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United States General Accounting Office: 
GAO: 

Testimony: 

Before the Subcommittee on Government Efficiency, Financial 
Management, and Intergovernmental Relations, Committee on Government 
Reform, House of Representatives: 

For Release on Delivery: 
Expected at 10 a.m. 
Tuesday, April 9, 2002: 

U.S. Government Financial Statements: 

FY 2001 Results Highlight the Continuing Need to Accelerate Federal 
Financial Management Reform: 

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

GAO-02-599T: 

Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today to discuss our report on the U.S. 
government's consolidated financial statements for fiscal years 2001 
and 2000. Both the consolidated financial statements and our report 
are included in the fiscal year 2001 Financial Report of the United 
States Government, which was issued by the Department of the Treasury 
(Treasury) on March 29, 2002, and is available through GAO's Internet 
site, at [hyperlink, http://www.gao.gov]. Your work and that of this 
subcommittee have been a catalyst to facilitate government management 
reform over the past 5 years and will be critical to ultimately 
restoring the confidence of citizens in the federal government as a 
financial steward that is accountable for its finances. 

As in the 4 previous fiscal years, we were unable to express an 
opinion on the consolidated financial statements because of certain 
material weaknesses in internal control and accounting and reporting 
issues. These conditions prevented us from being able to provide the 
Congress and American citizens an opinion as to whether the 
consolidated financial statements are fairly stated in conformity with 
U.S. generally accepted accounting principles. 

Until the problems discussed in our report are adequately addressed, 
they will continue to (1) hamper the government's ability to 
accurately report a significant portion of its assets, liabilities, 
and costs, (2) affect the government's ability to accurately measure 
the full cost and financial performance of certain programs and 
effectively manage related operations, and (3) significantly impair 
the government's ability to adequately safeguard certain significant 
assets and properly record various transactions. 

Progress is being made in addressing impediments to an unqualified 
opinion on the U.S. government's consolidated financial statements. 
For example, in fiscal year 2001, the Department of Agriculture (USDA) 
and certain other key agencies made significant improvements in 
estimating the cost of the government's lending programs and the net 
loan amounts expected to be collected, which had contributed to our 
disclaimer of opinion in prior years. However, many of the pervasive 
and generally longstanding material weaknesses we have reported for 
the past 4 years have not been fully resolved. The underlying causes 
of these issues are significant financial management systems 
weaknesses, problems with fundamental recordkeeping and financial 
reporting, incomplete documentation, and weak internal control. 

Across government, there are a range of financial management 
improvement initiatives underway that, if effectively implemented, 
will improve the quality of the government's financial management and 
reporting. For fiscal year 2001, 18 of the 24 Chief Financial Officers 
(CFO) Act agencies were able to attain unqualified audit opinions on 
their financial statements, which is the same number of agencies as 
last year and up from 6 agencies for fiscal year 1996. Also, the 
Office of Management and Budget (OMB) reported that, for the second 
consecutive year, all 24 CFO Act agencies met the statutory reporting 
deadline. Further, two agencies that did not receive unqualified 
opinions from their auditor last year were able to do so this year, 
including the Department of Justice, which received an unqualified 
opinion for the first time. However, two other agencies were unable to 
sustain the unqualified opinions received from their auditor last 
year. Additionally, for fiscal years 2001 and 2000, reports of 
inspectors general and their contract auditors indicated that only 3 
of the 24 CFO Act agencies had neither a material control weakness, an 
issue involving compliance with applicable laws and regulations, nor 
an instance of lack of substantial compliance with requirements of the 
Federal Financial Management Improvement Act (FFMIA) of 1996. 

The largest impediment to an unqualified opinion on the consolidated 
financial statements continues to be the Department of Defense's (DOD) 
serious financial management problems, which we have designated as 
high risk since 1995. DOD faces financial management problems that 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 because of pervasive weaknesses in 
financial management systems, operations, and controls. Overhauling 
financial management represents a major management challenge that goes 
far beyond financial accounting to the very fiber of the department's 
business operations and management culture. Cultural resistance to 
change and military service parochialism have played a significant 
role in impeding previous attempts to implement broad-based management 
reforms at DOD. The department has acknowledged that it confronts 
decades-old problems deeply grounded in the bureaucratic history and 
operating practices of a complex, multifaceted organization, and that 
many of these practices were developed piecemeal and evolved to 
accommodate different organizations, each with its own policies and 
procedures. In September 2001, Secretary of Defense Rumsfeld announced 
a DOD-wide initiative intended to transform the full range of the 
department's business processes, including decades-old financial 
systems that are not well interconnected. For the first time, the 
Quadrennial Defense Review prepared by DOD includes business process 
transformation as a key element. The Secretary has also taken action 
to set aside $100 million for financial modernization and to establish 
a number of top-level committees, councils, and boards, including the 
Business Initiative Council and the Defense Business Practices 
Implementation Board, to help develop and implement an integrated DOD-
wide strategy for fundamentally transforming business practices. 

Two other major impediments that must be overcome are the government's 
inability to account for billions of dollars of transactions between 
federal government entities and to properly prepare the consolidated 
financial statements. The heart of the intragovernmental transactions 
issue is that the government lacks clearly articulated business rules 
for these transactions so that they are handled consistently by 
agencies. Compounding this problem, agencies have not reconciled 
intragovernmental balances with their trading partners.[Footnote 1] As 
a result, information reported to Treasury is not reliable. OMB and 
Treasury have several initiatives underway to address this issue. With 
respect to properly preparing the consolidated financial statements, 
Treasury plans to develop a new system and procedures to prepare the 
financial statements. The continued leadership of both OMB and 
Treasury will be important to resolving both of these issues. 

Many agencies have been able to obtain unqualified audit opinions only 
by expending significant resources on extensive ad hoc procedures and 
making billions of dollars in adjustments to derive financial 
statements months after the end of a fiscal year. As I previously 
testified[Footnote 2] before this subcommittee, if agencies continue 
year after year to rely on significant costly and time-intensive 
manual efforts to achieve or maintain unqualified opinions without 
improving underlying financial management systems, it can serve to 
mislead the public as to the true status of the agency's financial 
management capabilities. An unqualified opinion achieved on this basis 
will become an accomplishment without much substance. 

Irrespective of the unqualified opinions on their financial 
statements, many agencies do not have timely, accurate, and useful 
financial information, including cost data, and do not have sound 
controls with which to make informed decisions and ensure 
accountability on an ongoing basis. For example, for fiscal year 2001, 
auditors for 17 of the 24 CFO Act agencies reported at least one 
material control weakness, compared to 15 such agencies for fiscal 
year 2000. In addition, for fiscal year 2001, reports of inspectors 
general and their contract auditors indicated that 20 of the 24 CFO 
Act agencies' financial management systems were not in substantial 
compliance with at least one of FFMIA's three federal financial 
management systems requirements, compared to 19 such agencies for 
fiscal year 2000. For the remaining four CFO Act agencies (the 
Departments of Energy and Labor, the General Services Administration 
(GSA), and the Social Security Administration (SSA)), auditors 
provided negative assurance, meaning that nothing came to their 
attention indicating these agencies' financial management systems do 
not meet FFMIA requirements. The auditors for these four agencies did 
not definitively state whether these agencies' systems substantially 
complied with FFMIA's requirements, which we believe is required under 
the statute. Ultimately, to fully meet the goals of financial 
management reform legislation, agencies will need to be able to 
generate timely, accurate, and useful financial and management 
information, including reporting performance results, to make 
decisions and monitor government performance every day. Agencies will 
also need to have effective internal controls in place and must ensure 
compliance with applicable laws and regulations. 

The President's Management Agenda Fiscal Year 2002 includes improved 
financial management performance as one of his five top governmentwide 
management goals. Other governmentwide initiatives include strategic 
management of human capital, competitive sourcing, expanded electronic 
government, and budget and performance integration. These initiatives 
cannot be addressed in an isolated or piecemeal fashion, but must be 
addressed in an integrated way to ensure that they drive a broader 
transformation of the cultures of federal agencies. The administration 
plans to use the Executive Branch Management Scorecard, which includes 
broad standards, to highlight agencies' progress in achieving 
management and performance improvements embodied in The President's 
Management Agenda Fiscal Year 2002. This is a step in the right 
direction to improving management and performance, but the value of 
the scorecards is not in the scoring, but in the degree to which 
scores lead to sustained focus and demonstrable improvements. It will 
be important that there be continuous rigor in the scoring process in 
order for this approach to be credible and effective. 

In August 2001, the Principals of the Joint Financial Management 
Improvement Program (JFMIP)—Secretary of the Treasury O'Neill, Office 
of Management and Budget Director Daniels, Office of Personnel 
Management (OPM) Director James, and I, as Comptroller General of the 
United States and chair for the group—began a series of periodic 
meetings that have resulted in unprecedented substantive deliberations 
and agreements focused on key financial management reform issues such 
as better defining measures for financial management success. These 
measures include being able to routinely provide timely, accurate, and 
useful financial information and having no material internal control 
weaknesses or material noncompliance with laws and regulations and 
FFMIA requirements, which are essential to meeting the CFO Act's 
expectations, The President's Management Agenda Fiscal Year 2002, and 
Secretary of Defense Rumsfeld's business process transformation 
initiative. In addition, the JFMIP Principals have agreed to 
significantly accelerate financial statement reporting so that the 
government's financial statements are more timely and to discourage 
costly efforts designed to obtain unqualified opinions on financial 
statements without addressing underlying systems challenges. For 
fiscal year 2004, audited agency financial statements are to be issued 
no later than November 15, with the U.S. government's audited 
consolidated financial statements becoming due by December 15. 

Federal agencies have started to make progress in their efforts to 
modernize their financial management systems. However, the need for 
timely, accurate, and useful financial and performance management 
information is greater than ever given the increasing demands on the 
federal budget.[Footnote 3] Indeed, the challenges of combating 
terrorism and ensuring our homeland security have come to the fore as 
urgent claims on our attention and on the federal budget. At the same 
time, the known fiscal pressures created by the retirement of the baby 
boom generation and rising health care costs remain. Correspondingly, 
the ultimate task of addressing today's needs without unduly 
exacerbating the long-range fiscal challenge has become much more 
difficult. 

As we look ahead we face an unprecedented demographic challenge. A 
nation that has prided itself on its youth will become older. In fact, 
in 2008—only 6 years from now—the first wave of baby boomers become 
eligible to claim their Social Security benefits. As the share of the 
population over 65 climbs to more than 20 percent in 2035, federal 
spending on the elderly will absorb larger and ultimately 
unsustainable shares of the federal budget. Federal health and 
retirement spending are expected to surge as people live longer and 
spend more time in retirement. In addition, advances in medical 
technology are likely to keep pushing up the cost of providing health 
care. Absent substantive reform of these entitlement programs, a rapid 
escalation of federal spending for Social Security, Medicare, and 
Medicaid is virtually certain to overwhelm the rest of the federal 
budget. 

On March 26, 2002, the Trustees of the Social Security and Medicare 
trust funds reported on the current and projected status of these 
programs over the next 75 years. The Trustees' reports highlight the 
need to address the long-term fiscal challenges facing the nation. The 
Trustees state that, while the near-term financial conditions have 
improved slightly since last year's reports, the programs continue to 
face substantial financial challenges in the not-too-distant future 
that need to be addressed soon. Once again, the Trustees underscored 
the fact that the most significant implication of these findings is 
that both Social Security and Medicare need to be reformed and 
strengthened at the earliest opportunity. The Trustees also stated 
that Medicare faces financial difficulties that in many ways are more 
severe than those confronting Social Security. 

These long-term demographic and fiscal pressures and the new 
commitments undertaken after September 11 sharpen the need to look at 
competing claims and new priorities. While reforming health and 
retirement entitlement programs is essential to preserving fiscal 
flexibility in the long term, a fundamental review of all programs and 
operations can create much-needed fiscal flexibility to address 
emerging needs and unexpected requirements. Given our long-range 
budget simulation work and various key trends, there is a clear and 
compelling need to consider what the proper role of the federal 
government should be in the 21st century and how the government should 
do business in the future. 

Timely, accurate, and useful financial and performance information can 
form the basis for reconsidering the relevance or "fit" of any federal 
program or activity in today's world and for the future. Such a review 
might identify programs that have proven to be outdated or 
persistently ineffective, or alternatively could prompt the government 
to update and modernize activities through such actions as improving 
program targeting and efficiency, consolidation, or reengineering 
processes and operations. The budget and performance integration 
initiative under The President's Management Agenda Fiscal Year 2002 
should help provide information for use in conducting such a review. 
In addition, any review should not be limited to only spending 
programs but should include the full range of more indirect tools of 
governance that the federal government uses to address national 
objectives. These tools include loans and loan guarantees, tax 
expenditures, and regulations. Ultimately, we should strive to hand to 
the next generation the legacy of a government that is effective, 
respected, responsive, and relevant to a changing society—a government 
that is as free as possible from outmoded commitments and operations 
that can inappropriately encumber the future. 

The Congress and President Bush face the challenge of sorting out 
these many claims on the federal budget without the fiscal benchmarks 
that guided us through the years of deficit reduction into surplus. 
Going forward, new rules and goals will be important both to ensure 
fiscal discipline and to prompt a focus on the longer term 
implications of decisions. It is still the case that the federal 
government needs a decision-making framework that permits it to 
evaluate choices against both today's needs and the longer term fiscal 
future that will be handed to future generations. As stewards of our 
nation's future, we must begin to prepare for tomorrow. In this 
regard, we must determine how best to address these structural 
challenges in a reasonably timely manner in order to identify specific 
actions that need to be taken. 

I would now like to highlight the major issues relating to the U.S. 
government's consolidated financial statements for fiscal years 2001 
and 2000. I will then discuss the urgency of providing sustained 
leadership and oversight to accelerate financial management reform, 
provide my perspectives on the importance of agencies' building upon 
their unqualified audit opinions by significantly improving underlying 
financial management systems, and underscore the need to address major 
impediments to an unqualified opinion on the consolidated financial 
statements. Also, I will present my observations on selected audit 
matters that are essential to protect the public interest and conclude 
with a few thoughts on several key challenges in preparing to meet 
tomorrow's fiscal needs. 

Highlights of Major Issues Relating to the U.S. Government's 
Consolidated Financial Statements for Fiscal Years 2001 and 2000: 

As I mentioned earlier, as has been the case for the past 4 fiscal 
years, a significant number of material weaknesses[Footnote 4] related 
to financial systems, fundamental recordkeeping and financial 
reporting, and incomplete documentation continued to (1) hamper the 
government's ability to accurately report a significant portion of its 
assets, liabilities, and costs, (2) affect the government's ability to 
accurately measure the full cost and financial performance of certain 
programs and effectively manage related operations, and (3) 
significantly impair the government's ability to adequately safeguard 
significant assets and properly record various transactions. Several 
of these material weaknesses (referred to hereafter as material 
deficiencies) resulted in conditions that continued to prevent us from 
expressing an opinion on the U.S. government's consolidated financial 
statements for the fiscal years ended September 30, 2001 and 2000. 
[Footnote 5] There may also be additional issues that could affect the 
consolidated financial statements that have not been identified. 

Major challenges include the federal government's inability to: 

* properly account for and report property, plant, and equipment and 
inventories and related property, primarily at DOD; 

* use effective processes and procedures to estimate the cost of 
certain major federal credit programs and the related loans receivable 
and loan guarantee liabilities; 

* support amounts reported for certain liabilities, such as 
environmental and disposal liabilities and related costs at DOD, and 
ensure complete and proper reporting for commitments and contingencies; 

* support major portions of the total net cost of government 
operations, most notably related to DOD and USDA, and ensure that all 
disbursements are properly recorded; 

* fully account for and reconcile intragovernmental activity and 
balances; and; 

* properly prepare the federal government's financial statements, 
including balancing the statements, eliminating substantial amounts of 
transactions between governmental entities, fully ensuring that the 
information in the consolidated financial statements is consistent 
with the underlying agency financial statements, and adequately 
reconciling the results of operations to budget results. 

In addition, we identified material weaknesses in internal control 
related to improper payments, tax collection activities, and computer 
security. Further, the financial management systems of most CFO Act 
agencies were again reported by their auditors not to be in 
substantial compliance with certain FFMIA requirements. 

For the fiscal year 2001 Financial Report of the United States 
Government, the government has for the first time presented: (1) 
comparative financial statements;[Footnote 6] (2) two new financial 
statements, namely, the Reconciliations of Net Operating 
Revenue/(Cost) to the Budget Surplus (Unaudited), and the Dispositions 
of the Budget Surplus (Unaudited); and (3) a Statement of Net Cost 
that arrays information classified by agency rather than by function, 
as was shown in prior years. 

I would now like to discuss in more detail the material deficiencies 
identified by our work. 

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

The government could not: satisfactorily determine that all such 
assets were included in the consolidated financial statements, verify 
that certain reported assets actually exist, or substantiate the 
amounts at which they were valued. A majority of the property, plant, 
and equipment and inventories and related property is the 
responsibility of DOD. Certain agencies, including DOD, did not 
maintain adequate systems or have sufficient records to provide 
reliable information on these assets. 

Loans Receivable and Loan Guarantee Liabilities: 

For fiscal year 2000, certain federal credit agencies responsible for 
significant portions of the government's lending programs, most 
notably USDA, were unable to properly estimate the cost of these 
programs, or estimate the net loan amounts expected to be collected, 
in conformity with U.S. generally accepted accounting principles and 
budgeting requirements. In fiscal year 2001, USDA and other key 
agencies made significant improvements to these estimates, and as a 
result, this item is not a material deficiency contributing to our 
disclaimer of opinion on the fiscal year 2001 consolidated financial 
statements. However, significant adjustments to the initial estimates 
of program costs, net loan amounts to be collected, and related 
footnotes were required during the audit process at certain key 
agencies, indicating that material internal control weaknesses 
continue to exist in processes and procedures for making such 
estimates. 

Liabilities and Commitments and Contingencies: 

The government could not adequately support amounts reported for 
certain liabilities. For example, it could not develop an accurate 
estimate of key components of DOD's environmental and disposal 
liabilities and accurately estimate military post-retirement health 
benefits liabilities included in federal employee and veteran benefits 
payable, which were reported at $581 billion in fiscal year 2001 and 
$192 billion in fiscal year 2000.[Footnote 7] In addition, the 
government could not determine whether commitments and contingencies, 
including those related to treaties and other agreements entered into 
to further the U.S. government's interests, were complete and properly 
reported. 

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 effective agency disbursement 
reconciliations affect reported net costs. As a result, the government 
was unable to support significant portions of the total net cost of 
government operations, most notably related to DOD and USDA. As it 
relates to disbursement reconciliations, several major agencies did 
not effectively reconcile disbursements to Treasury's records of 
disbursements, which is intended to be a key control to detect and 
correct errors and other misstatements in financial records in a 
timely manner. This is similar in concept to individuals reconciling 
their checkbooks with their bank statements each month. Although we 
have seen progress in this area over the past 5 years, there continued 
to be billions of dollars of unreconciled differences between 
agencies' and the Treasury's records of disbursements as of September 
30, 2001 and 2000, which could also affect the balance sheet. 

Accounting for and Reconciliation of Intragovernmental Activity and 
Balances: 

For several years, OMB and Treasury have required the CFO Act agencies 
to reconcile selected intragovernmental activity and balances with 
their trading partners. However, numerous agencies did not fully 
perform such reconciliations for fiscal years 2001 and 2000. For these 
fiscal years, amounts reported for agency trading partners for certain 
intragovernmental accounts were significantly out of balance. I will 
further discuss these issues later in this testimony. 

Preparation of Consolidated Financial Statements: 

The government did not have adequate systems, controls, and procedures 
to properly prepare its consolidated financial statements. 
Specifically, we identified problems with the elimination of 
intragovernmental activity and balances, reconciling operating results 
with budget results, and compiling the consolidated financial 
statements, such as adequately ensuring that the information for each 
agency that was included in the consolidated financial statements was 
consistent with the underlying agency financial statements. These 
matters are discussed further later in this testimony. Also, 
disclosure of certain financial information was not presented in the 
consolidated financial statements in conformity with U.S. generally 
accepted accounting principles. 

Ineffective Internal Control: 

In addition to the material deficiencies noted above, we found that 
(1) most agencies have not estimated the magnitude of improper 
payments in their programs, (2) material internal control weaknesses 
and systems deficiencies continue to affect the government's ability 
to effectively manage its tax collection activities, and (3) 
widespread and serious computer control weaknesses affect virtually 
all federal agencies. 

Improper Payments: 

Across 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, and include 
payments made for unauthorized purposes and for excessive amounts, 
such as overpayments to program recipients or contractors and vendors. 
The reasons for improper payments range from program design issues, to 
inadvertent errors, to fraud and abuse. While reported estimates of 
improper payments totaled approximately $19 billion for both fiscal 
years 2001 and 2000, the government did not estimate the full extent 
of improper payments. 

The Department of Health and Human Services (HHS) has been reporting a 
national estimate of improper Medicare Fee-for-Service payments as 
part of its annual financial statements since fiscal year 1996. In 
fiscal year 2001, HHS reported estimated improper Medicare Fee-for-
Service payments of $12.1 billion, or about 6.3 percent of such 
benefits—up from $11.9 billion, or 7 percent, a year earlier and down 
from $23.2 billion, or 14 percent, for fiscal year 1996. HHS's 
reporting and analysis of improper Medicare payments has helped lead 
to the implementation of several initiatives to identify and reduce 
such payments. Annual estimates of improper payments in future audited 
financial statements will provide information on the progress of these 
initiatives. 

However, most agencies have not estimated the magnitude of improper 
payments in their programs and comprehensively addressed this issue in 
their annual performance plans under the Government Performance and 
Results Act (GPRA) of 1993.[Footnote 8] For example, the Internal 
Revenue Service (IRS) follows up on only a portion of the suspicious 
Earned Income Tax Credit (EITC) claims it identifies, although the 
EITC has historically been vulnerable to high rates of invalid claims. 
During fiscal year 2000, IRS released the results of its study of EITC 
compliance for tax year 1997. In this study, which is not performed 
annually, IRS estimated that taxpayers filed returns claiming about 
$9.3 billion in invalid EITCs, of which $1.5 billion (16 percent) 
either was recovered or was expected to be recovered through 
compliance efforts. Although the full extent of refunds resulting from 
invalid EITCs is unknown, the IRS has not routinely estimated the 
potential magnitude of invalid refunds and has not disclosed an annual 
estimate of improper payments in its financial reports. As a result, 
the amount of improper payments included in the almost $26 billion IRS 
disbursed for EITC in fiscal year 2001 is unknown. 

Without a systematic measurement of the extent of improper payments, 
agency management cannot determine (1) if the problem is significant 
enough to require corrective action, (2) how much to invest in 
preventative internal control, (3) the success of efforts implemented 
to reduce improper payments, or (4) the magnitude or trends of 
improper payments, which limits the ability to pinpoint or target 
mitigation strategies. To help in making such determinations, OMB now 
requires agencies to provide information on erroneous payment rates 
for benefit and assistance programs expending over $2 billion annually. 

Tax Collection Activities: 

Material internal control weaknesses and systems deficiencies continue 
to affect the government's ability to effectively manage its tax 
collection activities.[Footnote 9] This situation continues to result 
in the need for extensive, costly, and time-consuming ad hoc 
programming and analyses, as well as material audit adjustments, to 
prepare basic financial information. As further discussed later in 
this testimony, this approach cannot be used to prepare such 
information on a timely, routine basis to assist in ongoing decision-
making. Additionally, the severity of the system deficiencies that 
give rise to the need to resort to such procedures for financial 
reporting purposes, as well as deficient physical safeguards, result 
in burden on taxpayers and lost revenue. 

The lack of appropriate subsidiary systems to track the status of 
taxpayer accounts and material weaknesses in financial reporting 
affect the government's ability to make informed decisions about 
collection efforts. Due to errors and delays in recording activity in 
taxpayer accounts, taxpayers were not always being credited for 
payments made on their tax liabilities. In addition, the 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. This could result in billions 
of dollars not being collected and adversely affect future compliance. 

The federal government continues to be vulnerable to lost tax revenue 
due to weaknesses in controls intended to maximize the government's 
ability to collect what is owed and to minimize the risk of payment of 
improper refunds. The government identifies billions of dollars of 
potentially underreported taxes and improper refunds each year. 
However, due in large part to perceived resource constraints, the 
federal government selects only a portion of the questionable cases it 
identifies for follow-up investigation and action. In addition, the 
federal government often does not initiate follow-up on the cases it 
selects until months after the related tax returns have been filed and 
any related refunds disbursed, affecting its chances of collecting 
amounts due on these cases. Consequently, the federal government is 
exposed to potentially significant losses from reduced revenue and 
disbursements of improper refunds. Finally, continued weaknesses in 
physical controls over cash, checks, and sensitive data received from 
taxpayers increase both the government's and the taxpayers' exposure 
to losses and increases the risk of taxpayers becoming victims of 
crimes committed through identity fraud. 

IRS senior management continues to be committed to addressing many of 
these operational and financial management issues and has made a 
number of improvements to address some of these weaknesses. Successful 
implementation of long-term efforts to resolve these serious problems 
will require the continued commitment of IRS management as well as 
substantial resources and expertise. 

Computer Security Weaknesses: 
GAO has reported computer security as a governmentwide high-risk area 
since February 1997.[Footnote 10] Computer security weaknesses are 
placing enormous amounts of government 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. The government is not in a position to estimate the full 
magnitude of actual damage and loss resulting from federal computer 
security weaknesses because it is likely that many such incidents are 
either not detected or not reported. Agencies have not yet established 
comprehensive security management programs that would provide the 
government with a framework for resolving computer security problems 
and managing computer security risk on an ongoing basis. 

The computer security weaknesses continue to cover the full range of 
computer security controls. For example, access controls were not 
effective in limiting or detecting inappropriate access to computer 
resources, such as ensuring that only authorized individuals can read, 
alter, or delete data. In addition, software change controls were 
ineffective in ensuring that only properly authorized and tested 
software programs were implemented. Further, duties were not 
appropriately segregated to reduce the risk that one individual could 
conduct unauthorized transactions without being detected. Finally, 
sensitive operating system software was not controlled, and adequate 
steps had not been taken to ensure continuity of operations. 

As we recently testified, the initial implementation of government 
information security reform provisions contained in the National 
Defense Authorization Act for fiscal year 2001 is a significant step 
in improving federal agencies' information security programs and 
addressing their serious, pervasive information security weaknesses. 
[Footnote 11] In its first report on the reform provisions, OMB 
commended agencies' improvement efforts but noted that many agencies 
have significant deficiencies in every important area of security. 
Agencies have noted benefits of this first-year implementation, 
including increased management attention to and accountability for 
information security. In addition, the administration has taken 
important actions to address information security, such as (1) 
development of plans to integrate information security into the 
Executive Branch Management Scorecard, which is discussed later in 
this testimony, (2) appointment of a Special Advisor for Cyberspace 
Security to coordinate interagency efforts to secure information 
systems, and (3) creation of the President's Critical Infrastructure 
Protection Board to recommend policies and coordinate programs, 
including government and industry's working closely together to 
address increasing interconnections and shared risks. 

Compliance with Applicable Laws and Regulations and FFMIA Requirements: 

Our work to determine compliance with selected provisions of 
applicable laws and regulations related to financial reporting was 
limited by the material weaknesses discussed above. Instances of 
noncompliance, some of which the agency auditors reported were 
material to individual agency financial statements, are included in 
individual agency audit reports. However, none of these instances were 
material to the U.S. government's consolidated financial statements. 
Additionally, as further discussed later in this testimony, for most 
CFO Act agencies, the auditors reported that agencies' financial 
management systems did not substantially comply with certain FFMIA 
requirements. 

Providing Sustained Leadership and Oversight to Accelerate Financial 
Management Reform: 

A year ago, in testimony[Footnote 12] before the subcommittee on the 
U.S. government's consolidated financial statements, I said that 
Treasury Secretary O'Neill, OMB Director Daniels, and I (who, as I 
mentioned earlier, along with OPM Director James, are the JFMIP 
Principals) had agreed on the need for aggressive action to accelerate 
progress in financial management reform. This has sparked our personal 
commitment to provide the leadership necessary to address pressing 
governmentwide financial management issues. Also since that time, 
President Bush has launched a promising new initiative, The 
President's Management Agenda Fiscal Year 2002, to provide direction 
to, and to closely monitor, management reform across government, which 
will encompass improved financial performance. Actions such as these 
are important elements of ensuring the government's full and effective 
implementation of the federal financial management reforms enacted by 
the Congress. 

The JFMIP Principals' Initiative: 

Over the past year, the JFMIP Principals have established an excellent 
working relationship, a basis for action, and a new sense of urgency 
through which significant and meaningful progress can be achieved. In 
August 2001, the JFMIP Principals began a series of periodic meetings 
that marked the first time all four of the Principals had gathered 
together in over 10 years. To date, these sessions have resulted in 
substantive deliberations and agreements focused on key issues such as: 

* Defining success measures for financial management performance that 
go far beyond an unqualified audit opinion on financial statements and 
include measures such as financial management systems that routinely 
provide timely, reliable, and useful financial information and no 
material internal control weaknesses or material noncompliance with 
laws and regulations and FFMIA requirements; 

* Restructuring the Federal Accounting Standards Advisory Board's 
(FASAB) composition to enhance the independence of the Board and 
increase public involvement in setting standards for federal financial 
accounting and reporting; 

* Significantly accelerating financial statement reporting so that the 
government financial statements are timely and to discourage costly 
efforts designed to obtain unqualified opinions on financial 
statements without addressing underlying systems challenges; 

* Establishing audit committees for the major federal agencies; 

* Addressing the impediments to an audit opinion on the U.S. 
government's consolidated financial statements; and; 

* Reporting social insurance financial information in the U.S. 
government's consolidated financial statements that includes 
information from the most recent reports issued by the Social Security 
and Medicare Trustees. 

Various aspects of the matters outlined above are further discussed in 
applicable sections later in this testimony. Future meetings, with the 
next meeting planned for May 2002, will enable the JFMIP Principals to 
reach agreements and monitor progress on strategies critical to the 
full and successful implementation of federal financial management 
reform and to provide greater transparency and accountability in 
managing federal programs and financial resources. 

The President's Management Agenda: 

President Bush has established an agenda for improving the management 
and performance of the federal government that targets the most 
apparent deficiencies where the opportunity to improve performance is 
the greatest. It is no accident that the President's Management Agenda 
has a strong correlation to GAO's high-risk list. This is just one 
example of how GAO and OMB have worked constructively to identify key 
issues deserving increased attention throughout government. As stated 
in the President's Management Agenda—and we wholeheartedly agree—there 
are few items more urgent than ensuring that the federal government is 
well run and results-oriented. 

The President's Management Agenda, which is a starting point for 
management reform, includes improved financial management performance 
as one of his five governmentwide management goals. Other 
governmentwide initiatives include strategic management of human 
capital, competitive sourcing, expanded electronic government, and 
budget and performance integration. 

The results of our audits of the U.S. government's consolidated 
financial statements helped to lay the foundation for the President's 
Management Agenda financial management performance initiative. The 
President's Management Agenda frames the problem this way: "A clean 
financial audit is a basic prescription for any well-managed 
organization, yet the federal government has failed all four [now 
five] audits since 1997. Moreover, most federal agencies that obtain 
clean audits only do so after making extraordinary labor-intensive 
assaults on financial records. Without accurate and timely financial 
information, it is not possible to accomplish the president's agenda 
to secure the best performance and high measure of accountability for 
the American people." 

In particular, the improved financial performance initiative is aimed 
at ensuring that federal financial systems produce accurate and timely 
information to support operating, budget, and policy decisions. Also, 
this initiative focuses special attention on addressing erroneous 
payments, which as discussed earlier, is another problem our audit 
identified. 

Under this governmentwide initiative, OMB will work with agencies to 
improve the timeliness, enhance the usefulness, and ensure the 
reliability of financial information. The expected result is financial 
management systems that routinely produce information that is (1) 
timely, to measure and effect performance immediately, (2) useful, to 
make more informed operational and investing decisions, and (3) 
reliable, to ensure consistent and comparable trend analysis over time 
and to facilitate better performance measurement and decisionmaking. 
This result is a key to successfully achieving the goals set out by 
the Congress in the CFO Act and other federal financial management 
reform legislation. 

The Executive Branch Management Scorecard: 

As we recently testified before this subcommittee,[Footnote 13] the 
administration plans to use the Executive Branch Management Scorecard 
to highlight agencies' progress in achieving management and 
performance improvements embodied in the President's Management 
Agenda. The Executive Branch Management Scorecard grades agencies' 
performance regarding the five governmentwide initiatives by using 
broad standards and a red-yellow-green coding system to indicate the 
level at which agencies are meeting the standards. 

In the financial management area, while recognizing the importance of 
achieving a clean opinion from auditors on financial statements, the 
scorecard focuses on the fundamental and systemic issues that must be 
addressed in order to generate timely, accurate, and useful financial 
information, sound internal structures, and effective compliance 
systems. The first scorecard's results show dramatically the extent of 
work remaining across government to improve financial and other 
management areas. For financial management, most agencies were scored 
in the red category. This is not surprising, considering the well-
recognized need to transform financial management and other business 
processes at agencies such as DOD, the results of our analyses under 
FFMIA, and the various financial management operations we have 
designated as high risk. 

Also, central to effectively addressing the federal government's 
management problems is recognition that the five governmentwide 
initiatives cannot be addressed in an isolated or piecemeal fashion. 
As stated in the President's Management Agenda, they are mutually 
reinforcing. More generally, the initiatives must be addressed in an 
integrated way to ensure that they drive a broader transformation of 
the cultures of federal agencies. 

Improved financial management, for example, is also a key to 
successfully achieving other governmentwide initiatives set out in the 
President's Management Agenda: 

* Strategic management of human capital: Financial management reform 
will require having the right people in CFO leadership positions and 
enough people with the right skills and knowledge to perform important 
financial operations. 

* Competitive sourcing: For example, accurately knowing the cost for 
providing goods and services in-house for comparison with private 
sector performance will be important in making sound sourcing 
decisions. 

* Expanded electronic government: Many e-government applications will 
likely be financial in nature, interact with financial systems and 
reporting, and greatly change the internal control environment. 

* Budget and performance integration: It is critical to focus on 
integrating accounting, budget, and performance information, which the 
CFO Act requires; reporting the cost of performance, which is 
essential to successfully implementing GPRA; and providing useful 
information for setting priorities and making informed budget 
decisions. 

The focus that the administration's scorecard approach brings to 
improving management and performance, including financial performance, 
is certainly a step in the right direction. The value of the 
scorecards is not in the scoring, but in the degree to which scores 
lead to sustained focus and demonstrable improvement over time. This 
will depend on continued efforts to assess progress and maintain 
accountability to ensure that agencies are able to, in fact, improve 
their performance. It will be important that there be continuous rigor 
in the scoring process in order for this approach to be credible and 
effective. Also, it is important to recognize that many of the 
challenges the federal government faces, such as improving financial 
management, are long-standing and complex, and will require sustained 
attention. 

Looking Beyond Unqualified Audit Opinions: 

Across government, there are financial management improvement 
initiatives that could ultimately lead to an unqualified opinion on 
the U.S. government's consolidated financial statements. However, 
accelerating the pace of completing ongoing and planned efforts to 
implement financial management reform is essential, as shown by 
reports of inspectors general and their contract auditors indicating 
that only 3 of the 24 CFO Act agencies had neither a material control 
weakness, an issue involving compliance with applicable laws and 
regulations, nor an instance of lack of substantial compliance with 
FFMIA requirements. While many of the pervasive and generally long-
standing material weaknesses we have reported for the past 4 years 
remain to be fully resolved, some progress continues to be made in 
addressing the underlying causes of these problems—significant 
financial systems weaknesses, problems with fundamental recordkeeping 
and financial reporting, incomplete documentation, and weak internal 
control. 

For fiscal year 2001, 18 of the 24 CFO Act agencies were able to 
attain unqualified audit opinions on their financial statements, which 
is the same number of agencies as last year and up from 6 agencies for 
fiscal year 1996. Also, OMB reported that, for the second consecutive 
year, all 24 CFO Act agencies met the statutory reporting deadline. 
Further, two agencies that did not receive unqualified opinions from 
their auditor last year were able to do so this year, including the 
Department of Transportation (DOT) and the Department of Justice, 
which received an unqualified opinion for the first time. However, two 
other agencies, the National Aeronautics and Space Administration 
(NASA) and the Federal Emergency Management Agency, were unable to 
sustain the unqualified opinions received from their auditor last year. 

In the case of NASA, as we recently testified[Footnote 14] before this 
subcommittee, after 5 years of receiving unqualified opinions on 
financial statements from its previous independent auditor, the new 
independent auditor disclaimed an opinion on the agency's fiscal year 
2001 financial statements. The fiscal year 2001 audit report also 
identified a number of significant internal control weaknesses related 
to accounting for space station material and equipment and to computer 
security. Finally, the auditor concluded that NASA's financial 
management systems do not substantially comply with federal financial 
management systems requirements and applicable federal accounting 
standards, as required by FFMIA. NASA's financial management 
difficulties are not new The weaknesses discussed in the auditor's 
report are consistent with the findings discussed in our previous 
reports. Since 1990, we have designated NASA's contract management 
problems as a high-risk area, due in part to financial management 
systems problems that make it difficult for NASA to assure contracts 
are being efficiently and effectively implemented.[Footnote 15] We 
have also reported on NASA's misstatement of its Statement of 
Budgetary Resources, lack of detailed support for amounts reported 
against certain cost limits, and lack of historical cost data for 
accurately projecting future cost.[Footnote 16] 

Irrespective of the unqualified opinions on their financial 
statements, many agencies do not have timely, accurate, and useful 
financial information and sound controls with which to make informed 
decisions and to ensure accountability on an ongoing basis. While 
agencies are making some progress in obtaining unqualified audit 
opinions on annual financial statements, many of these opinions were 
obtained by expending significant resources on extensive ad hoc 
procedures and making billions of dollars in adjustments to derive 
financial statements months after the end of a fiscal year. Several 
examples follow. The need for such time-consuming procedures primarily 
results from inadequate financial management systems. 

* Our unqualified opinions on IRS's fiscal years 2001 and 2000 
financial statements were made possible by the extraordinary efforts 
of IRS senior management and staff to develop processes to compensate 
for serious internal control and systems deficiencies. IRS was again 
compelled to rely extensively on costly, time-consuming processes; 
statistical projections; external contractors; substantial 
adjustments; and monumental human efforts that extended nearly four 
months after the September 30, 2001, fiscal year-end to derive 
reliable year-end balances for its financial statements. For example, 
IRS does not have a detailed record, or subsidiary ledger, for taxes 
receivable to allow it to track and manage amounts due from taxpayers. 
To enable it to report a reliable taxes receivable balance in the 
absence of a subsidiary ledger, IRS has, for the last five years, 
relied on a complex statistical sampling approach that requires 
substantial human and financial resources to conduct, takes months to 
complete, and yields tens of billions of dollars of adjustments. 
Similarly, IRS does not have an integrated property management system 
that appropriately records property and equipment additions and 
disposals as they occur and links costs on the accounting records to 
the property records. During fiscal year 2001, IRS expensed property 
additions during the year and then capitalized them at year-end based 
on analysis of expense records conducted by a contractor. 

* DOT's major agencies use the Departmental Accounting and Financial 
Information System (DAFIS), which cannot produce financial statements 
based on the information included within the system. As a result, DOT 
made about 850 adjustments, totaling about $41 billion, outside DAFIS 
to prepare the financial statements. These adjustments were recorded 
in a financial statement module, a tool used to process the 
adjustments. However, all DOT agencies did not use the financial 
statement module to prepare the financial statements, and the 
adjustments were not recorded in DAFIS. The DOT inspector general 
reported that DOT plans to have a new accounting system fully 
operational and compliant with accounting standards by January 2003. 

* Again, in fiscal year 2001, HHS attained an unqualified opinion on 
its financial statements. However, system and internal control 
weaknesses, such as lack of an integrated financial management system, 
continued to make it difficult for certain HHS components to prepare 
timely and reliable financial statements. For example, the National 
Institutes of Health used a manual year-end process to create and post 
correct Standard General Ledger accounts, generating about 19,000 
nonstandard accounting entries with an absolute value of approximately 
$348 billion. Also, the Centers for Medicare and Medicaid Services, 
continued to contract with independent public accounting firms, as it 
has since FY 1999, to validate contractor receivables. Further, the 
Administration for Children and Families and the Centers for Disease 
Control, produced their financial statements using a manually 
intensive process that required adjusting entries to their general 
ledgers with an absolute value of approximately $51 billion and $2 
billion, respectively. 

* The Department of Education's auditor expressed a qualified opinion 
on the department's fiscal year 2001 financial statements, primarily 
because of weaknesses in the department's financial reporting process. 
Consistent with prior years, Education relied on work-around 
procedures to prepare its financial statements, including significant 
manual adjustments, due to deficiencies in the current general ledger 
system and the lack of a fully integrated financial management system. 
Because of errors that existed in prior years, the department 
performed extensive analysis of certain general ledger account 
balances during fiscal year 2001, which resulted in manual adjustments 
to correct certain general ledger balances. However, the auditor noted 
that there were errors in certain manual adjustments that had been 
processed and approved by the department, resulting in additional 
manual adjustments being posted to the financial statements. 

* The Department of Veterans Affairs (VA) received unqualified audit 
opinions on its financial statements for fiscal years 2000 and 2001, 
but producing them required significant efforts to assemble, compile, 
and review the necessary financial information. In many cases, 
significant manual work-around procedures and "cuff' or out-of-date 
feeder systems are used, as VA has not yet completed its transition to 
a fully integrated financial management system. According to VA's 
auditors, timely account reconciliations were not consistently 
prepared at the department's medical centers and assets were not 
timely capitalized. Also, a significant number of manual adjustments 
were made during the year-end closing process. 

Situations such as these demonstrate the tremendous efforts, lasting 5 
months or more, that many agencies use to produce annual financial 
statements. These agencies undertake far more work to prepare 
financial statements, beginning at the close of a fiscal year, than 
would be necessary if they had financial systems in place to routinely 
provide the data. Information to compile agency financial statements 
should flow from their financial management systems. (The need for 
agencies to improve financial management systems is further discussed 
later in this testimony.) 

At the same time and as agreed to by the JFMIP Principals, there is a 
need to accelerate the timeliness of providing audited financial 
statements. March 1 is the current statutory deadline for the 24 CFO 
Act agencies to submit audited financial statements, 5 months after 
the close of the fiscal year. For fiscal year 2001 reporting, OMB 
pushed this time frame ahead to February 27. Beginning with fiscal 
year 2004, OMB will require these agencies to issue audited financial 
statements by November 15, 6 weeks after the fiscal year end. While 
this is important for timely financial reporting, it will be difficult 
for some agencies to sustain unqualified audit opinions and still meet 
the accelerated time frame for submitting audited financial statements. 

IRS is a case in point. With the extraordinary efforts described 
above, IRS found it extremely difficult to meet the February 27 
reporting timeline required by OMB for fiscal year 2001. If IRS is to 
meet the November 15 deadline and sustain an unqualified opinion on 
its financial statements, the tremendous amount of hard work and 
commitment that IRS has demonstrated in recent years will no longer be 
sufficient to achieve this goal unless accompanied by systemic changes 
in how IRS processes transactions, maintains its financial records, 
and reports its financial results. 

It will be difficult for agencies to continue to rely on significant 
costly and time-intensive manual efforts to achieve or maintain 
unqualified opinions until automated, integrated processes and systems 
are implemented that readily produce the necessary information. As a 
result, many agencies must accelerate their efforts to improve 
underlying financial management systems and controls, which is 
consistent with reaching the financial management success measures 
envisioned by the JFMIP Principals and called for by the President's 
Management Agenda. If agencies continue year after year to rely on 
significant costly and time-intensive manual efforts to achieve or 
maintain unqualified opinions without such improvements, this practice 
can serve to mislead the public as to the true status of the agency's 
financial management capabilities. An unqualified opinion will become 
an accomplishment without much substance. 

Addressing Major Impediments to Unqualified Opinion on Consolidated 
Financial Statements: 

As I mentioned earlier, for the past 5 fiscal years, the federal 
government has been required to prepare, and have audited, 
consolidated financial statements. Successfully meeting this 
requirement is tightly linked to the requirement for the 24 CFO Act 
agencies to also have audited financial statements. This has 
stimulated extensive cooperative efforts and considerable attention by 
agency chief financial officers, inspectors general, Treasury and OMB 
officials, and the General Accounting Office. With the benefit of 
several years' experience by the government in having the required 
financial statements subjected to audit, the time has come to focus 
even more intensified attention on the most serious obstacles to 
achieving an unqualified opinion on the U.S. government's consolidated 
financial statements. In this regard, the JFMIP Principals have 
discussed plans and strategies for addressing impediments to an 
unqualified opinion on the U.S. government's consolidated financial 
statements. 

Reforming Financial Management at DOD: 

This year, upon early implementation of certain provisions of the 
National Defense Authorization Act for fiscal year 2002,[Footnote 17] 
DOD reported that the department's financial management systems are 
not able to provide adequate evidence supporting material amounts in 
its financial statements. DOD asserted that it is unable to comply 
with applicable financial reporting requirements for (1) property, 
plant, and equipment, (2) inventory and operating materials and 
supplies, (3) military retirement health care actuarial liability, (4) 
environmental liabilities, (5) intragovernmental eliminations and 
related accounting adjustments, and (6) cost accounting by 
suborganization/responsibility segment and major program. Based 
largely on DOD's assertion, the DOD inspector general disclaimed an 
opinion on DOD's financial statements for fiscal year 2001 as it had 
for the previous 5 fiscal years. DOD's financial management 
deficiencies and reporting weaknesses substantially impair our ability 
to determine the reliability of the financial information reported in 
the government's overall financial reports. Until DOD corrects these 
material weaknesses, our ability to express an unqualified opinion on 
the U.S. government's consolidated financial statements will be 
impeded. 

As I previously stated, to date, none of the military services or 
major DOD components has passed the test of an independent financial 
audit because of pervasive weaknesses in DOD's financial management 
systems, operations, and internal control, including an inability to 
compile financial statements that comply with U.S. generally accepted 
accounting principles. The department has made progress in a number of 
areas, but is far from solving a range of serious financial management 
problems. Their resolution, however, is key to having auditable 
consolidated financial statements because DOD had budget authority of 
$352 billion for fiscal year 2001, or about 18 percent of the entire 
federal budget, and is accountable for a vast amount of government 
assets worldwide. 

Despite progress, ineffective asset accountability and lack of 
effective internal controls continue to adversely affect visibility 
over DOD's estimated $1 trillion investment in weapon systems and 
inventories. These weaknesses can affect the department's ability to 
ensure that materials are on hand when needed and its ability to 
prevent the purchase of assets already on hand. Further, unreliable 
cost and budget information related to a reported over $1.4 trillion 
of reported liabilities and about $735 billion[Footnote 18] of net 
costs negatively affects DOD's ability to effectively measure 
performance, reduce costs, and maintain adequate fund control. 

As part of our constructive engagement approach with DOD, I met with 
Secretary Rumsfeld last summer to provide our perspectives on the 
underlying causes of the problems that have impeded past reform 
efforts at the department and to discuss options for addressing these 
challenges. The underlying causes discussed were: 

* a lack of sustained top-level leadership and management 
accountability for correcting problems; 

* deeply embedded cultural resistance to change, including military 
service parochialism and stovepiped operations; 

* a lack of results-oriented goals and performance measures and 
monitoring; and; 

* inadequate incentives for seeking change. 

In this regard, I also attended the initial March 15, 2002, meeting of 
DOD's Business Practices Implementation Board, which is composed of 
outside experts to advise the department on its effort to address 
these underlying causes. 

As we testified before this subcommittee last month and in May 2001, 
[Footnote 19] our experience has shown there are several key elements 
that collectively would enable the department to effectively address 
the underlying causes of its inability to resolve its long-standing 
financial management problems. These elements, which are key to any 
successful approach to financial management reform, include: 

* addressing the department's financial management challenges as part 
of a comprehensive, integrated, DOD-wide business process reform; 

* providing for sustained leadership by the Secretary of Defense and 
resource control to implement needed financial management reforms; 

* establishing clear lines of responsibility, authority, and 
accountability for such reform tied to the Secretary; 

* incorporating results-oriented performance measures and monitoring 
tied to financial management reforms; 

* providing appropriate incentives or consequences for action or 
inaction; 

* establishing an enterprisewide system architecture to guide and 
direct financial management modernization investments; and; 

* ensuring effective oversight and monitoring. 

The department has acknowledged the need for fundamental reform of its 
business practices. Specifically, the department's September 30, 2001, 
Quadrennial Defense Review reported that: "While America's businesses 
have streamlined and adopted new business models to react to fast-
moving changes in markets and technologies, the Defense Department has 
lagged behind without an overarching strategy to improve its business 
practices." 

Action on many of the key areas central to successfully achieving 
desired financial management and related business process 
transformation goals—particularly those that rely on longer term 
systems improvements—will take a number of years to fully implement. 
Secretary Rumsfeld has estimated that his envisioned transformation 
may take 8 or more years to complete. Consequently, both long-term 
actions focused on the Secretary's envisioned business transformation 
and short-term actions focused on improvements within existing systems 
and processes will be critical going forward. Short-term actions in 
particular will be critical if the department is to achieve the 
greatest possible accountability over existing resources and more 
reliable data for day-to-day decisionmaking while longer-term systems 
and business process reengineering efforts are under way. 

Beginning with the Secretary's recognition of the need for a 
fundamental transformation of the department's business processes, and 
building on some of the work begun under past administrations, DOD has 
taken a number of positive steps in many of these key areas. For 
example, DOD has taken action to set aside $100 million for financial 
modernization and, as discussed previously, established a number of 
top-level committees, councils and boards to help guide its financial 
transformation efforts. At the same time, the challenges remaining in 
each of these key areas are daunting. The JFMIP Principals have 
invited DOD Comptroller Zakheim to their planned May 2002 meeting to 
discuss the department's transformation effort and to begin a 
constructive engagement with DOD on this important initiative. 

Focusing on Intragovernmental Transactions: 

For several years, OMB and Treasury have required the CFO Act agencies 
to reconcile selected intragovernmental activity and balances with 
their trading partners. However, numerous agencies did not fully 
perform such reconciliations for fiscal year 2000. Beginning with 
fiscal year 2001, OMB and Treasury required agency chief financial 
officers to report on the extent and results of intragovernmental 
activity and balances reconciliation efforts. The inspectors general 
reviewed these reports and communicated the results of their reviews 
to OMB, Treasury, and GAO. A substantial number of the CFO Act 
agencies did not fully perform the required reconciliations for fiscal 
year 2001, citing reasons such as (1) trading partners' not providing 
needed data, (2) limitations and incompatibility of agency and trading 
partner systems, and (3) human resource issues. For fiscal years 2001 
and 2000, amounts reported for agency trading partners for certain 
intragovernmental accounts were significantly out of balance. In 
addition, solutions will be required to resolve significant 
differences reported in other intragovernmental accounts, primarily 
related to appropriations. 

To help address certain issues that contributed to the out-of-balance 
condition for intragovernmental activity and balances, OMB has stated 
that it is implementing the recommendations included in a study 
conducted for the JFMIP in fiscal year 2001. OMB is also pursuing 
other changes to address core problems in this area, such as enhancing 
governmentwide business rules for transactions among trading partners, 
requiring quarterly reconciliations of intragovernmental activity and 
balances, and modifying certain standard general ledger accounts 
required to be used by federal agencies. Resolving this problem 
remains a difficult challenge and will require commitment by the CFO 
Act agencies and continued strong leadership by OMB. 

Preparing the Consolidated Financial Statements: 

The government did not have adequate systems, controls, and procedures 
to properly prepare its consolidated financial statements. Also, 
disclosure of certain financial information was not presented in the 
consolidated financial statements in conformity with U.S. generally 
accepted accounting principles. 

Elimination of Intragovernmental Activity and Balances: 

Consolidated financial statements are intended to present the results 
of operations and financial position of the components that comprise a 
reporting entity as if the entity were a single enterprise. When 
preparing the consolidated financial statements, the preparer must 
eliminate intragovernmental activity and balances between the 
agencies. Because of agencies' problems in handling their 
intragovernmental transactions, Treasury's ability to eliminate these 
transactions is impaired. Significant differences reported in 
intragovernmental accounts as noted above have been identified. 
Intragovernmental activity and balances are "dropped" or "offset" in 
the preparation of the consolidated financial statements rather than 
eliminated through balanced accounting entries. This contributes to 
the government's inability to determine the impact of these 
differences on amounts reported in the consolidated financial 
statements. 

Reconciling Operating Results with Budget Results: 

The government did not have a process to effectively identify and 
report items needed to reconcile adequately the operating results, 
which for fiscal year 2001 showed a net operating cost of $514.8 
billion, to the budget results, which for the same period showed a 
unified surplus of $127 billion. 

Consolidated Financial Statement Compilation: 

The government could not adequately ensure that the information for 
each agency that was included in the consolidated financial statements 
was consistent with the underlying agency financial statements. This 
problem is compounded by the need for broad changes in the structure 
of the government's Standard General Ledger (SGL) accounts and the 
process for maintaining the SGL. For example, changes are needed that 
will result in direct alignment by SGL account from agencies' 
financial statement line items to like items reported in the 
consolidated financial statements. 

To make the fiscal year 2001 consolidated financial statements 
balance, Treasury recorded a net $17.3 billion decrease to net 
operating cost on the Statement of Operations and Changes in Net 
Position, which it labeled unreconciled transactions. For the prior 
fiscal year, a net $4.8 billion in unreconciled transactions was 
recorded as a decrease to net operating revenue in the accompanying 
consolidated financial statements.[Footnote 20] An additional net $3.9 
billion and $.2 billion of unreconciled transactions were improperly 
recorded in net cost for fiscal years 2001 and 2000, respectively. 
Treasury attributes these net unreconciled transaction amounts 
primarily to the government's inability to properly identify and 
eliminate transactions between governmental entities, agency 
adjustments that affected net position, and other errors. However, 
Treasury was unable to adequately identify and explain the gross 
components of such amounts. Unreconciled transactions also may exist 
because the government does not have effective controls over 
reconciling net position.[Footnote 21] 

The net position reported in the consolidated financial statements is 
derived by subtracting liabilities from assets, rather than through 
balanced accounting entries. Further, the process used to prepare the 
consolidated financial statements requires significant human and 
financial resources and does not adequately leverage the existing work 
and work products resulting from federal agencies' audited financial 
statements. 

Treasury plans to develop a new system and procedures to prepare the 
consolidated financial statements. These actions are intended to, 
among other things, directly link information from agencies' financial 
statements to amounts reported in the consolidated financial 
statements and facilitate the reconciliation of net position. 

Improving Financial Management Systems: 

The inability to produce the data needed to efficiently and 
effectively manage the day-to-day operations of the federal government 
and provide accountability to taxpayers and the Congress has been a 
long-standing weakness at most federal agencies. The President's 
Management Agenda recognizes that the central challenge to producing 
reliable, useful, and timely data throughout the year and at year-end 
is overhauling the government's financial management information 
systems. The CFO Act calls for the modernization of financial 
management systems, including the systematic measurement of 
performance, the development of cost information, and the integration 
of program, budget, and financial information. 

FFMIA builds on the CFO Act by emphasizing the need for agencies to 
have systems that can generate timely, accurate, and useful 
information with which to make informed decisions and to ensure 
accountability on an ongoing basis. FFMIA requires the 24 departments 
and agencies covered by the CFO Act to implement and maintain 
financial management systems that comply substantially with (1) 
federal financial management systems requirements, (2) applicable 
federal accounting standards, and (3) the U.S. Standard General Ledger 
(SGL) at the transaction level. These requirements are at the center 
of the financial management success measures expressed by the JFMIP 
Principals and are key elements for scoring agencies' financial 
management performance using the Executive Branch Management Scorecard. 

For fiscal year 2001, auditors for 20 of the 24 CFO Act agencies 
reported that agencies' financial management systems did not 
substantially comply with one or more of FFMIA's three requirements. 
[Footnote 22] For the remaining four CFO Act agencies (the Departments 
of Energy and Labor, GSA, and SSA), auditors provided negative 
assurance, meaning that nothing came to their attention indicating 
these agencies' financial management systems do not meet FFMIA 
requirements. The auditors for these four agencies did not 
definitively state whether these agencies' systems substantially 
complied with FFMIA's requirements. 

In this regard, OMB Bulletin 01-02, Audit Requirements for Federal 
Financial Statements, does not require auditors to make an affirmative 
statement regarding an agency's financial management system's 
substantial compliance with FFMIA, but rather permits auditors to 
report negative assurance, meaning that their report can be based on 
limited audit testing that disclosed no substantial instances of FFMIA 
noncompliance. If readers of the audit report do not understand this 
distinction, which is important in terms of how much audit testing is 
required, they may have a false impression that the auditor is stating 
that they found the systems to be substantially compliant. To provide 
positive assurance, or an opinion, which is what we believe the law 
requires, auditors need to perform sufficient testing to determine 
whether the system is in substantial compliance. 

Noncompliance with FFMIA is indicative of the overall continuing poor 
condition of many financial management systems across government. 
[Footnote 23] We have consistently reported over the past few years 
that the reasons for systems noncompliance included nonintegrated 
financial management systems, inadequate reconciliation procedures, 
untimely recording of financial information, noncompliance with the 
SGL, lack of adherence to the accounting standards, and weak security 
controls over information systems. We have also reported that agency 
remediation plans, required by FFMIA, may not adequately address the 
system deficiencies. 

While agencies continue to make some progress in addressing their 
financial management systems weaknesses, the serious shortcomings 
reported for these systems result in the lack of reliable financial 
information needed for managing day-to-day operations effectively, 
efficiently, and economically; measuring program performance; 
executing the budget; maintaining accountability; and preparing 
financial statements. Having such financial information is the goal of 
FFMIA and the CFO Act, necessary for implementing GPRA, and critical 
to the transition to a more results-oriented federal government as 
envisioned in the President's Management Agenda. 

For example, agency financial management systems are required to 
produce information on the full cost of programs and projects. This is 
not a new expectation—the requirement for managerial cost information 
has been in place for more than a decade, since 1990, under the CFO 
Act, and since 1998 stemming from applicable accounting standards. 
Yet, some agencies are only able to provide cost accounting 
information at the end of the fiscal year through periodic cost 
surveys. The lack of timely information on the full cost of operations 
precludes meaningful data that is needed to make resource allocation 
choices, reach contracting-out decisions, determine program 
efficiencies, assess user fees, and report performance. 

To remedy these deficiencies and carry out the President's Management 
Agenda for improving financial management, OMB and the CFO Act 
agencies will need to aggressively and rigorously collaborate. This 
will be critical, since overhauling agency financial management 
systems is a difficult challenge. Our work to identify financial 
management best practices in world-class organizations[Footnote 24] 
has identified key factors for successfully modernizing financial 
systems, including (1) reengineering business processes in conjunction 
with implementing new technology, (2) developing systems that support 
the partnership between finance and operations, and (3) translating 
financial data into meaningful data. We identified other financial 
management best practices as well, such as (1) providing clear strong 
executive leadership, (2) making financial management an entitywide 
priority, and (3) building a culture of control and accountability. 

The size and complexity of many federal agencies and the discipline 
needed to overhaul or replace their financial management systems 
present a significant challenge—not simply a challenge to overcome a 
technical glitch, but a demanding management challenge that requires 
attention from the highest levels of government along with sufficient 
human capital resources to effect lasting change. We recognize that it 
will take time, investment, and sustained emphasis on correcting 
deficiencies to improve federal financial management systems to the 
level required by FFMIA. The JFMIP Principals' leadership, commitment, 
and oversight will be important to provide the needed impetus to meet 
this challenge. 

Protecting The Public Interest: 

Two audit matters have recently come to the fore and are key to 
protecting the public interest. One matter involves auditors' 
responsibility for reporting on internal control, and the other 
concerns auditor independence. 

Auditors' Responsibility for Reporting on Internal Control: 

We have long believed that auditors have an important responsibility 
to provide an opinion on the effectiveness of internal control over 
financial reporting and compliance with applicable laws and 
regulations. Currently, this is not required by American Institute of 
Certified Public Accountants (AICPA) auditing standards or by OMB in 
its guidance[Footnote 25] to auditors conducting federal agency 
financial statement audits. 

For financial statements audits that we conduct—which include the U.S. 
government's consolidated financial statements, the financial 
statements of the IRS, the Schedules of Federal Debt managed by the 
Bureau of Public Debt, and the financial statements of the Federal 
Deposit Insurance Corporation and numerous small entities' operations 
and funds—we issue a separate opinion on the effectiveness of internal 
control over financial reporting and compliance with applicable laws 
and regulations. 

For years we have provided opinions on internal control effectiveness 
because of the importance of internal control to protecting the 
public's interest. Our reports have engendered major improvements in 
internal control. As you might expect, as part of the annual audit of 
our own financial statements, we practice what we recommend to others 
and contract with a CPA firm for both an opinion on our financial 
statements and an opinion on the effectiveness of our internal control 
over financial reporting and compliance with applicable laws and 
regulations. 

Recently, GAO and the President's Council on Integrity and Efficiency 
jointly issued the Financial Audit Manual to provide guidance to 
auditors conducting federal agency financial statement audits. This 
manual calls for these auditors to test internal control over 
financial reporting and compliance with applicable laws and 
regulations, and thus provides a foundation for issuing a separate 
opinion on the effectiveness of internal control. Although OMB 
requires testing of these internal controls, auditors are not required 
to provide an opinion on internal control effectiveness. However, we 
found that 3 of the 24 CFO Act agency auditors (those for GSA, SSA, 
and the Nuclear Regulatory Commission) provided an opinion on the 
effectiveness of internal control as of September 30, 2001. 

Also, the JFMIP Principals have agreed that a measure of financial 
management success is for an agency to have no material control 
weaknesses. By giving assurance about internal control, auditors of 
federal financial statements can better serve their clients and other 
financial statements users and protect the public interest by having a 
greater role in providing assurances of the effectiveness of internal 
control in deterring fraudulent financial reporting, protecting 
assets, and providing an early warning of internal control weaknesses. 

Auditor Independence: 

The independence of auditors—both in fact and appearance—is critical 
to the credibility of financial reporting. Auditors have the 
capability of performing a range of valuable services for their 
clients, and providing certain nonaudit services can ultimately be 
beneficial to federal entities. However, in some circumstances, it is 
not appropriate for auditors to perform both audit and certain 
nonaudit services for the same client. In these circumstances, the 
auditor, the client, or both will have to make a choice as to which of 
these services the auditor will provide. 

These concepts, which I strongly believe are in the public interest, 
are reflected in the revisions to auditor independence requirements 
for government audits,[Footnote 26] which GAO recently issued as part 
of Government Auditing Standards.[Footnote 27] The new independence 
standard has gone through an extensive deliberative process over 
several years, including extensive public comments and input from my 
Advisory Council on Government Auditing Standards.[Footnote 28] The 
standard, among other things, toughens the rules associated with 
providing nonaudit services and includes a principle-based approach to 
addressing this issue, supplemented with certain safeguards. The two 
overarching principles in the standard for nonaudit services are that: 

* auditors should not perform management functions or make management 
decisions, and; 

* auditors should not audit their own work or provide nonaudit 
services in situations where the amounts or services involved are 
significant or material to the subject matter of the audit. 

Both of these principles should be applied using a substance-over-form 
determination. Under the revised standard, auditors are allowed to 
perform certain nonaudit services provided the services do not violate 
these principles; however, in most circumstances certain additional 
safeguards would have to be met. For example: (1) personnel who 
perform allowable nonaudit services would be precluded from performing 
any related audit work, (2) the auditor's work could not be reduced 
beyond the level that would be appropriate if the nonaudit work were 
performed by another unrelated party, and (3) certain documentation 
and quality assurance requirements must be met. The new standard 
includes an express prohibition regarding auditors' providing certain 
bookkeeping or record keeping services and limits payroll processing 
and certain other services, all of which are presently permitted under 
current independence rules of the AICPA. 

The focus of these changes to the government auditing standards is to 
better serve the public interest and to maintain a high degree of 
integrity, objectivity, and independence for audits of government 
entities and entities that receive federal funding. However, these 
standards apply only to audits of federal entities and those 
organizations receiving federal funds, and not to auditors of public 
companies. In the transmittal letter issuing the new independence 
standard, we expressed our hope that the AICPA will raise its 
independence standards to those contained in the new standard in order 
to eliminate any inconsistency between this standard and their current 
standards. 

The new independence standard is the first of several steps GAO has 
planned in connection with nonaudit services covered by government 
auditing standards. In May 2002, we plan to issue a question and 
answer document concerning our independence standard, and I will ask 
my Advisory Council on Government Auditing Standards to review and 
monitor this area to determine what, if any, additional steps may be 
appropriate. In addition, the JFMIP Principals have agreed that the 24 
major federal departments and agencies covered by the CFO Act should 
have audit committees. The scope, structure, and timing of this new 
requirement will be determined over the next several months. This will 
include determining what role these audit committees might play in 
connection with nonaudit services. 

Preparing to Meet Tomorrow's Fiscal Needs: 

Several of the matters I previously discussed related to preparing to 
meet tomorrow's fiscal needs warrant repeating. The requirement for 
timely, accurate, and useful financial and performance management 
information is greater than ever. Both the long-term fiscal pressures 
created by the retirement of the baby boom generation and the new 
commitments undertaken in the aftermath of September 11 sharpen the 
need to look at competing claims on federal budgetary resources and 
new priorities. In previous testimony, I noted that it should be the 
norm to reconsider the relevance or "fit" of any federal program or 
activity in today's world and for the future.[Footnote 29] Such a 
fundamental review is necessary both to increase fiscal flexibility 
and to make government fit the modern world. Stated differently, there 
is a need to consider what the proper role of the federal government 
should be in the 21st century and how the government should do 
business in the future. 

As we look ahead we face an unprecedented demographic challenge. A 
nation that has prided itself on its youth will become older. Between 
now and 2035, the number of people who are 65 or over will double. As 
the share of the population over 65 climbs, federal spending on the 
elderly will absorb larger and ultimately unsustainable shares of the 
federal budget. Federal health and retirement spending are expected to 
surge as people live longer and spend more time in retirement. In 
addition, advances in medical technology are likely to keep pushing up 
the cost of providing health care. Moreover, the baby boomers will 
have left behind fewer workers to support them in retirement, 
prompting a slower rate of economic growth from which to finance these 
higher costs. Absent substantive change in related entitlement 
programs, large deficits will return, requiring a combination of 
unprecedented spending cuts in other areas, and/or unprecedented tax 
increases, and/or substantially increased borrowing from the public 
(or correspondingly less debt reduction than would otherwise have been 
the case). These trends have widespread implications for our society, 
our economy, and the federal budget. 

On March 26, 2002, the Trustees of the Social Security and Medicare 
trust funds reported on the current and projected status of these 
programs over the next 75 years. The Trustees' reports highlight the 
need to address the long-term fiscal challenges facing the nation. The 
Trustees state that, while the near-term financial conditions have 
improved slightly since last year's reports, the programs continue to 
face substantial financial challenges in the not-too-distant future 
that need to be addressed soon. Once again, the Trustees underscored 
the fact that the most significant implication of these findings is 
that both Social Security and Medicare need to be reformed and 
strengthened at the earliest opportunity. The Trustees also stated 
that Medicare faces financial difficulties that in many ways are more 
severe than those confronting Social Security. 

Early action to change these programs would yield the highest fiscal 
dividends for the federal budget and would provide a longer period for 
prospective beneficiaries to make adjustments in their own planning. 
Waiting to take action entails risks. First, we lose an important 
window where today's relatively large workforce can increase saving 
and enhance productivity, two elements critical to growing the future 
economy. Second, we lose the opportunity to reduce the burden of 
interest in the federal budget, thereby creating a legacy of higher 
debt as well as elderly entitlement spending for the relatively 
smaller workforce of the future. Third, and most critically, we risk 
losing the opportunity to phase in changes gradually so that all can 
make the adjustments needed in private and public plans to accommodate 
this historic shift. 

In a closely related matter, I have previously testified[Footnote 30] 
before this subcommittee on the need to synchronize the timing of the 
Trustees' reports with agency and consolidated financial statements. 
Once again, the U.S. government's consolidated financial statements 
reported an update of key indicators of the financial status of the 
Social Security and Medicare trust funds from the Trustees' reports. 
The Trustees issued their reports the same week as the consolidated 
financial statements. Without this update, the government would have 
provided two different reports on the sustainability of these 
important programs, which could cause confusion and reduce confidence 
in the credibility of the U.S. government's consolidated financial 
statements. This updated information will not be available when the 
U.S. government's consolidated financial statements are issued on an 
accelerated basis, beginning with fiscal year 2004. The JFMIP 
Principals are considering ways to ensure that reports issued by the 
Social Security and Medicare Trustees, agency financial statements, 
and the U.S. government's consolidated financial statements present 
social insurance financial information that is consistent and more 
timely. In our view, the Congress may need to enact legislation that 
will require earlier reporting and issuance of the Trustees' reports 
in order to allow for timely social insurance information to be 
included in agencies' and the U.S. government's consolidated financial 
statements. 

While addressing the challenges of Social Security and Medicare is key 
to ensuring future fiscal flexibility, a fundamental review of all 
programs and operations can create much-needed fiscal flexibility to 
address emerging needs. As I have stated previously, it is healthy for 
the nation periodically to review and update its programs, activities, 
and priorities.[Footnote 31] Many programs were designed years ago to 
respond to earlier challenges. Ultimately, we should strive to hand to 
the next generations the legacy of a government that is effective and 
relevant to a changing society—a government as free as possible of 
outmoded commitments and operations that can inappropriately encumber 
the future. 

A reexamination of existing programs and activities could help weed 
out programs that have proven to be outdated or persistently 
ineffective or alternatively could prompt us to update and modernize 
activities through such actions as improving program targeting and 
efficiency, consolidation, or reengineering of processes and 
operations. Such a review should not be limited to only spending 
programs but should include the full range of tools of governance that 
the federal government uses to address national objectives such as 
loans, guarantees, tax expenditures, and regulations. 

In the last decade the Congress put in place a series of laws designed 
to improve information about cost and performance. This framework and 
the information it provides can help structure and inform the debate 
about what the federal government should do. In addition, GAO has 
identified a number of areas warranting reconsideration based on 
program performance, targeting, and costs. Every year, we issue a 
report identifying specific options, many scored by the Congressional 
Budget Office, for congressional consideration stemming from our audit 
and evaluation work.[Footnote 32] This report provides opportunities 
for (1) reassessing objectives of specific federal programs, (2) 
improved targeting of benefits, and (3) improving the efficiency and 
management of federal initiatives. 

Today the Congress and President Bush face the challenge of sorting 
out these many claims on the federal budget without the fiscal 
benchmarks that guided us through the years of deficit reduction into 
surplus. However, it is still the case that the federal government 
needs a decision-making framework that permits it to evaluate choices 
against both today's needs and the longer-term fiscal future that will 
be handed to future generations. As a way to frame the debate, targets 
can remind us that today's decisions are not only about current needs 
but also about how fiscal policy affects the choices over the longer-
term. Other nations have found it useful to embrace broader targets 
such as debt-to-GDP ratios, or surpluses equal to a percent of GDP 
over the business cycle. To work over time targets should not be rigid—
it is in the nature of things that they will sometimes be missed. 
Reaching a target is not a straight line but an iterative process. The 
other nations we have studied have found that targets prompted them to 
take advantage of windows of opportunity to save for the future and 
that decisionmakers must have flexibility each year to weigh pressing 
short-term needs and adjust the fiscal path without abandoning the 
longer-term framework. 

The events of the past year have served to highlight the benefits of 
fiscal flexibility. Addressing the long-term drivers in the budget is 
essential to preserving any flexibility in the long term. In the 
nearer term a fundamental review of existing programs and operations 
can also create much-needed fiscal flexibility. In this regard, we 
must determine how best to address the necessary structural challenges 
in a reasonably timely manner in order to identify specific actions 
that need to be taken. As stewards of our nation's future, we must 
begin to prepare for tomorrow. 

Closing Comments: 

Our report on the U.S. government's consolidated financial statements 
for fiscal years 2001 and 2000 highlights the need to continue 
addressing the government's serious financial management weaknesses. 
Looking beyond current progress by agencies in attaining unqualified 
opinions on financial statements, it will be essential for the 
government to begin moving away from the extraordinary efforts many 
agencies now use to prepare financial statements and toward giving 
prominence to strengthening the government's financial systems, 
reporting, and controls. This approach becomes even more critical as 
the government progresses to an accelerated financial statement 
reporting time frame, and it is the only way the government can meet 
the end goal of making timely, accurate, and useful financial 
information routinely available to the Congress, other policymakers, 
and the American public. 

The requirement for timely, accurate, and useful financial and 
performance management information is greater than ever, as the 
Congress and the administration prepare to meet tomorrow's fiscal 
challenges. This type of financial information is central to managing 
the government's operations more efficiently, effectively, and 
economically and in supporting GPRA. Moreover, meaningful financial 
and performance information can form the basis for reconsidering the 
relevance or "fit" of any federal program or activity in today's world 
and for the future. 

In closing Mr. Chairman, I want to underscore the importance of the 
additional impetus provided by President Bush through his President's 
Management Agenda and the Executive Branch Management Scorecard for 
coming to grips with federal financial management problems, indeed 
management problems across the board. Regarding DOD in particular, 
Secretary of Defense Rumsfeld's vision and approach for transforming 
the department's full range of business processes is serious and 
encouraging. These efforts will be key to fulfilling the President's 
Management Agenda and addressing the largest obstacle to an 
unqualified opinion on the U.S. government's consolidated financial 
statements. The cooperative efforts spearheaded by the JFMIP 
Principals have been most encouraging in developing the short- and 
long-term strategies and plans necessary to address many of the 
problems I have discussed this morning. In addition, GAO has probably 
never had a better working relationship with OMB and cabinet level and 
other key officials on a range of "good government issues" that are of 
critical importance and are inherently non-partisan in nature. While 
these and other factors provide an enhanced likelihood for success, in 
the end it is results that count. 

Finally, I want to reiterate the value of sustained congressional 
interest in these issues, as demonstrated by this hearing and those 
you have held over the past several years to oversee financial 
management reform. 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] 

Footnotes: 

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

[2] U.S. General Accounting Office, U.S. Government Financial 
Statements: FY 2000 Reporting Underscores the Need to Accelerate 
Federal Financial Management Reform, [hyperlink, 
http://www.gao.gov/products/GAO-01-570T] (Washington, D.C.: Mar. 30, 
2001). 

[3] Additionally, beginning on April 4, 2002, the Secretary of the 
Treasury exercised statutory authority to suspend some investments and 
reinvestments of the Federal Employees Retirement System's Government 
Securities Investment Fund's (G-Fund) receipts and maturing securities 
to prevent Treasury from exceeding the government's current $5,950 
billion debt ceiling. The Secretary reported that the G-Fund will 
receive complete restoration of all funds temporarily affected by this 
action, including full and automatic restoration of any interest that 
would have been credited to the Fund. 

[4] 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. 

[5] We previously reported that material deficiencies prevented us 
from expressing an opinion on the U.S. government's consolidated 
financial statements for fiscal years 1997, 1998, and 1999. 

[6] Numerous amounts previously reported for fiscal year 2000 have 
been restated in the U.S. government's consolidated financial 
statements for fiscal years 2001 and 2000. Given our disclaimer of 
opinion on the U.S. government's consolidated financial statements for 
fiscal year 2000 and because the dollar amounts involved were not 
material, we did not audit these changes. 

[7] For fiscal year 2001, the military postretirement health benefits 
liability increased by $389 billion due primarily to (1) a $293 
billion increase attributable to provisions of the fiscal year 2001 
National Defense Authorization Act (Public Law 106-398) that expand 
certain benefits to Medicare-eligible DOD retirees, their dependents, 
and survivors, and (2) a $91 billion increase associated with changes 
in medical trend assumptions. 

[8] U.S. General Accounting Office, Financial Management: Billions in 
Improper Payments Continue to Require Attention, [hyperlink, 
http://www.gao.gov/products/GAO-01-44] (Washington, D.C.: Oct. 27, 
2000). 

[9] U.S. General Accounting Office, Financial Audit: IRS's Fiscal 
Years 2001 and 2000 Financial Statements, [hyperlink, 
http://www.gao.gov/products/GAO-02-414] (Washington, D.C.: Feb. 27, 
2002). 

[10] See, for example, U.S. General Accounting Office, High-Risk 
Series: An Update, [hyperlink, http://www.gao.gov/products/GAO-01-263] 
(Washington, D.C.: Jan. 2001). 

[11] U.S. General Accounting Office, Information Security: Additional 
Actions Needed to Fully Implement Reform Legislation, [hyperlink, 
http://www.gao.gov/products/GAO-02-470T] (Washington, D.C.: Mar. 6, 
2002). 

[12] [hyperlink, http://www.gao.gov/products/GAO-01-570T]. 

[13] U.S. General Accounting Office, Managing for Results: Next Steps 
to Improve the Federal Government's Management and Performance, 
[hyperlink, http://www.gao.gov/products/GAO-02-439T] (Washington, 
D.C.: Feb. 15, 2002). 

[14] U.S. General Accounting Office, National Aeronautics and Space 
Administration: Leadership and Systems Needed to Effect Financial 
Management Improvements, [hyperlink, 
http://www.gao.gov/products/GAO-02-551T] (Washington, D.C.: March 20, 
2002). 

[15] See, for example, [hyperlink, 
http://www.gao.gov/products/GAO-01-263]. 

[16] U.S. General Accounting Office, Major Management Challenges and 
Program Risks: NASA, [hyperlink, 
http://www.gao.gov/products/GA0-01-258] (Washington, D.C.: Jan. 2001); 
U.S. General Accounting Office, Financial Management: Misstatement of 
NASA's Statement of Budgetary Resources, [hyperlink, 
http://www.gao.gov/products/GA0-01-438] (Washington, D.C.: Mar. 30, 
2001); and U.S. General Accounting Office, NASA: International Space 
Station and Shuttle Cost Limits, [hyperlink, 
http://www.gao.gov/products/GA0-01-1000R] (Washington, D.C.: Aug. 31, 
2001). 

[17] The Fiscal Year 2002 National Defense Authorization Act contains 
provisions that will provide a framework for redirecting the 
department's resources from the preparation and audit of financial 
statements to improvement of DOD's financial management systems and 
financial management policies, procedures, and internal controls. 
Under this new legislation, the department will also be required to 
report to the Congress on how resources have been redirected and the 
progress that has been achieved. 

[18] This amount was reported on the department's fiscal year 2001 
financial report, whereas the $352 billion discussed in the preceding 
paragraph represents an estimate of the amount of budget authority 
shown in the documents accompanying the President's budget submission. 
The principal difference is attributable to a $389 billion increase in 
the military postretirement health benefits liability under new 
legislation extending benefits to Medicare-eligible military retirees 
and their beneficiaries. Other differences between these amounts are 
the result of (1) timing differences in the receipt of budgetary 
resources and recording associated expenses and (2) unknown errors in 
the amounts shown in the financial statements, which were unauditable. 

[l9] U.S. General Accounting Office, DOD Financial Management: 
Integrated Approach, Accountability, Transparency, and Incentives Are 
Keys to Effective Reform, [hyperlink, 
http://www.gao.gov/products/GAO-02-537T] (Washington, D.C.: Mar. 2002) 
and U.S. General Accounting Office, DOD Financial Management: 
Integrated Approach, Accountability, and Incentives Are Keys to 
Effective Reform, [hyperlink, http://www.gao.gov/products/GAO-01-681T] 
(Washington, D.C.: May 8, 2001). 

[20] Last year a net $7.3 billion in unreconciled transactions was 
recorded as an increase in net position. As discussed in footnote 6 of 
this testimony, numerous amounts previously reported for fiscal year 
2000 have been restated in the U.S. government's consolidated 
financial statements for fiscal years 2001 and 2000, including this 
amount. 

[21] In prior years, the government reported unreconciled transactions 
as a change in net position. Although the government 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 revenue/(cost) in the U.S. government's consolidated 
financial statements for fiscal years 2001 and 2000. 

[22] GA0 plans to report to the Congress, by October 1, 2002, on 
agencies' FFMIA implementation for fiscal year 2001, as required by 
FFMIA. 

[23] U.S. General Accounting Office, Financial Management: FFMIA 
Implementation Critical for Federal Accountability, [hyperlink, 
http://www.gao.gov/products/GAO-02-29] (Washington, D.C.: Oct. 1, 
2001). 

[24] U.S. General Accounting Office, Executive Guide: Creating Value 
Through World-class Financial Management, [hyperlink, 
http://www.gao.gov/products/GAO/AIMD-00-134] (Washington, D.C.: Apr. 
2000). 

[25] Office of Management and Budget, Audit Requirements for Federal 
Financial Statements, Bulletin 01-02 (Washington, D.C.: Oct. 19, 2000). 

[26] U.S. General Accounting Office, Government Auditing Standards, 
Amendment No. 3, Independence, [hyperlink, 
http://www.gao.gov/products/GAO-02-388G] (Washington, D.C.: Jan. 2002). 

[27] Government Auditing Standards was first published in 1972 and is 
commonly referred to as the "Yellow Book." It covers federal entities 
and those organizations receiving federal funds. Various laws require 
compliance with the standards in connection with audits of federal 
entities and funds. Furthermore, many states and local governments and 
other entities, both domestically and internationally, have 
voluntarily adopted these standards. 

[28] The Advisory Council includes 20 experts in financial and 
performance auditing and reporting—drawn from all levels of 
government, academia, private enterprise, and public accounting—who 
advise the Comptroller General on Government Auditing Standards. 

[29] U.S. General Accounting Office, Budget Issues: Long-Term Fiscal 
Challenges, [hyperlink, http://www.gao.gov/products/GAO-02-467T] 
(Washington, D.C.: Feb. 27, 2002) and U.S. General Accounting Office, 
Budget Issues: Effective Oversight and Budget Discipline are Essential—
Even in a Time of Surplus, [hyperlink, 
http://www.gao.gov/products/GAO/T-AIMD-00-73] (Washington, D.C.: Feb. 
1, 2000). 

[30] U.S. General Accounting Office, Auditing the Nation's Finances: 
Fiscal Year 1999 Results Continue to Highlight Major Issues Needing 
Resolution, [hyperlink, http://www.gao.gov/products/GAO/T-AIMD-00-137] 
(Washington, D.C.: Mar. 31, 2000). 

[31] [hyperlink, http://www.gao.gov/products/GAO/T-AIMD-00-73]. 

[32] U.S. General Accounting Office, Supporting Congressional 
Oversight: Framework for Considering Budgetary Implications of 
Selected GAO Work, [hyperlink, http://www.gao.gov/products/GA0-01-447] 
(Washington, D.C.: Mar. 9, 2001). 

[End of section]