Internal Revenue Service: Results of Fiscal Year 1999 Financial Statement
Audit (Testimony, 02/29/2000, GAO/T-AIMD-00-104).

Pursuant to a congressional request, GAO discussed the results of its
fiscal year (FY) 1999 financial statement audit of the Internal Revenue
Service (IRS).

GAO noted that: (1) while IRS has made progress in addressing some of
the issues from GAO's audit of its FY 1998 financial statements, the
results of GAO's FY 1999 financial audit revealed that IRS continues to
experience pervasive material weaknesses in the design and operation of
its automated financial management and related operational systems,
accounting procedures, documentation, recordkeeping, and internal
controls, including computer security controls; (2) specifically, the
major issues identified in GAO's FY 1999 audit includes the following:
(a) deficiencies in controls to properly manage unpaid assessments,
resulting in both taxpayer burden and potentially billions of dollars in
lost revenue to the government; (b) deficiencies in controls over tax
refunds, permitting the disbursement of potentially billions of dollars
of improper refunds; (c) vulnerabilities in controls over hardcopy tax
receipts and taxpayer data that increase the government's and taxpayers'
risk of loss or inappropriate disclosure of taxpayer data; (d)
vulnerabilities in computer security that may allow unauthorized
individuals to access, alter, or abuse proprietary IRS programs and
electronic data and taxpayer information; (e) the failure to reconcile
IRS' fund balance with Treasury records throughout FY 1999, resulting in
IRS' inability to routinely ensure accountability and proper use of its
funds; (f) inadequate systems and controls that resulted in the
inability to properly account for IRS' property and equipment and
related costs; (g) inadequate budgetary controls, resulting in IRS'
inability to assure that its budgetary resources are being properly
accounted for, reported, and controlled; and (h) an inadequate financial
reporting process that continued to result in IRS' inability to reliably
prepare several of the required financial statements and financial
management systems that do not comply with the requirements of the
Federal Financial Management and Improvement Act of 1996; (3) many of
the problems facing IRS represent serious agencywide financial
management and operational challenges that will require a substantial
and continuous commitment of resources, time, and expertise to correct;
(4) IRS has major efforts under way to modernize both its organizational
structure and its information systems; and (5) these efforts appear to
be heading IRS in the right direction, but, as IRS itself has stated,
successful modernization of its information systems will take years to
fully achieve.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-AIMD-00-104
     TITLE:  Internal Revenue Service: Results of Fiscal Year 1999
	     Financial Statement Audit
      DATE:  02/29/2000
   SUBJECT:  Financial statement audits
	     Internal controls
	     Computer security
	     Financial management systems
	     Strategic information systems planning
	     Reporting requirements
	     Tax refunds
	     Financial records
	     Tax administration systems
IDENTIFIER:  Earned Income Tax Credit
	     U.S. Government Standard General Ledger

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   * For Release on Delivery
     Expected at
     10 a.m.

Tuesday,

February 29, 2000

GAO/T-AIMD-00-104

internal revenue service

Results of Fiscal Year 1999 Financial Statement Audit

        Statement of Gregory D. Kutz

Associate Director, Governmentwide Accounting and Financial Management
Issues

Accounting and Information Management Division

Testimony

Before the Subcommittee on Government Management, Information and
Technology, Committee on Government Reform, House of Representatives

United States General Accounting Office

GAO

Mr. Chairman and Members of the Subcommittee:

We are pleased to be here today to discuss the results of our audit of the
Internal Revenue Service's (IRS) fiscal year 1999 financial statements, for
which we are issuing our report today. This audit is important because it
provides an independent report to IRS senior management, the Congress, and
the nation's taxpayers on IRS' progress in improving its financial and
operations management. IRS' financial statements are important to the
federal government because they report on its stewardship of $1.9 trillion
in federal tax revenues collected, $185 billion in tax refunds disbursed,
and $21 billion in net taxes receivable owed to the government. They also
report on IRS' activities associated with its fiscal year 1999
appropriations of over $8 billion.

IRS has a demanding responsibility in collecting taxes, processing tax
returns, and enforcing the tax laws in its role as the nation's tax
collector. The size and complexity of IRS' operations present additional
challenges to its management. IRS is a large, complex, decentralized
organization with about 100,000 people in 4 regional offices, 33 district
offices, 10 service centers, 3 computing centers, and numerous other field
offices that it operates throughout the United States.

About 1 year ago, we appeared before this Subcommittee to discuss the
results of our audit of IRS' fiscal year 1998 financial statements. At that
hearing, we noted that serious internal control and financial management
issues continued to plague the agency. While IRS has made progress in
addressing some of these issues, the results of our fiscal year 1999
financial audit revealed that the agency continues to experience pervasive
material weaknesses in the design and operation of its automated financial
management and related operational systems, accounting procedures,
documentation, recordkeeping, and internal controls, including computer
security controls. As they relate to IRS' administrative activities, these
weaknesses prevented us from rendering an unqualified opinion on five of
IRS' six financial statements, although IRS made significant progress in
reporting more reliable information on its balance sheet. IRS was able to
reliably report on the results of its custodial activities for fiscal year
1999, including tax revenue received, refunds disbursed, and taxes
receivable due from the public. However, this achievement, as well as other
improvements in the reliability of certain amounts reported on its balance
sheet, comes at a high cost in that it takes extensive, costly, and
time-consuming efforts to overcome pervasive internal control and systems
weaknesses.

The major issues identified in our fiscal year 1999 audit include the
following:

   * deficiencies in controls to properly manage unpaid assessments,
     resulting in both taxpayer burden and potentially billions of dollars
     in lost revenue to the government;
   * deficiencies in controls over tax refunds, permitting the disbursement
     of potentially billions of dollars of improper refunds;
   * vulnerabilities in controls over hardcopy tax receipts and taxpayer
     data that increase the government's and taxpayers' risk of loss or
     inappropriate disclosure of taxpayer data;
   * vulnerabilities in computer security that may allow unauthorized
     individuals to access, alter, or abuse proprietary IRS programs and
     electronic data and taxpayer information;
   * the failure to reconcile IRS' fund balance with Treasury records
     throughout fiscal year 1999, resulting in IRS' inability to routinely
     ensure accountability and proper use of its funds;
   * inadequate systems and controls that resulted in the inability to
     properly account for IRS' property and equipment and related costs;
   * inadequate budgetary controls, resulting in IRS' inability to assure
     that its budgetary resources are being properly accounted for,
     reported, and controlled; and
   * an inadequate financial reporting process that continued to result in
     (1) IRS' inability to reliably prepare several of the required
     financial statements and (2) financial management systems that do not
     comply with the requirements of the Federal Financial Management
     Improvement Act (FFMIA) of 1996.

Many of these issues have plagued IRS since we began auditing the agency's
financial statements for fiscal year 1992, first under the authority of the
Chief Financial Officers Act of 1990 and later under the authority of the
Government Management Reform Act of 1994. Beginning with our first audit, we
have issued reports containing numerous recommendations to assist IRS in
correcting these deficiencies. IRS has had some success in addressing some
of these deficiencies. Specifically, in fiscal year 1999, we noted
improvements in IRS' (1) overall financial reporting, (2) records of
accounts payable, (3) amounts held in suspense, (4) documentation of unpaid
tax assessments, (5) reconciliation of fund balance with Treasury, (6)
computer security, and (7) handling of hardcopy taxpayer receipts and data,
including courier security. Additionally, for the past 3 years, IRS has been
able to compensate for some of its internal control and systems deficiencies
through ad hoc computer programming and substantial manual intervention to
derive reliable year-end information on its tax revenue and refund
activities.

During fiscal year 1999, IRS focused substantial efforts on developing
compensating processes to work around its serious systems and control
weaknesses in order to derive year-end balances for its financial
statements. These processes and efforts enabled IRS to improve the
reliability of its reported year-end information. However, this approach
relies heavily on costly, time-consuming processes, statistical projections,
external consultants, and monumental human efforts to derive year-end
balances due to the lack of reliable financial management and operational
systems. More important, this approach does not produce the timely and
reliable financial and performance information IRS needs for decision-making
on an ongoing basis, nor does it address the underlying financial management
and operational issues that adversely affect IRS' ability to effectively
fulfill its responsibilities as the nation's tax collector. The challenge
for IRS will be to build on the improvements made in fiscal year 1999 in
future years to not only improve its compensating processes but also to
develop and implement the fundamental long-term solutions that are needed to
address the management challenges we have identified.

Many of the problems facing IRS represent serious agencywide financial
management and operational challenges that will require a substantial and
continuous commitment of resources, time, and expertise to correct. IRS has
major efforts under way to modernize both its organizational structure and
its information systems. These efforts appear to be heading the agency in
the right direction, but, as IRS itself has stated, successful modernization
of its information systems will take years to fully achieve.

While many of IRS' problems require long-term solutions, others, while
serious, can be effectively addressed in the near term through concerted
effort on the part of IRS management. During fiscal year 1999, IRS senior
management demonstrated a high level of involvement and commitment to
overcome some of the operational and financial management issues identified
by our audits, and this involvement contributed significantly to the actions
taken during the year to address some of these issues. Continued involvement
and commitment at this level will be essential to IRS' ability to
successfully address the serious problems that remain.

I would now like to summarize the major issues identified in our fiscal year
1999 audit.

Management of Unpaid Tax Assessments

IRS continues to lack a subsidiary ledger that tracks and accumulates unpaid
assessments and their status on an ongoing basis. Because it lacks such a
subsidiary ledger, IRS is unable to promptly identify and focus collection
efforts on accounts most likely to prove collectible and is impeded in its
ability to prevent or detect and correct errors in taxpayers' accounts.
Additionally, IRS records continued to contain errors and IRS continues to
experience significant delays in recording activity in taxpayer accounts.
Also, during fiscal year 1999, IRS continued to enter into installment
agreements with taxpayers for less than the full amount of taxes owed, and
IRS did not always promptly release liens filed against the property of
taxpayers who subsequently paid off or otherwise satisfied their outstanding
tax liabilities. These conditions resulted in instances of unnecessary
taxpayer burden and lost opportunities to collect outstanding taxes owed. We
found the following.

   * Significant delays-in some instances in excess of 10 years-in recording
     payments made by taxpayers to related taxpayer accounts. We also found
     payments that were not recorded at all in related taxpayer accounts.
     Some of these delayed or unrecorded payments were made in the late
     1980s.

   * Delays in making or recording assessments against taxpayers. In some
     instances, these delays resulted in lost opportunities for IRS to
     offset refunds owed to taxpayers for subsequent tax periods against
     their outstanding tax liabilities. In one case, an individual received
     a $15,000 refund at the same time that IRS identified this individual
     as owing nearly $350,000 in outstanding taxes. However, the tax
     assessment was not recorded in IRS' systems until nearly 9 months
     later.

   * Delays in correcting erroneous assessments resulting from data input
     errors. In one case, it took 18 months for IRS to correct an input
     error that resulted in an erroneous assessment of over $160,000 against
     a taxpayer who was actually due a refund. The case file indicated that
     IRS personnel believed the assessment was erroneous 10 months before
     correcting the account.
   * Installment agreements whose payment terms will not result in full
     payment of the outstanding taxes and that are thus not in compliance
     with the Internal Revenue Code. In one case, the taxpayer entered into
     an installment agreement covering five separate tax periods with a
     total outstanding balance of $115,000. However, only $43,000 (37
     percent) would be collected before the expiration of the statutory
     collection period for these tax liabilities, assuming the taxpayer
     continues to make the payments through the statutory collection
     periods.
   * Delays in releasing tax liens against properties owned by taxpayers who
     paid off or otherwise satisfied their tax liabilities. Specifically, in
     26 percent of the cases we tested, IRS did not release the applicable
     federal tax lien within the 30-day requirement stipulated in the
     Internal Revenue Code. In one case, we found that the taxpayer had paid
     off his three outstanding tax liabilities by October 1998; however, as
     of December 1999-14 months later-IRS had not initiated action to
     release the lien against the taxpayer's property.

The first two conditions discussed above most frequently surfaced in cases
involving unpaid payroll taxes, where separate accounts are established and
assessments recorded for a related tax liability. IRS' current systems
cannot automatically link each of the multiple assessments made for the one
tax liability. Consequently, if the business or one of its officers pays
some or all of the outstanding taxes, IRS' systems are unable to
automatically reflect the payment as a reduction in the related account or
accounts. In 45 percent of the unpaid payroll tax cases we reviewed
involving multiple assessments, we found that payments were not accurately
recorded to reflect each responsible party's reduction in tax liability.
IRS' efforts to address this serious system deficiency have thus far had
limited success in reducing the extent of inaccuracies in taxpayer accounts.

We also identified many instances in which accounts that appeared to have
some collection potential were not being actively pursued by IRS. This was
in part due to IRS' changing its criteria for determining which accounts
would be actively worked in response to an increasing inventory workload and
its judgment that resource constraints would not permit the agency to
actively pursue the cases. There is a point at which it ceases to be cost
effective to pursue collection. However, for numerous cases, available
information indicated that the taxpayers had financial resources available
to pay at least some of the amounts owed; yet these cases were not being
actively pursued. Additionally, in one case, IRS had seized property owned
by a taxpayer who owed over $4 million in outstanding taxes and was in the
process of auctioning it off to collect on at least a portion of these
taxes, yet, with no reasonable explanation, IRS pulled the property from
auction and later returned it to the taxpayer. IRS' failure to pursue
certain taxpayers owing taxes to the federal government could result in
billions of dollars in outstanding amounts going uncollected and adversely
affect future compliance.

Controls Over Refunds

IRS does not compare tax returns to W-2s and 1099s at the time tax returns
are processed because it believes this (1) is not practical due to the
intensive labor involved in performing such comparisons and (2) would
adversely affect IRS' ability to promptly process tax returns and issue
refunds. However, IRS has never provided us with a cost-benefit analysis to
support its contentions, as we previously recommended. Additionally, our
work on unpaid assessments has shown that once an inappropriate refund has
been made, there is little likelihood that IRS will be able to recover it.

Instead of this up-front comparison, IRS relies on automated programs that
are run months later, with subsequent follow-up on some identified
differences serving as a compensating detective control. However, in
addition to IRS' running these programs too late to prevent issuance of
erroneous or fraudulent refunds, we found that IRS is not effectively
applying this detective control to millions of tax returns estimated to have
billions of dollars of underreported tax liabilities. For example, for tax
year 1996, IRS' matching program for individual taxpayers screened about 155
million individual income tax returns and found that about 12 million (8
percent) had potential underreported taxes due totaling at least
$15 billion. However, IRS investigated only about 3.1 million (26 percent)
of these tax returns, accounting for estimated underreported taxes due of
about $5.2 billion (35 percent). In addition, IRS did not investigate any of
the more than 688,000 discrepancies found by its matching program for
employment tax returns filed during fiscal year 1996. According to IRS,
resource constraints kept it from investigating more of these discrepancies.
The full magnitude of the potential unpaid taxes related to the
discrepancies not investigated by IRS is unknown. Additionally, to the
extent that IRS does not actively pursue collection of the cases identified
in its matching program for which it assesses additional taxes, the
effectiveness of this process is further diminished.

Historically, EITCs have been vulnerable to high rates of invalid claims.
Since most EITCs result in refunds, the risk of invalid refunds being
disbursed is significantly increased. In an effort to minimize this risk,
IRS relies on past experience to screen tax returns claiming EITCs to
identify (for detailed examination) EITC claims considered most likely to be
invalid. During fiscal year 1999, IRS examiners using this screening process
examined about 573,000 tax returns claiming $1.25 billion in EITCs and found
that $1.08 billion (86 percent) were invalid. These examinations are an
important control mechanism for detecting questionable claims and deterring
future invalid claims, but they do not prevent the disbursement of
inappropriate refunds relating to EITCs. The magnitude of refunds resulting
from invalid EITCs is unknown. In fiscal year 1998, IRS began implementing a
5-year EITC compliance initiative intended to address noncompliance problems
with EITCs. IRS is in the process of evaluating the effectiveness of its
initiative. However, the high rate of invalid EITC claims found during IRS
examinations suggests that invalid EITC claims continue to be significant.

Manual Tax Receipts and Taxpayer Information

Specifically, in fiscal year 1999, we continued to find that IRS employed
individuals to process cash, checks, and other taxpayer data before
receiving satisfactory results of fingerprint checks. At the seven IRS
service centers that reported data, 4,835 employees that were hired to
process taxpayer receipts or data for the 1999 filing season entered on duty
before their fingerprint checks were completed. Fingerprint check results
for 138 (3 percent) of these employees later disclosed unsuitable
backgrounds. Of the 138 employees, the backgrounds of 65 (47 percent) were
considered severe enough to result in their termination or forced
resignation from IRS. We also identified other weaknesses, including
returned refund checks that were not immediately voided or locked up as
required by IRS policy, and service center guards and staff who did not ask
a courier for identification before he entered the service center or before
they handed him a $28 million deposit, even though he was not the regular
courier. We found that similar weaknesses existed at commercial lockbox
banks IRS contracts with to process tax receipts, including the hiring of
temporary employees to handle taxpayer receipts and other data before
receiving satisfactory fingerprint results.

These weaknesses increased IRS' vulnerability to theft or loss. For example,
in fiscal year 1999, IRS identified 37 actual or alleged employee thefts of
receipts at IRS field offices and lockbox banks, totaling over
$1 million. An additional eight cases were opened during the period in which
the amount potentially stolen was not quantified because the investigations
were still ongoing and the thefts had not yet been verified, or the stolen
checks were never negotiated. Our work in prior years has shown that
employee thefts have also occurred in the past and have resulted in taxpayer
burden. Furthermore, the number of thefts not identified by IRS is unknown.

IRS has taken action to address some of the control deficiencies related to
tax receipts and taxpayer data that we reported in prior years. For example,
IRS eliminated the use of bicycle or foot couriers to transport deposits to
financial institutions and issued enhanced courier security procedures after
year-end. Also, unauthorized personnel, such as security guards, are now
prohibited from accepting tax payments at service centers.

Nonetheless, it is important that corrective action be taken to address the
remaining vulnerabilities because these issues are critical to IRS'
successfully meeting its customer service goals.

Computer Security

IRS substantially improved computer security at its facilities and corrected
a significant number of the computer security weaknesses identified in our
previous audits. In addition, IRS has established and is implementing a
servicewide computer security planning and management program that, when
fully implemented, should help IRS effectively manage its computer security
risks. As part of its effort to implement this program, IRS is updating its
access control standards to reflect changes in technology and operating
environments, providing computer security training to personnel, and
conducting computer security self-assessment reviews that identify and
mitigate vulnerabilities on a proactive basis.

At the same time, much remains to be done to resolve the significant control
weaknesses that exist within IRS' computing environment. During fiscal year
1999, we continued to find serious weaknesses with IRS' general controls
designed to protect computing resources such as networks, computer
equipment, software programs, data, and facilities from unauthorized use,
modification, loss, and disclosure. Such computing resources also include
systems operated and maintained by other government entities such as
Treasury's Financial Management Service. IRS did not always (1) effectively
implement controls to prevent, limit, or detect access to computing
resources, (2) adequately segregate system administration and security
administration responsibilities, (3) optimally configure system software to
ensure the security and integrity of system programs, files, and data, (4)
sufficiently plan or test the activities required to restore critical
business systems when unexpected events occur, and (5) routinely monitor key
networks and systems to identify unauthorized activities and inappropriate
system configurations. In addition, internal controls over IRS' key computer
applications that manage budget execution, tax return input, and receipt
processing do not provide adequate assurance that only authorized personnel
have access to the applications and related data, that the data are complete
and accurate, and that application and data integrity is maintained.

These weaknesses increase the risk that data processed by IRS' computer
systems are not reliable. If IRS does not adequately mitigate these
weaknesses, unauthorized individuals could gain access to critical hardware
and software where they may intentionally or inadvertently add, alter, or
delete sensitive data or computer programs. These individuals could also
obtain personal taxpayer information and use it to commit financial crimes
using taxpayers' names (identity fraud), such as fraudulently establishing
credit and running up debts.

Fund Balance With Treasury

Despite substantial efforts, IRS was unable to reconcile its administrative
fund balance with Treasury accounts throughout fiscal year 1999. Such
reconciliations are required by Treasury policy and are analogous to
companies or individuals reconciling their checkbooks to monthly bank
statements.

Unlike during fiscal year 1998, when IRS did not attempt to reconcile its
fund balance, IRS made a concerted effort to reconcile its fund balance with
Treasury accounts during fiscal year 1999. IRS devoted significant time and
staff resources to try to correct its records for the effects of these
adjustments. However, its efforts were hindered due to its inability to
correct its records for unsupported adjustments of approximately
$84 million and $60 million recorded to its general ledger in fiscal years
1997 and 1998, respectively, to force its records to match Treasury's
records. These adjustments represented an accumulation of unidentifiable
differences between Treasury's and IRS' records. IRS had posted these
adjustments for several years without first performing the necessary
research to determine whether adjustments to the general ledger were, in
fact, needed or whether some or all of these differences were attributable
to errors in Treasury's records. This is similar to an individual not
reconciling his or her checkbook with monthly bank statements for years, and
then adjusting the checkbook to agree with the balance per the latest bank
statement without first verifying that the bank had not made any mistakes.
Because some of the adjustments IRS had made related to differences going
back as far as fiscal year 1995, IRS' ability to research and make proper
correcting entries was further hindered.

In late January 2000, after several unsuccessful attempts, IRS was able to
provide us with a reconciliation of its 1999 fiscal year-end fund balance
with Treasury that was sufficiently complete to enable us to conclude that
the amount reported in its financial statements for fund balance with
Treasury as of September 30, 1999, was reliable. However, reconciling
differences between IRS and Treasury records related to payroll continue to
exist. These differences need to be fully researched to determine the extent
to which IRS' fund balance may be misstated and in need of further
adjustments. These unresolved differences and IRS' lack of routine and
complete reconciliations during fiscal year 1999 raise serious concerns
about its ongoing ability to ensure that it complies with the law governing
the use of its budget authority. Without this crucial control, it is
difficult, if not impossible, for IRS to determine if operating funds are
being properly spent or if reported amounts for program costs, assets, and
liabilities are reliable.

Property and Equipment

During fiscal year 1999, we continued to find significant errors in the
quantities and valuations of P&E included in IRS' P&E subsidiary records.
These errors are the result of ineffective IRS procedures to capture
additions and disposals of P&E. Specifically, IRS relies on individuals
across the country to inform those responsible for maintaining the
subsidiary records of any P&E additions or disposals. At one IRS location we
visited, the procedure for updating the P&E records for property purchases
consisted of the individual receiving the property making a long-distance
telephone call to another individual responsible for recording the
acquisition in the subsidiary records. We found that procedures for
recording P&E frequently were not followed, resulting in numerous errors.
For example, we found that 25 percent of the 106 P&E items we inventoried at
IRS field offices were not included in the P&E records, including
videoconferencing equipment and three recently acquired mail-sorting
machines that cost over $800,000 each. We also noted that 200 personal
computers that had been disposed of were still included in IRS' records. In
addition, we found that P&E was consistently recorded based on internal
documents such as purchase orders or requisitions that may not reflect the
actual invoice price paid, and that, contrary to federal accounting
standards, shipping and installation costs were excluded from the recorded
value. We found other valuation errors in IRS' records, such as a Compaq
laptop computer recorded at a cost of $310,000 and a copy of Microsoft
Office software that cost $212 but was erroneously recorded at $212,300.

The quality of its P&E records was so poor that IRS determined it could not
rely on the records to report the balance on its financial statements.
Consequently, IRS hired a consulting firm to develop a balance based
primarily on a statistical estimate. The resulting estimate of $1.3 billion
of net P&E at September 30, 1999, in turn resulted in an upward adjustment
of over $1 billion (600 percent) to IRS' accounting records. This
substantial adjustment confirmed our fiscal year 1998 conclusion that IRS'
P&E balance was likely materially understated. In addition to the problems
previously discussed, this substantial adjustment was necessary because IRS
excluded over $250 million of external software and systems development
costs and $65 million of assets under capital lease. The material adjustment
to IRS' P&E balance was also necessary because IRS' prior practice of using
Treasury's capitalization threshold of $50,000 was inappropriate. The use of
this threshold in the past resulted in hundreds of millions of dollars in
P&E purchases being expensed in the year of purchase instead of being
properly reported as assets. While IRS' costly and time-consuming effort did
produce a reasonable P&E balance at year-end, its inability to distinguish
P&E asset purchases from expenses or to reliably report depreciation expense
continued to contribute to its inability to produce reliable statements of
net cost, changes in net position, and financing.

Before IRS undertook its costly year-end estimate of P&E, we recommended
that its management ensure that systems and controls be in place for fiscal
year 2000 to properly record additions and disposals of P&E. If IRS does not
implement needed improvements for fiscal year 2000, it will have spent over
$1 million on an estimate that was reliable for only 1 day, and it may be
unable to properly account for the billions of dollars it plans to spend on
tax systems modernization over the next decade.

Budgetary Controls

We found errors in 42 percent of a statistical sample of 130 undelivered
orders at September 30, 1999, including the following.

   * Undelivered orders dating back as far as 1996 that IRS should have
     deobligated. For example, we found $2.8 million for an undelivered
     order relating to computer services for which the last invoice was
     received in fiscal year 1996, but the remaining unneeded amount had not
     been deobligated.
   * Goods or services that had been received but the amount was not removed
     from IRS' undelivered orders. For example, we found fiscal year 1999
     telephone services for approximately $2 million that were not recorded
     as expenses and reductions of undelivered orders, and $2.2 million of
     computer services that had been received before September 30, 1999, but
     were still shown as an undelivered order. These overstatements of
     undelivered orders resulted in understatements of IRS' accounts
     payable.

Additionally, we found that IRS' automated controls over the use of its
budgetary resources were not effective. Specifically, IRS allowed excessive
numbers of individuals to have the capability to override its automated
spending controls. We found that 76 percent of the 1,749 users that had
access to IRS' budgetary control system had some capabilities to override
controls that could allow expenditures to exceed amounts obligated. Of these
users, 87 also had the ability to override appropriation-level spending
controls that could allow expenditures to exceed amounts appropriated.

IRS also did not promptly record all expenditures in the accounts of the
appropriations authorized to pay them. Instead, for some expenditures for
which the funding information and/or supporting documentation was
incomplete, IRS recorded the transactions in suspense accounts while
awaiting supporting documentation. IRS made substantial improvements in its
handling of suspense items and was able to reduce the amount held in
suspense from more than $140 million at September 30, 1998, to about $8
million at September 30, 1999. However, transactions continue to remain in
suspense for months or, in some cases, years. For example, IRS still had a
number of charges from the General Services Administration that were
recorded in its suspense account in 1996. Until these suspense transactions
are posted to the proper appropriation accounts and matched with
corresponding obligation records, IRS cannot ensure that its outstanding
obligations and disbursements do not exceed available budget authority.

Financial Reporting

   * IRS' general ledger (1) did not always use the standard federal
     accounting classification structure, (2) was not current or accurate,
     and (3) was not supported by adequate audit trails for P&E, program
     costs, federal tax revenue, federal tax refunds, or taxes receivable.
     Consequently, IRS continued to be unable to rely on its general ledger
     to support its financial statements.
   * Underlying detail records supporting transactions in the general ledger
     were inaccurate. For example, in testing a detailed list supporting
     accounts payable, we found that the list was both incomplete and
     included invalid items. Specifically, 10 percent of the items we tested
     from this list were not valid accounts payable, and 20 percent of items
     we tested from other sources were inappropriately excluded from this
     list.
   * The costs of IRS' two largest programs, customer service and
     compliance, are intermingled on its statement of net cost. The costs
     reported for these two programs for fiscal year 1999 include amounts
     for activities that we believe are inconsistent with the nature of the
     programs. For example, IRS included funding for customer service
     activities such as taxpayer walk-in service and taxpayer education
     efforts in accounting for and reporting costs of its compliance
     activities. Similarly, IRS considered all non-face-to-face contacts
     with taxpayers forms of customer service, including compliance-related
     activities such as telephone tax collection and correspondence
     examinations of tax returns. We found that in 11 percent of the cases
     we reviewed, staff working on activities that included correspondence
     examinations or telephone tax collections charged all of their time to
     customer service. Consequently, IRS is unable to reliably report to the
     Congress or the public the appropriate information on the cost of
     either of its two largest programs.

IRS' financial statements are affected by material amounts that are either
not recorded in the general ledger until the subsequent year or not recorded
at all. As a result, IRS' general ledger is perpetually materially
incomplete and must be supplemented by extensive analysis and material
adjustments to recognize transactions that were omitted from the general
ledger. These supplemental procedures are costly, labor intensive, prone to
error, and typically require several months to complete. This approach also
requires effective internal controls if it is to produce reliable
information. However, IRS did not effectively supervise this process to
ensure that errors were caught and corrected before they adversely affected
the financial statements. For example, we found material discrepancies in
IRS' records that, had we not brought them to IRS' attention, would have
resulted in an error of over $102 million on IRS' financial statements going
uncorrected. As a result of these problems, IRS cannot produce reliable
agencywide financial statements or financial performance information
throughout the year as a management tool, as is standard practice in private
industry and some federal entities.

Because of the weaknesses and issues discussed above, we continued to find
that IRS' financial management systems did not substantially comply with the
Federal Financial Management Systems Requirements (FFMSR), federal
accounting standards, and the U.S. Government Standard General Ledger (SGL)
at the transaction level. These weaknesses also indicate that IRS cannot
accumulate and report the full costs of its activities on a regular basis as
required by federal accounting standards.

Remaining Financial Management Issues

We have assisted IRS in formulating corrective actions to address its
serious internal control and financial management issues by providing
recommendations over the years, and we will continue to work with IRS on
these matters. We recognize that IRS' financial management systems were not
designed to meet current systems and financial reporting standards. We also
recognize that IRS' problems did not occur overnight and that it will take
years for IRS to fully correct its systems-related deficiencies. However, we
believe that continued progress in resolving a number of the serious
internal control issues that IRS faces can be addressed in the near term
through continued dedicated efforts on the part of IRS management.
Additionally, successful implementation of IRS' longer term efforts and
resolution of the serious problems that continue to be identified by our
audits will also require substantial management commitment, resources, and
expertise.

Mr. Chairman, this concludes my prepared statement. I would be pleased to
answer any questions.

Contacts and Acknowledgements

Appendix I

Components of IRS' 1999 Unpaid Assessments

Figure 1: Components of IRS' $231 Billion of Unpaid Assessments: FY 1999

(Dollars in billions)

Appendix II

Comparison of IRS' Taxes Receivable Between 1998 and 1999

Figure 2: Estimated Collectibility for IRS' Taxes Receivable: Fiscal Years
1998 and 1999 (Dollars in Billions)

(919469)

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