This is the accessible text file for GAO report number GAO-05-814R 
entitled 'Financial Audit: Restatements to the Department of State's 
Fiscal Year 2003 Financial Statements' which was released on September 
21, 2005. 

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September 20, 2005: 

Mr. Sid L. Kaplan:
Acting Assistant Secretary and Chief Financial Officer:
Department of State: 

The Honorable Howard J. Krongard:
Inspector General:
Department of State: 

Subject: Financial Audit: Restatements to the Department of State's 
Fiscal Year 2003 Financial Statements: 

As you know, the Secretary of the Treasury, in coordination with the 
Director of the Office of Management and Budget (OMB), is required to 
annually prepare and submit audited financial statements of the U.S. 
government to the President and Congress. We are required to audit 
these consolidated financial statements (CFS) and report on the results 
of our work.[Footnote 1] An issue meriting concern and close scrutiny 
that emerged during our fiscal year 2004 CFS audit was the growing 
number of Chief Financial Officers (CFO) Act agencies that 
restated[Footnote 2] certain of their financial statements for fiscal 
year 2003 to correct errors.[Footnote 3] Errors in financial statements 
can result from mathematical mistakes, mistakes in the application of 
accounting principles, or oversight or misuse of facts that existed at 
the time the financial statements were prepared. Frequent restatements 
to correct errors can undermine public trust and confidence in both the 
entity and all responsible parties. Further, when restatements do 
occur, it is important that financial statements clearly communicate 
and readers of the restated financial statements understand that the 
financial statements originally issued by management in the previous 
year and the opinion thereon should no longer be relied on and instead 
the restated financial statements and related auditor's opinion should 
be used. 

Eleven of the 23 CFO Act agencies[Footnote 4] restated certain of their 
financial statements for fiscal year 2003. Five CFO Act agencies had 
restatements in fiscal year 2003 covering their fiscal year 2002 
financial statements. Three CFO Act agencies had restatements covering 
both years. We noted that the extent of the restatements to CFO Act 
agencies' fiscal year 2003 financial statements varied from agency to 
agency, ranging from correcting two line items on an agency's balance 
sheet to correcting numerous line items on several of another agency's 
financial statements. In some cases, the net operating results of the 
agency were affected by the restatement. The amounts of the agencies' 
restatements ranged from several million dollars to more than $91 
billion. 

Nine of the 11 agencies that had restatements for fiscal year 2003 
received unqualified opinions on their originally issued fiscal year 
2003 financial statements. The auditors for 6 of these 9 agencies 
issued unqualified opinions on the restated financial statements, 
replacing the previous unqualified opinions on the respective agencies' 
original fiscal year 2003 financial statements. The auditors for 2 of 
these 9 withdrew their unqualified opinions on the fiscal year 2003 
financial statements and issued other than unqualified opinions on the 
respective agencies' restated fiscal year 2003 financial statements 
because they could not determine whether there were any additional 
misstatements and the effect of any such misstatements on the restated 
fiscal year 2003 financial statements. For the remaining agency, the 
principal auditor of the agency's fiscal year 2004 financial statements 
was not the principal auditor of the agency's fiscal year 2003 
financial statements, and an audit opinion on the agency's restated 
fiscal year 2003 financial statements was not issued. 

Our review focused on the 9 agencies with restatements for fiscal year 
2003 that received unqualified opinions on their originally issued 
fiscal year 2003 financial statements.[Footnote 5] These were the 
Department of Agriculture, Department of State (State), Department of 
Justice, Department of Transportation, Department of Health and Human 
Services, General Services Administration, National Science Foundation, 
Nuclear Regulatory Commission, and Office of Personnel Management. 

Because of the varying nature and circumstances surrounding the 
restatements, we are issuing a number of separate reports on the 
matter. This report communicates our observations regarding State's 
fiscal year 2003 restatements. Going forward, we hope that the lessons 
learned from the fiscal year 2003 restatements, together with our 
recommendations, (1) help State avoid the need for restatements to its 
future financial statements and (2) help ensure that State's auditor 
applies appropriate auditing procedures for journal voucher entries in 
the Bureau of International Organizations unfunded and funded 
liabilities accounts, which is where the original fiscal year 2003 
financial statements were subsequently found to have been misstated. 

We reviewed four key areas with respect to the restatements of State's 
fiscal year 2003 financial statements: (1) the nature and cause of the 
errors that necessitated the restatements, including planned corrective 
actions by the agency and its auditors; (2) the timing of communicating 
the material misstatement to users of the financial statements; (3) the 
extent of transparency[Footnote 6] exhibited in disclosing the nature 
and impact of the material misstatement in the financial statements and 
the reissued auditor's report; and (4) audit issues that contributed to 
the failure to detect the errors that necessitated the restatements 
during the audit of the agency's fiscal year 2003 financial statements. 

Results in Brief: 

Failure to properly record journal voucher entries for two large 
transactions that together accounted for most of a $927 million error 
and inadequate management review of these journal vouchers to detect 
the improper entries led to the material error that necessitated 
State's restatements of certain of its fiscal year 2003 financial 
statements. We determined that State's auditor did not detect the 
errors because the fiscal year 2003 audit tests performed by the 
auditor were not designed to detect journal voucher entry errors for 
the affected accounts. In addition, the title of State's note 
disclosure of the restatements could be misinterpreted. 

We are making a recommendation to State's Acting CFO to address the 
issues we identified with respect to the journal voucher errors that 
necessitated the fiscal year 2003 restatements. We are also making a 
recommendation to State's Inspector General to work with the contracted 
independent public accountant (IPA) to ensure that audit tests to 
detect any similar journal voucher errors in the future are 
implemented. 

In commenting on a draft of this report, State's Acting CFO stated that 
his office agrees with our recommendation for management to evaluate 
whether State's new journal voucher review procedures are effective and 
that State is currently reviewing the effectiveness of these 
procedures. State's Inspector General concurred with our recommendation 
and stated that his office will work with the IPA to implement audit 
steps in conformance with the Financial Audit Manual (FAM)[Footnote 7] 
to test journal vouchers in the Bureau of International Organizations 
unfunded and funded liabilities accounts. We also received technical 
comments from State's Acting CFO and Inspector General, which we have 
incorporated as appropriate. 

Background: 

In conducting the fiscal year 2004 audit of the CFS, we reviewed the 23 
CFO Act agencies' performance and accountability reports for possible 
restatements and identified 11 agencies that had restated certain of 
their audited fiscal year 2003 financial statements. 

The primary intended users of federal agencies' financial reports are 
citizens, Congress, federal executives, and federal program 
managers.[Footnote 8] Each of these groups may use federal agencies' 
financial statements to satisfy their specific needs. Citizens are 
interested in many aspects of the federal government, particularly 
federal programs that affect their financial well-being. Congress is 
interested in monitoring and assessing the efficiency and effectiveness 
of federal programs. Federal executives, such as central agency 
officials at OMB and the Department of the Treasury (Treasury), are 
interested in federal financial statements to assist the President of 
the United States. OMB assists the President in overseeing the 
preparation of the federal budget by formulating the President's 
spending plans, evaluating the effectiveness of agency programs, 
assessing competing funding demands among agencies, and setting funding 
priorities. Treasury assists the President in managing the finances of 
the federal government and prepares the CFS, which is based on audited 
financial statements prepared by federal agencies. GAO audits the CFS 
and reports on the results of its audit. Finally, federal program 
managers use agency financial statements as tools for managing their 
operations within the limits of the spending authority granted by 
Congress. 

The primary accounting and auditing standards that apply to restatement 
disclosures by federal entities are the Federal Accounting Standards 
Advisory Board's Statement of Federal Financial Accounting Standards 
(SFFAS) No. 21, Reporting Corrections of Errors and Changes in 
Accounting Principles, and the American Institute of Certified Public 
Accountants (AICPA) Codification of Auditing Standards, AU section 561, 
Subsequent Discovery of Facts Existing at the Date of the Auditor's 
Report.[Footnote 9]

Objective, Scope, and Methodology: 

The objective of our review of restatements of State's fiscal year 2003 
financial statements was to determine the nature and cause of the 
errors, the transparency and timing of communicating the material 
misstatements, any audit issues relating to such misstatements, and any 
actions being taken to help preclude similar errors from occurring in 
the future. 

We reviewed the nature and causes of the restatements, and we also 
examined corrective actions taken by State to help preclude similar 
errors from occurring in the future. We interviewed the preparers and 
auditors of State's fiscal year 2003 financial statements, including 
staff from the agency's Office of Inspector General (OIG), and we 
obtained and reviewed relevant audit documentation. 

In our review, we considered certain accounting and auditing standards, 
including SFFAS No. 21; the Financial Accounting Standards Board's 
Statement of Financial Accounting Standards No. 16, Prior Period 
Adjustments; and the AICPA Codification of Auditing Standards, AU 
section 420, Consistency of Application of Generally Accepted 
Accounting Principles, AU section 508, Reports on Audited Financial 
Statements, and AU section 561. 

We performed our review of the restatements of State's fiscal year 2003 
financial statements from December 2004 to July 2005 in accordance with 
U.S. generally accepted government auditing standards. 

We requested comments on a draft of this report from State's Acting CFO 
and Inspector General or their designees. Written comments from State's 
Acting CFO and Inspector General are reprinted in enclosures I and II, 
respectively, and are also discussed in the Agency Comments section. 

Issues Related to Restatement of Certain of State's Fiscal Year 2003 
Financial Statements: 

With respect to the restatement of certain of State's fiscal year 2003 
financial statements, we identified the following three areas that need 
improvement: (1) review of journal voucher transactions for the Bureau 
of International Organizations accounts, (2) design of journal voucher 
audit steps for the Bureau of International Organizations accounts, and 
(3) the title of the note disclosure of the restatements. These issues 
are discussed in detail below. 

Bureau of International Organizations Journal Voucher Transactions Were 
Not Sufficiently Reviewed: 

Certain of State's financial statements for fiscal year 2003 were 
restated to reflect activity related to approximately $927 million in 
liabilities incurred by the department's Bureau of International 
Organizations. Specifically, in connection with recording two large 
transactions in fiscal year 2003 that involved the reclassification of 
certain liabilities as funded liabilities from unfunded liabilities, a 
State official informed us that State failed to record the companion 
proprietary[Footnote 10] journal entries that are necessary once a 
liability has been funded. As a result, Unexpended Appropriations--Used 
was overstated by approximately $927 million, and Expended 
Appropriations was understated by approximately $927 million. The 
overall effect of the errors was that the amounts for Unexpended 
Appropriations and Cumulative Results of Operations on the originally 
issued fiscal year 2003 Balance Sheet and fiscal year 2003 Statement of 
Changes in Net Position were materially overstated and understated, 
respectively, by $927 million. 

State officials discovered the fiscal year 2003 errors in late October 
2004, during State's year-end analysis of the fiscal year 2004 
financial statements. Through analytical procedures and research, State 
observed inconsistencies between the unfunded and funded liabilities 
accounts. Following the discovery, State informed its IPA of the 
errors, which was appropriate. State completed its analysis of the 
errors on November 10, 2004. According to State, two incorrectly 
entered journal vouchers primarily caused the errors. 

Although State had a process for reviewing journal vouchers, it was not 
followed in the case of these two journal vouchers. The process called 
for a supervisor to approve journal vouchers before they were entered 
into the general ledger. According to a State official, however, the 
erroneous journal vouchers were not reviewed by a supervisor before 
they were entered into the accounting system. According to another 
State official, prior to the discovery of these errors, State took 
steps to improve its journal voucher postings by strengthening its 
journal voucher review process. Specifically, accounting personnel who 
create journal vouchers are now required to have a coworker review and 
sign the journal voucher before forwarding it for supervisory approval. 
The Director or Deputy Director of Financial Reporting and Analysis is 
then required to enforce compliance with the approval process by 
reviewing the approved journal vouchers--including determining that 
they have been signed by a supervisor--before the journal vouchers are 
entered into the accounting system. 

Journal Voucher Audit Steps Did Not Detect Errors in the Bureau of 
International Organizations Accounts: 

The above-noted accounting breakdown was not discovered during the 
audit of the department's fiscal year 2003 financial statements because 
the fiscal year 2003 audit tests performed by State's IPA were not 
designed to detect journal voucher errors in the Bureau of 
International Organizations unfunded and funded liabilities accounts. 

The FAM states that during the audit planning process, the auditor 
should identify conditions that significantly increase inherent, fraud, 
and control risk. Among other things, the auditor should perform 
procedures to identify account balances and transactions that might 
signal inherent risk. According to FAM 260.40, to detect evidence of 
possible material misstatement due to fraud, the auditor should examine 
journal entries and other adjustments, including reclassifications, 
consolidating entries, and other routine and nonroutine journal entries 
and adjustments. This section of the FAM also states that the auditor 
should obtain an understanding of the financial reporting process and 
the controls over journal entries and other adjustments; identify and 
select journal entries and other adjustments for testing; determine the 
nature, timing, and extent of the testing; and inquire of individuals 
involved in the financial reporting process about inappropriate or 
unusual activity related to the processing of journal entries and 
adjustments. If the IPA had identified the journal vouchers involving 
the Bureau of International Organizations accounts as presenting 
increased inherent, fraud, or control risk and had then followed the 
above-noted FAM procedures, the errors that necessitated the 
restatements might have been detected. 

According to State's OIG, future audit tests will be designed to detect 
any material journal voucher errors in the Bureau of International 
Organizations unfunded and funded liabilities accounts. 

The Title of State's Note Disclosure of the Restatements Could Be 
Misinterpreted: 

The notes to State's comparative fiscal years 2004 and 2003 financial 
statements included a note disclosure titled "Prior Period Adjustment." 
This title could be misinterpreted, since the note disclosure discussed 
the adjustment to correct the $927 million material misstatement and 
the adjustment represented a restatement rather than a prior period 
adjustment as defined by SFFAS No. 21. 

Conclusions: 

The restatements were caused by an error that State identified. State 
corrected the error and issued restated financial statements. Going 
forward, the key will be for State to ensure that the planned 
corrective actions to address the cause of the error are fully and 
effectively implemented. In addition, it will be important that State's 
OIG work with State's IPA to ensure that audit tests to detect any 
similar errors in the future are fully and effectively implemented. 

Recommendations for Executive Action: 

We recommend that State's Acting CFO determine whether the new journal 
voucher review procedures established to ensure adequate review of 
Bureau of International Organizations journal voucher transactions are 
being fully and effectively implemented. 

We recommend that State's Inspector General work with State's IPA to 
ensure that audit tests in conformance with the FAM to test journal 
vouchers in the Bureau of International Organizations unfunded and 
funded liabilities accounts are fully and effectively implemented. 

Agency Comments: 

In commenting on a draft of this report, State's Acting CFO stated that 
his office agrees with our recommendation for management to evaluate 
whether State's new journal voucher review procedures are effective and 
that State is currently reviewing the effectiveness of these 
procedures. State's Inspector General concurred with our recommendation 
and stated that his office will work with the IPA to implement audit 
steps in conformance with the FAM to test journal vouchers in the 
Bureau of International Organizations' unfunded and funded liabilities 
accounts. We also received technical comments from State's Acting CFO 
and Inspector General, which we have incorporated as appropriate. 

Within 60 days of the date of this report, we would appreciate 
receiving a written statement on actions taken to address these 
recommendations. 

We are sending copies of this report to the Chairmen and Ranking 
Minority Members of the Senate Committee on Homeland Security and 
Governmental Affairs; the Subcommittee on Federal Financial Management, 
Government Information, and International Security, Senate Committee on 
Homeland Security and Governmental Affairs; the House Committee on 
Government Reform; and the Subcommittee on Government Management, 
Finance and Accountability, House Committee on Government Reform. In 
addition, we are sending copies to the Fiscal Assistant Secretary of 
the Treasury and the Controller of OMB. This report is also available 
at no charge on GAO's Web site at www.gao.gov. 

We appreciate the courtesy and cooperation extended to us by your staff 
throughout our work. We look forward to continuing to work with your 
offices to help improve financial management in the federal government. 
If you have any questions about the contents of this report, please 
contact me at (202) 512-3406 or engelg@gao.gov. 

Signed by: 

Gary T. Engel: 

Director: 

Financial Management and Assurance: 

[End of section] 

Enclosure I: Comments from the Acting Assistant Secretary and Chief 
Financial Officer, Department of State: 

United States Department of State: 
Assistant Secretary and Chief Financial Officer: 
Washington, D.C. 20520: 

SEP 13 2005: 

Gary T. Engel, Director:
Financial Management and Assurance: 
Government Accountability Office: 
441 G Street, NW:
Room 5476: 
Washington, DC 20548: 

Dear Mr. Engel: 

We appreciate the opportunity to comment on the Government 
Accountability Office's (GAO) draft report entitled Financial Audit: 
Restatements to the Department of State's Fiscal Year 2003 Financial 
Statements, dated August 2005. 

We agree with your recommendations for management to evaluate whether 
our new journal voucher (JV) review procedures are effective. In that 
regard, we have strengthened controls over this process and are 
currently reviewing the effectiveness of these procedures. 

If you have questions or require additional information, please contact 
Sheila Conley, Managing Director, Financial Policy Reporting and 
Analysis, at (202) 663-1447. 

Sincerely,

Signed by: 

Sid Kaplan, Acting: 

[End of section] 

Enclosure II: Comments from the Inspector General, Department of State: 

United States Department of State and the Broadcasting Board of 
Governors: 

Inspector General: 

August 31, 2005: 

Gary T. Engel, Director:
Financial Management and Assurance: 
Government Accountability Office: 
441 G Street, NW:
Room 5476: 
Washington, DC 20548: 

Dear Mr. Engel: 

The Office of Inspector General (OIG) appreciates the opportunity to 
comment on the Government Accountability Office's (GAO) draft report 
entitled Restatements to tire Department of State's Fiscal Year 2003 
Financial Statements, dated August 2005. 

Based on GAO's agreement to incorporate the technical changes OIG 
communicated to it on August 31, OIG concurs with GAO's recommendation. 
OIG will work with the independent public accountant to implement audit 
steps in conformance with the Financial Audit Manual to test journal 
vouchers in the Bureau of International Organizations' unfunded and 
funded liabilities accounts. 

If you have any questions or need any additional information, please 
contact Mark W. Duda, Assistant Inspector General for Audits, at (2172) 
663-0372 or Gayle Voshell, Director of the Financial Management 
Division, at (703) 2842698. 

Sincerely,

Signed by: 

Howard J. Krongard: 
Inspector General: 

cc: RM - Mr. Sid L. Kaplan, Acting; 
RM/DCFO - Mr. Chris H. Flaggs; 
RM/GAO - Ms. Julianne Shinnick; 
Leonard G. Birnbaum and Company, LL.P - Mr. Leslie A. Leiper: 

[End of section] 

(198364): 

FOOTNOTES

[1] The Government Management Reform Act of 1994 has required such 
reporting, covering the executive branch of government, beginning with 
financial statements prepared for fiscal year 1997. 31 U.S.C.  331 
(e). The federal government has elected to include certain financial 
information on the legislative and judicial branches in the CFS as 
well. 

[2] A financial statement restatement occurs when an entity either 
voluntarily or prompted by its auditors or regulators revises public 
financial information that has previously been reported. 

[3] According to Federal Accounting Standards Advisory Board, Statement 
of Federal Financial Accounting Standards (SFFAS) No. 21, Reporting 
Corrections of Errors and Changes in Accounting Principles, prior 
period financial statements presented should be restated only to 
correct errors that caused such statements to be materially misstated. 

[4] The Federal Emergency Management Agency (FEMA) was transferred to 
the Department of Homeland Security (DHS) effective March 1, 2003. With 
this transfer, FEMA was no longer required to prepare and have audited 
stand-alone financial statements under the CFO Act, leaving 23 CFO Act 
agencies for the remainder of fiscal year 2003 and for fiscal year 
2004. The DHS Financial Accountability Act, Pub. L. No. 108-330, 118 
Stat. 1275 (October 16, 2004), added DHS to the list of CFO Act 
agencies, increasing the number of CFO Act agencies again to 24 
beginning in fiscal year 2005. 

[5] The 2 agencies that had restatements for fiscal year 2003 but did 
not receive unqualified opinions on their originally issued fiscal year 
2003 financial statements were the Department of Defense and the Small 
Business Administration. 

[6] Transparency is the full, accurate, and timely disclosure of 
information. 

[7] GAO/President's Council on Integrity and Efficiency, Financial 
Audit Manual, GAO-01-765G (Washington, D.C.: July 2001), updated by GAO-
04-1015G and GAO-04-942G (July 2004). 

[8] Federal Accounting Standards Advisory Board, Statement of Federal Financial Accounting Concepts No. 1, Objectives of Federal Financial Reporting. 

[9] Generally accepted government auditing standards incorporate AICPA 
reporting and auditing standards unless the Comptroller General of the 
United States excludes them by formal announcement. 

[10] Proprietary accounts provide the information for the financial 
statements based on Federal Accounting Standards Advisory Board 
standards and are intended to provide an economic, rather than a 
budgetary, measure of operations and resources.