IRS Financial Audits: Status of Efforts to Resolve Financial Management
Weaknesses (Testimony, 09/19/96, GAO/T-AIMD-96-170).

GAO discussed the Internal Revenue Service's (IRS) efforts to prepare
reliable financial statements and improve its financial management,
focusing on: (1) IRS implementation of GAO recommendations to correct
financial management weaknesses; (2) IRS progress in addressing major
problems that have prevented GAO from expressing an opinion on its
financial statements; (3) IRS problems in developing Tax Systems
Modernization (TSM); and (4) how IRS financial management weaknesses
affect Department of the Treasury and governmentwide financial
statements. GAO noted that: (1) IRS is implementing some short-term
interim strategies to resolve financial management problems in time for
its fiscal year 1996 financial statement audit; (2) IRS will need to
make more sweeping changes and devise long-term solutions to fully
address problems in its accounting for administrative operations,
reporting accounts receivable, and accounting for revenue; (3) many IRS
actions for correcting management and technical problems in developing
TSM are incomplete and do not fully respond to the recommendations; (4)
IRS financial information provides significant input to and greatly
affects the preparation and audit of Treasury and governmentwide
financial statements; and (5) it will be essential for IRS to follow
through on its short-term and long-term efforts to improve its financial
statements and financial management systems.

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

 REPORTNUM:  T-AIMD-96-170
     TITLE:  IRS Financial Audits: Status of Efforts to Resolve 
             Financial Management Weaknesses
      DATE:  09/19/96
   SUBJECT:  Tax administration
             Tax administration systems
             Financial statement audits
             Financial management systems
             Systems design
             Federal agency accounting systems
             Financial records
             Administrative costs
             Accounts receivable
             Government collections
IDENTIFIER:  TSM
             IRS Tax System Modernization Program
             
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Cover
================================================================ COVER


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

For Release on Delivery
Expected at
10:30 a.m.
Thursday,
September 19, 1996

IRS FINANCIAL AUDITS - STATUS OF
EFFORTS TO RESOLVE FINANCIAL
MANAGEMENT WEAKNESSES

Statement of Gene L.  Dodaro
Assistant Comptroller General
Accounting and Information Management Division

GAO/T-AIMD-96-170

GAO/AIMD-96-170T


(901722)


Abbreviations
=============================================================== ABBREV

  CFO - Chief Financial Officer
  EFTPS - Electronic Federal Tax Payment System
  FICA - Federal Insurance Compensation Act
  GPO - Government Printing Office
  IRS - Internal Revenue Service
  TSM - Tax Systems Modernization

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

We are pleased to be here today to discuss IRS' efforts to both
prepare reliable financial statements, as required by the expanded
Chief Financial Officers (CFO) Act of 1990, and make fundamental
financial management improvements.  Our recent reports and
testimonies,\1 including our March 1996 testimony before the
Subcommittee, detailed the substantial problems IRS has in accounting
for over $1 trillion in monies collected from American taxpayers and
billions of dollars in delinquent taxes owed to the government. 
Until resolved, these weaknesses will continue to affect the
credibility of information used to report the results of IRS'
financial operations and measure its performance. 

While serious problems have been identified, the CFO requirements
have provided the impetus for efforts to improve IRS operations. 
They have

  -- led to IRS top managers having a much better understanding than
     ever before of IRS' serious accounting and reporting problems,

  -- provided information on the magnitude of IRS' tax receivables
     collection problems, and

  -- identified the need for stronger controls over such areas as
     payroll operations. 

IRS has made some progress in responding to the problems we have
identified.  Over the past 4 years, we have made 59 recommendations
to improve IRS' financial management systems and reporting.  IRS
agreed with these recommendations and has been working to implement
them and correct its financial management systems and information
problems.  In our assessment this year, we determined that IRS had
completed 17 of these recommendations and efforts are underway to
address the remaining areas.  As part of our audit of IRS' fiscal
year 1996 financial statements, we will examine additional actions
IRS has taken to complete other recommendations we have made. 

However, many difficult problems remain to be corrected before we
would be able to express an opinion on IRS' financial statements. 
With our assistance, IRS is working on a plan of interim strategies
to solve these problems, with a goal of having these matters resolved
in time for the fiscal year 1996 financial statement audit.  For some
areas, especially in accounting for revenue, IRS will need to make
more sweeping changes to fully address systems problems.  In these
cases, longer-term solutions involving reprogramming software for
IRS' antiquated systems and developing new systems will be required. 

Follow-through by IRS is essential to ensure that its short- and
long-term plans are carried out and effectively solve financial
management problems.  In the past, IRS has not always provided the
follow-through needed to complete necessary corrective measures. 
Solving these problems is essential to provide reliable financial
information and ensure taxpayers that their tax dollars are properly
accounted for in accordance with federal accounting standards.  The
accuracy of IRS' financial statements is also key to both IRS and the
Congress for (1) ensuring adequate accountability for IRS programs,
(2) assessing the impact of tax policies, and (3) measuring IRS'
performance and cost effectiveness in carrying out its numerous tax
enforcement, customer service, and collection activities. 

Today, we will focus on

  -- the status of IRS' efforts to implement our recommendations and
     develop a detailed plan with explicit, measurable goals and a
     set timetable for actions to correct its financial management
     weaknesses;

  -- IRS' progress in addressing the major problems that have
     prevented us from expressing an opinion on its financial
     statements;

  -- the impact that IRS' problems in developing Tax Systems
     Modernization have on improving financial information; and

  -- the significant adverse affect that delays in resolving IRS'
     financial management weaknesses could have on preparing and
     auditing Treasury's agencywide financial statements and the
     financial statements for the entire government. 


--------------------
\1 Our recent reports and testimonies detailing IRS' financial
management problems are listed in attachment I. 


   ADDRESSING SERIOUS FINANCIAL
   MANAGEMENT PROBLEMS
---------------------------------------------------------- Chapter 0:1

IRS prepares separate sets of financial statements showing the
results of its operations for (1) administrative operations, which
include $8 billion in payroll and other expenses, and (2) custodial
functions, which reflect $1.4 trillion in tax collections.  IRS began
preparing these annual statements starting with those for fiscal year
1992 as part of a pilot program under the CFO Act of 1990. 

We have been unable to express an opinion on the reliability of these
financial statements for any of the 4 fiscal years from 1992 through
1995.  We identified fundamental problems with both the
administrative and the financial statements and IRS has not yet fully
corrected them.  Until resolved, they will continue to prevent us
from expressing an opinion on IRS' financial statements in the
future.  The following sections outline these problems and IRS'
improvement plans and progress. 


      ACCOUNTING FOR
      ADMINISTRATIVE OPERATIONS
      HAS IMPROVED BUT PROBLEMS
      REMAIN
-------------------------------------------------------- Chapter 0:1.1

Each year, IRS spends billions of dollars in operating expenses to
(1) process tax returns, provide taxpayer assistance, and manage tax
programs, (2) enforce tax laws, and (3) develop and maintain
information systems.  For fiscal year 1995, IRS reported $8.1 billion
in operating costs, including $5.3 billion for payroll and other
personnel costs and $2.8 billion for the cost of goods and services,
such as rent, printing, and acquiring and maintaining automatic data
processing equipment. 

Our initial financial audits identified serious problems in
accounting for and reporting on IRS administrative operations, which
has resulted in IRS making improvement in these areas.  For example,
IRS has successfully

  -- implemented a financial management system (which according to
     Treasury, conforms to the government's Standard General Ledger)
     to account for its appropriated funds, which has helped IRS to
     correct some of its past transaction processing problems that
     diminished the accuracy and reliability of its cost information,
     and

  -- transferred its payroll processing to the Department of
     Agriculture's National Finance Center and, as a result, improved
     its accounting for payroll expenses. 

These improvements have made IRS' accounting for its administrative
operations much better today than it was 4 years ago.  For example,
we are now able to substantiate IRS' payroll expenses of about $5
billion.  However, the following two major problems still need to be
fully corrected. 

  -- A significant portion of IRS' reported $3 billion in nonpayroll
     operating expenses for goods and services could not be verified. 

  -- The amounts IRS reported as appropriations available for
     expenditure for operations could not be reconciled fully with
     Treasury's central accounting records showing these amounts, and
     in the past, hundreds of millions of dollars in gross
     differences had been identified. 


         RECEIPT OF GOODS AND
         SERVICES
------------------------------------------------------ Chapter 0:1.1.1

We found several problems in attempting to substantiate amounts IRS
reported as having been spent for goods and services.  IRS did not
have support for when and if certain goods or services were received
and, in other instances, did not have support for reported expense
amounts.  For example, IRS accepts Government Printing Office (GPO)
bills as being accurate and records an expense in its financial
records without first verifying that the printing goods and services
being billed were actually delivered and accepted.  Also, in
instances where IRS could provide information showing proper receipt
and acceptance of goods and services, expenses were often recorded in
the wrong fiscal year.  This problem occurs because (1) IRS offices
that receive and accept goods and services do not always forward to
IRS accounting offices evidence supporting these actions and (2) IRS
accounting offices used inconsistent, and in some cases incorrect,
policies and procedures for recording expenses. 

Ensuring that goods and services have been received and properly
accounted for are fundamental accounting steps and controls.  Over
the past 4 years, we have recommended that IRS

  -- revise its procedures to incorporate the requirements that
     accurate receipt and acceptance data on invoiced items be
     obtained prior to payment and that supervisors ensure that these
     procedures are carried out, and

  -- revise its document control procedures to require IRS units that
     actually receive goods and services to promptly forward
     receiving reports to accounting offices so that these
     transactions can be properly accounted for. 

IRS believes the core issue for correcting its receipt and acceptance
problems relate to properly accounting for transactions with other
federal agencies.  IRS plans to address this issue by

  -- completely and accurately documenting its current accounting
     systems and control procedures for procuring, receiving,
     accepting, and paying for goods and services through other
     federal agencies, such as GPO and the General Services
     Administration, and recording the related budgetary, expense,
     and cash disbursement transactions;

  -- identifying and evaluating the reliability of available
     documentary evidence and systems, which until this point have
     been developed and utilized primarily to meet operational rather
     than financial reporting objectives;

  -- working with other federal agencies to explore ways to improve
     the timeliness, nature, and extent of documentation supporting
     interagency payments that would allow IRS to properly account
     for these interagency transactions; and

  -- developing both short- and long-term improvements to its
     accounting systems and control procedures, including
     modifications to its automated systems to allow for direct
     interfaces between its operating systems and its general ledger
     accounting system. 

IRS is now beginning to deal with this problem in a comprehensive
way.  To that end, it has engaged an accounting firm for assistance
in carrying out this plan.  We are closely monitoring IRS' and its
contractor's progress because, only through an intense, concerted
effort, will the proposed solutions be implemented on time for the
fiscal year 1996 audit. 


         FUND BALANCE
         RECONCILIATION ISSUES
------------------------------------------------------ Chapter 0:1.1.2

Also, we could not verify the accuracy of IRS' Fund Balance with
Treasury accounts that are related to IRS' appropriation accounts for
its operations.  The Fund Balance accounts are used to record cash
receipts and cash disbursements for these appropriations.  These
accounts are much like checking accounts with a bank, and their
balances represent the amount of appropriations available to IRS for
expenditure.  Accordingly, like bank checking accounts, each month,
these accounts must be reconciled with the bank's records, and any
differences reported to the bank.  In this case, the banker is the
Treasury and the differences are great. 

These accounts have been unreconciled in each of the years we have
audited IRS' financial statements.  The net reconciling differences
are made up of gross differences in the hundreds of millions of
dollars.  For example, we reported last year that IRS was researching
$13 million in net differences that consisted of $661 million of
increases and $674 million of decreases. 

We have recommended that IRS

  -- promptly resolve differences between IRS and Treasury records of
     IRS' cash balances and adjust accounts accordingly and

  -- promptly investigate and record suspense account items to
     appropriate appropriation accounts. 

In fiscal year 1995, IRS hired a contractor to provide information on
the differences between IRS and Treasury records through fiscal year
1995 and established a task force to resolve the differences the
contractor identified.  IRS found that documentation was no longer
available to resolve prefiscal year 1993 differences, which resulted
in $10 million of net positive cash reconciling differences being
written off.  IRS has not yet completed the research necessary to
resolve fiscal year 1993, 1994, and 1995 differences.  Further,
additional research is required to resolve differences held in IRS'
Suspense Accounts and Budget Clearing Accounts at Treasury. 

To this end, IRS has developed plans to

  -- complete its posting of adjustments to its appropriation
     accounts for fiscal year 1995 based on our review of these
     adjustments, and

  -- engage a contractor to assist in completing its reconciliation
     of balances remaining in its Budget Clearing Accounts and
     Suspense Accounts. 

IRS plans to complete the necessary adjustments to its records and
Treasury's records prior to the closing of its books for fiscal year
1996.  In addition to completing this research, IRS must ensure that
effective processes and procedures are in place to routinely
reconcile its Fund Balance with Treasury accounts.  In this regard,
IRS has created a unit to manage the reconciliation of these accounts
on an ongoing basis. 

Overall, IRS' success in resolving the basic accounting and control
issues involving its administrative operations will be indicative of
its commitment and ability to resolve larger and more complex issues
involving accounts receivable and revenue accounting. 


      ACCOUNTS RECEIVABLE COULD
      NOT BE VERIFIED
-------------------------------------------------------- Chapter 0:1.2

We could not verify the validity of either the $113 billion of
accounts receivable or the $46 billion of collectible accounts
receivables that IRS reported on its fiscal year 1995 financial
statements.  In our audit of IRS' fiscal year 1992 financial
statements, after performing a detailed analysis of IRS' receivables
as of June 30, 1991, we estimated that only $65 billion of about $105
billion in gross reported receivables that we reviewed was valid for
financial reporting purposes and that only $19 billion of the valid
receivables was collectible.  At the time, IRS had reported that $66
billion of the $105 billion was collectible. 

In our audit of IRS' fiscal year 1992 financial statements, we
recommended that IRS take steps to ensure the accuracy of the
balances reported in its financial statements by, in the long-term,

  -- identifying which assessments currently recorded in the
     masterfile represent valid receivables and

  -- designating new assessments that should be included in the
     receivables balance as they are recorded. 

We recommended also that, until these capabilities are implemented,
IRS rely on statistical sampling to determine what portion of its
assessments represent valid receivables. 

Subsequently, we helped IRS develop a statistical sampling method
that, if properly applied, would allow it to reliably estimate and
report valid and collectible accounts receivable on its financial
statements.  We evaluated and tested IRS' use of the method as part
of our succeeding financial audits and found that IRS made errors in
carrying out the statistical sampling procedures, which rendered the
sampling results unreliable.  For the fiscal year 1995 audit, for the
first time, IRS tried, also without success, to specifically identify
its accounts receivable. 

Further, IRS' accounting and reporting for accounts receivable is
hampered by the limitations of its financial management system.  IRS'
system is not designed to specifically identify and separately track
from detailed taxpayer records those owing taxes reportable as
accounts receivable. 

To mitigate this system's limitation in fiscal year 1995, IRS
reported accounts receivable by using the uncollected assessment
information from its computer system's master files, which were
automatically sorted into either compliance assessments or financial
receivables.  In this way, IRS planned to identify the amount
specifically related to financial receivables and report it as valid
accounts receivable as of September 30, 1995. 

However, when we tested a sample of the automated sorting results, we
found cases in which the financial management system's data were
incorrect, and thus, did not properly segregate compliance
assessments from financial receivables.  We identified instances in
which compliance assessments were classified as financial
receivables, and thus, incorrectly included as accounts receivable;
and other cases in which financial receivables were classified as
compliance assessments, and thus, improperly excluded from accounts
receivable.  Based on the testing results, we concluded that the
process IRS used in 1995 was unreliable for projecting the total
inventory of outstanding assessments.  Consequently, the accounts
receivable reported on the fiscal year 1995 financial statements
could not be relied on. 

IRS' plans call for improving accounts receivable reporting in the
short term by

  -- analyzing, by September 30, 1996, its inventory of uncollected
     assessments to determine ways to resolve issues concerning the
     financial management system's underlying data limitations and

  -- reliably determining, by January 6, 1997, the estimated amount
     of accounts receivable that is collectible. 

Also, IRS needs to review and update current policies and procedures
for maintaining documentation supporting accounts receivable, and
when necessary, train employees to properly record detailed taxpayer
transactions.  Currently, IRS is reviewing its policies for retaining
documentation supporting accounts receivable. 

In addition, IRS will be challenged to fully meet the federal
accounting standards for accounting for accounts receivable, which
become effective for fiscal year 1998.  IRS will need to

  -- design its financial management system to analyze all
     outstanding amounts to properly identify and report valid
     accounts receivable and the amount expected to be collected;

  -- track all activity affecting IRS' accounts receivable balance,
     including collections as a result of enforcement efforts, tax
     abatements, and aging of receivables; and

  -- provide dollar information about its compliance assessments. 


      ACCOUNTING FOR REVENUE
-------------------------------------------------------- Chapter 0:1.3

Our audit of IRS' fiscal year 1995 financial statements found that

  -- the amounts of total revenue (reported to be $1.4 trillion for
     fiscal year 1995) and tax refunds (reported to be $122 billion
     for fiscal year 1995) could not be verified or reconciled to
     accounting records maintained for individual taxpayers in the
     aggregate and

  -- the amounts reported for various types of taxes collected
     (social security, income, and excise taxes, for example) could
     not be substantiated. 

Our financial audits have found that IRS' financial statement amounts
for revenue, in total and by type of tax, were not derived from its
revenue general ledger accounting system or its master files of
detailed individual taxpayer records.  The revenue accounting system
does not contain detailed information by type of tax, such as
individual income tax or corporate tax, and the master file cannot
summarize the taxpayer information needed to support the amounts
identified in the system.  As a result, IRS relied without much
success on alternative sources, such as Treasury schedules, to obtain
the summary total by type of tax needed for its financial statement
presentation. 

To substantiate the Treasury figures, our audits attempted to
reconcile IRS' master files--the only detailed records available of
tax revenue collected--with Treasury records.  For fiscal year 1994,
for example, we found that IRS' reported total of $1.3 trillion for
revenue collections taken from Treasury schedules was $10.4 billion
more than what was recorded in IRS' master files.  Because IRS was
unable to satisfactorily explain-- and we could not determine--the
reasons for this difference, the full magnitude of the discrepancy
remains uncertain. 

In addition to the difference in total revenues collected, we also
found large discrepancies between information in IRS' master files
and the Treasury data used for the various types of taxes reported in
IRS' financial statements.  For fiscal year 1994, for example, some
of the larger reported amounts in IRS' financial statement for which
IRS had insufficient support were $615 billion in individual taxes
collected--this amount was $10.8 billion more than what was recorded
in IRS' master files; $433 billion in social security insurance taxes
collected--this amount was $5 billion less than what was recorded in
IRS' master files; and $148 billion in corporate income taxes--this
amount was $6.6 billion more than what was recorded in IRS' master
files.  Thus, IRS did not know and we could not determine if the
reported amounts were correct.  These discrepancies also further
reduce our confidence in the accuracy of the amount of total revenues
collected. 


         CAUSES OF IRS' REVENUE
         ACCOUNTING PROBLEM
------------------------------------------------------ Chapter 0:1.3.1

Contributing to these discrepancies is a fundamental problem in the
way tax payments are reported to IRS.  About 80 percent, or about
$1.1 trillion, of total tax payments are made by businesses and
typically include (1) taxes withheld from employees' checks for
income taxes, (2) Federal Insurance Compensation Act (FICA)
collections, and (3) the employer's matching share of FICA.  IRS
requires business taxpayers to make tax payments using federal tax
deposit coupons. 

The payment coupons identify the type of tax return to which they
relate (such as a Form 941, Quarterly Wage and Tax Return) but do not
specifically identify either the type of taxes being paid or the
individuals whose tax withholdings are being paid.  For example, a
payment coupon indicating that a deposit relates to a Form 941 return
can cover payments for employees' tax withholding, FICA taxes, and an
employer's FICA taxes.  Because only the total dollars being
deposited are indicated on the coupon, IRS knows that the entire
amount relates to a Form 941 return but does not know how much of the
deposit relates to the different kinds of taxes covered by that type
of return. 

Consequently, at the time tax payments are made, IRS is not provided
information on the ultimate recipient of the taxes collected. 
Furthermore, the type of tax being collected is not distinguished
early in the collection stream.  This creates a massive
reconciliation process involving billions of transactions and
subsequent tax return filings. 

For example, when an individual files a tax return, IRS initially
accepts amounts reported as a legitimate record of a taxpayer's
income and taxes withheld.  For IRS' purposes, these amounts
represent taxes paid because they cannot be readily verified to the
taxes reported by an individual's employer as having been paid.  At
the end of each year, IRS receives information on individual
taxpayers' earnings from the Social Security Administration.  IRS
compares the information from the Social Security Administration to
the amounts reported by taxpayers with their tax returns.  However,
this matching process can take 2-1/2 years or more to complete,
making IRS' efforts to identify noncompliant taxpayers extremely slow
and significantly hindering IRS' ability to collect amounts
subsequently identified as owed from false or incorrectly reported
amounts. 

Consistent with this process, IRS' system is designed to identify
only total receipts by type of return and not the entity which is to
receive the funds collected, such as the General Fund at Treasury for
employee income tax withholdings or the Social Security Trust Fund
for FICA.  Ideally, the system should contain summarized information
on detailed taxpayer accounts, and such amounts should be readily and
routinely reconciled to the detailed taxpayer records in IRS' master
files. 

Also, IRS has not yet established an adequate procedure to reconcile
the revenue data that the system does capture with data recorded and
reported by Treasury.  Further, documentation describing what IRS'
financial management system is programmed to do is neither
comprehensive nor up to date, which means that IRS does not yet have
a complete picture of the financial system's operations--a
prerequisite to fixing the problems. 

Beginning with our audit of IRS' fiscal year 1992 financial
statements, we have made recommendations to correct weaknesses
involving IRS' revenue accounting system and processes.  They include

  -- addressing limitations in the information submitted to IRS with
     tax payments by requiring that payments identify the type of
     taxes being collected,

  -- implementing procedures to complete reconciliations of revenue
     and refund amounts with amounts reported by the Treasury, and

  -- documenting IRS' financial management system to identify and
     correct the limitations and weaknesses that hamper its ability
     to substantiate the revenue and refund amounts reported on its
     financial statements. 


         SHORT-TERM FIXES TO
         REVENUE ACCOUNTING
         PROBLEMS
------------------------------------------------------ Chapter 0:1.3.2

The problem of identifying collections by type of tax results from
inherent limitations in IRS' present financial system.  To correct
this problem in the short term, IRS has developed a methodology that
uses software programs IRS believes will capture from its revenue
financial management system the detailed revenue and refund
transactions that would support reported amounts in its future
financial statements.  In short, this approach is directed at
developing reasonable estimates of taxes by type of tax collected by
using the capabilities of IRS' present systems. 

To reconcile IRS' tax revenue data with Treasury's balances, IRS'
plans call for the extracts from these software programs to be
available in accordance with the following schedule: 

  -- Data for the first 6 months of fiscal year 1996 will be
     available by October 1, 1996. 

  -- Data for the entire fiscal year will be available by January 15,
     1997. 

To provide an allocation of taxes between social security, income,
and excise taxes, IRS plans call for the extracts from these software
programs to be available in the following timeframes: 

  -- Allocations for the first three quarters of fiscal year 1996 are
     due by November 30, 1996. 

  -- An allocation for the final quarter of fiscal year 1996 is due
     by January 30, 1997. 

Also, regarding the issue of reconciling accounting records with
individual taxpayer accounts, IRS is trying to better understand the
differences between its systems and Treasury's records.  To gain this
understanding, IRS plans to soon complete documentation of its
revenue financial management system in the near future.  This is
critical to (1) aid in identifying better interim solutions for
reporting revenues and refunds and (2) provide better insights on the
longer term system fixes needed to enable IRS to readily and reliably
provide the underlying support for its reported revenue and refund
amounts. 


         FIXING REVENUE ACCOUNTING
         PROBLEM LONG-TERM
------------------------------------------------------ Chapter 0:1.3.3

IRS has not yet put in place the necessary procedures to routinely
reconcile activity in its summary accounting records with that
maintained in its detailed master file records or taxpayer accounts. 
This problem is further exacerbated by IRS' financial management
system, which was not designed to support financial statement
presentation and thus significantly hinders IRS' ability to identify
the ultimate recipient of collected taxes. 

Longer term system fixes are necessary to achieve more reliable
reporting of these amounts.  In this regard, as part of Tax Systems
Modernization, IRS has designed the Electronic Federal Tax Payment
System (EFTPS) to electronically receive deposits from businesses. 
EFTPS is planned to be operational by the end of 1996.  If
implemented as designed, EFTPS will have the capability to collect
actual receipt information for excise and social security taxes. 

However, not all employers will be required to use EFTPS to make
their federal tax deposit payments.  According to IRS officials,
approximately 20 percent of the employers that make federal tax
deposit payments will have the option of remaining with the current
system, which provides limited information.  Therefore, even if
employers that use EFTPS are required to provide additional
information on social security and excise taxes, to the extent that
some businesses still make deposits using the current system, IRS
will not have the complete information it needs to determine
collections from excise and social security taxes. 

In addition, IRS will have to make changes to meet criteria for
determining revenue that are contained in federal accounting
standards, which will be effective for fiscal year 1998.  This will
require IRS to account for the source and disposition of all taxes in
a manner that enables accurate reporting of cash collections and
accounts receivable and appropriate transfers of revenue to the
various trust funds and the general fund.  To achieve this, IRS'
accounting system will need to capture the flow of all
revenue-related transactions from assessment to ultimate collection
and disposition. 

Also, IRS' revenue accounting system does not meet the government's
standard general ledger or other financial management systems
requirements.  According to IRS, these requirements are not being met
because the revenue accounting system was designed more than 10 years
ago to post transactions to taxpayers' accounts.  IRS is in the
initial stages of developing a new revenue financial accounting
system that is expected to meet the government's standard general
ledger and other financial management systems requirements.  However,
the new system is not expected to be completed until after 1998. 


   TSM PROBLEMS IMPACT IRS'
   FINANCIAL INFORMATION
---------------------------------------------------------- Chapter 0:2

IRS' capability to develop and make automated systems changes is an
area of continuing concern, as we have discussed in our reports and
testimonies on IRS' Tax Systems Modernization (TSM).  (See attachment
I.) In March 1996, we testified before the Subcommittee on IRS'
significant challenges in financial management and systems
modernization, which are central to IRS' guardianship of federal
revenues and ability to function efficiently in an increasingly
technological environment. 

In summary, IRS has initiated actions that begin to implement the
dozens of recommendations we have previously made to correct
management and technical problems in developing TSM.  Many of these
actions are still incomplete and do not yet respond fully to any of
our recommendations.  As a result, until IRS makes more progress in
correcting its management and technical weaknesses, its ability to
develop systems and make changes to correct financial management
problems will be hampered. 


   IRS TOUCHES FINANCIAL REPORTING
   ACROSS GOVERNMENT
---------------------------------------------------------- Chapter 0:3

The CFO Act, as expanded by the Government Management Reform Act of
1994, requires the 24 CFO Act agencies to prepare, and subject to
audit, financial statements covering all accounts and associated
activities of each office, bureau, and activity of the agency.  This
requirement begins with agencies' financial statements for fiscal
year 1996.  Audit reports are to be prepared by March 1, 1997, and
each year thereafter. 

In addition to agencywide financial statements, the expanded CFO Act
requires the Secretary of the Treasury to annually prepare
consolidated financial statements depicting the Executive Branch's
financial status.  This requirement begins with financial statements
for fiscal year 1997; GAO is to audit them by March 31 of each year,
beginning in 1998. 

IRS' financial information will provide significant input to the
preparation and audit of both Treasury's agencywide and the
governmentwide financial statements.  For example,

  -- with $1.4 trillion in tax revenue, IRS accounts for the vast
     majority of the government's total reported fiscal year 1995
     revenue and

  -- IRS' $113 billion in reported accounts receivables is over
     two-thirds, or about 68 percent, of the government's total
     fiscal year 1995 accounts receivables, which Treasury reported
     to be more than $166 billion. 

Also, IRS financial reporting affects the financial reports of the
government agencies for which IRS collects tax receipts, such as the
Social Security Administration for the Social Security Trust Fund and
the Department of Labor for the Unemployment Trust Fund.  Beginning
in fiscal year 1998, to meet federal accounting standards, IRS will
have to disclose the reasons for any continuing noncompliance with
the laws relating to the disposition of tax revenue to trust funds
and the amount of overfunding or underfunding, if reasonably
estimable. 

As a central government financial management leader, it is essential
for the Department of the Treasury to ensure that the problems IRS
faces in preparing financial statements on its operations are
promptly resolved so that these problems do not delay the
preparation, or affect the credibility, of Treasury's agencywide
financial statements.  Also, unless IRS' financial management
problems are dealt with, they will affect the ability to render an
opinion on the governmentwide financial statements. 


   IRS FOLLOW-THROUGH WILL BE
   CRITICAL
---------------------------------------------------------- Chapter 0:4

In summary, it will be essential for IRS to follow-through and ensure
that its planned short-term, interim actions are completed on
schedule to improve the reliability of IRS' financial statements, and
we will continue to work with IRS in doing so.  We also will continue
to monitor IRS' efforts to complete our recommendations and implement
longer term systems improvements.  The Subcommittee's continued
oversight of IRS' progress in implementing the CFO Act and preparing
auditable financial statements will provide important impetus as
well. 


-------------------------------------------------------- Chapter 0:4.1

Mr.  Chairman, this concludes my statement.  I would be happy to now
respond to any questions. 


RECENT GAO REPORTS AND TESTIMONIES
RELATED TO IRS' FINANCIAL
MANAGEMENT AND TSM PROBLEMS
=========================================================== Appendix I


   FINANCIAL AUDIT REPORTS
--------------------------------------------------------- Appendix I:1

Financial Audit:  Examination of IRS' Fiscal Year 1992 Financial
Statements (GAO/AIMD-93-2, June 30, 1993)

Financial Audit:  Examination of IRS' Fiscal Year 1993 Financial
Statements (GAO/AIMD-94-120, June 15, 1994)

Financial Audit:  Examination of IRS' Fiscal Year 1994 Financial
Statements (GAO/AIMD-95-141, August 4, 1995)

Financial Audit:  Examination of IRS' Fiscal Year 1995 Financial
Statements (GAO/AIMD-96-101, July 11, 1996)


   REPORTS AND TESTIMONIES RELATED
   TO IRS FINANCIAL AUDITS AND TSM
--------------------------------------------------------- Appendix I:2

IRS Operations:  Significant Challenges in Financial Management and
Systems Modernization (GAO/T-AIMD-96-56, March 6, 1996)

Tax Systems Modernization:  Management and Technical Weaknesses Must
Be Overcome To Achieve Success (GAO/T-AIMD-96-75, March 26, 1996)

Tax Systems Modernization:  Progress in Achieving IRS' Business
Vision (GAO/T-GGD-96-123, May 9, 1996)

Letter to the Chairman, Committee on Governmental Affairs, U.S. 
Senate, on security weaknesses at IRS' Cyberfile Data Center
(AIMD-96-85R, May 9, 1996)

Financial Audit:  Actions Needed to Improve IRS Financial Management
(GAO/T-AIMD-96-96, June 6, 1996)

Tax Systems Modernization:  Actions Underway But IRS Has Not Yet
Corrected Management and Technical Weaknesses (GAO/AIMD-96-106, June
7, 1996)

Tax Systems Modernization:  Cyberfile Project Was Poorly Planned and
Managed (GAO/AIMD-96-140, August 26, 1996)

Internal Revenue Service:  Business Operations Need Continued
Improvement (GAO/AIMD/GGD-96-152, September 9, 1996)

Internal Revenue Service:  Critical Need to Continue Improving Core
Business Practices (GAO/T-AIMD/GGD-96-188, September 10, 1996)


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