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Sustained Improvement in Federal Financial Management Is Crucial to 
Addressing Our Nation's Future Fiscal Challenges' which was released on 
February 9, 2005.

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Testimony:

Before the Committee on Government Reform, House of Representatives:

For Release on Delivery Expected at 2:00 p.m. Wednesday, February 9, 
2005:

Fiscal Year 2004 U.S. Government Financial Statements:

Sustained Improvement in Federal Financial Management Is Crucial to 
Addressing Our Nation's Future Fiscal Challenges:

Statement of David M. Walker: 
Comptroller General of the United States:

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-05-284T]:

GAO Highlights:

Highlights of GAO-05-284T, testimony before the Committee on Government 
Reform, House of Representatives: 

Why GAO Did This Study:

GAO is required by law to annually audit the consolidated financial 
statements of the U.S. government. Proper accounting and reporting 
practices are essential in the public sector. The U.S. government is 
the largest, most complex, and most diverse entity on earth today. Its 
services—homeland security, national defense, Social Security, health 
care, mail delivery, and food inspection, to name a few—directly affect 
the well-being of almost every American. Sound decisions on the current 
results and future direction of vital federal government programs and 
policies are made more difficult without timely, reliable, and useful 
financial and performance information.

Until the problems discussed in GAO’s audit report on the U.S. 
government’s consolidated financial statements are adequately 
addressed, they will continue to (1) hamper the federal government’s 
ability to reliably report a significant portion of its assets, 
liabilities, costs, and other information; (2) affect the federal 
government’s ability to reliably measure the full cost as well as the 
financial and nonfinancial performance of certain programs; (3) impair 
the federal government’s ability to adequately safeguard significant 
assets and properly record various transactions; and (4) prevent the 
federal government from having reliable financial information to 
operate in an economical, efficient, and effective manner.

What GAO Found:

The federal government completed its consolidated financial statements 
on December 15, 2004. This is just 76 days after the end of the fiscal 
year—a record for timeliness. However, as in the previous 7 fiscal 
years, certain material weaknesses in internal control and in selected 
accounting and financial reporting practices resulted in conditions 
that continued to prevent GAO from being able to provide the Congress 
and American citizens an opinion as to whether the consolidated 
financial statements of the U.S. government are fairly stated in 
conformity with U.S. generally accepted accounting principles. Three 
major impediments to an opinion on the consolidated financial 
statements continue to be (1) serious financial management problems at 
the Department of Defense, (2) the federal government’s ineffective 
process for preparing the consolidated financial statements, and (3) 
the federal government’s inability to adequately account for and 
reconcile intragovernmental activity and balances between federal 
agencies. Further, in our opinion, the federal government did not 
maintain effective internal control over financial reporting and 
compliance due to numerous material weaknesses.

While GAO was unable to express an opinion on the consolidated 
financial statements of the U.S. government, several key items deserve 
emphasis in order to put the information contained in the financial 
statements and Management’s Discussion and Analysis in perspective. 
First, the federal government reported a $412.3 billion unified budget 
deficit and a $568 billion on-budget deficit in fiscal year 2004, 
representing approximately 3.6 percent and 4.9 percent of gross 
domestic product (GDP), respectively. Second, the U.S. government’s 
reported liabilities, commitments, and other obligations grew by over 
$13 trillion in fiscal year 2004, primarily due to enactment of the new 
Medicare prescription drug benefit, and now surpass $43 trillion, 
representing close to four times current GDP. In addition, while the 
size of the nation’s long-term fiscal imbalance grew significantly 
during the fiscal year, the retirement of the “baby boom” generation is 
closer to becoming a reality. Given these and other factors, it seems 
clear that the nation’s current fiscal path is unsustainable and that 
tough choices by the President and the Congress will be necessary in 
order to address the nation’s large and growing fiscal imbalance. 

An emerging issue during fiscal year 2004 that merits concern and close 
scrutiny was the growing number of Chief Financial Officers (CFO) Act 
agencies that restated certain of their financial statements for fiscal 
year 2003 to correct errors. Frequent restatements to correct errors 
can undermine public trust and confidence in both the entity and all 
responsible parties. The material internal control weaknesses discussed 
in this testimony serve to increase the risk that additional errors may 
occur and not be identified on a timely basis by management or the 
auditors, resulting in further restatements.

www.gao.gov/cgi-bin/getrpt?GAO-05-284T.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Jeffrey C. Steinhoff or 
Gary T. Engel at (202) 512-2600.

[End of section]

Mr. Chairman:

I am pleased to be here today to discuss our report on the U.S. 
government's consolidated financial statements for fiscal years 2004 
and 2003. Both the consolidated financial statements and our report are 
included in the fiscal year 2004 Financial Report of the United States 
Government, which was issued by the Department of the Treasury 
(Treasury) in mid-December, 2004, and is available through GAO's 
Internet site, at [Hyperlink, http://www.gao.gov], and Treasury's 
Internet site, at [Hyperlink, http://www.fms.treas.gov/fr/index.html].

I would like to thank you for continuing the annual tradition of 
oversight hearings on this important subject. The involvement of your 
subcommittee remains critical to ultimately assuring continued progress 
in the financial management area while enhancing public confidence in 
the federal government as a financial steward that is accountable for 
its finances.

The federal government completed its consolidated financial statements 
on December 15, 2004. This is just 76 days after the end of the fiscal 
year--a record for timeliness. However, as in the 7 previous fiscal 
years, certain material weaknesses[Footnote 1] in internal control and 
in selected accounting and financial reporting practices resulted in 
conditions that continued to prevent us from being able to provide the 
Congress and American citizens an opinion as to whether the 
consolidated financial statements of the U.S. government were fairly 
stated in conformity with U.S. generally accepted accounting principles 
(GAAP). Until the problems discussed in our report are adequately 
addressed, they will continue to (1) hamper the federal government's 
ability to reliably report a significant portion of its assets, 
liabilities, costs, and other related information; (2) affect the 
federal government's ability to reliably measure the full cost as well 
as the financial and nonfinancial performance of certain programs; (3) 
impair the federal government's ability to adequately safeguard 
significant assets and properly record various transactions; and (4) 
prevent the federal government from having reliable financial 
information to operate in an economical, efficient, and effective 
manner. Sound decisions on the current results and future direction of 
vital federal programs and policies are made more difficult without 
timely, reliable, and useful financial and performance information.

While the federal government has not yet been able to prepare auditable 
financial statements, the requirement to do so at the consolidated 
level, as well as at the agency level, has already yielded important 
results. We see continuous movement toward the ultimate goals of annual 
accountability and, more importantly, of development of the day-to-day 
financial information that the federal government will need to best 
address today's budgetary challenges and the looming longer-term fiscal 
imbalance driven by, among other things, demographic trends, rising 
health care costs, and new homeland security and defense commitments. 
Across government, financial management improvement initiatives are 
under way, and if effectively implemented, have the potential to 
appreciably improve the quality of the federal government's financial 
management and reporting. Individual federal agencies continue to make 
some progress in their efforts to modernize their financial management 
systems and improve financial management performance as called for in 
the President's Management Agenda.[Footnote 2]

The Office of Management and Budget (OMB) accelerated the fiscal year 
2004 financial statements reporting date for agencies to November 15, 
2004, as compared with January 30, 2004, for fiscal year 2003. Twenty-
two of 23 Chief Financial Officers (CFO) Act agencies[Footnote 3] were 
able to issue their fiscal year 2004 financial statements by the 
accelerated reporting date and the last one was issued during the first 
week of December. These reporting dates represent a significant 
improvement over fiscal year 2003 in the timeliness of CFO Act 
agencies' issuance of their financial statements.

As shown in appendix I, for fiscal year 2004, 18 of 23 CFO Act agencies 
were able to attain unqualified audit opinions on their financial 
statements from inspectors general and their contract auditors 
responsible for those audits. With accelerated reporting, which we 
support in concept, it is even more imperative that federal agency 
management continue to work toward fully resolving the pervasive and 
generally long-standing material weaknesses that have been reported at 
the agency level for the past 9 fiscal years. Otherwise, federal 
agencies may risk incurring additional costs while at the same time 
sacrificing reliability to achieve accelerated reporting.

In identifying improved financial performance as one of its five 
governmentwide initiatives, the President's Management Agenda 
recognized that a clean (unqualified) financial audit opinion is a 
basic prescription for any well-managed organization. The Principals of 
the Joint Financial Management Improvement Program (JFMIP)[Footnote 4] 
defined certain measures, in addition to receiving an unqualified 
financial statement opinion, for achieving financial management 
success. These additional measures include being able to routinely 
provide timely, accurate, and useful financial and performance 
information and having no material internal control weaknesses or 
material noncompliance with laws and regulations and the requirements 
of the Federal Financial Management Improvement Act of 1996 
(FFMIA).[Footnote 5] As shown in appendix II, while the severity and 
magnitude of the problems identified vary greatly, our analysis of 
audit reports of inspectors general and their contract auditors showed 
that for fiscal year 2004 only 4 of the 23 CFO Act agencies had neither 
a material weakness in internal control, an issue involving compliance 
with applicable laws and regulations, nor an instance of lack of 
substantial compliance with the requirements of FFMIA.

In this testimony, I will discuss why sound financial management today 
and in the future is central to meeting our nation's large and growing 
long-term fiscal imbalance. I will also discuss the growing number of 
CFO Act agencies that restated certain of their financial statements 
for fiscal year 2003 to correct errors--an emerging issue that merits 
concern and close scrutiny. I will then highlight the major issues 
relating to the consolidated financial statements for fiscal years 2004 
and 2003, discuss systems problems that continue to hinder federal 
agency accountability, and describe progress that has been made toward 
addressing major impediments to an opinion on the consolidated 
financial statements.

The Nation's Fiscal Imbalance:

First, I would like to spend a few minutes discussing our nation's 
worsening financial condition and long-range fiscal outlook. Last week, 
I spoke on this issue at the National Press Club as part of the Outlook 
2005 Conference, which was attended by government, corporate, and 
nonprofit executives from around the country. I have attached a copy of 
my remarks at that conference to my testimony today as appendix III.

While we are unable to express an opinion on the U.S. government's 
consolidated financial statements, several key items deserve emphasis 
in order to put the information contained in the financial statements 
and the Management's Discussion and Analysis section of the Financial 
Report of the United States Government into context.

First, the federal government reported a $412.3 billion unified budget 
deficit and a $568 billion on-budget deficit in fiscal year 2004, 
representing approximately 3.6 percent and 4.9 percent of gross 
domestic product (GDP), respectively.[Footnote 6] Second, the U.S. 
government's reported liabilities, commitments, and other obligations 
grew by over $13 trillion in fiscal year 2004, primarily due to the 
enactment of the new Medicare prescription drug benefit, and now 
surpass $43 trillion, representing close to four times current 
GDP.[Footnote 7]

In March 2004, the Trustees of the Social Security and Medicare trust 
funds issued their respective 2004 annual reports on the current and 
projected status of these two programs. Once again, the trustees' 
reports confirmed that both the Social Security and Medicare programs 
are unsustainable in their present form. The trustees also noted that 
Medicare's financial difficulties are much more severe than those 
confronting Social Security. Furthermore, the new prescription drug 
benefit has significantly increased the federal government's 
commitments associated with the Medicare program. Specifically, in 
their 2004 report, the trustees estimated the present value cost to the 
federal government of this new benefit over the next 75 years to be 
$8.1 trillion as of January 1, 2004. The trustees reiterated the 
message contained in their previous reports that action to address the 
financial difficulties facing Social Security and Medicare should be 
taken in a timely manner and that the sooner these financial challenges 
are addressed, the more varied and less disruptive the solutions can 
be.

The federal government's gross debt[Footnote 8] as of September 2004 
was about $7.4 trillion, or about $25,000 for every man, woman, and 
child in the country. But that number excludes such items as the gap 
between promised and funded Social Security and Medicare benefits, 
veterans' health care, and a range of other liabilities, commitments, 
and contingencies that the federal government has pledged to support. 
If these items are factored in, the current dollar burden for every 
American rises to about $145,000 per person, or about $350,000 per 
full-time worker.

Current financial reporting does not clearly and transparently show the 
wide range of responsibilities, programs, and activities that may 
either obligate the federal government to future spending or create an 
expectation for such spending. Thus, it provides an unrealistic and 
even misleading picture of the federal government's overall 
performance, financial condition, and future fiscal outlook. Few 
federal agencies adequately show the results they are getting with the 
taxpayer dollars they spend. In addition, too many significant federal 
government revenues--as well as commitments and obligations such as 
those associated with Social Security and Medicare--are not adequately 
and consistently disclosed in the federal government's consolidated 
financial statements and budget, and current federal financial 
reporting standards do not require such disclosure. The Federal 
Accounting Standards Advisory Board recently completed a project on 
accounting and reporting of earmarked funds, which include the Social 
Security and Medicare trust funds, and has a project underway to 
consider recognition, measurement, and display of social insurance 
obligations.

Figure 1 shows some selected fiscal exposures. The spectrum of these 
exposures ranges from explicit liabilities shown on the consolidated 
financial statements to implicit promises embedded in current policy or 
public expectations.[Footnote 9] These liabilities, commitments, and 
promises have created a fiscal imbalance that will put unprecedented 
strains on the nation's future spending and tax policies. Although 
economic growth can help, the projected fiscal gap is now so large that 
the federal government will not be able to simply grow its way out of 
the problem. Tough choices by the President and the Congress are 
inevitable.

Figure 1: Selected Fiscal Exposures: Sources and Examples[A]:

[See PDF for image] 

[A] All figures are for end of fiscal year 2004, except Social Security 
and Medicare estimates, which are as of January 1, 2004.

[B] This amount includes $845 billion held by military and civilian 
pension and postretirement health funds that would offset the explicit 
liabilities reported by those funds.

[C] Figures for Social Security and Medicare are net of debt held by 
the trust funds ($1,531 billion for Social Security, $256 billion for 
Medicare Part A, and $24 billion for Medicare Part B) and represent net 
present value estimates over a 75-year period. Over an infinite 
horizon, the estimate for Social Security would be $10.4 trillion, 
$21.8 trillion for Medicare Part A, $23.2 trillion for Medicare Part B, 
and $16.5 trillion for Medicare Part D.

[End of figure] 

GAO's fiscal policy simulations illustrate that the fiscal policies in 
place today--absent substantive entitlement reform or unprecedented 
changes in tax and/or spending policies--will result in large, 
escalating, and persistent deficits that are economically unsustainable 
over the long term. Assuming that discretionary spending grows with 
inflation and all existing tax cuts are allowed to expire when 
scheduled under current law, spending for Social Security and health 
care programs would grow to consume over three-quarters of federal 
revenue by 2040. Moreover, if all expiring tax provisions are extended 
and discretionary spending keeps pace with the economy, by 2040 total 
federal revenues may be adequate to pay little more than interest on 
the federal debt. Without reform, known demographic trends, rising 
health care costs, and projected growth in federal spending for Social 
Security, Medicare, and Medicaid will result in massive fiscal 
pressures that, if not effectively addressed, could cripple the 
economy, threaten our national security, and adversely affect the 
quality of life of Americans in the future.

Figure 2: Composition of Spending as a Share of GDP Assuming 
Discretionary Spending Grows with GDP after 2005 and All Expiring Tax 
Provisions Are Extended:

[See PDF for image] 

Notes: Although expiring tax provisions are extended, revenue as a 
share of GDP increases through 2015 due to (1) real bracket creep, (2) 
more taxpayers becoming subject to the alternative minimum tax, and (3) 
increased revenue from tax-deferred retirement accounts. After 2015, 
revenue as a share of GDP is held constant.

[End of figure]

The President and the Congress face the challenge of sorting out the 
many claims on the federal budget without the budget enforcement 
mechanisms or fiscal benchmarks that guided the federal government 
through the years of deficit reduction into a brief period of federal 
surpluses. While a number of steps will be necessary to address this 
challenge, as outlined in my February 2, 2005, remarks at the Press 
Club, truth and transparency in federal government financial reporting 
and budgeting are essential elements of any attempt to address the 
nation's long-term fiscal challenges. Further, Congress needs to have 
access to the long-term cost of selected spending and tax proposals 
before they enact related laws. The fiscal risks just mentioned can be 
managed only if they are properly accounted for and publicly disclosed, 
including the many existing commitments facing the federal government. 
In addition, new budget control mechanisms will be required, along with 
effective approaches to successfully engage in a fundamental review, 
reassessment, and reprioritization of the base of federal government 
programs and policies. In this regard, we should not assume that all 
defense and homeland security expenditures are both necessary and 
prudent. Furthermore, the use of across-the-board adjustments to 
address the spending imbalance serves to avoid making the necessary 
difficult choices, is inequitable, and simply will not get the job 
done.

Potential Impact of Restatements on Agencies' Financial Statements:

An emerging issue during fiscal year 2004 that merits concern and close 
scrutiny was the growing number of CFO Act agencies that restated 
certain of their financial statements for fiscal year 2003 to correct 
errors. As shown in appendix II, at least 11[Footnote 10] of the 23 CFO 
Act agencies fell into this category as compared with at least 5 CFO 
Act agencies that had restatements covering their fiscal year 2002 
financial statements in fiscal year 2003. At least 3 CFO Act agencies 
had restatements in both years. For example, in fiscal year 2003, one 
agency misstated certain of its fiscal year 2002 financial statements 
by about $1 billion. The following year, this same agency restated 
certain of its fiscal year 2003 financial statements by over $5 
billion. Nonetheless, for both years, the agency received unqualified 
audit opinions on its financial statements.

Nine of the 11 agencies having restatements for fiscal year 2003 had 
received unqualified opinions on their originally issued fiscal year 
2003 financial statements. Seven of the nine auditors issued 
unqualified opinions on the restated financial statements, which in 
substance replace the auditors' opinions on their respective agencies' 
original fiscal year 2003 financial statements. For two of these nine, 
the auditors not only withdrew their unqualified opinion on the fiscal 
year 2003 financial statements but also issued other than unqualified 
opinions[Footnote 11] on their respective agencies' restated fiscal 
year 2003 financial statements because they could not determine whether 
there were any additional misstatements and the effect that such could 
have on the restated fiscal year 2003 financial statements.

The material internal control weaknesses discussed in this testimony 
increase the risk that additional misstatements may occur and not be 
identified on a timely basis by management or the auditors, resulting 
in further restatements. Frequent restatements to correct errors can 
undermine public trust and confidence in both the entity and all 
responsible parties. According to Statement of Federal Financial 
Accounting Standards (SFFAS) No. 21, Reporting Corrections of Errors 
and Changes in Accounting Principles, prior period financial statements 
presented should only be restated for corrections of errors that caused 
such statements to be materially misstated. Errors in financial 
statements 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. The 
restatements to CFO Act agencies' fiscal year 2003 financial statements 
ranged from correcting two line items on one agency's balance sheet to 
numerous line items on several of another agency's financial 
statements. The amounts of the agencies' restatements ranged from 
several million dollars to over $91 billion.

As part of our fiscal year 2004 audit, we reviewed certain federal 
agencies' fiscal year 2003 Statement of Budgetary Resources 
(SBR)[Footnote 12] for consistency of (1) certain information reported 
in the SBR with related information reported in the agencies' other 
financial statements and notes and (2) the offsetting receipts and net 
outlays reported in the SBR with published governmentwide reports. We 
found significant inconsistencies in these areas, which we brought to 
the attention of these agencies and their auditors prior to completion 
of their fiscal year fiscal year 2004 audits. For example, we notified 
a federal agency that the net outlays reported in its fiscal year 2003 
SBR were overstated by about $91 billion due to certain offsetting 
receipts that were not reported in the SBR as offsets to outlays, as 
required by OMB guidance. In fiscal year 2004, this agency's fiscal 
year 2003 SBR was restated, reducing its previously reported net 
outlays from $596 billion to $505 billion. At least four of the nine 
agencies that received unqualified opinions on their fiscal year 2003 
financial statements restated certain of these financial statements in 
fiscal year 2004 to address some of the significant inconsistencies we 
identified in the SBR.

The transparency of the restatements in the agency auditors' reports 
and the agencies' financial statements is also a concern of 
ours.[Footnote 13] We believe that the auditor's report should clearly 
inform the reader about the correction of a material misstatement. In 
our view, the reader of the financial statements and auditor's report 
should be able to readily 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 the related auditor's opinion should be used. 
The reader should also be able to gain at least a basic understanding 
as to why the agency needed to restate its prior year financial 
statements and the impact of the restatement on the financial 
statements.

In our preliminary review of the fiscal year 2003 restatements, several 
issues regarding the inadequate transparency in connection with the 
reporting on the restatements were readily apparent. First, two of the 
nine agency auditors that had issued unqualified opinions the previous 
year on their respective agencies' originally issued fiscal year 2003 
financial statements did not include a reference to management's 
restatement footnote in their audit reports. Second, while our analysis 
of restatements is just underway, the information included in the 
auditors' reports along with the agency's financial statements were in 
some instances not sufficient in our view for a reader of the financial 
statements to clearly understand the error that occurred and the 
effects it had on the financial statements. Third, while U.S. generally 
accepted accounting principles do not expressly require financial 
statements to be labeled as restated, 9 of the 11 agencies having 
fiscal year 2003 restatements did so, which we support. However, 2 of 
the 11 did not label their prior year restated financial statements as 
restated, which we believe also demonstrates a lack of transparency. As 
I highlighted earlier, in keeping with full transparency and 
accountability, when restatements occur, all readers should be able to 
understand the ramifications of what happened and that the financial 
statements originally issued by management, along with the related 
auditor's opinion, should no longer be relied on. Furthermore, agencies 
that have to restate their prior year financial statements for material 
errors should not refer to their prior year opinions as having been 
unqualified since, by definition, the restatement means they should not 
have received an unqualified opinion on their prior year's 
statement(s).

We plan to perform a more detailed review of the nature and causes of 
the restatements during our audit of the fiscal year 2005 consolidated 
financial statements, and later this year will report separately on the 
results of this work.

Highlights of Major Issues Related to the U.S. Government's 
Consolidated Financial Statements for Fiscal Years 2004 and 2003:

As I mentioned earlier, as has been the case for the previous 7 fiscal 
years, the federal government continues to have a significant number of 
material weaknesses related to financial systems, fundamental 
recordkeeping and financial reporting, and incomplete documentation. 
Several of these material weaknesses, which generally have existed for 
years, contributed to our disclaimer of opinion on the U.S. 
government's consolidated financial statements for the fiscal years 
ended September 30, 2004, and 2003.[Footnote 14] Appendix IV describes 
these material deficiencies in more detail and highlights their primary 
effects on the consolidated financial statements and on the management 
of federal government operations. There may also be additional issues 
that could affect the consolidated financial statements that have not 
been identified. The material deficiencies we identified were the 
federal government's inability to:

* satisfactorily determine that property, plant, and equipment and 
inventories and related property, primarily held by the Department of 
Defense (DOD), were properly reported in the consolidated financial 
statements;

* reasonably estimate or adequately support amounts reported for 
certain liabilities, such as environmental and disposal liabilities, or 
determine whether commitments and contingencies were complete and 
properly reported;

* support significant portions of the total net cost of operations, 
most notably related to DOD, and adequately reconcile disbursement 
activity at certain agencies;

* ensure that the federal government's consolidated financial 
statements were consistent with the underlying audited agency financial 
statements, balanced, and in conformity with GAAP;

* adequately account for and reconcile intragovernmental activity and 
balances between federal agencies; and:

* resolve material differences that exist between the total net outlays 
reported in federal agencies' SBRs and the records used by Treasury to 
prepare the Statements of Changes in Cash Balance.

In addition to these material deficiencies, we found four other 
material weaknesses in internal control as of September 30, 2004. These 
weaknesses are discussed in more detail in appendix V, including their 
primary effects on the consolidated financial statements and on the 
management of federal government operations. These material weaknesses 
were the federal government's inability to:

* implement effective processes and procedures for properly estimating 
the cost of certain lending programs, related loan guarantee 
liabilities, and value of direct loans;

* determine the extent to which improper payments exist;

* identify and resolve information security control weaknesses and 
manage information security risks on an ongoing basis; and:

* effectively manage its tax collection activities.

Continuing Systems Problems Hinder Accountability:

The ability to produce the data needed for efficient and effective 
management of day-to-day operations in the federal government and 
provide the necessary accountability to taxpayers and the Congress has 
been a long-standing challenge at most federal agencies. The results of 
the fiscal year 2004 assessments performed by agency inspectors general 
or their contract auditors under FFMIA show that these problems 
continue to affect financial management systems at most of the 23 CFO 
Act agencies. While the problems are much more severe at some agencies 
than at others, the nature and severity of the problems indicate that 
overall, management at most CFO Act agencies lacks the complete range 
of information needed for accountability, performance reporting, and 
decision making. These problems include nonintegrated financial 
systems, lack of accurate and timely recording of data, inadequate 
reconciliation procedures, and noncompliance with accounting standards 
and the U.S. Government Standard General Ledger (SGL).

The inability of agencies to meet federal financial management systems 
requirements continues to be the major barrier to achieving compliance 
with FFMIA. Under FFMIA, CFO Act agency auditors are required to report 
whether agencies' financial management systems substantially comply 
with (1) federal financial management systems requirements, (2) 
applicable federal accounting standards, and (3) the SGL at the 
transaction level as part of the agencies' financial statement audits. 
These factors are critical for improving accountability over government 
operations and routinely producing sound cost and operating performance 
information. As shown in figure 3, instances of noncompliance with 
federal financial management systems requirements were the compliance 
issue most frequently reported by auditors. These instances of 
noncompliance involved not only core financial systems, but also 
administrative and programmatic systems.

Figure 3: Auditors' FFMIA Assessments for Fiscal Years 2000 through 
2004:

[See PDF for image] 

[End of figure] 

For fiscal year 2004, auditors for 16 of the 23 CFO Act agencies 
reported that the agencies' financial management systems did not comply 
substantially with one or more of FFMIA's three requirements. For 6 of 
the remaining 7 CFO Act agencies, auditors provided negative assurance, 
meaning that nothing came to their attention indicating that the 
agencies' financial management systems did not substantially meet FFMIA 
requirements. The auditors for these 6 agencies did not definitively 
state whether the agencies' systems substantially complied with FFMIA 
requirements, as is required under the statute. In contrast, auditors 
for the Department of Labor provided positive assurance by stating 
that, in their opinion, the department's financial management systems 
substantially complied with the requirements of FFMIA. The Department 
of Homeland Security (DHS) was not subject to the requirements of the 
CFO Act in fiscal year 2004[Footnote 15] and, consequently, was not 
required to comply with FFMIA. Accordingly, DHS's auditors did not 
report on DHS's compliance with FFMIA. However, the auditors identified 
and reported deficiencies that related to the aforementioned three 
requirements of FFMIA. With the recent passage of the Department of 
Homeland Security Financial Accountability Act,[Footnote 16] DHS has 
been designated as a CFO agency. With this designation, DHS is now 
required to implement and maintain financial management systems that 
comply with FFMIA, and its auditors will be required to report on the 
department's financial management systems' compliance beginning with 
fiscal year 2005.

In an effort to address problems such as nonintegrated systems, 
inadequate reconciliations, and lack of compliance with the SGL, a 
number of agencies have efforts underway to implement new financial 
management systems or to upgrade existing systems. Agencies expect that 
the new systems will provide reliable, useful, and timely data to 
support managerial decision making and assist taxpayer and 
congressional oversight. Whether in government or the private sector, 
implementing and upgrading systems is a difficult job and brings a 
degree of new risk. Organizations that follow and effectively implement 
accepted best practices in systems development and implementation 
(commonly referred to as disciplined processes) can manage and reduce 
these risks to acceptable levels. However, our work at DOD,[Footnote 
17] the Department of Health and Human Services (HHS),[Footnote 18] and 
the National Aeronautics and Space Administration[Footnote 19] has 
shown that these agencies, which all have experienced significant 
problems in implementing new financial management systems, are not 
following the necessary disciplined processes for efficient and 
effective development and implementation of such systems. Further, the 
Department of Veterans Affairs recently halted pilot implementation of 
its new core financial system, in which it had invested a reported $249 
million. The problems cited by the Department of Veterans Affairs 
Office of Inspector General were similar to those we noted at DOD, HHS, 
and the National Aeronautics and Space Administration. As the federal 
government moves forward with ambitious modernization efforts to 
identify opportunities to eliminate redundant systems and enhance 
information reliability and availability, adherence to disciplined 
processes will be a crucial element to reduce risks to acceptable 
levels. Given the nature and magnitude of the problems facing federal 
agencies, we recognize that it will take time, investment, and 
sustained emphasis to successfully modernize agencies' underlying 
financial management systems.

Addressing Major Impediments to an Opinion on Consolidated Financial 
Statements:

For the past 8 fiscal years, the federal government has been required 
to prepare, and have its consolidated financial statements audited. 
Successfully meeting this requirement is closely linked to the 
requirements for the CFO Act agencies (and now all covered executive 
agencies) to also have audited financial statements. This has resulted 
in extensive cooperative efforts and considerable attention by agency 
chief financial officers, inspectors general, Treasury and OMB 
officials, and GAO. With the benefit of the past 8 years' experience in 
having the required financial statements subjected to audit, more 
intensified attention will be needed on the most serious obstacles to 
achieving an opinion on the U.S. government's consolidated financial 
statements. There are three primary ongoing reasons why the 
consolidated financial statements remained unauditable for fiscal year 
2004: (1) serious financial management problems at DOD, (2) the federal 
government's ineffective process for preparing the consolidated 
financial statements, and (3) the federal government's inability to 
adequately account for and reconcile intragovernmental activity and 
balances between federal agencies.

Financial Management at DOD:

Essential to achieving an opinion on the consolidated financial 
statements is resolution of the serious financial management problems 
at DOD, which we have designated as high risk[Footnote 20] since 1995. 
Overhauling DOD's financial management operations represents a 
challenge that goes far beyond financial accounting to the very fiber 
of DOD's range of business operations, management information systems, 
and culture. DOD's financial management problems are pervasive, 
complex, long-standing, and deeply rooted in virtually all business 
operations throughout the department. To date, none of the military 
services or major DOD components has passed the test of an independent 
financial audit[Footnote 21] because of pervasive weaknesses in 
financial management systems, operations, and controls. The seriousness 
of the weaknesses in DOD's business operations underscores the 
importance of no longer condoning the status quo at DOD. Although the 
Secretary of Defense and several key agency officials have shown 
commitment to transformation, as evidenced by key initiatives such as 
the Business Management Modernization Program and the Financial 
Improvement Initiative, little tangible evidence of significant broad-
based and sustainable improvements has been seen in DOD's business 
operations to date. For example, the department's former comptroller 
started the Financial Improvement Initiative with the goal of obtaining 
an unqualified opinion for fiscal year 2007 on DOD's departmentwide 
financial statements; however, the initiative still lacks a clearly 
defined, well-documented, and realistic plan to make the stated goal a 
reality. In particular, the initiative lacks several of the key 
elements critical to success, including (1) a comprehensive, integrated 
plan; (2) results-oriented goals and performance measures; and (3) 
effective oversight and monitoring. For DOD to successfully transform 
its business operations, it will need a comprehensive and integrated 
business transformation plan; people with the skills, responsibility, 
and authority to implement the plan; an effective process and related 
tools, such as a business enterprise architecture;[Footnote 22] and 
results-oriented performance measures that link institutional, unit, 
and individual personnel goals and expectations to promote 
accountability for results.

Preparing the Consolidated Financial Statements:

The federal government continued to have inadequate systems, controls, 
and procedures to ensure that the consolidated financial statements are 
consistent with the underlying audited agency financial statements, 
balanced, and in conformity with GAAP. During fiscal year 2004, 
Treasury made progress in laying the foundation to address certain 
long-standing material deficiencies in preparing the consolidated 
financial statements. Foremost is the ongoing development of a new 
system, the Governmentwide Financial Reporting System (GFRS), to 
collect agency financial statement information directly from federal 
agencies' audited financial statements rather than using federal 
agencies' SGL data as Treasury had done in previous years to compile 
the consolidated financial statements. The goal of the new system is to 
be able to directly link information from federal agencies' audited 
financial statements to amounts reported in the consolidated financial 
statements, a concept that we strongly support. For the fiscal year 
2004 reporting process, Treasury's GFRS was able to capture certain 
agency financial information from agencies' audited financial 
statements, which is an important first step. The automated system, 
though, was not yet at the stage of development that it could be used 
to compile the consolidated financial statements from the information 
that was captured.

Intragovernmental Activity and Balances:

Federal agencies are unable to adequately account for and reconcile 
intragovernmental activity and balances. OMB and Treasury require the 
CFOs of 35 executive departments and agencies to reconcile, on a 
quarterly basis, selected intragovernmental activity and balances with 
their trading partners.[Footnote 23] In addition, these agencies are 
required to report to Treasury, the agency's inspector general, and GAO 
on the extent and results of intragovernmental activity and balances 
reconciliation efforts as of the end of the fiscal year.

A substantial number of the agencies did not fully perform the required 
reconciliations for fiscal years 2004 and 2003. For fiscal year 2004, 
based on trading partner information provided in GFRS, Treasury 
produced a "Material Difference Report" for each agency showing amounts 
for certain intragovernmental activity and balances that significantly 
differed from those of its corresponding trading partners. After 
analysis of the material differences, a significant number of CFOs 
cited differing accounting methodologies, accounting errors, and timing 
differences for their material differences with their trading partners. 
Many CFOs simply indicated that they were unable to explain the 
differences with their trading partners. For both fiscal years 2004 and 
2003, amounts reported by federal agency trading partners for certain 
intragovernmental accounts were significantly out of balance. As a 
result, the federal government's ability to determine the impact of 
these differences on the amounts reported in the consolidated financial 
statements is impaired. Resolving the intragovernmental transactions 
problem remains a difficult challenge and will require a commitment by 
federal agencies and strong leadership and oversight by OMB.

Closing Comments:

The U.S. government is the largest, most complex and most diverse 
entity on earth today. Its services and programs--homeland security, 
national defense, Social Security, health care, mail delivery, and food 
inspection, to name just a few--directly affect the well-being of 
almost every American. Our nation's large and growing long-term fiscal 
imbalance, which is driven largely by known demographic trends and 
rising health care costs--coupled with new homeland security and 
defense commitments and the recent downward trend in revenue as a share 
of GDP--continues to sharpen the need to fundamentally review and 
reexamine basic federal entitlements, as well as other mandatory and 
discretionary spending and tax policies. Clearly, tough choices will be 
required to address the resulting structural imbalance.

Sound decisions on the current results and future direction of vital 
federal programs and policies are made more difficult without timely, 
reliable, and useful financial and performance information. Proper 
accounting and financial reporting practices are essential in the 
public sector. Until the problems discussed in our audit report are 
adequately addressed, they will continue to present a number of adverse 
implications for the federal government and the taxpayers, which are 
outlined in our report. At the same time, the need for timely, 
reliable, and useful financial and performance information is greater 
than ever.

There will need to be ongoing and sustained top management attention to 
business systems transformation at DOD to address what are some of the 
most difficult financial management challenges in the federal 
government. As noted in our recent high-risk report, we also believe 
that the implementation of a new Chief Management Officer position at 
DOD will be needed in order for the department to succeed in its 
overall business transformation plan. Further, continued leadership 
from OMB and Treasury will be important to resolve the issues that have 
prevented us from expressing an opinion on the consolidated financial 
statements.

In closing, Mr. Chairman, I want to reiterate the value of sustained 
congressional interest in these issues, as demonstrated by your 
subcommittee's hearings. It will also be key that the appropriations, 
budget, authorizing, and oversight committees hold agency top 
leadership accountable for resolving these problems and that they 
support improvement efforts.

Contacts:

For further information regarding this testimony, please contact 
Jeffrey C. Steinhoff, Managing Director, and Gary T. Engel, Director, 
Financial Management and Assurance, at (202) 512-2600.

[End of section]

Appendix I: Fiscal Year 2004 Audit Results:

Selected Major Federal Departments and Agencies: Fiscal Year 2004 
Audit Results, Principal Auditors, and Number of Other Audit 
Contractors: 

23 CFO Act agencies: Agency for International Development; 
Audit results: Unqualified; 
Principal auditor: Inspector General; 
Number of other audit contractors: 1.

23 CFO Act agencies: Agriculture; 
Audit results: Unqualified; 
Principal auditor: Inspector General; 
Number of other audit contractors: 3.

23 CFO Act agencies: Commerce; 
Audit results: Unqualified; 
Principal auditor: KPMG LLP; 
Number of other audit contractors: 0.

23 CFO Act agencies: Defense; 
Audit results: Disclaimer; 
Principal auditor: Inspector General; 
Number of other audit contractors: 1.

23 CFO Act agencies: Education; 
Audit results: Unqualified; 
Principal auditor: Ernst & Young LLP; 
Number of other audit contractors: 0.

23 CFO Act agencies: Energy; 
Audit results: Unqualified; 
Principal auditor: KPMG LLP; 
Number of other audit contractors: 0.

23 CFO Act agencies: Environmental Protection Agency; 
Audit results: Unqualified; 
Principal auditor: Inspector General; 
Number of other audit contractors: 0.

23 CFO Act agencies: General Services Administration; 
Audit results: Unqualified; 
Principal auditor: PricewaterhouseCoopers LLP; 
Number of other audit contractors: 0.

23 CFO Act agencies: Health and Human Services; 
Audit results: Unqualified; 
Principal auditor: Ernst & Young LLP; 
Number of other audit contractors: 3.

23 CFO Act agencies: Housing and Urban Development; 
Audit results: Disclaimer; 
Principal auditor: Inspector General; 
Number of other audit contractors: 1.

23 CFO Act agencies: Interior; 
Audit results: Unqualified; 
Principal auditor: KPMG LLP; 
Number of other audit contractors: 0.

23 CFO Act agencies: Justice; 
Audit results: Disclaimer; 
Principal auditor: KPMG LLP; 
Number of other audit contractors: 2.

23 CFO Act agencies: Labor; 
Audit results: Unqualified; 
Principal auditor: R. Navarro & Associates, Inc; 
Number of other audit contractors: 2.

23 CFO Act agencies: National Aeronautics and Space; 
Administration; 
Audit results: Disclaimer; 
Principal auditor: Ernst & Young LLP; 
Number of other audit contractors: 0.

23 CFO Act agencies: National Science Foundation; 
Audit results: Unqualified; 
Principal auditor: KPMG LLP; 
Number of other audit contractors: 0.

23 CFO Act agencies: Nuclear Regulatory Commission; 
Audit results: Unqualified; 
Principal auditor: R. Navarro & Associates, Inc; 
Number of other audit contractors: 0.

23 CFO Act agencies: Office of Personnel Management; 
Audit results: Unqualified; 
Principal auditor: KPMG LLP; 
Number of other audit contractors: 0.

23 CFO Act agencies: Small Business Administration; 
Audit results: Qualified[A]; 
Principal auditor: Cotton & Company LLP; 
Number of other audit contractors: 0.

23 CFO Act agencies: Social Security Administration; 
Audit results: Unqualified; 
Principal auditor: PricewaterhouseCoopers LLP; 
Number of other audit contractors: 2.

23 CFO Act agencies: State; 
Audit results: Unqualified; 
Principal auditor: Leonard G. Birnbaum and; 
Company, LLP; 
Number of other audit contractors: 4.

23 CFO Act agencies: Transportation; 
Audit results: Unqualified; 
Principal auditor: Inspector General; 
Number of other audit contractors: 2.

23 CFO Act agencies: Treasury; 
Audit results: Unqualified; 
Principal auditor: KPMG LLP; 
Number of other audit contractors: 5[B].

23 CFO Act agencies: Veterans Affairs; 
Audit results: Unqualified; 
Principal auditor: Deloitte & Touche LLP; 
Number of other audit contractors: 0.

Other major agency: Homeland Security; 
Audit results: Disclaimer; 
Principal auditor: KPMG LLP; 
Number of other audit contractors: 0. 

Source: GAO.

[A] The Small Business Administration received qualified opinions on 
its fiscal year 2004 consolidated balance sheet and statements of net 
cost, changes in net position, and financing, and an unqualified 
opinion on its fiscal year 2004 combined statement of budgetary 
resources.

[B] In addition, GAO audited the Internal Revenue Service's financial 
statements and the Schedules of Federal Debt Managed by the Bureau of 
the Public Debt.

[End of table]

[End of section]

Appendix II: Fiscal Year 2004 and 2003 Agency Results: 

Agency: Agency for International Development; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003. 

Agency: Agriculture; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies restated previous year financial statements: 2004; 
Agencies restated previous year financial statements: 2003. 

Agency: Commerce; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003. 

Agency: Defense; 
Agencies restated previous year financial statements: 2004. 

Agency: Education; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003. 

Agency: Energy; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies auditors' reported unqualified opinions with no material 
weaknesses or noncompliance: 2004; 
Agencies auditors' reported unqualified opinions with no material 
weaknesses or noncompliance: 2003. 

Agency: Environmental Protection Agency; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003. 

Agency: General Services Administration; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies restated previous year financial statements: 2004. 

Agency: Health and Human Services; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies restated previous year financial statements: 2004; 
Agencies restated previous year financial statements: 2003. 

Agency: Homeland Security; N/A.

Agency: Housing and Urban Development; 
Agencies auditors’ rendered unqualified opinions: 2003. 

Agency: Interior; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies restated previous year financial statements: 2003. 

Agency: Justice; 
Agencies auditors’ rendered unqualified opinions: 2003: (a); 
Agencies restated previous year financial statements: 2004. 

Agency: Labor; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies auditors' reported unqualified opinions with no material 
weaknesses or noncompliance: 2004. 

Agency: National Aeronautics and Space Administration; N/A. 

Agency: National Science Foundation; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies restated previous year financial statements: 2004; 
Agencies auditors' reported unqualified opinions with no material 
weaknesses or noncompliance: 2004; 
Agencies auditors' reported unqualified opinions with no material 
weaknesses or noncompliance: 2003. 

Agency: Nuclear Regulatory Commission; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003: (b); 
Agencies restated previous year financial statements: 2004. 

Agency: Office of Personnel Management; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies restated previous year financial statements: 2004. 

Agency: Small Business Administration; 
Agencies restated previous year financial statements: 2004. 

Agency: Social Security Administration; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies auditors' reported unqualified opinions with no material 
weaknesses or noncompliance: 2004; 
Agencies auditors' reported unqualified opinions with no material 
weaknesses or noncompliance: 2003. 

Agency: State; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies restated previous year financial statements: 2004. 

Agency: Transportation; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies restated previous year financial statements: 2004; 
Agencies restated previous year financial statements: 2003. 

Agency: Treasury; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003; 
Agencies restated previous year financial statements: 2003. 

Agency: Veterans Affairs; 
Agencies auditors’ rendered unqualified opinions: 2004; 
Agencies auditors’ rendered unqualified opinions: 2003. 

Total; 
Agencies auditors’ rendered unqualified opinions: 2004: 18; 
Agencies auditors’ rendered unqualified opinions: 2003: 18; 
Agencies restated previous year financial statements: 2004: 11; 
Agencies restated previous year financial statements: 2003: 5 (c); 
Agencies auditors' reported unqualified opinions with no material 
weaknesses or noncompliance: 2004: 4; 
Agencies auditors' reported unqualified opinions with no material 
weaknesses or noncompliance: 2003: 3. 

[A] The auditors for the Department of Justice withdrew the unqualified 
opinion that had been previously rendered on the department's fiscal 
year 2003 financial statements and issued a disclaimer of opinion on 
these restated financial statements.

[B] The auditors for the Nuclear Regulatory Commission withdrew the 
unqualified opinion that had been previously rendered on the 
commission's fiscal year 2003 financial statements and issued a 
qualified opinion on these restated financial statements.

[C] 20 of the agencies listed, including the 5 with restatements, had 
received unqualified opinions on their originally issued fiscal year 
2002 financial statements.

[End of table] 

[End of section]

Appendix III: Outlook 2005 Conference The National Press Club February 
2, 2005:

Saving our Nation's Future: An Intergovernmental Challenge:

Keynote Address By the Honorable David M. Walker, Comptroller General 
of the United States:

Thank you for that kind introduction and for the opportunity to speak 
to you today.

As a federal official speaking at this state and local conference, it 
is important to note at the outset that in today's world governments, 
institutions, and individuals are increasingly interconnected and 
interdependent. This trend is occurring both internationally and 
domestically and among different economic and social sectors. From a 
federal, state, and local government perspective, this interconnection 
and interdependence involves a range of issues, including tax policy, 
education, the environment, health care, homeland security, social 
welfare, and transportation.

I could talk about any number of intergovernmental challenges, but 
today I plan to brighten the lights and turn up the heat on an 
overarching problem that too many people seem content to put on the 
back burner. That problem is our nation's worsening financial condition 
and long-range fiscal outlook.

I'm sad to say that since I last spoke on this issue here at the 
National Press Club back in September of 2003, our nation's long-range 
fiscal imbalance has deteriorated significantly. Furthermore, as you 
all know, most state and local governments also have their own fiscal 
challenges and are having to make increasingly difficult choices.

We now confront three large and interrelated national deficits. The 
first is a large federal budget deficit. The second is a growing 
balance-of-payments deficit. And the third is an alarming personal 
savings deficit.

Frankly, it's easy to dismiss government deficits and debt as someone 
else's problem. But in my view, every American has both a personal 
reason and a civic responsibility to become more informed and involved 
in the coming debate over our collective fiscal future.

The American people need to realize that the fiscal choices being made 
in Washington today have profound consequences for the future of our 
country, and our children. In a nutshell, these fiscal choices will 
directly affect our future national security, economic vitality, and 
quality of life.

In the past, Americans have shrugged off warnings about the impending 
deficit and debt crises. Many Americans are too focused on today and 
aren't thinking enough about tomorrow. As Walter Shapiro pointed out in 
a recent column in USA Today, low interest rates and modest inflation 
give many Americans a false sense of security. These false perceptions 
are reinforced by the government's financial statements, which 
currently do not provide a full and fair view of our nation's current 
financial condition and long-term outlook. The simple truth is that our 
nation's financial condition is much worse than advertised. In 
addition, due largely to the looming retirement of the baby boomers, 
surging health care costs, and relatively low federal revenues as a 
percentage of the economy, we now face decades of red ink.

One aspect of government financial reporting in which I'm directly 
involved as Comptroller General of the United States is the audit of 
the federal government's consolidated financial statements. Every year, 
the federal government is required to issue a comprehensive report on 
its finances and operations. My agency, the U.S. Government 
Accountability Office (GAO), has a statutory responsibility to audit 
these financial statements. As the person who has to sign GAO's audit 
report, and a CPA, I have an official as well a professional and 
personal interest in ensuring that the federal government is 
accountable to the taxpayers. The federal government's fiscal 2004 
report was issued in record time. Unfortunately, for the eighth year in 
a row, GAO was unable to vouch for the accuracy and completeness of the 
information in the financial statements.

Recent accountability failures in the private sector underscore the 
importance of accurate and timely financial reporting. The scandals at 
Enron, Worldcom, and other corporations have led to restatements of 
financial statements and bankruptcies that have harmed countless 
shareholders, employees, pensioners, and other stakeholders, including 
entire communities. Here in Washington, the recently announced 
restatements at Fannie Mae and Freddie Mac hit uncomfortably close to 
home. We at GAO are committed to doing our best to ensure that such 
accountability failures are not repeated in the federal government.

Beyond the financial statement numbers, what does the federal 
government's annual report say about the results that are being 
achieved with the taxpayer dollars being spent? The answer is not much! 
It's bad enough that too few agencies adequately show the results they 
are getting with the taxpayer dollars they spend, but policymakers also 
frequently do not focus on the long-term impact of new spending and tax 
proposals before taking action on related legislation. Particularly 
troubling are the enormous commitments that we face in connection with 
Social Security, Medicare, Medicaid, and veteran's health care. Down 
the line, we could also be facing potential federal bailouts of several 
entities like the Pension Benefit Guaranty Corporation.

Over the years, our federal fiscal debates have gone from millions to 
billions to trillions. Unless you're an economist, a statistician, an 
actuary, or a CPA, these numbers are mind-boggling. What's a million 
dollars? When it comes to the federal government, a million dollars is 
practically pocket change. Last year, the federal government 
experienced a deficit that averaged more than $1 billion each and every 
day. That is more than $750,000 a minute.

If you're honest about keeping score and include promised but unfunded 
Social Security and Medicare benefits along with explicit benefit and 
other commitments, the federal government's obligations, current 
liabilities and unfunded fiscal commitments are over $43 trillion and 
rising. In the last year alone, this amount has risen by more than $13 
trillion, largely due to the new Medicare prescription drug benefit. 
Yes, that's trillions with 12 zeros rather than billions with 9 zeros. 
To put that number into perspective, even with the recent run up in 
housing prices, the estimated total net worth of every American, 
including Bill Gates and other billionaires, is only about $47 
trillion. That means that every American would have to fork over more 
than 90 percent of their net worth to cover the government's current 
promises. Stated differently, the current burden for every American 
works out to more than $145,000. The numbers are even worse for full-
time workers, whose share now exceeds $350,000. That amount is growing 
every day and it isn't even tax deductible! Keep in mind that the 
average family income in this country is around $42,000 a year.

As bad as these numbers are, it's the real-life consequences of 
unchecked deficits that are truly frightening. For example, if we 
continue as we have, higher interest rates are inevitable. It's only a 
matter of when and how high. As government borrows more and more money 
to finance its debt, less money will be available for companies to 
invest to stay competitive in today's global economy. Without 
meaningful changes, long-term economic growth will suffer, and along 
with it American jobs and purchasing power. And don't forget that high 
budget deficits can lead to slower growth, higher interest rates and 
higher inflation, which in many respects is the cruelest tax of all.

By continuing to run huge budget deficits, America is partially ceding 
control over its own destiny to others. Why? Because America's personal 
savings rate has reached historic lows. So guess who's been financing 
much of our spending spree in recent years? The answer is foreign 
investors. Since 1993 the share of publicly held debt owned by 
international investors has more than doubled, from 19% to over 40%. 
Last year, foreign investors purchased nearly $399 billion in Treasury 
securities--just $13 billion less than the size of the 2004 deficit! If 
these foreign investors lose confidence in U.S. securities as a safe 
haven and start to move their money elsewhere, our economy could take a 
serious and sudden hit. The recent decline in the value of the dollar 
may be a warning shot in this regard.

Mounting deficits and debt will also eventually imperil many government 
programs and services that Americans have come to take for granted. The 
reality is that government functions like national defense, homeland 
security, education, transportation, and our judicial system fall under 
the category of "discretionary spending." These programs are facing 
increasing budget pressures, and our ability to respond to new and 
emerging needs is also being constrained. If we don't get serious soon, 
many important programs at the state and local level will also feel the 
crunch. Right now, state and local governments play a key role in a 
range of important functions, such as educating our children, housing 
the poor, delivering health care, and building roads and bridges. But 
in the future, state and local governments may not be able to count on 
as much federal help. Furthermore, states may also face additional 
unfunded federal mandates.

In the past, particularly in the decades since World War II, America 
was the world's engine of economic growth. We still are, but our long-
term fiscal gap is so great today that there's no way we'll be able to 
grow our way out of the problem. Using plausible assumptions, closing 
our fiscal gap would require average real growth in double-digits for 
the next 75 years. By any measure, that's unrealistic. In fact, even 
during the boom years of the 1990s, the economy grew at an average 
annual real rate of only 3.2 percent.

If we continue on our present path, we'll see pressure for deep 
spending cuts or dramatic tax increases. GAO's long-term budget 
simulations paint a chilling picture. If we do nothing, by 2040 we may 
have to cut federal spending by more than half or raise federal taxes 
by more than two and half times to balance the budget. Clearly, the 
status quo is both unsustainable and difficult choices are unavoidable. 
And the longer we wait, the more onerous our options will become and 
the less transition time we will have.

So how do we start to turn things around? At the federal level, a 
crucial first step is to insist on truth and transparency in government 
operations, including federal financial reporting. The federal 
government must provide a fuller and fairer picture of existing budget 
deficits, the so-called "trust funds," and the growing financial 
burdens facing every American.

On the budget side, the current 10-year cash-flow projections are an 
improvement over past practices. But given known demographic trends, 
even these projections fail to capture the long-term consequences of 
today's spending and tax policy choices. In my view, elected 
representatives should have more explicit information on the present 
value dollar costs of major spending and tax bills--before they vote on 
them. This was not the case when Congress passed the Medicare 
prescription drug bill with its $8.1 trillion price tag. The time has 
also come to reinstate budget controls, such as reasonable spending 
caps and responsible "pay-go" rules which would require any new 
spending increases or tax cuts to be paid for by equivalent tax 
increases and/or spending cuts.

Further reforms to the substance and timing of the current 
appropriations and authorization processes may also be needed. When 
considering these reforms, we should look to the states. In some ways, 
the states are way ahead of the federal government in dealing with 
fiscal imbalances. They have made hard choices in the past--partly 
driven by their state constitutions, partly by their inability to print 
money and partly by their sensitivity to their bond ratings!:

From a more strategic and results based perspective, we also need to 
develop a set of key national performance and outcome-based indicators 
to measure America's position and progress on a range of economic, 
security, environmental, and social issues. Key indicators can help to 
inform strategic planning, enhance performance and accountability 
reporting, and improve key decision-making. Several countries, states, 
and localities have already adopted key indicator systems, but I'm 
sorry to say the United States still lacks such a system at the 
national level. This has meant that at times our policymakers have been 
flying blind, not unlike an airplane pilot at night without an 
instrument panel. Importantly, we are currently looking at how states 
use performance information to reprioritize their budgets in tight 
fiscal times. We are also working with the National Academies and the 
OECD to help make key indicators become a reality in the U.S. and 
elsewhere.

Think about it. Each year, the federal government spends more than $2 
trillion on a wide range of programs and operations, provides hundreds 
of billions of dollars in tax preferences, and issues thousands of 
pages of regulations. And it does all this without having enough 
knowledge about whether federal policies, programs, and activities are 
making a real difference. Based on where we are headed, we need to 
engage in a base-line review of the entire federal government that 
encompasses three key dimensions.

First, we need to undertake a top-to-bottom review of government 
programs, policies, functions, and activities to ensure their relevance 
for the 21ST century. This includes both discretionary and mandatory 
spending. Today, many if not most government policies and programs are 
based on conditions that existed when Harry Truman or Dwight Eisenhower 
were President. We cannot afford to spend increasingly limited taxpayer 
dollars on government policies and programs that were designed to deal 
with the problems of the past or can't show they're that making a 
meaningful difference today. Congress and the President need to decide 
which programs and policies remain priorities, which should be 
overhauled, and which have outlived their usefulness. Importantly, 
increases in targeted earmark spending combined with across-the-board 
cuts are not substitutes for making tough and informed choices about 
the base of government. These trends can result in adding fat and 
protecting ineffective programs while cutting muscle from high-priority 
and high-performing programs.

Second, we need to revisit existing tax policy and enforcement efforts. 
Every year, our government forgoes hundreds of billions of revenue 
because of existing tax preferences, significant uncollected back 
taxes, and tax evasion. In fact, in some years, the cost of tax 
preferences exceeds total discretionary spending. Our complex tax 
system distorts decisions to work, save, and invest--and that dampens 
economic growth. Complexity also creates opportunities for tax evasion 
through vehicles such as tax shelters. All of this raises questions 
about fairness with taxpayers wondering whether their friends, 
neighbors and business competitors are paying their fair share. 
Clearly, comprehensive tax reform is needed. Reform could also better 
position the United States to compete in today's global economy--one 
that is increasingly knowledge-based and subject to fast-paced 
technological change. It's important to recognize that the ripple 
effects of comprehensive tax reform will be felt at all levels of 
government.

Third, entitlement reform is essential. We need to put Social Security 
and Medicare on a sound footing and make them solvent, sustainable, and 
secure for both current and future generations. Actually, the problems 
with Social Security are not that difficult to solve. In fact, we now 
have a window of opportunity to exceed the expectations of all 
Americans--whether they'll be retiring 30 days or 30 years from now. 
I'd be happy to tell you more about how we can do this during the 
question and answer period.

On the other hand, it seems clear that the biggest single domestic 
challenge is health care, of which Medicare and Medicaid are a big 
part. Mounting health care costs are a problem for governments, 
employers, and individuals. Despite repeated efforts to rein in health 
care spending, costs continue to climb. Between 1990 and 2000, U.S. 
health care spending rose from $696 billion to $1.3 trillion. Spending 
on health care is projected to more than double again by the end of 
this decade. Clearly, such growth is unsustainable, and it's one of the 
main reasons why both the Medicare and Medicaid programs are on GAO's 
high-risk list. It's also one of the reasons that Medicaid costs 
represent the fastest growing and one of the largest budget items--
second only to education--for states.

The problems affecting Medicare and Medicaid will be much more 
difficult to solve than Social Security. More broadly, we need to 
reconsider how we define, deliver, and finance health care in this 
country--both in the public and the private sectors. We need to weigh 
unlimited individual wants against specific societal needs and decide 
how responsibility for health care should be divided among employers, 
individuals, and governments.

Despite the huge amounts of money we're spending on medical care, broad 
access to basic coverage remains an elusive goal. The rising cost of 
government health care programs increases budget pressures at both the 
federal and state levels. Rising health care costs are also 
discouraging additional pension coverage, constraining wage increases, 
and reducing the tax base because an increasing percentage of employee 
compensation is coming in the form of nontaxable benefits like health 
insurance. Some reports suggest that rising health care premiums are 
also causing companies to move jobs offshore, cut overall employment 
levels, and hire part-time rather than full-time workers.

As you may have heard about in news stories, GAO recently released its 
new high-risk report, which deals primarily with the here and now. 
GAO's high-risk report lists current government programs and functions 
that need special focus and immediate attention. In addition, yesterday 
we issued a report on the results of a GAO forum on our long-range 
fiscal challenges.

In the next couple of weeks, GAO will be issuing its 21ST Century 
Challenges Report, which will discuss where we are and where we're 
headed as a nation. This report will include a number of illustrative 
questions that policymakers should consider in examining the base of 
government. Frankly, it's going to take many years to get us back on a 
prudent and sustainable long-term fiscal track but the time to start is 
now.

There's clearly a real payoff for prompt action. By acting now, both 
America and Americans can minimize the need for drastic measures and 
give all of us more time to adjust to any changes. By acting now, we 
can help to ensure that the miracle of compounding eventually works for 
us rather than against us--as it is today. By acting now, we can also 
avoid a dangerous upward spiral of deficits and debt that will 
ultimately harm America and every American family. By acting now, we 
can enhance our credibility with investors and improve public 
confidence in the government's ability to deal with large, complex and 
controversial fiscal issues before a crisis is upon us. Finally, by 
acting now, we can reduce the burdens that will otherwise be imposed on 
our children and grandchildren and give them more freedom of choice 
over what role they would like for government to play in the future.

As a member of the Sons of the American Revolution, I sometimes wonder 
what the Founding Fathers would think if they came back today. George 
Washington, Thomas Jefferson, Benjamin Franklin, Alexander Hamilton, 
and the other founders can seem larger than life, but most of them 
earned a living as farmers and businessmen. They understood first hand 
both the value of thrift and the perils of personal and public debt. 
Theirs was, after all, a world with debtors' prisons. With good reason, 
Ben Franklin said, "He who goes a borrowing goes a sorrowing."

At the same time, our first Secretary of the Treasury, Alexander 
Hamilton, was a realist who recognized that adding debt in times of war 
or economic recession may be a temporary necessity. It seems clear, 
however, that our Founding Fathers did not believe that adding debt in 
the normal course of events was either prudent or appropriate.

No less than the father of our country, George Washington felt that the 
most important personal value was courage and the most important 
institutional value was fiscal responsibility. His views are 
particularly timely at this point in our nation's history.

Somehow, in the last 200 years we seem to have forgotten the sound 
advice from Washington, Hamilton and Franklin. If the Founding Fathers 
were to return today, I have no doubt they'd be justifiably proud of 
many things our nation has accomplished, as we are. But I suspect many 
of them would be shocked and saddened by our willingness to forgo 
fiscal discipline and pile on both personal and public debt. It's 
likely that our Founding Fathers would see our mounting debt as a 
violation of our stewardship responsibility to future generations of 
Americans.

This is at the heart of my message. For the debate about our fiscal 
future is, ultimately, not about numbers but about values. The debate 
we are really having is about the kind of world we're prepared to pass 
on to our children and grandchildren. The time has come for responsible 
public officials to heed George Washington's words by demonstrating 
more individual courage and recommitting to institutional fiscal 
responsibility.

It's very important to emphasize here that the nation's fiscal 
imbalance is not a partisan issue. There are many players we could 
blame for our current financial situation. After all, it's been many 
years in the making. The point is that while we can't change the past, 
we can and must do something about our future.

Overcoming our fiscal challenges will take the combined efforts of both 
sides of the aisle in Washington and in every state capital. Right now, 
what we need are leaders who will acknowledge that we have a problem 
and are willing do something about it. In this regard, actions speak 
louder than words.

In my judgment, the worst thing that could happen is to continue on our 
present path and do nothing. Because once a crisis is upon us, we face 
terrible choices. And while it's true that other nations also have 
long-range fiscal challenges, who wants to be the best looking horse in 
the glue factory?

Although my message is sobering and I want you to take our situation 
seriously, I don't want you to go away thinking that things are 
hopeless or that I am pessimistic. That's far from true and those who 
know me will attest to the fact that I am a results oriented optimistic 
by nature. After all, America has overcome much more serious challenges 
in the past. Furthermore, in America, anything is possible with 
leadership, vision, commitment, and persistence. But we need to get 
serious and we need to act soon. Keep in mind, the passengers on the 
Titanic had a smooth ride and a great time until the very moment the 
ship hit the iceberg.

Today, every American needs to be part of the solution. In my view, our 
best hope for change is for people who live on Main Street to recognize 
the magnitude of our challenge and appreciate the risks posed by these 
deficits to them, their children and their grandchildren.

If the folks who live on Main Street remain silent, significant and 
sustainable change is unlikely. After all, why should any elected 
official stick his or her neck out on a complex and controversial issue 
if no one cares? Younger Americans especially need to become active in 
this discussion because they and their children will bear the heaviest 
burden if today's leaders fail to act.

State and local governments need to play a strong role in our fiscal 
challenge debate, because in the end, every government entity and 
public servant, myself included, is in the same boat. After all, bad 
news eventually flows down hill. This means we've got to start paddling 
together, or we'll surely sink separately.

My hope is that when you leave here today, you will spread the word 
among your friends and colleagues at the state and local level. We have 
to start doing something about America's triple deficits. Everyone from 
governors and mayors to rank-and-file state and local employees have a 
stake in this cause, and they need to become more informed and involved 
in demanding change and suggesting constructive and realistic 
solutions.

In closing, one of my favorite Presidents is Theodore Roosevelt. As a 
person of strong character who was trustbuster, environmentalist, 
internationalist and a winner of both the Medal of Honor and the Nobel 
Peace Prize, he showed that if you put your mind to something, anything 
is possible. TR said, "Fighting for the right [cause] is the noblest 
sport the world affords." When it comes to our current fiscal 
challenges, I hope you'll join me in working together as modern-day 
patriots to insist on the facts, speak the truth, and help save our 
nation's future.

Thank you for your time and attention. I'd be happy to answer any 
questions that you may have.

[End of section]

Appendix IV: Material Deficiencies:

The federal government did not maintain adequate systems or have 
sufficient, reliable evidence to support information reported in the 
consolidated financial statements, as described below. These material 
deficiencies contributed to our disclaimer of opinion on the federal 
government's consolidated financial statements and also constitute 
material weaknesses in internal control.

Property, Plant, and Equipment and Inventories and Related Property:

The federal government could not satisfactorily determine that 
property, plant, and equipment (PP&E) and inventories and related 
property were properly reported in the consolidated financial 
statements. Most of the PP&E and inventories and related property are 
the responsibility of the Department of Defense (DOD). As in past 
years, DOD did not maintain adequate systems or have sufficient records 
to provide reliable information on these assets. Other agencies, most 
notably the National Aeronautics and Space Administration, reported 
continued weaknesses in internal control procedures and processes 
related to PP&E.

Without reliable asset information, the federal government does not 
fully know the assets it owns and their location and condition and 
cannot effectively (1) safeguard assets from physical deterioration, 
theft, or loss; (2) account for acquisitions and disposals of such 
assets; (3) ensure that the assets are available for use when needed; 
(4) prevent unnecessary storage and maintenance costs or purchase of 
assets already on hand; and (5) determine the full costs of programs 
that use these assets.

Liabilities and Commitments and Contingencies:

The federal government could not reasonably estimate or adequately 
support amounts reported for certain liabilities. For example, DOD was 
not able to estimate with assurance key components of its environmental 
and disposal liabilities. In addition, DOD could not support a 
significant amount of its estimated military postretirement health 
benefits liabilities included in federal employee and veteran benefits 
payable. These unsupported amounts related to the cost of direct health 
care provided by DOD-managed military treatment facilities. Further, 
the federal government could not determine whether commitments and 
contingencies, including those related to treaties and other 
international agreements entered into to further the U.S. government's 
interests, were complete and properly reported.

Problems in accounting for liabilities affect the determination of the 
full cost of the federal government's current operations and the extent 
of its liabilities. Also, improperly stated environmental and disposal 
liabilities and weak internal control supporting the process for their 
estimation affect the federal government's ability to determine 
priorities for cleanup and disposal activities and to appropriately 
consider future budgetary resources needed to carry out these 
activities. In addition, when disclosures of commitments and 
contingencies are incomplete or incorrect, reliable information is not 
available about the extent of the federal government's obligations.

Cost of Government Operations and Disbursement Activity:

The previously discussed material deficiencies in reporting assets and 
liabilities, material deficiencies in financial statement preparation, 
as discussed below, and the lack of adequate disbursement 
reconciliations at certain federal agencies affect reported net costs. 
As a result, the federal government was unable to support significant 
portions of the total net cost of operations, most notably related to 
DOD.

With respect to disbursements, DOD and certain other federal agencies 
reported continued weaknesses in reconciling disbursement activity. For 
fiscal years 2004 and 2003, there was unreconciled disbursement 
activity, including unreconciled differences between federal agencies' 
and the Department of the Treasury's (Treasury) records of 
disbursements and unsupported federal agency adjustments, totaling 
billions of dollars, which could also affect the balance sheet.

Unreliable cost information affects the federal government's ability to 
control and reduce costs, assess performance, evaluate programs, and 
set fees to recover costs where required. Improperly recorded 
disbursements could result in misstatements in the financial statements 
and in certain data provided by federal agencies for inclusion in the 
President's budget concerning obligations and outlays.

Preparation of Consolidated Financial Statements:

During fiscal year 2004, Treasury made progress in laying the 
foundation to address certain long-standing material deficiencies in 
preparing the consolidated financial statements. Foremost is the 
ongoing development of a new system, the Governmentwide Financial 
Reporting System (GFRS), to collect agency financial statement 
information directly from federal agencies' audited financial 
statements rather than using federal agencies' Standard General Ledger 
data as Treasury had done in previous years to compile the consolidated 
financial statements. The goal of the new system is to be able to 
directly link information from federal agencies' audited financial 
statements to amounts reported in the consolidated financial 
statements, a concept that we strongly support. Once Treasury is able 
to achieve this, it would eliminate a major impediment to our being 
able to audit the consolidated financial statements.

For the fiscal year 2004 reporting process, Treasury's GFRS was able to 
capture certain agency financial information from agencies' audited 
financial statements, which is an important first step. The automated 
system, though, was not yet at the stage of development that it could 
be used to compile the consolidated financial statements from the 
information that was captured. Therefore, for fiscal year 2004, 
Treasury had to rely primarily on Excel spreadsheets and extensive 
manual procedures to prepare the consolidated financial statements. As 
discussed in our scope limitation section of our audit report, the 
federal government could not produce the fiscal year 2004 consolidated 
financial statements in time for us to complete all of our planned 
auditing procedures. In addition, for fiscal year 2004, the federal 
government continued to have inadequate systems, controls, and 
procedures to ensure that the consolidated financial statements are 
consistent with the underlying audited agency financial statements, 
balanced, and in conformity with U.S. generally accepted accounting 
principles (GAAP). Specifically, during our fiscal year 2004 audit, we 
found the following:[Footnote 24]

* Treasury's process for compiling the consolidated financial 
statements did not ensure that the information in these statements was 
fully consistent with the underlying information in federal agencies' 
audited financial statements and other financial data.

* Treasury's ability to timely prepare a complete set of consolidated 
financial statements was greatly impaired because in some cases the 
financial information provided by federal agencies to Treasury did not 
agree to the agencies' audited financial statements, causing Treasury 
to have to resort to last-minute, alternative methods to gather the 
needed information. These problems were compounded by Treasury's 
reliance on internal controls that were dependent on procedures that 
would attempt to identify any errors after they were made by an agency 
(detective controls) rather than implementation of internal controls 
that may have prevented or minimized the errors from occurring 
(preventive controls).

* Other internal control weaknesses existed in Treasury's process for 
preparing the consolidated financial statements, involving a lack of 
(1) segregation of duties, (2) appropriate documentation of certain 
policies and procedures for preparing the consolidated financial 
statements, (3) adequate support for adjustments made to the 
consolidated financial statements, and (4) required management reviews.

* Information system weaknesses existed within the segments of GFRS 
that were used during the fiscal year 2004 reporting process. We found 
that inappropriate access to GFRS was granted to certain Treasury 
personnel and that the GFRS database was not configured to prevent the 
alteration of data submitted by federal agencies and was used for both 
production and testing during the fiscal year 2004 reporting process.

* Treasury did not have the infrastructure to address the magnitude of 
the fiscal year 2004 financial reporting challenges it was faced with, 
such as an incomplete financial reporting system, compressed time 
frames for compiling the financial information, and inaccurate and 
incomplete information provided by certain federal agencies. We found 
that personnel at Treasury's Financial Management Service had excessive 
workloads that required an extraordinary amount of effort and 
dedication to compile the consolidated financial statements; however, 
there were not enough personnel with specialized financial reporting 
experience to ensure accurate and reliable financial reporting by the 
accelerated reporting date. Nevertheless, a foundation for the future 
was put into place and a number of lessons were learned.

* To make the fiscal years 2004 and 2003 consolidated financial 
statements balance, Treasury recorded a net $3.4 billion increase and a 
net $24.5 billion decrease, respectively, to net operating cost on the 
Statements of Operations and Changes in Net Position, which it labeled 
"Unreconciled Transactions Affecting the Change in Net 
Position."[Footnote 25] An additional net $1.2 billion and $11.3 
billion of unreconciled transactions were recorded in the Statement of 
Net Cost for fiscal years 2004 and 2003, respectively. Treasury is 
unable to fully identify and quantify all components of these 
unreconciled activities.

* Treasury eliminated many intragovernmental activity and balances 
through accounting entries for fiscal year 2004 rather than "dropping" 
or "offsetting" the amounts as it has done in the past, which is a 
positive step. However, as discussed below, amounts reported for 
federal agency trading partners[Footnote 26]for certain 
intragovernmental accounts were significantly out of balance, resulting 
in the need for unsupported intragovernmental elimination entries in 
order to force the Statement of Operations and Changes in Net Position 
into balance. Treasury's ability to eliminate certain intragovernmental 
activity and balances continues to be impaired by the federal agencies' 
problems in handling their intragovernmental transactions, which are 
noted below. In addition, significant differences in other 
intragovernmental accounts, primarily related to appropriations, have 
not been reconciled and still remain unresolved. Therefore, the federal 
government continues to be unable to determine the impact of 
unreconciled intragovernmental activity and balances to the 
consolidated financial statements.

* The federal government did not have an adequate process to identify 
and report items needed to reconcile the operating results, which for 
fiscal year 2004 showed a net operating cost of $615.6 billion, to the 
budget results, which for the same period showed a unified budget 
deficit of $412.3 billion. In addition, a net $23.2 billion "net amount 
of all other differences" was needed to force this statement into 
balance.

* The consolidated financial statements include certain financial 
information for the executive, legislative, and judicial branches, to 
the extent that federal agencies within those branches have provided 
Treasury such information. However, there are undetermined amounts of 
assets, liabilities, costs, and revenues that are not included, and the 
federal government did not provide evidence or disclose in the 
consolidated financial statements that such excluded financial 
information was immaterial.

* Treasury did not have an adequate process to ensure that the 
financial statements, related notes, Stewardship Information, and 
Supplemental Information are presented in conformity with GAAP. For 
example, we found that certain financial information required by GAAP 
was not disclosed in the consolidated financial statements. Treasury 
did not provide us with documentation of its rationale for excluding 
this information. As a result of this and certain of the material 
deficiencies noted above, we were unable to determine if the missing 
information was material to the consolidated financial statements. In 
an effort to begin addressing this issue, we found that Treasury 
collected certain additional financial information required by GAAP in 
its new process for fiscal year 2004. However, due to the compressed 
time frames to compile the consolidated financial statements and 
because GFRS is still being developed, Treasury plans to analyze this 
information in fiscal year 2005 and determine how or whether to 
disclose this information in future years' consolidated financial 
statements.

Accounting for and Reconciliation of Intragovernmental Activity and 
Balances:

Federal agencies are unable to adequately account for and reconcile 
intragovernmental activity and balances. The Office of Management and 
Budget (OMB) and Treasury require the chief financial officers (CFO) of 
35 executive departments and agencies to reconcile, on a quarterly 
basis, selected intragovernmental activity and balances with their 
trading partners. In addition, these agencies are required to report to 
Treasury, the agency's inspector general, and GAO on the extent and 
results of intragovernmental activity and balances reconciliation 
efforts as of the end of the fiscal year.

A substantial number of the agencies did not fully perform the required 
reconciliations for fiscal years 2004 and 2003. For fiscal year 2004, 
based on trading partner information provided in GFRS, Treasury 
produced a "Material Difference Report" for each agency showing amounts 
for certain intragovernmental activity and balances that significantly 
differed from those of its corresponding trading partners. After 
analysis of the material differences, a significant number of CFOs 
cited differing accounting methodologies, accounting errors, and timing 
differences for their material differences with their trading partners. 
Many CFOs simply indicated that they were unable to explain the 
differences with their trading partners. For both fiscal years 2004 and 
2003, amounts reported by federal agency trading partners for certain 
intragovernmental accounts were significantly out of balance. As a 
result, the federal government's ability to determine the impact of 
these differences on the amounts reported in the consolidated financial 
statements is impaired. Resolving the intragovernmental transactions 
problem remains a difficult challenge and will require a commitment by 
federal agencies and strong leadership and oversight by OMB.

Net Outlays--A Component of the Budget Deficit:

OMB Bulletin No. 01-09, Form and Content of Agency Financial 
Statements, states that outlays in federal agencies' Statement of 
Budgetary Resources (SBR) should agree with the net outlays reported in 
the budget of the U.S. government. In addition, Statement of Federal 
Financial Accounting Standards No. 7, Accounting for Revenue and Other 
Financing Sources and Concepts for Reconciling Budgetary and Financial 
Accounting, requires explanation of any material differences between 
the information required to be disclosed (including net outlays) in the 
financial statements and the amounts described as "actual" in the 
budget of the U.S. government.

The federal government reported in the Statement of Changes in Cash 
Balance from Unified Budget and Other Activities (Statement of Changes 
in Cash Balance) a budget deficit for fiscal year 2004 of $412.3 
billion. The budget deficit is calculated by subtracting actual budget 
outlays from actual budget receipts.[Footnote 27] In previous years, 
the Statement of Changes in Cash Balance reported actual budget outlays 
and actual budget receipts; however, for fiscal year 2004, the federal 
government chose not to disclose budget outlays and budget receipts in 
this financial statement and only included the budget deficit. As we 
reported for fiscal year 2003, we found $140 billion in differences 
between the total net outlays reported in selected federal agencies' 
audited SBRs and Treasury's central accounting records, which it uses 
to prepare the Statement of Changes in Cash Balance. Treasury again 
chose for fiscal year 2004 to use its central accounting records to 
prepare the Statement of Changes in Cash Balance without a process for 
identifying and resolving the differences between its central 
accounting records and net outlay amounts reported in the agencies' 
audited SBRs. For fiscal year 2004, while Treasury no longer disclosed 
this information in the Statement of Changes in Cash Balance, we again 
found material differences between the total net outlays reported in 
certain federal agencies' audited SBRs and the records Treasury used to 
prepare the Statement of Changes in Cash Balance totaling about $69 
billion. In addition, we also noted reported internal control 
weaknesses regarding certain agencies' SBRs.

OMB's efforts in working with the agencies resulted in some notable 
improvements in reducing the approximately $140 billion of differences 
that we reported in fiscal year 2003 between the total net outlays 
reported in the federal agencies' SBRs and the Statement of Changes in 
Cash Balance. As we reported, two agencies, Treasury and HHS, accounted 
for about 83 percent of these differences. We found that the major 
cause of the differences for the two agencies for fiscal year 2003 was 
the treatment of offsetting receipts.[Footnote 28] Some offsetting 
receipts for these two agencies had not been included in the agencies' 
SBRs, which would have reduced the agencies' net outlays and made the 
amounts more consistent with Treasury's records used to prepare the 
Statement of Changes in Cash Balance. In fiscal year 2004, a major 
component of HHS restated its fiscal year 2003 net outlays in its SBR, 
and Treasury obtained a waiver from OMB exempting it from reporting 
certain offsetting receipts in its SBR totaling about $16.9 billion 
until further research is performed. However, about $75 billion of 
differences we found for fiscal year 2003 still remained unreconciled 
as of September 30, 2004.

Until the material differences between the total net outlays reported 
in the federal agencies' SBRs and the records used to prepare the 
Statement of Changes in Cash Balance are timely reconciled, the effect 
of these differences on the U.S. government's consolidated financial 
statements will be unknown.

[End of section]

Appendix V: Other Material Weaknesses:

The federal government did not maintain effective internal control over 
financial reporting (including safeguarding assets) and compliance with 
laws and regulations as of September 30, 2004. In addition to the 
material deficiencies discussed in appendix IV, we found the following 
four other material weaknesses in internal control.

Loans Receivable and Loan Guarantee Liabilities:

Federal agencies continue to have material weaknesses and reportable 
conditions related to their lending activities. In fiscal year 2004, 
significant deficiencies in the processes and procedures used to 
estimate the costs of certain lending programs and value of loans 
receivable increased. While the Small Business Administration (SBA) 
made noteworthy progress to improve its cost estimation processes, 
additional improvements are still needed at SBA to fully resolve the 
deficiencies in the area so that reasonable estimates can be produced 
and audited in a timely manner. Further, this year at the Department of 
Housing and Urban Development (HUD), a new material weakness was 
reported. HUD lacked adequate management reviews of underlying data and 
cost estimation methodologies that resulted in material errors being 
undetected, and significant adjustments were needed. These material 
weaknesses at SBA and HUD, plus deficiencies at the Department of 
Agriculture and the Department of Education relating to the processes 
and procedures for estimating credit program costs, continue to 
adversely affect the federal government's ability to support annual 
budget requests for these programs, make future budgetary decisions, 
manage program costs, and measure the performance of lending 
activities. Further, these weaknesses and the complexities associated 
with estimating the costs of lending activities greatly increase the 
risk that significant errors in agency and governmentwide financial 
statements could occur and go undetected.

Improper Payments:

Across the federal government, improper payments occur in a variety of 
programs and activities, including those related to health care, 
contract management, federal financial assistance, and tax 
refunds.[Footnote 29] Many improper payments occur in federal programs 
that are administered by entities other than the federal government, 
such as states and municipalities. Generally, improper payments result 
from a lack of or an inadequate system of internal control, but some 
result from program design issues. Federal agencies' estimates of 
improper payments based on available information for fiscal year 2004 
exceeded $45 billion. This estimate could increase significantly over 
the next several years as agencies become more effective at estimating 
and reporting improper payment amounts for programs and activities that 
are susceptible to significant improper payments.[Footnote 30]

Fiscal year 2004 represents the first full year that federal agencies 
were required to include the reports required by the Improper Payments 
Information Act of 2002 (IPIA)[Footnote 31] in their Performance and 
Accountability Reports (PAR). IPIA raised improper payments to a new 
level of importance by requiring federal agencies to annually review 
all programs and activities and identify those that may be susceptible 
to significant improper payments. Federal agencies are to then estimate 
the annual amount of improper payments for those programs and 
activities identified as susceptible to significant improper payments. 
The law further requires federal agencies to report to the Congress the 
improper payment estimates and information on the actions the agency is 
taking to reduce the improper payments. The Office of Management and 
Budget (OMB) implementation guidance required that estimates and, if 
applicable, the corrective action report, be included in federal 
agencies' PARs beginning with fiscal year 2004.[Footnote 32]

The OMB guidance also required 44 programs of 14 CFO Act agencies to 
report improper payment information in their fiscal year 2003 PARs. 
Last year, we reported that those 14 CFO Act agencies reported the 
required improper payment amounts for 29 of the 44 programs,[Footnote 
33] suggesting that despite the enhanced emphasis on improper payments 
and legislative reporting requirements, those agencies appeared to be 
struggling with estimating improper payment amounts for about one-third 
of their programs.

Our preliminary reviews of 29 federal agencies' fiscal year 2004 PARs 
further suggest that a number of agencies were not well positioned to 
meet the reporting requirements of IPIA. For example, while most 
agencies acknowledged the IPIA reporting requirements in their PARs, 8 
of the 44 programs with previous reporting requirements as noted above 
indicated that they would be able to estimate and report on improper 
payments sometime within the next 4 years but could not do so now. 
Another 5 programs in 2 agencies with previous reporting requirements 
determined that improper payment amounts were insignificant for their 
programs. Further, 4 additional programs in 4 agencies with prior 
reporting requirements did not estimate improper payment amounts for 
their programs and were silent as to whether they would report 
estimates in future reports. Therefore, 32 of the 44 programs with 
previous reporting requirements reported estimates or reported that 
their improper payment amounts were insignificant in their fiscal year 
2004 PARs.

Until all agencies develop and implement a systematic measurement of 
the extent of improper payments, the federal government cannot 
determine (1) the extent to which improper payments exist, (2) 
mitigation strategies and the appropriate amount of investments to 
reduce them, and (3) the success of efforts implemented to reduce 
improper payments.

Information Security:

Although progress has been made, serious and widespread information 
security control weaknesses continue to place federal assets at risk of 
inadvertent or deliberate misuse, financial information at risk of 
unauthorized modification or destruction, sensitive information at risk 
of inappropriate disclosure, and critical operations at risk of 
disruption. GAO has reported information security as a high-risk area 
across government since February 1997. Such information security 
control weaknesses could result in compromising the reliability and 
availability of data that are recorded in or transmitted by federal 
financial management systems. A primary reason for these weaknesses is 
that federal agencies have not yet fully institutionalized 
comprehensive security management programs, which are critical to 
identifying information security control weaknesses, resolving 
information security problems, and managing information security risks 
on an ongoing basis. The Congress has shown continuing interest in 
addressing these risks, as evidenced by hearings on information 
security and enactment of the Federal Information Security Management 
Act of 2002[Footnote 34] and the Cyber Security Research and 
Development Act.[Footnote 35] In addition, the administration has taken 
important actions to improve information security, such as integrating 
information security into the Executive Branch Management 
Scorecard.[Footnote 36]

Tax Collection Activities:

Material internal control weaknesses and systems deficiencies continue 
to affect the federal government's ability to effectively manage its 
tax collection activities,[Footnote 37] an issue that has been reported 
in our financial statement audit reports for the past 7 years. Due to 
errors and delays in recording activity in taxpayer accounts, taxpayers 
were not always credited for payments made on their taxes owed, which 
could result in undue taxpayer burden. In addition, the federal 
government did not always follow up on potential unreported or 
underreported taxes and did not always pursue collection efforts 
against taxpayers owing taxes to the federal government.

Weaknesses in controls over tax collection activities continue to 
affect the federal government's ability to efficiently and effectively 
account for and collect revenue. Additionally, weaknesses in financial 
reporting of revenues affect the federal government's ability to make 
informed decisions about collection efforts. As a result, the federal 
government is vulnerable to loss of tax revenue and exposed to 
potentially billions of dollars in losses due to inappropriate refund 
disbursements.

(198359):

FOOTNOTES

[1] A material weakness is a condition that precludes the entity's 
internal control from providing reasonable assurance that 
misstatements, losses, or noncompliance material in relation to the 
financial statements or to stewardship information would be prevented 
or detected on a timely basis.

[2] The President's Management Agenda is the administration's strategy 
for improving the management and performance of the federal government. 
Its purpose is to identify and address the most significant problems 
facing the federal government. It contains five governmentwide and nine 
agency-specific goals to improve federal management and deliver results 
to the American people.

[3] The Federal Emergency Management Agency (FEMA) was transferred to 
the new Department of Homeland Security (DHS) effective March 1, 2003. 
With this transfer, FEMA is no longer required to prepare and have 
audited stand-alone financial statements under the CFO Act, leaving 23 
CFO Act agencies for fiscal year 2004. DHS, along with most other 
executive branch agencies, is required to prepare and have audited 
financial statements under the Accountability of Tax Dollars Act of 
2002, Pub. L. No. 107-289, 116 Stat. 2049 (Nov. 7, 2002). The DHS 
Financial Accountability Act, Pub. L. No. 108-330, 118 Stat. 1275 (Oct. 
16, 2004), added DHS to the list of CFO Act agencies and deleted FEMA, 
increasing the number of CFO Act agencies again to 24 for fiscal year 
2005. 

[4] JFMIP was a joint and cooperative undertaking of the Department of 
the Treasury, GAO, OMB, and the Office of Personnel Management working 
in cooperation with each other and other federal agencies to improve 
financial management practices in the federal government. Leadership 
and program guidance were provided by the four Principals of JFMIP--the 
Comptroller General of the United States, the Secretary of the 
Treasury, and the Directors of OMB and the Office of Personnel 
Management. Although JFMIP ceased to exist as a stand-alone 
organization as of December 1, 2004, the JFMIP Principals will continue 
to meet at their discretion.

[5] FFMIA of 1996, Pub. L. No. 104-208, div. A, § 101(f), title VIII, 
110 Stat. 3009, 3009-389 (Sept. 30, 1996)

[6] The transactions of the Postal Service and the Social Security 
trust funds are classified as off-budget. As such, their reported 
surpluses--$4 billion for the Postal Service and $151 billion for the 
Social Security trust funds--are excluded from the on-budget deficit 
but included in the unified budget deficit.

[7] This represents the sum of selected fiscal exposures net of certain 
revenues (e.g., payroll taxes, beneficiary premiums) that fund some of 
these exposures.

[8] The federal government's gross debt consists of debt held by the 
public and intragovernmental debt holdings.

[9] While the selected fiscal exposures list provides some perspective 
on the range and magnitude of exposures facing the federal government, 
it is neither meant to be comprehensive nor to represent a universally 
agreed-upon list. A broader discussion of fiscal exposures can be found 
in GAO, Fiscal Exposures: Improving the Budgetary Focus on Long-Term 
Costs and Uncertainties, GAO-03-213 (Washington, D.C.: Jan. 24, 2003).

[10] The number of reported restatements in this testimony differs from 
our audit report dated December 6, 2004, because it includes one 
additional agency for which audit documentation was not made available 
to us in time to complete our planned audit procedures as of the date 
of our audit report.

[11] The auditors for the Department of Justice withdrew the 
unqualified opinion that had been previously rendered on the 
department's fiscal year 2003 financial statements and issued a 
disclaimer of opinion on these restated financial statements, and the 
auditors for the Nuclear Regulatory Commission withdrew the unqualified 
opinion on the commission's fiscal year 2003 financial statements and 
issued a qualified opinion on these restated financial statements. 

[12] The Statement of Budgetary Resources provides information about 
how the resources available to the agencies were obtained 
(appropriations, other receipts, etc.) and used (obligations incurred 
and status of unobligated resources), and also reports the agencies' 
net outlays. 

[13] U.S. auditing standards require, in certain circumstances, that 
auditors' reports refer to or discuss restatements.

[14] We previously reported that material deficiencies prevented us 
from expressing an opinion on the consolidated financial statements of 
the U.S. government for fiscal years 1997 through 2003.

[15] For fiscal year 2004, DHS is required to prepare and have audited 
financial statements under the Accountability of Tax Dollars Act of 
2002, Pub. L. No. 107-289, 116 Stat. 2049 (Nov. 7, 2002).

[16] Pub. L. No. 108-330, 118 Stat. 1275, 1277 (Oct. 16, 2004).

[17] GAO, DOD Business Systems Modernization: Billions Continue to Be 
Invested with Inadequate Management Oversight and Accountability, GAO-
04-615 (Washington, D.C.: May 27, 2004). 

[18] GAO, Financial Management Systems: Lack of Disciplined Processes 
Puts Implementation of HHS' Financial System at Risk, GAO-04-1008 
(Washington, D.C.: Sept. 23, 2004).

[19] GAO, National Aeronautics and Space Administration: Significant 
Actions Needed to Address Long-standing Financial Management Problems, 
GAO-04-754T (Washington, D.C.: May 19, 2004).

[20] GAO identifies areas at high risk due to either their greater 
vulnerabilities to waste, fraud, abuse, and mismanagement or major 
challenges associated with their economy, efficiency, or effectiveness.

[21] Although not major DOD components, the Military Retirement Fund 
received an unqualified opinion on its fiscal year 2004 financial 
statements, and the DOD Medicare-Eligible Retiree Health Care Fund 
received a qualified opinion on its fiscal year 2004 financial 
statements.

[22] A business enterprise architecture is a well-defined blueprint for 
operational and technological change.

[23] Trading partners are U.S. government agencies, departments, or 
other components included in the consolidated financial statements that 
do business with each other.

[24] Most of the issues we identified in fiscal year 2004 existed in 
fiscal year 2003, and some have existed for a number of years. In 
September 2004, we reported in greater detail on the issues we 
identified, in GAO, Financial Audit: Process for Preparing the 
Consolidated Financial Statements of the U.S. Government Needs Further 
Improvement, GAO-04-866 (Washington, D.C.: Sept. 10, 2004). This report 
includes about 140 recommendations to the federal government.

[25] Although Treasury was unable to determine how much of the 
unreconciled transactions, if any, relate to operations, it reported 
unreconciled transactions as a component of net operating cost in the 
consolidated financial statements.

[26] Trading partners are U.S. government agencies, departments, or 
other components included in the consolidated financial statements that 
do business with each other.

[27] Receipts and net outlays (unified budget amounts) are also 
reported in governmentwide reports-specifically, in the President's 
Budget (annually); Treasury's Final Monthly Treasury Statement, as part 
of leading economic indicators on federal finances (quarterly); and 
Treasury's Annual Combined Statement of Receipts, Outlays, and Balances 
of the United States Government.

[28] Offsetting receipts are collections that are credited to general 
fund, special fund, or trust fund receipt accounts and that offset 
gross outlays at the agency or governmentwide level.

[29] Improper payments include inadvertent errors, such as duplicate 
payments and miscalculations, payments for unsupported or inadequately 
supported claims, payments for services not rendered, payments to 
ineligible beneficiaries, and payments resulting from fraud and abuse 
by program participants and/or federal employees.

[30] OMB defines the term "significant improper payments" as "annual 
erroneous payments in the program exceeding both 2.5 percent of program 
payments and $10 million."

[31] Pub. L. No. 107-300, 116 Stat. 2350 (Nov. 26, 2002).

[32] OMB Memorandum M-03-13, Improper Payments Information Act of 2002 
(Public Law 107-300) (Washington, D.C.: May 21, 2003).

[33] GAO, Financial Management: Fiscal Year 2003 Performance and 
Accountability Reports Provide Limited Information on Governmentwide 
Improper Payments, GAO-04-631T (Washington, D.C.: Apr. 15, 2004).

[34] Title III of the E-Government Act of 2002, Pub. L. No. 107-347, 
116 Stat. 2899, 2946 (Dec. 17, 2002).

[35] Pub. L. No. 107-305, 116 Stat. 2367 (Nov. 27, 2002).

[36] The Executive Branch Management Scorecard highlights agencies' 
progress in achieving management and performance improvements embodied 
in the President's Management Agenda.

[37] GAO, Financial Audit: IRS's Fiscal Years 2004 and 2003 Financial 
Statements, GAO-05-103 (Washington, D.C.: Nov. 10, 2004).