Financial Management: Challenges Facing the IRS (Testimony, 01/09/97,
GAO/T-AIMD-97-34).

This testimony addresses the financial management challenges confronting
the Internal Revenue Service (IRS). GAO discusses the specific financial
management problems cited in GAO's audits of IRS financial statements,
the measures IRS needs to take to overcome these problems, and how the
Commission on Restructuring the Internal Revenue Service can further
efforts to strengthen IRS operations.

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

 REPORTNUM:  T-AIMD-97-34
     TITLE:  Financial Management: Challenges Facing the IRS
      DATE:  01/09/97
   SUBJECT:  Financial statement audits
             Financial management
             Federal agency accounting systems
             Tax administration
             Cost accounting
             Financial records
             Accounting procedures
             Government collections
             Accounts receivable
IDENTIFIER:  IRS Tax System Modernization Program
             TSM
             IRS Enforcement Revenue Information System
             Social Security Trust Fund
             
******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO report.  Delineations within the text indicating chapter **
** titles, headings, and bullets are preserved.  Major          **
** divisions and subdivisions of the text, such as Chapters,    **
** Sections, and Appendixes, are identified by double and       **
** single lines.  The numbers on the right end of these lines   **
** indicate the position of each of the subsections in the      **
** document outline.  These numbers do NOT correspond with the  **
** page numbers of the printed product.                         **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
** A printed copy of this report may be obtained from the GAO   **
** Document Distribution Center.  For further details, please   **
** send an e-mail message to:                                   **
**                                                              **
**                                            **
**                                                              **
** with the message 'info' in the body.                         **
******************************************************************


Cover
================================================================ COVER


Before the Commission on Restructuring the
Internal Revenue Service

For Release on Delivery
Expected at
10 a.m.
Thursday,
January 9, 1997

FINANCIAL MANAGEMENT - CHALLENGES
FACING THE IRS

Statement of Gregory M.  Holloway
Director, Governmentwide Audits
Accounting and Information Management Division

GAO/T-AIMD-97-34

GAO/AIMD-97-34T


(901751)


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

  CFO - Chief Financial Officer
  IRS - Internal Revenue Service
  TSM - Tax Systems Modernization

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

Messrs.  Chairmen and Members of the Commission: 

I would like to thank you for inviting me to talk with you about the
financial management challenges that the Internal Revenue Service
(IRS) confronts as it looks to the future.  A hearing on this subject
is especially timely considering the many efforts across government
to improve financial management through implementation of the Chief
Financial Officers (CFO) Act. 

I would like to begin by discussing why it is important for IRS to
have good financial management.  Then I will discuss the specific
financial management problems identified in our audits of IRS'
financial statements, the actions needed by IRS to respond to the
financial management challenges and how this Commission can further
these efforts to improve IRS' operations. 


   GOOD FINANCIAL MANAGEMENT IS A
   KEY FOUNDATION TO MANAGING IRS'
   OPERATIONS
---------------------------------------------------------- Chapter 0:1

Without accurate and timely accounting, financial reporting, and
auditing, it is impossible to know how well or poorly IRS has
performed in certain facets of its operations such as tax
collections.  In addition, IRS' management and the Congress' ability
to make informed decisions that are "fact based" is substantially
hindered when the underlying information that provides the basis for
decisions is called into question or when fundamental information is
lacking.  Our efforts to audit IRS accounting records have resulted
in disclaimers of opinion each year.  This means that we were unable
to determine whether the amounts reported by IRS in its financial
statements were right or wrong.  Financial reporting at this level
and auditable financial statements, as required by the CFO Act, are
fundamental tenets of effective financial management. 

Our disclaimer of opinion means that you do not know whether IRS
correctly reported the amount of tax it collected in total, how much
money IRS has collected by type of tax and on accounts receivables,
the cost of its operations including tax systems modernization (TSM),
or any other meaningful measure of IRS' financial performance.  In
essence, poor accounting and financial reporting, especially when
combined with the absence of an audit, obscures facts.  As a result,
users of information reported or taken from the underlying accounting
systems, risk making errant decisions--whether for budget purposes or
operationally--because they relied on questionable information in
making decisions. 

Four of the more significant reasons IRS needs good financial
management are to

  -- provide for its day to day operations basic accounting that
     meets the minimal financial management goals of the CFO Act for
     financial reporting, implement effective internal control
     procedures--including safeguarding of assets, and ensure IRS'
     compliance with pertinent laws and regulations--for example, the
     Anti-deficiency Act and others related to budget integrity;

  -- ensure accurate accounting for and reporting of revenue
     collections in compliance with the law and help the Congress and
     others assess the impacts of various tax policies on the budget
     and to offer accountability to the American taxpayer;

  -- better assess and improve IRS' operating performance; and

  -- improve its image as a fair tax collector that holds itself to
     the same or higher standards than it applies to the taxpaying
     public. 

Over the 4 years that we have performed financial statement audits at
IRS, IRS has moved from

  -- an agency that did not and could not reconcile its fund accounts
     (Fund Balance With Treasury), akin to a taxpayer's bank account,
     to an agency that now attempts to reconcile its accounts
     regularly even though some unresolved amounts still exist and

  -- an agency that could not support the propriety of amounts
     recorded in its accounting records or that they were recorded in
     the right accounting period to an agency that has developed and
     is implementing a strategy that if properly carried out, should
     be able to accomplish both. 

If IRS does not achieve and sustain the capacity to perform day to
day accounting on its over $7 billion in annual appropriations and
the more than $1.4 trillion in taxes it collects, it will not be able
to credibly report on the cost and effectiveness of its operations. 
Furthermore, like any other business or individual that may have
similar problems, IRS can assert that no money is missing and that it
is in compliance with the Anti-Deficiency Act and other laws;
however, if these problems persist, it cannot and does not know if
its assertion is true. 

The following example shows the implications of poor accounting and
financial reporting for IRS' day to day operations. 

  -- In recent years, IRS has reported the costs of TSM along with
     projected future costs.  However, IRS does not know what its TSM
     costs have been in total or by specific project.  Its efforts to
     achieve cost accounting for TSM obscure the nature and amount of
     actual costs of TSM projects through grouping large amounts of
     costs into generic codes as opposed to tracking these costs on a
     project specific basis.  In addition, no separate records were
     maintained on TSM costs incurred before 1994.  Also, IRS cannot
     readily link costs projected to be incurred in IRS' investment
     strategy with costs that are recorded in its accounting records. 
     To do so would require substantial analysis that would likely
     require using estimating techniques for which results could not
     be validated.  Thus, no credible records exist to make
     cost-benefit analysis of the overall project or to assess each
     project segment as it moves through various stages. 

In addition to day to day accounting and reporting, IRS' ability to
accurately account for and report tax collections is critical to the
Congress, the federal government as a whole, and the American
taxpayer.  IRS' inability to account for tax collections in total and
by type of tax collected reduces the Congress' and others' ability to
(1) fully assess the effectiveness of tax policies to achieve their
intended goals, (2) know the amount the general revenue fund is
subsidizing the Social Security Trust Fund, (3) determine whether
excise taxes are being collected and distributed in accordance with
legislation, and (4) assess IRS' collection efforts on unpaid taxes. 
While IRS is making interim efforts to increase its capability to
account for tax collections, longer term solutions will be needed
before IRS will be able to provide this information in an accurate
and timely manner. 

The following example shows the implications of poor accounting and
reporting for tax collections. 

  -- In recent years, IRS has reported collections against accounts
     receivables of about $25 billion annually.  However, IRS cannot
     reliably report cash collections on accounts receivable, and the
     amounts reported are estimates.  IRS' financial management
     system does not include a detailed record of debtors who owe
     taxes (a subsidiary accounts receivable record) that tracks
     these accounts and their related activity from one reporting
     period to the next.  As a result, IRS has to employ sampling
     techniques to project estimated collections on accounts
     receivable.  The lack of a detailed subsidiary record also
     severely hampers the ability to readily and reliably assess the
     performance of IRS' various collection efforts because reliable
     information on accounts receivable activity from one period to
     the next is not readily available. 

The ability to account for day to day operations and tax collections
accurately is the foundation for any efforts to assess and improve
IRS' operational performance.  Even though IRS reports that it
collects over $1.4 trillion in taxes and processes billions of
documents including tax returns, refunds, correspondence, and the
manifold other things it does as part of its tax administration
mandate, this reporting does not tell you how well it did it or the
cost effectiveness of operations.  Good financial management would
include developing a cost accounting system that accurately tracks
the costs of each part of IRS' operations.  In addition, the related
outcomes from operational improvement efforts, including additional
revenue collected and other qualitative performance indicators, would
be accounted for and linked to the respective operational costs
associated with accomplishing the outcomes.  Right now, IRS does not
have the capacity to account for its costs and outcomes in a manner
consistent with good financial management. 

The following example shows the implications of not having good
financial management accounting and reporting in place. 

  -- IRS reported, as part of its compliance initiative budget
     requests, that it would achieve certain levels of return in
     collecting unpaid taxes with the additional funding.  These
     requests typically showed past performance from compliance
     initiatives and projected future collections expected from the
     proposed compliance initiative.  They also typically showed that
     a substantial return on investment had been and would be
     achieved from compliance initiatives. 

IRS' financial management systems, however, cannot reliably provide
information that links cash collected on tax accounts with its
respective programs used to collect unpaid taxes and the program's
related costs, including those supported by its compliance
initiatives.  As a result, the information provided as IRS'
performance from compliance initiatives was prepared using estimates,
selective analysis of information, and unvalidated criteria.  We
found that the reported incremental collections and the associated
costs were not verifiable.  IRS currently has a system under
development (called the Enforcement Revenue Information System) that
will attempt to track and correlate this information. 

Finally, IRS needs to have good financial management to show that it
does not have a double standard for financial management--one that
taxpayers must adhere to and another that applies to itself.  If IRS
had to prepare its own tax return, with the many problems we have
found during our financial statement audits of IRS, it would not pass
the scrutiny of an IRS audit.  Many of its expenses would be
disallowed because they were unsupported or reported in the wrong
year, and the amounts and nature of its revenue would be questioned. 

As much as any federal agency and more than most, IRS routinely
interacts with taxpayers.  Taxpayers' views of the government and on
the fairness of tax administration are shaped in a big way by their
perception of IRS.  For IRS to demand the kind of recordkeeping it
requires for taxpayers to support tax returns (a form of financial
reporting) and to not be able to sustain a comparable or better set
of records to support its own financial reporting does not bode well. 
These concerns and views have been conveyed in many published
articles on the state of financial management at IRS, and these
articles clearly show taxpayers' expectation for IRS to be able to
meet the standards that it expects others to meet. 

The financial management problems I have discussed today are but a
few of the challenges that IRS must confront.  These, though, must be
overcome for IRS to be able to credibly report the results from its
operations whether through annually required financial statements or
ad hoc reports provided to the Congress and other users on the
various aspects of its operations. 

It is crucial that IRS maintain its capacity to process the billions
of documents and handle the multitude of other tax administration
challenges that it is responsible for managing.  However, as
evidenced in the examples I have highlighted for you today, it is
comparably crucial that IRS address its many financial management
problems so that decisionmakers can make "fact based," informed
decisions on IRS' staffing levels, tax policies, and other matters
based on the verifiable reported results from IRS' operations. 


   REASONS FOR GAO'S DISCLAIMER OF
   OPINION AND ACTIONS NEEDED TO
   CORRECT THEM
---------------------------------------------------------- Chapter 0:2

We issued disclaimers of opinion on each of our four annual audits of
IRS' financial statements (from fiscal year 1992 through fiscal year
1995).  Notable improvement has occurred across IRS as a result of
these audits, which were required by the CFO Act as expanded by the
Government Management Reform Act.  These two pieces of legislation,
and particularly their requirement for audited financial statements,
have been instrumental in bringing IRS' top-level management focus to
financial management problems that had been neglected for years. 
Because of our audit efforts, IRS' management, for the first time,
has a fuller understanding of the depth and breadth of the financial
management problems that beset the agency and has, as a result, begun
taking actions to address the problems. 

The reasons for our disclaimers of opinion were IRS' inability to

  -- provide support for its reported over $1.4 trillion in collected
     revenues in total and by type of tax (i.e., income, social
     security, etc.),

  -- accurately identify and provide support for its reported tax
     receivables that were estimated in the tens of billions,

  -- reconcile its Fund Balance With Treasury accounts (these
     accounts represent IRS' remaining approved budgetary spending
     authority--the federal government equivalent of bank accounts),
     and

  -- accurately account for and provide support for significant
     amounts of its almost $3 billion annually in nonpayroll expenses
     to establish that these expenses were appropriately included in
     the respective years' reported expenses. 

IRS has made progress on addressing some of these problems, and we
have worked closely with it to identify interim solutions to address
the problems that can be fixed quicker and partially address the
problems that will require longer term solutions.  IRS has developed
an action plan, with specific timetables and deliverables, to attempt
to address the reasons for our audit disclaimer.  To date, IRS
reported it has

  -- identified substantially all of the reconciling items for its
     Fund Balance With Treasury accounts, except for certain amounts
     that IRS has deemed not to be cost-beneficial to research
     further because they were thought to be insignificant or that
     IRS had exhausted all avenues available to resolve the
     difference and could not;

  -- designed an interim solution, until longer term solutions can be
     identified and implemented, to capture the detailed support for
     revenue and accounts receivable; and

  -- begun designing a short-term and a long-term strategy to fix the
     problems that contribute to its nonpayroll expenses being
     unsupported or reported in the wrong period. 

We are currently reviewing progress in each of these areas as part of
our audit of IRS' fiscal year 1996 financial statements and will
report the status of these efforts as part of our report that will be
issued at the completion of this audit. 

In closing, I want to reiterate that preparing auditable financial
statements and obtaining an unqualified audit opinion on those
financial statements are basic to good financial management and one
indicator of the condition of financial management of an entity. 
While IRS has made progress, the catalyst for fixing the problems
will be its senior management's continued commitment as well as
sustained effective congressional oversight.  IRS has recognized its
problems and essentially knows what needs to be done.  It is now a
matter of carrying out improvement plans. 


-------------------------------------------------------- Chapter 0:2.1

This concludes my statement, and I will be glad to answer any
questions. 


*** End of document. ***