs and
also review and reexamine all other major programs, policies, and
activities on both the spending and the revenue side of the budget.
Programs that run through the tax code--sometimes referred to as tax
expenditures^5--must be reexamined along with those that run through the
spending side. As we move forward, the federal government needs to start
making tough choices in setting priorities and linking resources and
activities to results. I recently provided all members of the new Congress
with a package of materials to help them understand facts regarding the
long-term fiscal imbalance of the federal government, why we should act
sooner rather than later, and what types of changes need to be
considered.^6
5In addition to the reported net cost, the federal government foregoes tax
revenues as a result of preferential provisions, such as tax exclusions,
credits, and deductions. These revenue losses are referred to as tax
expenditures.
Meeting our nation's large, growing, and structural fiscal imbalance will
require a multipronged approach:
o increasing transparency and enhancing the relevancy of key
financial, performance, and budget reporting and estimates to
highlight our long-term fiscal challenges;
o reinstituting and strengthening budget controls for both
spending and tax policies to deal with both near-term and
longer-term deficits;
o strengthening oversight of programs and activities, including
creating approaches to better facilitate the discussion of
integrated solutions to crosscutting issues; and
o reengineering and reprioritizing the federal government's
existing programs, policies, and activities to address 21st
century challenges and capitalize on related opportunities.
In two of my January 2007 testimonies,^7 I proposed a number of
ideas for consideration to improve the transparency of long-term
costs, including supplemental reporting in the President's budget
submission and additional cost information on proposals before
adoption. In November 2006, I provided the congressional
leadership with recommendations, based on the work of GAO, for
consideration for the agenda of the 110th Congress.^8 These
recommendations focused on three areas: (1) targets for near-term
oversight, (2) policies and programs that are in need of
fundamental reform and reengineering, and (3) governance issues.
One of the areas I pointed out that warranted congressional
attention was the development of a portfolio of outcome-based key
national indicators (e.g., economic, security, social,
environmental) to help measure progress toward national outcomes,
assess conditions and trends, and help communicate complex issues.
The Congress could take a leadership role in highlighting the need
for a U.S. national indicator system to inform strategic planning,
enhance performance and accountability reporting, inform
congressional oversight and decision making, and stimulate greater
citizen engagement. In my view, this should include consideration
of a public/private partnership to help make this key concept a
reality sooner rather than later.
In order to effectively address our long-term fiscal imbalance,
fundamental reform of existing entitlement programs is essential.
However, entitlement reform alone will not get the job done. We
also need to reprioritize and constrain other federal government
spending and generate more revenues--hopefully through a reformed
tax system. GAO's 21st Century Challenges: Reexamining the Base of
the Federal Government^9 contains a suggested list of specific
federal activities for reexamination, illustrative reexamination
questions, and perspectives on various strategies, processes, and
approaches for congressional consideration stemming from our audit
and evaluation work that can be used in reexamining the federal
base. Answers to these questions may draw on the work of GAO and
others; however, only elected officials can and should decide
which issues to address as well as how and when to address them.
Addressing these problems will require tough choices, and our
fiscal clock is ticking. As a result, the time to start is now, to
help save our future.
Restatements to Financial Statements
The federal government restated certain of its fiscal year 2005
consolidated financial statements to correct errors.^10
Restatements relating to property, plant, and equipment resulted
from misstatements by the Department of Defense, which had
received a disclaimer on its originally issued as well as its
restated fiscal year 2005 financial statements.^11 Certain other
restatements that were made to the consolidated financial
statements related to errors that occurred during the preparation
of the fiscal year 2005 Reconciliation of Net Operating Cost and
Unified Budget Deficit.
Since fiscal year 2004, we have reported our concerns about
restatements to federal agencies' previously issued financial
statements. During fiscal year 2005, we reviewed the causes and
nature of the restatements made by nine CFO act agencies in fiscal
year 2004 to their fiscal year 2003 financial statements. Between
2005 and 2006 we issued reports covering five of these nine CFO
act agencies that included recommendations for improvements in
internal controls and procedures to prevent or detect future
similar errors.^12 In October 2006, we issued a capping report to
the Office of Management and Budget (OMB), which communicated our
observations on the transparency and timeliness of the nine
federal agencies and their auditor's restatement disclosures.^http
The primary contributing factor for the restatement disclosure
issues that we identified was insufficient guidance available at
the time to both the agencies' management and their respective
auditors for disclosure of the restatements and the timeliness of
such disclosures. In August 2005, OMB revised Circular No. A-http6,
Financial Reporting Requirements, which provides additional
guidance to federal agencies' management regarding disclosure of
restatements to previously issued financial statements. Revisions
made to OMB Circular No. A-http6 address many of our concerns
regarding the agencies' disclosure of restatements. In addition,
in August 2006, OMB issued Bulletin No. 06-03, Audit Requirements
for Federal Financial Statements, which provides some information
regarding reporting on restatements. However, we believe that OMB
needs to timely provide additional, though complementary,
restatement guidance. As such, our October 2006 report contained
recommendations to OMB to further improve the restatement guidance
available to agencies' management and the agencies' respective
auditors. In addition, the January 2007 revision of generally
accepted government auditing standards (GAGAS) includes a section
on reporting on restatement of previously issued financial
statements.^14
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
2006 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.
Highlights of Major Issues Related to the U.S. Government�s
Consolidated Financial Statements for Fiscal Years 2006 and 2005
As has been the case for the previous nine 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. The underlying material weaknesses in
internal control, 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, 2006, and 2005.^15
Appendix I describes the material weaknesses that contributed to
our disclaimer of opinion 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. The material weaknesses that contributed to our
disclaimer of opinion 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 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 (1) consistent with the underlying audited agency
financial statements, (2) balanced, and (3) in conformity with
GAAP; and
o identify and either resolve or explain material differences that
exist between certain components of the budget deficit reported in
Treasury's records, used to prepare the Reconciliation of Net
Operating Cost and Unified Budget Deficit and Statement of Changes
in Cash Balance from Unified Budget and Other Activities, and
related amounts reported in federal agencies' financial statements
and underlying financial information and records.
Due to the material weaknesses and the 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 contributed to our
disclaimer of opinion, which were discussed above, we found the
following four other material weaknesses in internal control as of
September 30, 2006. 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 other material
weaknesses were the federal government's inability to
o implement effective credit reform estimation and related
financial reporting processes,
o determine the full 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.
Individual federal agency financial statement audit reports
identify additional reportable conditions^16 in internal control,
some of which were reported by agency auditors as being material
weaknesses at the individual agency level. These additional
reportable conditions do not represent material weaknesses at the
governmentwide level. Regarding agencies' internal controls, in
December 2004, OMB revised its Circular No. A-123, Management's
Responsibility for Internal Control, to provide guidance to
federal managers on improving the accountability and effectiveness
of federal programs and operations by establishing, assessing,
correcting, and reporting on management controls. Requiring
federal managers, at the executive level, to focus on internal
control demonstrates a renewed emphasis on identifying and
addressing internal control weaknesses.
OMB recognized that due to the complexity of some agencies,
implementation of these new requirements may span more than 1
year. Accordingly, certain agencies have adopted multiyear
implementation plans. OMB stated that it will continue to work
with the Chief Financial Officers Council to identify potential
areas for additional guidance and share agencies' best practices.
It will be important that OMB monitor and oversee federal
agencies' implementation of these new requirements.
System Problems at Agencies Continue to Hinder Accountability
For fiscal year 2006, 18 of 24 CFO Act agencies were able to
attain unqualified opinions on their financial statements by the
November 15, 2006, reporting deadline established by OMB (see app.
III). The independent auditor of the Department of State
subsequently withdrew its disclaimer of opinion on the
department's fiscal year 2006 financial statements and reissued an
unqualified opinion on such financial statements dated December
12, 2006. As a result, 19 CFO Act agencies received unqualified
opinions on their fiscal year 2006 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 2006 assessments performed by
agency inspectors general or their contract auditors under the
Federal Financial Management Improvement Act of 1996 (FFMIA) show
that serious problems continue to affect financial management
systems at most of the 24 CFO Act agencies. These problems include
nonintegrated financial systems, lack of accurate and timely
recording of data, inadequate reconciliation procedures,
noncompliance with accounting standards and the U.S. Government
Standard General Ledger (SGL), and weak security over information
systems. 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 lacks the
complete range of information needed for accountability, decision
making, and performance reporting.
Under FFMIA, as a part of the CFO Act agencies' financial
statement audits, CFO Act agency auditors are required 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. These factors are critical for improving
accountability over government operations and routinely producing
sound cost and operating performance information. Noncompliance
with federal financial management systems requirements was the
deficiency most frequently reported by auditors. These
deficiencies involved not only core financial systems, but also
administrative and programmatic systems.
The ability of federal financial management systems to
substantially address FFMIA requirements has not advanced at the
same pace as obtaining unqualified opinions on agency financial
statements. As shown in figure 3, in fiscal year 2006, auditors
for 17 of the 24 CFO Act agencies reported that the agencies'
financial management systems did not substantially comply with one
or more of FFMIA's three requirements compared to auditors for 20
of the 24 CFO Act agencies in fiscal year 1997.
Figure 3: Auditors' FFMIA Assessments for Fiscal Years 1997
through 2006
Note: Data come from independent auditors' reports for fiscal
years 1997 through 2006 prepared by agency inspectors general and
contract auditors.
For 6 of the 7 CFO Act agencies whose auditors did not report
substantial noncompliance with FFMIA requirements for fiscal year
2006, auditors provided negative assurance, meaning that nothing
came to their attention indicating that the agencies' financial
management systems did not substantially fulfill FFMIA
requirements. The auditors for these 6 agencies^17 did not
definitively state whether the agencies' systems substantially
complied with FFMIA requirements, as is required under the
statute. In contrast, auditors for the Agency for International
Development (AID) provided positive assurance by stating that the
agency's financial management systems substantially complied with
the requirements of FFMIA. AID's auditors had not reported AID's
financial management systems as substantially compliant in prior
years. Further, auditors for GSA cited actions taken to address
financial reporting controls and provided negative assurance on
FFMIA in fiscal year 2006; whereas, in fiscal year 2005 they had
reported the agency's systems as not compliant. Conversely,
auditors for the Department of Labor (Labor) reported that the
agencies' financial management systems did not substantially
comply with FFMIA requirements in fiscal year 2006 due to newly
identified weaknesses in Labor's information security controls.
The auditors had not reported any FFMIA compliance issues at the
agency in fiscal years 2004 and 2005.
In an effort to address FFMIA-related problems such as
nonintegrated systems, inadequate reconciliations, and lack of
compliance with the SGL, a number of agencies have efforts
underway to implement new financial management systems or to
upgrade existing systems. Agencies expect that the new systems
will provide reliable, useful, and timely data to support
managerial decision making, help provide accountability to
taxpayers, and assist in congressional oversight. Whether in
government or the private sector, implementing and upgrading
systems is a resource-consuming and difficult job that brings a
degree of risk. Organizations that follow and effectively
implement accepted best practices in systems development and
implementation (commonly referred to as disciplined processes) can
manage and reduce these risks to acceptable levels. The failure to
do so can have serious repercussions. For example, auditors at the
Department of Energy (Energy) and the National Aeronautical and
Space Administration (NASA) have reported many issues related to
the implementation of new financial management systems at those
agencies. NASA has received disclaimers of opinion on their
financial statements since implementing their new system in fiscal
year 2003. While management at both agencies are taking actions to
address the problems resulting from the systems implementation,
more work is needed to meet FFMIA requirements and obtain an
unqualified opinion on their financial statements.
The financial management line of business is OMB's initiative to
help address the need to reduce the cost and improve the outcome
of federal financial systems implementations. This initiative
promotes leveraging of shared service solutions to enhance the
government's performance and services. OMB has projects under way
to develop standard business processes, a common governmentwide
accounting structure, and specific measures to assess the
performance of shared service providers to help provide a
foundation for the financial management line of business
initiative. Because the federal government is one of the largest,
most complex organizations in the world, operating, maintaining,
and modernizing its financial management systems represents a
monumental challenge--from both cost and technical perspectives.
As pressure mounts to increase accountability, and efforts to
diminish federal spending intensify, sustained and committed
leadership will be a key factor in the successful implementation
of governmentwide initiatives.
Addressing Major Impediments to an Opinion on the Consolidated
Financial Statements
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 efforts
by DOD officials and 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.
Financial Management at DOD
Essential to further 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 is one of the largest
and most complex organizations in the world. For decades, we have
reported on the lack of efficiency and effectiveness in DOD's
business operations, including financial management, and the
effect these deficiencies have had on the department's, and the
government's, ability to oversee, manage, and report on its
operations. DOD's financial management weaknesses are pervasive,
complex, long-standing, and deeply rooted in virtually all its
business operations. Execution of DOD's business operations spans
a wide range of defense organizations, including the military
services and their respective major commands and functional
activities, numerous large defense agencies and field activities,
and various combatant and joint operational commands that are
responsible for military operations for specific geographic
regions or theaters of operations. The nature and severity of
DOD's business operations and system deficiencies not only affect
financial reporting, but also impede the ability of DOD managers
to receive and utilize the full range of information needed to
effectively manage day-to-day operations. Such weaknesses
adversely affect DOD's (and the 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, including supporting warfighters and their families. To
date, none of the military services or major DOD components has
passed the test of an independent financial audit^18 because of
pervasive weaknesses in business management processes, controls,
and systems. Moreover, of the 27 areas on GAO's high-risk list,
DOD has 8 of its own high-risk areas and shares responsibility for
7 governmentwide high-risk areas.^19
Effective oversight, reporting, and decision making depends upon
information that is timely, reliable, and useful. DOD has
transformation efforts underway to improve its business management
processes, control, and systems. These efforts will take many
years to complete and represent a huge challenge to the department
since improvements must be made while continuing to support
ongoing operations and activities. While the department is making
progress in developing and implementing approaches to better
understand and address weaknesses in its business operations, more
remains to be done.
On March 1, 2006, I testified^20 that DOD had issued a third key
component of its business transformation strategy: the Financial
Improvement and Audit Readiness (FIAR) Plan.^21 According to DOD,
the FIAR Plan, which was issued in December 2005 and updated in
June and September of 2006, is intended to provide DOD components
with a construct for resolving problems affecting the accuracy,
reliability, and timeliness of financial information, and
obtaining clean financial statement audit opinions. In addition,
the FIAR Plan outlines the business rules and oversight structure
DOD has established to guide financial improvement activities and
audit preparation efforts. According to DOD, its June and
September 2006 FIAR Plan updates were largely intended to refine
previous versions of the plan by (1) identifying milestones that
must be met for assertions regarding the reliability of reported
financial statement information to occur on time, (2) improving
consistency between components regarding their corrective actions
and milestones, and (3) expanding on earlier descriptions of how
the FIAR Plan will be integrated with the Enterprise Transition
Plan. We have reported and made numerous recommendations to DOD
regarding DOD's efforts to develop and implement its Business
Enterprise Architecture and Transition Plan and obtain favorable
audit opinions. In addition, we have reviewed the FIAR Plan and
related updates, and discussed them with DOD and OMB. However, we
cannot comment on specific focus areas or milestones identified in
the FIAR Plan because we have not seen any of the underlying
component or other subordinate plans upon which the FIAR Plan is
based.
DOD has taken important steps toward developing key components of
its business transformation strategy. However, we continue to
stress that while the reliability of reported financial statement
information is important, the effectiveness of DOD's FIAR Plan in
addressing the department's financial management deficiencies will
ultimately be measured by the department's ability to provide
timely, reliable, and useful information for day-to-day management
and decision making. Furthermore, the department continues to lack
a comprehensive, enterprisewide approach to planning and decision
making and the sustained leadership needed to ensure successful
transformation and address systemic business challenges. More
specifically, DOD has not yet developed a plan that covers all key
business functions, and contains results-oriented goals, measures,
and expectations that link organizational and individual
performance goals, while also being clearly linked to DOD's
overall investment plans. Furthermore, as we previously testified,
because of the complexity and long-term nature of business
transformation, we continue to believe that DOD needs a Chief
Management Official (CMO) with significant authority, experience,
and tenure to provide sustained leadership and integrate DOD's
overall business transformation efforts. The National Defense
Authorization Act for Fiscal Year 2006^22 directs the department
to study the feasibility of a CMO position in DOD. In this regard,
the Institute for Defense Analysis issued its report in December
2006 and, among other things, called upon the Congress to
establish a Deputy CMO (executive level III official) at the
department. Further, in May 2006, the Defense Business Board
recommended, among other things, the creation of a Principal Under
Secretary of Defense, as a level II official with a 5-year term
appointment, to serve as CMO. I strongly support an executive
level II official and believe that someone at this level is needed
to be successful given the magnitude of the challenge and the need
to effect change across the department. It is important to note
that a CMO would not assume the responsibilities of the
undersecretaries of defense, the service secretaries, or other DOD
officials for the day-to-day management of the department. Rather,
the CMO would be responsible and accountable for planning,
integrating, and executing the overall business transformation
effort. The reason I am so passionate about the need for a CMO at
DOD is that progress at DOD has historically been painfully slow.
A host of well-intended past improvement initiatives have largely
failed. I am concerned that without a CMO who is responsible and
accountable for demonstrable results and sustained success,
history will continue to repeat itself.
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.
Intragovernmental Activity and Balances
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.^23 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 CFO Act agencies did not adequately
perform the required reconciliations for fiscal years 2006 and
2005. For these fiscal years, based on trading partner information
provided in the Governmentwide Financial Reporting System (GFRS)
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 as of the end of the fiscal
year. After analysis of the "Material Difference Reports" for
fiscal year 2006, we noted that a significant number of CFOs were
unable to adequately explain the differences with their trading
partners or did not provide adequate documentation to support
responses on the CFO Representations. For both fiscal years 2006
and 2005, amounts reported by federal agency trading partners for
certain intragovernmental accounts were significantly out of
balance. In addition, for fiscal year 2006, about 31 percent of
the significant agencies identified by Treasury and OMB did not
perform the required audit procedures on their intragovernmental
trading partner data included in the footnotes to their closing
packages.^24 As a result of the above, the federal government's
ability to determine the effect of these differences on the
amounts reported in the consolidated financial statements is
significantly impaired.
To help address this longstanding problem, on November http, 2006,
OMB issued Memorandum No. M-07-03, Business Rules for
Intragovernmental Transactions, which has also been incorporated
in the Treasury Financial Manual.^25 The OMB memorandum added
criteria for resolving intragovernmental disputes and major
differences between trading partners for certain intragovernmental
transactions by creating the Chief Financial Officers Council's
Intragovernmental Dispute Resolution Committee.^26 Resolving the
intragovernmental transactions problem remains a difficult
challenge and will require a strong commitment by federal agencies
to fully implement the recently issued business rules, and
continued strong leadership by OMB.
Preparing the Consolidated Financial Statements
While further progress was demonstrated in fiscal year 2006, 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. For
fiscal year 2006, Treasury showed progress by demonstrating that
amounts in the Statement of Social Insurance were consistent with
the underlying federal agencies' audited financial statements and
that the Balance Sheet and Statement of Net Cost were consistent
with federal agencies' audited financial statements prior to
eliminating intragovernmental activity and balances. However,
Treasury's process for compiling the consolidated financial
statements did not ensure that the information in the remaining
three principal financial statements and notes were fully
consistent with the underlying information in federal agencies'
audited financial statements and other financial data. During
fiscal year 2006, Treasury, in coordination with OMB, developed
and began implementing corrective action plans 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. Resolving some of
these internal control weaknesses will be a difficult challenge
and will require a strong commitment from Treasury and OMB as they
execute and implement their corrective action plans.
The Need for an Improved Federal Financial Reporting Model
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 government's $450 billion net
operating cost for the year ended September 30, 2006, fiscal
simulations by GAO and others show that over the long-term, we
face large and growing structural deficits due primarily to
Medicare and other social insurance commitments.
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.
After a decade of reporting at the governmentwide level perhaps
now is an appropriate time to step back and consider the need for
further revisions to the current federal financial reporting
model, which would affect both consolidated and agency financial
reporting. While the current reporting model recognizes some of
the unique needs of the federal government, a broad
reconsideration of the federal financial reporting model could
address the following types of questions:
o What kind of information is most relevant and useful for a
sovereign nation?
o Do traditional financial statements convey information in a
transparent manner?
o What is the role of the balance sheet in the federal government
reporting model?
o How should items that are unique to the federal government, such
as social insurance commitments and the power to tax, be reported?
Engaging in a reevaluation of this nature could stimulate
discussion that would bring about a new way of thinking about the
federal government's financial and performance reporting needs. To
understand various perceptions and needs of the stakeholders for
federal financial reporting, a wide variety of stakeholders from
the public and private sector should be consulted. Ultimately, the
goal of such a reevaluation would be reporting enhancements that
can help the Congress deliberate strategies to address the federal
government's challenges, including those of our growing long-term
fiscal imbalance.
More specifically, we continue to support several specific
improvements to federal financial reporting. For example, the
federal government's financial reporting should be expanded to
disclose the reasons for significant changes during the year in
scheduled social insurance benefits and funding. It should also
include a Statement of Fiscal Sustainability--providing a
long-term look at the sustainability of current federal fiscal
policy in the context of all major federal spending programs and
tax policies. The reporting on fiscal sustainability should
include additional information that will assist in understanding
the sustainability of current social insurance and other federal
programs, including key measures of fiscal sustainability and
intergenerational equity,^27 projected annual cash flows, and
changes in fiscal sustainability during the reporting period. We
believe that such reporting needs to reflect the significant
commitments associated with the Social Security and Medicare
programs while recognizing a liability for the net assets
(principally investments in special U.S. Treasury securities) of
the "trust funds." Other areas to consider might include the
reporting of key outcome-based performance information. We support
the current efforts of the Federal Accounting Standards Advisory
Board (FASAB) to begin a project on fiscal sustainability
reporting. In addition, an easily understandable summary annual
report should be prepared and published that includes in a clear,
concise, and transparent manner, key financial and performance
information embodied in the Financial Report.
Closing Comments
In closing, given the federal government's current financial
condition and growing 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 more difficult
without such information. Until the problems discussed in this
testimony are effectively addressed, they will continue to have
adverse implications for the federal government and the taxpayers.
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.
Across government, financial management improvement initiatives
are underway, and if effectively implemented, have the potential
to greatly improve the quality of financial management information
as well as the efficiency and effectiveness of agency operations.
By the end of my term as Comptroller General, I would like to see
the civilian CFO Act agencies routinely producing not only annual
financial statements that can pass the scrutiny of a financial
audit, but also quarterly financial statements and other
meaningful financial and performance data to help guide decision
makers on a day-to-day basis. For DOD, my expectations are not as
high given the current status of DOD's financial management
practices, yet it is realistic for at least major portions of
DOD's financial information to become auditable by the end of my
term. Moreover, progress on developing meaningful financial and
performance reporting on the federal government will be a key area
that I will continue to champion. I am determined to do whatever I
can to help ensure that we are not the first generation to leave
our children and grandchildren a legacy of failed fiscal
stewardship and the hardships that would bring.
Finally, I want to emphasize the value of sustained congressional
interest in these issues, as demonstrated by this subcommittee's
leadership. It will be key that, going forward, the
appropriations, budget, authorizing, and oversight committees hold
agency top leadership accountable for resolving the remaining
problems and that they support improvement efforts.
^6GAO, Fiscal Stewardship: A Critical Challenge Facing Our Nation,
[36]GAO-07-362SP (Washington, D.C.: January 2007); The Nation's Long-Term
Fiscal Outlook: September 2006 Update, [37]GAO-06-1077R (Washington, D.C.:
Sept. 15, 2006); Understanding the Similarities and Differences between
Accrual and Cash Deficits, [38]GAO-07-117SP (Washington, D.C.: December
2006) and its supplement, Accrual and Cash Deficits: Update for Fiscal
Year 2006, [39]GAO-07-341SP (Washington, D.C.: Jan. 22, 2007);
Understanding the Primary Components of the Annual Financial Report of the
United States, [40]GAO-05-958SP (Washington, D.C.: September 2005); and
Statement of the Comptroller General of the United States transmitting
GAO's report on the U.S. government's consolidated financial statements
for fiscal years 2006 and 2005.
^7GAO, Long-term Budget Outlook: Saving Our Future Requires Tough Choices
Today, [41]GAO-07-342T (Washington, D.C.: Jan. 11, 2007); Long-term Budget
Outlook: Deficits Matter--Saving Our Future Requires Tough Choices Today,
[42]GAO-07-389T (Washington, D.C.: Jan. 23, 2007).
^8GAO, Suggested Areas for Oversight for the 110th Congress,
[43]GAO-07-235R (Washington, D.C.: Nov. 17, 2006).
^9GAO, 21st Century Challenges: Reexamining the Base of the Federal
Government, [44]GAO-05-325SP , (Washington, D.C.: February 2005).
^10According 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.
^11In addition to the Department of Defense, at least three other Chief
Financial Officers (CFO) act agencies restated certain of their fiscal
year 2005 financial statements to correct misstatements.
^12GAO, Financial Audit: Restatements to the Department of State's Fiscal
Year 2003 Financial Statements, [45]GAO-05-814R (Washington, D.C.: Sept.
20, 2005); Financial Audit: Restatements to the Nuclear Regulatory
Commission's Fiscal Year 2003 Financial Statements, [46]GAO-06-30R
(Washington, D.C.: Oct. 27, 2005); Financial Audit: Restatements to the
General Services Administration's Fiscal Year 2003 Financial Statements,
[47]GAO-06-70R (Washington, D.C.: Dec. 6, 2005); Financial Audit:
Restatements to the National Science Foundation's Fiscal Year 2003
Financial Statements, [48]GAO-06-229R (Washington, D.C.: Dec. 22, 2005);
and Financial Audit: Restatements to the Department of Agriculture's
Fiscal Year 2003 Financial Statements, [49]GAO-06-254R (Washington, D.C.:
Jan. 26, 2006).
^13GAO, Financial Audit: Restated Financial Statements: Agencies'
Management and Auditor Disclosures of Causes and Effects and Timely
Communication to Users, [50]GAO-07-91 (Washington, D.C.: Oct. 5, 2006).
^14GAGAS, promulgated by the Comptroller General of the United States, are
to be followed by federal auditors and audit organizations and by other
auditors auditing federal organizations, programs, or activities when
required by law, contract, or policy. These standards pertain to auditors'
professional qualifications, the quality of audit effort, and the
characteristics of professional and meaningful audit reports. GAGAS
incorporate American Institute of Certified Public Accountants' field work
and reporting standards and the related Statements on Auditing Standards
for financial audits unless the Comptroller General of the United States
excludes them by formal announcement.
^15We previously reported that certain material weaknesses prevented us
from expressing an opinion on the consolidated financial statements of the
U.S. government for fiscal years 1997 through 2005.
^16Reportable conditions are matters coming to our attention that, in our
judgment, should be communicated because they represent significant
deficiencies in the design or operation of internal control that could
adversely affect the federal government's ability to meet the internal
control objectives described in our audit report.
^17The CFO Act agencies whose auditors provided negative assurance were
the Department of Commerce, Environmental Protection Agency, General
Services Administration (GSA), National Science Foundation, Office of
Personnel Management, and the Social Security Administration.
^18Although not major DOD components, the Military Retirement Fund
received an unqualified audit opinion on its fiscal year 2006 financial
statements, and the DOD Medicare Eligible Retiree Health Care Fund
received a qualified audit opinion on its fiscal year 2006 financial
statements.
^19GAO, High-Risk Series: An Update, [51]GAO-07-310 (Washington, D.C.:
January 2007). 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 seven 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, (6) real property, and
(7) protection of critical technologies.
^20GAO, 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,
[52]GAO-06-406T (Washington, D.C.: Mar. 1, 2006).
^21The Business Enterprise Architecture and the Enterprise Transition Plan
are the other two key components of DOD's business transformation
strategy.
^22National Defense Authorization Act for Fiscal Year 2006, Pub. L. No.
109-163, S 907, 119 Stat. 3136, 3403 (Jan. 6, 2006).
^23Trading partners are U.S. government agencies, departments, or other
components included in the consolidated financial statements that do
business with each other.
^24GFRS uses a closing package methodology that has been developed to
capture each federal agency's information and link the agencies' audited
financial statements to the governmentwide consolidated financial
statements.
^25Treasury Financial Manual, Bulletin No. 2007-3, Intragovernmental
Business Rules.
^26The U.S. Chief Financial Officer's Council is an organization of the
CFOs and Deputy CFOs of the largest federal agencies and senior officials
of OMB and Treasury who work collaboratively to improve financial
management in the U.S. government.
^27Intergenerational equity assesses the extent to which different age
groups may be required to assume financial burdens to sustain federal
responsibilities.
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.
GAO Contacts and Acknowledgments
For further information regarding this testimony, please contact
Jeffrey C. Steinhoff, Managing Director; Gary T. Engel, Director;
and Paula Rascona, Acting Director; Financial Management and
Assurance, at (202) 512-2600. Key contributions to this testimony
were also made by staff on the Consolidated Financial Statement
audit team.
Appendix I: Material Weaknesses Contributing to Our Disclaimer of
Opinion
The continuing material weaknesses discussed below contributed to
our disclaimer of opinion on the federal government's consolidated
financial statements. 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.
Property, Plant, and Equipment and Inventories and Related Property
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.
Liabilities and Commitments and Contingencies
The federal government could not reasonably estimate or adequately
support amounts reported for certain liabilities. For example, DOD
was not able to estimate with assurance key components of its
environmental and disposal liabilities. In addition, DOD could not
support a significant amount of its estimated military
postretirement health benefits liabilities included in federal
employee and veteran benefits payable. These unsupported amounts
related to the cost of direct health care provided by DOD-managed
military treatment facilities. Further, the federal government
could not determine whether commitments and contingencies,
including those related to treaties and other international
agreements entered into to further the U.S. government's
interests, were complete and properly reported.
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.
Cost of Government Operations and Disbursement Activity
The previously discussed material weaknesses in reporting assets
and liabilities, material weaknesses 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 2006 and 2005, there was unreconciled
disbursement activity, including unreconciled differences between
federal agencies' and the Department of the Treasury's (Treasury)
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 Budget of the United States
Government concerning obligations and outlays.
Accounting for and Reconciliation of Intragovernmental Activity
and Balances
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. 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 adequately perform
the required reconciliations for fiscal years 2006 and 2005. For
these fiscal years, based on trading partner information provided
in the Governmentwide Financial Report 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 as of the end of the fiscal year. After analysis of the
Material Difference Reports for fiscal year 2006, we noted that a
significant number of CFOs were unable to adequately explain the
differences with their trading partners or did not provide
adequate documentation to support responses on the CFO
Representations. For both fiscal years 2006 and 2005, amounts
reported by federal agency trading partners for certain
intragovernmental accounts were significantly out of balance. In
addition, for fiscal year 2006, about 31 percent of the
significant agencies identified by Treasury and OMB did not
perform the required audit procedures on their intragovernmental
trading partner data included in the footnotes to their closing
packages.^1 As a result of the above, the federal government's
ability to determine the impact of these differences on the
amounts reported in the consolidated financial statements is
significantly impaired.
Preparation of Consolidated Financial Statements
While further progress was demonstrated in fiscal year 2006, 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). In addition, as
discussed in our scope limitation section of our audit report,
Treasury could not provide the final fiscal year 2006 consolidated
financial statements and supporting documentation in time for us
to complete all of our planned auditing procedures. During our
fiscal year 2006 audit, we found the following:^2
o Treasury showed progress by demonstrating that amounts in the
Statement of Social Insurance were consistent with the underlying
federal agencies' audited financial statements and that the
Balance Sheet and the Statement of Net Cost were consistent with
federal agencies' financial statements prior to eliminating
intragovernmental activity and balances. However, Treasury's
process for compiling the consolidated financial statements did
not ensure that the information in the remaining three principal
financial statements and notes were fully consistent with the
underlying information in federal agencies' audited financial
statements and other financial data.
o To make the fiscal years 2006 and 2005 consolidated financial
statements balance, Treasury recorded net decreases of $11 billion
and $4.1 billion, respectively, to net operating cost on the
Statement of Operations and Changes in Net Position, which it
labeled "Other--Unmatched transactions and balances."^3 An
additional net $10.4 billion and $3.2 billion of unmatched
transactions were recorded in the Statement of Net Cost for fiscal
years 2006 and 2005, 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 fully
identify and report items needed to reconcile the operating
results, which for fiscal year 2006 showed a net operating cost of
$449.5 billion, to the budget results, which for the same period
showed a unified budget deficit of $247.7 billion.
o Treasury's elimination of 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. This resulted in the need for unsupported
intragovernmental elimination entries by Treasury in order to
force the Statements of Operations and Changes in Net Position
into balance. In addition, differences in other intragovernmental
accounts, primarily related to transactions with the General Fund,
have not been reconciled, still remain unresolved, and total
hundreds of billions of dollars. Therefore, the federal government
continues to be unable to determine the impact of unreconciled
intragovernmental activity and balances on the consolidated
financial statements.
o We have consistently reported that certain financial information
required by GAAP was not disclosed in the consolidated financial
statements. In 2006, the Federal Accounting Standards Advisory
Board issued a new standard that eliminated or lessened the
disclosure requirements for the consolidated financial statements
related to certain information that Treasury had not been
reporting.^4 There continued, though, to be other disclosures
required by GAAP that are not disclosed in the consolidated
financial statements. Treasury has plans to address certain of the
omitted disclosures in future years' consolidated financial
statements. Because of certain of the material weaknesses noted in
our audit report, we were unable to determine if the omitted
information was material to the consolidated financial statements.
o Treasury continued to make progress in addressing certain other
internal control weaknesses in Treasury's process for preparing
the consolidated financial statements. However, internal control
weaknesses continued to exist involving 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) effective 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, as we have reported
in past years, there continue to be 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 As in previous years, Treasury did not have adequate systems and
personnel to address the magnitude of the fiscal year 2006
financial reporting challenges it faced, such as (1) GFRS
undergoing further development^5 and not yet being fully
operational, and (2) weaknesses in Treasury's process for
preparing the consolidated financial statements as discussed
above. 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 help ensure
reliable financial reporting by the reporting date.
o During fiscal year 2006, Treasury, in coordination with OMB,
developed and began implementing corrective action plans 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.
Resolving some of these internal control weaknesses will be a
difficult challenge and will require a strong commitment from
Treasury and OMB as they execute and implement their corrective
action plans.
Outlays and Receipts�Components of the Budget Deficit
Both the Reconciliation of Net Operating Cost and Unified Budget
Deficit and Statement of Changes in Cash Balance from Unified
Budget and Other Activities report the budget deficit for fiscal
years 2006 and 2005 of $247.7 billion and $318.6 billion,
respectively.^6 The budget deficit is calculated by subtracting
actual budget outlays (outlays) from actual budget receipts
(receipts).
For several years, we have been reporting material unreconciled
differences between the total net outlays reported in selected
federal agencies' Statement of Budgetary Resources (SBR) and
Treasury's central accounting records used to compute the budget
deficit^7 reported in the consolidated financial statements. OMB
and Treasury have been working with federal agencies to reduce
these material unreconciled differences. Such efforts have
resulted in significantly reducing the net outlay differences in
fiscal year 2006. However, billions of dollars of differences
still exist in this and other components of the deficit because
the federal government does not have effective processes and
procedures for identifying, resolving, and explaining material
differences in the components of the deficit between Treasury's
central accounting records and information reported in agency
financial statements and underlying agency financial information
and records. Until these differences are timely reconciled by the
federal government, their effect on the U.S. government's
consolidated financial statements will be unknown.
In fiscal year 2006, we again noted that 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 also affect the
agencies' ability to 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,^8 and certain amounts reported in the
President's Budget.
^1GFRS uses a closing package methodology that has been developed to
capture each federal agency's information and link the agencies' audited
financial statements to the governmentwide consolidated financial
statements.
^2Most of the issues we identified in fiscal year 2006 existed in fiscal
year 2005, and many have existed for a number of years. In April 2006, we
reported in greater detail on the issues we identified, in GAO, Financial
Audit: Significant Internal Control Weaknesses Remain in Preparing the
Consolidated Financial Statements of the U.S. Government, [53]GAO-06-415
(Washington, D.C.: Apr. 21, 2006). This report includes numerous
recommendations to Treasury and OMB.
^3Although Treasury was unable to determine how much of the unmatched
transactions and balances, if any, relate to operations, it reported this
amount as a component of net operating cost in the consolidated financial
statements.
^4SFFAS No. 32, Consolidated Financial Report of the United States
Government Requirements, Implementing Statement of Federal Financial
Accounting Concepts 4, "Intended Audience and Qualitative Characteristics
for the Consolidated Financial Report of the United States Government"
(Washington, D.C.: Sept. 28, 2006).
^5See GAO, Financial Management Systems: Lack of Disciplined Processes
Puts Effective Implementation of Treasury's Governmentwide Financial
Report System at Risk, [54]GAO-06-4http (Washington, D.C.: Apr. 21, 2006).
^6The budget deficit, receipts, and outlays amounts are reported in
Treasury's Monthly Treasury Statement and the Budget of the United States
Government.
^7See GAO's audit report on its audit of the federal government's fiscal
year 2005 financial statements that was incorporated in the 2005 Financial
Report of the U.S. Government published by Treasury. Also, see GAO,
Financial Audit: Process for Preparing the Consolidated Financial
Statements of the U.S. Government Needs Improvement, [55]GAO-04-45
(Washington, D.C.: Oct. 30, 2003).
^8Treasury'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
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, 2006. In addition to the material weaknesses discussed in
appendix I that contributed to our disclaimer of opinion, we found
the following four other material weaknesses in internal control.
Loans Receivable and Loan Guarantee Liabilities
Federal agencies accounting for the majority of the reported
balances for direct loans and loan guarantee liabilities continue
to have internal control weaknesses related to their credit reform
estimation and related financial reporting processes. While
progress in addressing these long-standing weaknesses was reported
by federal credit agencies, these issues and the complexities
associated with estimating the costs of lending activities
significantly increase the risk that material misstatements in
agency and governmentwide financial statements could occur and go
undetected. Further, these weaknesses 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.
Improper Payments
Under the leadership of OMB, agencies have continued to make
progress in addressing improper payments. Improvements, though,
are still needed to fully address the requirements of the Improper
Payments Information Act of 2002 (IPIA).^1 Major challenges remain
in meeting the goals of the act and ultimately better ensuring the
integrity of payments.^2 The IPIA requires federal 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. In addition, OMB has established a program-specific
initiative under the President's Management Agenda for 15 federal
agencies to hold federal agency managers accountable for meeting
the goals of IPIA and to ensure that the necessary attention and
resources are dedicated to meeting the IPIA requirements.
For fiscal year 2006, federal agencies' estimates of improper
payments, based on available information, totaled about $42
billion, a net increase of about $4 billion, or an 11 percent
increase, from the prior year improper payment estimate of $38
billion.^4 This increase was primarily attributable to 10 newly
reported programs with improper payment estimates totaling about
$2.3 billion and certain federal agencies reporting an increase in
estimates for programs that had previously reported.
We found that some agencies have not annually reviewed all
programs and activities, have not estimated improper payments for
all risk-susceptible programs, or have not estimated improper
payments for all components of risk-susceptible programs. For
example, we noted that in fiscal year 2006, improper payment
estimates were not made for 9 risk-susceptible federal programs,
including Medicaid, with total program outlays of about $183
billion for fiscal year 2006. Further, we noted some agencies
reported noncompliance issues and major management challenges
related to IPIA implementation, including the methodologies used
to estimate improper payments, adequacy of agency documentation,
management oversight, and contract management.
Information Security
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 by hearings on
the implementation of the Federal Information Security Management
Act of 2002^5 and on information security. In addition, the
administration has taken important actions to improve information
security, such as requiring agencies in OMB Memorandum M-06-16^6
to perform specific actions to protect certain personally
identifiable information and issuing extensive guidance on
information security.
Tax Collection Activities
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 9
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.
^1Pub. L. No. 107-300, 116 Stat. 2350 (Nov. 26, 2002).
^2See GAO, Improper Payments: Incomplete Reporting under the Improper
Payments Information Act Masks the Extent of the Problem, [56]GAO-07-254T
(Washington, D.C.: Dec. 5, 2006).
^3IPIA defines improper payments as any payment that should not have been
made or that was made in an incorrect amount (including overpayments and
underpayments) under statutory, contractual, administrative, or other
legally applicable requirements. It includes any payment to an ineligible
recipient, any payment for an ineligible service, any duplicate payment,
payments for services not received, and any payment that does not account
for credit for applicable discounts. OMB's guidance defines significant
improper payments as those in any particular program that exceed both 2.5
percent of program payments and $10 million annually.
^4In their fiscal year 2006 Performance and Accountability Reports (PAR),
selected federal agencies updated their fiscal year 2005 improper payment
estimates to reflect changes since issuance of their fiscal year 2005
PARs. These updates increased the governmentwide improper payment estimate
for fiscal year 2005 from $38 billion to $39 billion.
^5Title III of the E-Government Act of 2002, Pub. L. No. 107-347, 116
Stat. 2899, 2946 (Dec. 17, 2002).
^6OMB Memorandum No. M-06-16, Protection of Sensitive Agency Information
(June 23, 2006).
^7GAO, Financial Audit: IRS's Fiscal Years 2006 and 2005 Financial
Statements, [57]GAO-07-http6 (Washington, D.C.: Nov. 9, 2006).
Appendix III: Fiscal Year 2006 Audit Results
Table 3: CFO Act Agencies: Fiscal Year 2006 Audit Results and Principal
Auditors
Agencies'
auditors
Opinion reported Agency for Unqualified SQRT OIG
rendered by material International
CFO Act agency weaknesses or Principal Development
agencies auditor noncompliance auditor
Agriculture Unqualified SQRT OIG
Commerce Unqualified SQRT KPMG LLP
Defense Disclaimer SQRT OIG
Education Unqualified SQRT Ernst & Young,
LLP
Energy a SQRT KPMG LLP
Environmental Unqualified SQRT OIG
Protection
Agency
General Unqualified SQRT Pricewaterhouse
Services Coopers LLP
Administration
Health and Unqualified SQRT Pricewaterhouse
Human Services Coopers LLP
Homeland b SQRT KPMG LLP
Security
Housing and Unqualified SQRT OIG
Urban
Development
Interior Unqualified SQRT KPMG LLP
Justice Unqualified SQRT KPMG LLP
Labor Unqualified SQRT KPMG LLP
National Disclaimer SQRT Ernst & Young,
Aeronautics LLP
and Space
Administration
National Unqualified Clifton
Science Gunderson LLP
Foundation
Nuclear Unqualified SQRT R. Navarro &
Regulatory Associates,
Commission Inc.
Office of Unqualified SQRT KPMG LLP
Personnel
Management
Small Business Unqualified SQRT KPMG LLP
Administration
Social Unqualified Pricewaterhouse
Security Coopers LLP
Administration
State c SQRT Leonard G.
Birnbaum and
Company, LLP
Transportation Qualified SQRT OIG
Treasury Unqualified SQRT KPMG LLP
Veterans Unqualified SQRT Deloitte &
Affairs Touche LLP
Source: GAO.
aFor fiscal year 2006, only the Consolidated Balance Sheet of the
Department of Energy was subjected to audit, and the auditor qualified its
opinion on this statement.
bFor fiscal year 2006, only the Consolidated Balance Sheet and the related
Statement of Custodial Activity of the Department of Homeland Security
were subjected to audit; the auditor was unable to express an opinion on
these two financial statements.
cThe auditor of the Department of State's (State) fiscal year 2006
financial statements disclaimed an opinion because they were not provided
complete financial statements or responses to certain requests for
evidential material in time to meet the November 15, 2006, reporting
deadline. Subsequently, the auditors satisfied themselves about the
amounts presented on the financial statements. As a result, the auditor
issued an unqualified opinion on State's fiscal year 2006 financial
statements dated December 12, 2006.
(198511)
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