This is the accessible text file for GAO report number GAO-04-886T 
entitled 'Fiscal Year 2003 U.S. Government Financial Statements: 
Sustained Improvement in Federal Financial Management Is Crucial to 
Addressing Our Nation's Future Fiscal Challenges' which was released on 
July 08, 2004.

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GAO Highlights:

Highlights of GAO-04-886T, testimony before the Subcommittee on 
Financial Management, the Budget, and International Security, 
Committee on Governmental Affairs, U.S. Senate:  

Why GAO Did This Study:

GAO is required to annually audit the consolidated financial statements 
of the U.S. government.

Proper accounting and reporting practices are essential in the public 
sector. The U.S. government is the largest, most diverse, most complex, 
and arguably the most important entity on earth today. Its services—
homeland security, national defense, Social Security, mail delivery, 
and food inspection, to name a few—directly affect the well-being of 
almost every American. But sound decisions on the future direction of 
vital federal government programs and policies are made more difficult 
without timely, accurate, and useful financial and performance 
information.

Until the problems discussed in GAO’s audit report on the U.S. 
government’s consolidated financial statements are adequately 
addressed, they will continue to (1) hamper the federal government’s 
ability to accurately report a significant portion of its assets, 
liabilities, and costs; (2) affect the federal government’s ability to 
accurately measure the full cost as well as the financial and 
nonfinancial performance of certain programs while effectively managing 
related operations; and (3) significantly impair the federal 
government’s ability to adequately safeguard certain significant assets 
and properly record various transactions.

What GAO Found:

As in the 6 previous fiscal years, certain material weaknesses in 
internal control and in selected accounting and reporting practices 
resulted in conditions that continued to prevent GAO from being able 
to provide the Congress and American citizens an opinion as to whether 
the consolidated financial statements of the U.S. government are fairly 
stated in conformity with U.S. generally accepted accounting 
principles. Three major impediments to an opinion on the consolidated 
financial statements continue to be (1) serious financial management 
problems at DOD, (2) the federal government’s inability to fully 
account for and reconcile transactions between federal government 
entities, and (3) the federal government’s ineffective process for 
preparing the consolidated financial statements.

For fiscal year 2003, 20 of 23 Chief Financial Officers (CFO) Act 
agencies received unqualified opinions, the same number received by 
these agencies in fiscal year 2002, up from 6 for fiscal year 1996. 
However, only 3 of the CFO Act agencies had neither a material weakness 
in internal control, an issue involving compliance with applicable laws 
and regulations, nor an instance of lack of substantial compliance with 
Federal Financial Management Improvement Act requirements. 

The requirement for timely, accurate, and useful financial and 
performance management information is greater than ever as our nation 
faces major long-term fiscal challenges that will require tough choices 
in setting priorities and linking resources to results. Given the 
nation’s large and growing long-term fiscal imbalance, which is driven 
largely by known demographic trends and health care costs, coupled with 
new homeland security and defense commitments, the status quo is 
unsustainable. Current financial reporting does not clearly and 
transparently show the wide range of responsibilities, programs, and 
activities that may either obligate the federal government to future 
spending or create an expectation for such spending and provides an 
unrealistic and even misleading picture of the federal government’s 
overall performance and financial condition. In addition, too many 
significant federal government commitments and obligations, such as 
Social Security and Medicare, are not adequately addressed in the 
federal government’s financial statements and budget process, and 
current federal financial reporting standards do not require such 
disclosure.

A top-to-bottom review of government activities to ensure their 
relevance and fit for the 21st century and their relative priority is 
long overdue. The federal government needs a three-pronged approach to 
(1) restructure existing entitlement programs, (2) reexamine the base 
of discretionary and other spending, and (3) review and revise the 
federal government’s tax policy and enforcement programs. New 
accounting and reporting approaches, budget control mechanisms, and 
metrics are needed for considering and measuring the impact of spending 
and tax policies and decisions over the long term.

www.gao.gov/cgi-bin/getrpt?GAO-04-886T.

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

[End of section]

Testimony: 

Before the Subcommittee on Financial Management, the Budget, and 
International Security, Committee on Governmental Affairs, U.S. Senate:

For Release on Delivery Expected at 10:30 a.m. EDT Thursday, July 8, 
2004:

Fiscal Year 2003 U.S. Government Financial Statements:

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

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

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-886T]:

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 2003 
and 2002.[Footnote 1] Both the consolidated financial statements and 
our report are included in the fiscal year 2003 Financial Report of the 
United States Government, which was issued by the Department of the 
Treasury (Treasury) on February 27, 2004, and is available through 
GAO's Internet site, at [Hyperlink, http://www.gao.gov], and Treasury's 
Internet site, at [Hyperlink, http://www.fms.treas.gov/fr/index.html].

As in the 6 previous fiscal years, certain material weaknesses[Footnote 
2] in internal control and in selected accounting and reporting 
practices resulted in conditions that continued to prevent us from 
being able to provide the Congress and American citizens an opinion as 
to whether the consolidated financial statements of the U.S. government 
are fairly stated in conformity with U.S. generally accepted accounting 
principles (GAAP). Until the problems discussed in our report are 
adequately addressed, they will continue to (1) hamper the federal 
government's ability to accurately report a significant portion of its 
assets, liabilities, and costs; (2) affect the federal government's 
ability to accurately measure the full cost as well as the financial 
and nonfinancial performance of certain programs while effectively 
managing related operations; and (3) significantly impair the federal 
government's ability to adequately safeguard certain significant assets 
and properly record various transactions.

While the federal government has not yet been able to prepare auditable 
financial statements, the requirement to do so at the consolidated 
level as well as at the agency level has already yielded important 
results. We see continuous movement toward the ultimate goals of annual 
accountability and, more importantly, of development of the day-to-day 
financial information that the federal government will need to best 
address today's budgetary challenges and the looming longer-term fiscal 
imbalance driven by demographic trends, rising health care costs, and 
new homeland security and defense commitments. Across government, 
financial management improvement initiatives are under way that, if 
effectively implemented, have the potential to appreciably improve the 
quality of the federal government's financial management and reporting. 
Federal agencies continue to make progress in their efforts to 
modernize their financial management systems and improve financial 
management performance as called for in the President's Management 
Agenda.[Footnote 3]

The Principals of the Joint Financial Management Improvement Program 
(JFMIP)[Footnote 4] agreed with the Office of Management and Budget's 
(OMB) initiative to accelerate the agency financial statements 
reporting date to November 15 for fiscal year 2004. For fiscal year 
2003, OMB required the Chief Financial Officers (CFO) Act 
agencies[Footnote 5] to deliver their Performance and Accountability 
Reports, including their audited financial statements, to OMB by 
January 30, 2004. However, to prepare for meeting the required November 
15 accelerated reporting date for fiscal year 2004, OMB encouraged the 
CFO Act agencies to accelerate the issuance of their fiscal year 2003 
audited financial statements to November 15, 2003, or as close to that 
date as possible. OMB reported that 8 CFO Act agencies--the Department 
of Education, the Environmental Protection Agency, the Department of 
Health and Human Services, the National Science Foundation, the Social 
Security Administration, the Department of the Treasury, the Agency for 
International Development, and the Department of Veterans Affairs--were 
able to issue their fiscal year 2003 financial statements with 
unqualified audit opinions by mid-November 2003. Another 10 CFO Act 
agencies issued their financial statements by December 31, 2003, and 
the remaining 5 CFO Act agencies issued by the end of January 2004. A 
24th major agency, the Department of Homeland Security (DHS),[Footnote 
6] issued its financial statements on February 13, 2004. DHS faced a 
herculean challenge with respect to issuing audited financial 
statements, since the department had been in operation only for the 
last 7 months of the fiscal year and involved a transfer of operations 
from a number of diverse entities, some with known financial management 
problems.

While these results represent a significant improvement over previous 
years in the timeliness of CFO Act agencies' issuance of audited 
financial statements, they also demonstrate the significant challenges 
that the federal government will face in meeting the November 15 
accelerated reporting date for fiscal year 2004. Auditors at several of 
the CFO Act agencies reported that the agencies may not be able to 
produce auditable financial statements within the accelerated time 
frame for fiscal year 2004 without making fundamental changes to 
improve a number of their financial management practices. For example, 
certain federal agency auditors reported that major improvements are 
needed in (1) management controls to monitor established policies and 
procedures for conducting financial analyses and reconciliations 
throughout the year, (2) fully integrating financial management 
systems, and (3) providing adequate and skilled staff to support 
efficient, effective preparation of federal agency consolidated 
financial statements. Our experience as the auditor of the financial 
statements of the Internal Revenue Service, which successfully 
accelerated its reporting to November 15 beginning with its fiscal year 
2002 financial statements, showed that significant changes had to be 
made to improve routine financial management procedures in order to be 
able to accelerate reporting.

For fiscal year 2003, as in fiscal year 2002, 20 of 23 CFO Act agencies 
were able to attain unqualified audit opinions on their financial 
statements (see table 1 and app. I),[Footnote 7] up from 6 agencies for 
fiscal year 1996. This is the same number of unqualified opinions 
received by these CFO Act agencies for fiscal year 2002. However, 2 
agencies' fiscal year 2003 opinions were different from those they 
received for fiscal year 2002. The Agency for International Development 
received an unqualified opinion on all of its fiscal year 2003 
financial statements for the first time, while the National Aeronautics 
and Space Administration (NASA), which for fiscal year 2002 received an 
unqualified opinion on its financial statements, received a disclaimer 
of opinion for fiscal year 2003. DHS, which as I mentioned before 
prepared consolidated financial statements for fiscal year 2003 
covering its first 7 months of operations, received a qualified opinion 
on two of the six required financial statements.[Footnote 8]

In identifying improved financial performance as one of its five 
governmentwide initiatives, the President's Management Agenda 
recognized that a clean (unqualified) financial audit opinion is a 
basic prescription for any well-managed organization. At the same time, 
it recognized that "most federal agencies that obtain clean audits only 
do so after making extraordinary, labor-intensive assaults on financial 
records" at or after year-end. The President's Management Agenda 
further recognized that without sound internal control and accurate and 
timely financial information, it is not possible to accomplish the 
agenda and secure the best performance and highest measure of 
accountability for the American people. The JFMIP Principals have 
defined certain measures, in addition to receiving an unqualified 
financial statement opinion, for achieving financial management 
success. These additional measures include being able to routinely 
provide timely, accurate, and useful financial and performance 
information and having no material internal control weaknesses or 
material noncompliance with laws and regulations and the requirements 
of the Federal Financial Management Improvement Act of 1996 
(FFMIA).[Footnote 9] As shown in table 1, while the severity and 
magnitude of the problems identified vary greatly, reports of 
inspectors general and their contract auditors indicated that for 
fiscal year 2003 only 3 of the 23 CFO Act agencies had neither a 
material weakness in internal control, an issue involving compliance 
with applicable laws and regulations, nor an instance of lack of 
substantial compliance with the requirements of FFMIA.

Table 1: Fiscal Year 2003 CFO Act Agency Results Reported by Auditors:

Agencies with unqualified opinions: 20[A]; 
Agencies with unqualified opinions and no material weaknesses or 
noncompliances: 3[B].

Source: GAO.

[A] Agriculture, Commerce, Education, Energy, Health and Human 
Services, Housing and Urban Development, Interior, Justice, Labor, 
State, Transportation, Treasury, Veterans Affairs, Agency for 
International Development, Environmental Protection Agency, General 
Services Administration, National Science Foundation, Nuclear 
Regulatory Commission, Office of Personnel Management, and Social 
Security Administration.

[B] Energy, National Science Foundation, and Social Security 
Administration.

[End of table]

In this testimony, I will highlight the major issues relating to the 
consolidated financial statements for fiscal years 2003 and 2002, 
discuss systems problems that continue to hinder federal agency 
accountability, and describe progress that has been made toward 
addressing major impediments to an opinion on the consolidated 
financial statements. I will also discuss why sound financial 
management today and in the future is critical to meeting tomorrow's 
fiscal needs and the need for "truth and transparency" in connection 
with our nation's financial condition and fiscal outlook.

Highlights of Major Issues Related to the U.S. Government's 
Consolidated Financial Statements for Fiscal Years 2003 and 2002:

As I mentioned earlier, as has been the case for the previous 6 fiscal 
years, the federal government continues to have a significant number of 
material weaknesses related to financial systems, fundamental 
recordkeeping and financial reporting, and incomplete documentation. 
Several of these material weaknesses (referred to hereafter as material 
deficiencies) resulted in conditions that continued to prevent us from 
forming and expressing an opinion on the U.S. government's consolidated 
financial statements for the fiscal years ended September 30, 2003 and 
2002.[Footnote 10] 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 the Department of 
Defense (DOD);

* reasonably estimate or adequately 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 ensure that all 
disbursements are properly recorded;

* fully account for and reconcile intragovernmental activity and 
balances;

* demonstrate how net outlay amounts reported in the consolidated 
financial statements were related to net outlay amounts reported in the 
underlying federal agencies' financial statements; and:

* effectively prepare the federal government's financial statements, 
including ensuring that the consolidated financial statements are 
consistent with the underlying audited agency financial statements, 
balanced, and in conformity with GAAP.

In addition to these material deficiencies, we identified four other 
material weaknesses in internal control related to loans receivable and 
loan guarantee liabilities, improper payments, information security, 
and tax collection activities.

The material weaknesses identified by our work are discussed in more 
detail in appendix II, and their primary effects are described in 
appendix III.

Recurring Systems Problems Hinder Accountability:

The ability 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 
challenge at most federal agencies. The results of the fiscal year 2003 
assessments performed by agency inspectors general or their contract 
auditors under FFMIA show that these problems continue to plague the 
financial management systems used by most of the CFO Act agencies. 
While the problems are much more severe at some agencies than at 
others, their nature and severity indicate that overall, management at 
most CFO Act agencies lacks the full range of information needed for 
accountability, performance reporting, and decision making. These 
problems include nonintegrated financial systems, lack of accurate and 
timely recording of data, inadequate reconciliation procedures, and 
noncompliance with accounting standards and the U.S. Government 
Standard General Ledger (SGL).

Agencies' inability to meet the federal financial management systems 
requirements continues to be the major barrier to achieving compliance 
with FFMIA. Under FFMIA, CFO Act agency auditors are required to 
report, as part of the agencies' financial statement audits, whether 
agencies' financial management systems substantially comply with (1) 
federal financial management systems requirements, (2) applicable 
federal accounting standards, and (3) the SGL at the transaction level. 
As shown in figure 1, auditors most frequently reported instances of 
noncompliance with federal financial management systems requirements. 
These instances of noncompliance involved not only core financial 
systems, but also administrative and programmatic systems.

Figure 1: Auditors' FFMIA Assessments for Fiscal Years 2000, 2001, 
2002, and 2003:

[See PDF for image]

[End of figure]

For fiscal year 2003, auditors for 17 of the 23 CFO Act agencies 
reported that the agencies' financial management systems did not comply 
substantially with one or more of FFMIA's three requirements. For the 
remaining 6 CFO Act agencies, auditors provided negative assurance, 
meaning that nothing came to their attention indicating that the 
agencies' financial management systems did not substantially meet FFMIA 
requirements. The auditors for these 6 agencies did not definitively 
state whether the agencies' systems substantially complied with FFMIA 
requirements, as is required under the statute. DHS is not subject to 
the requirements of the CFO Act and, consequently, is not required to 
comply with FFMIA. Accordingly, DHS's auditors did not report on DHS's 
compliance with FFMIA. However, the auditors identified and reported 
deficiencies that related to the aforementioned three requirements of 
FFMIA.

Federal agencies have recognized the seriousness of their financial 
systems weaknesses and have efforts under way to implement or upgrade 
their financial systems to alleviate long-standing problems, but some 
of these efforts face significant challenges. For example, as we 
testified in May 2004,[Footnote 11] we have identified several issues 
related to NASA's financial management systems modernization effort: 
(1) NASA did not involve key stakeholders in the design and 
implementation of the agency's new financial management system's core 
financial module; (2) NASA did not follow key best practices for 
acquiring and implementing this system; and (3) the new system lacks 
key external reporting capabilities for property and budgetary data. In 
addition, as I will discuss later in this testimony, DOD faces major 
challenges in its efforts to develop a business enterprise 
architecture. We recognize that it will take time, investment, and 
sustained emphasis to improve agencies' underlying financial management 
systems.

Addressing Major Impediments to an Opinion on Consolidated Financial 
Statements:

As I mentioned earlier, for the past 7 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 requirements for the 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 GAO. With the 
benefit of the past 7 years' experience by the federal government in 
having the required financial statements subjected to audit, more 
intensified attention will be needed on the most serious obstacles to 
achieving an opinion on the U.S. government's consolidated financial 
statements. Three major impediments to an opinion on the consolidated 
financial statements are (1) serious financial management problems at 
DOD, (2) the federal government's inability to fully account for and 
reconcile transactions between federal government entities, and (3) the 
federal government's ineffective process for preparing the consolidated 
financial statements.

Financial Management at DOD:

Essential to achieving an opinion on the consolidated financial 
statements is resolution of the serious financial management problems 
at DOD, which we have designated as high risk[Footnote 12] since 1995. 
In accordance with section 1008 of the National Defense Authorization 
Act for Fiscal Year 2002,[Footnote 13] DOD reported that for fiscal 
year 2003, it was not able to provide adequate evidence supporting 
material amounts in its financial statements. DOD stated that it is 
unable to comply with applicable financial reporting requirements for 
(1) property, plant, and equipment (PP&E); (2) inventory and operating 
materials and supplies; (3) environmental liabilities; (4) 
intragovernmental eliminations and related accounting adjustments; (5) 
disbursement activity; and (6) cost accounting by responsibility 
segment. Although DOD represented that the military retirement health 
care liability data had improved for fiscal year 2003, the cost of 
direct health care provided by DOD-managed military treatment 
facilities was a significant amount of DOD's total recorded health 
care liability and was based on estimates for which adequate support 
was not available.

DOD continues to confront pervasive decades-old financial management 
and business problems related to its systems, processes (including 
internal controls), and people (human capital). These problems preclude 
the department from producing accurate, reliable, and timely 
information to make sound decisions and to accurately report on its 
billions of dollars of assets. DOD's long-standing business management 
systems problems adversely affect the economy, effectiveness, and 
efficiency of its operations and have resulted in a lack of adequate 
accountability across all major business areas. To date, none of the 
military services or major DOD components has passed the test of an 
independent financial audit[Footnote 14] because of pervasive 
weaknesses in financial management systems, operations, and controls.

Additionally, the department's stovepiped, duplicative, and 
nonintegrated systems contribute to its vulnerability to fraud, waste, 
and abuse. In this regard, we have recently testified on problems 
related to military pay[Footnote 15] and unused airline tickets.
[Footnote 16] Vulnerability to fraud, waste, and abuse continues 
despite substantial systems investment. For fiscal year 2004, DOD 
requested approximately $19 billion to operate, maintain, and modernize 
its reported 2,274 business systems. The duplicative and stovepiped 
nature of DOD's systems environment is illustrated by the numerous 
systems it has in the same functional areas. For example, DOD reported 
that it has 565 systems to support logistics functions. These systems 
are not integrated and thus have multiple points of data entry, which 
can result in significant data integrity problems.

Further, DOD continues to lack effective management oversight and 
control over business systems modernization investments. The actual 
funding continues to be distributed among the military services and 
defense agencies, thereby enabling the numerous DOD components to 
continue to develop stovepiped, parochial solutions to the department's 
long-standing financial management and business operation challenges. 
Lacking a departmentwide focus and effective management oversight and 
control of business systems investment, DOD continues to invest 
billions of dollars in systems that fail to provide integrated 
corporate solutions to its long-standing business operations problems.

Over the past 14 years, DOD has initiated several broad-based reform 
efforts intended to fundamentally reform its business operations and 
improve the reliability of information used in the decision-making 
process. While these initiatives produced some incremental 
improvements, they did not result in the fundamental reform necessary 
to resolve the department's long-standing management challenges. 
Secretary Rumsfeld has made business transformation a priority. For 
example, through its Business Management Modernization Program, DOD is 
continuing its efforts to develop and implement a business enterprise 
architecture and establish effective management and control over its 
business system modernization investments.

However, we recently reported[Footnote 17] that after about 3 years of 
effort and over $203 million in obligations, we have not seen 
significant change in the content of DOD's architecture or in DOD's 
approach to investing billions of dollars annually in existing and new 
systems. Few actions have been taken to address the recommendations we 
made in our previous reports,[Footnote 18] which were aimed at 
improving DOD's plans for developing the next version of the 
architecture and implementing the institutional means for selecting and 
controlling both planned and ongoing business systems investments. To 
date, DOD has not addressed 22 of our 24 recommendations.

Currently, DOD has various initiatives under way to support its efforts 
to obtain an unqualified audit opinion on its fiscal year 2007 
financial statements. Because there are not yet detailed plans guiding 
these activities, however, it is unclear whether and how they support 
each other and whether they support this goal. Therefore, the 
feasibility of meeting this goal is as yet unknown.

The seriousness of DOD's business management weaknesses underscores the 
importance of no longer condoning "status quo" business operations at 
DOD. Cultural resistance to change, military service parochialism, and 
stovepiped operations have all contributed significantly to the failure 
of 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.

To improve the likelihood that the department's current business 
transformation efforts will be successful, we have previously 
suggested[Footnote 19] that a chief management official[Footnote 20] 
position be created. Previous failed attempts to improve DOD's business 
operations illustrate the need for sustained involvement of DOD 
leadership in helping to assure that DOD's financial and overall 
business process transformation efforts remain a priority. While the 
Secretary and other key DOD leaders have demonstrated their commitment 
to the current business transformation efforts, the long-term nature of 
these efforts requires the development of an executive position capable 
of providing strong and sustained executive leadership over a number of 
years and various administrations.

This position would provide the sustained attention essential for 
addressing key stewardship responsibilities such as strategic planning, 
performance and financial management, and business systems 
modernization in an integrated manner. This position could be filled by 
an individual, appointed by the President and confirmed by the Senate, 
for a set term of 7 years with the potential for reappointment. Such an 
individual should have a proven track record as a business process 
change agent in large, complex, and diverse organizations--experience 
necessary to spearhead business process transformation across the 
department, and potentially administrations, and serve as an integrator 
for the needed business transformation efforts.

Further, in a recent report[Footnote 21] we also suggest that to 
improve management oversight, accountability, and control of the 
department's business systems funding, Congress may wish to consider 
providing the funds to operate, maintain, and modernize DOD's business 
systems to the functional areas, known as domains, rather than the 
military services and the defense agencies. Currently, each military 
service and defense agency receives its own funding and is largely 
autonomous in deciding how to spend these funds, thereby hindering the 
development of broad-based, integrated corporate system solutions to 
common DOD-wide problems. We believe it is critical that funds for DOD 
business systems be appropriated to the domain owners in order to 
provide for accountability and the ability to prevent the continued 
parochial approach to systems investment that exists today. The domains 
would establish a hierarchy of investment review boards with DOD-wide 
representation, including the military services and defense agencies. 
These boards would be responsible for reviewing and approving 
investments to develop, operate, maintain, and modernize business 
systems for the domain portfolio, including ensuring that investments 
were consistent with DOD's business enterprise architecture.

DOD still has a long way to go, and top leadership must continue to 
stress the importance of achieving lasting improvement that truly 
transforms the department's business systems and operations. Only 
through major transformation, which will take time and sustained 
leadership from top management, will DOD be able to meet the mandate of 
the CFO Act and achieve the President's Management Agenda goal of 
improved financial performance.

Intragovernmental Transactions:

OMB and Treasury require the CFOs of 35 executive departments and 
agencies, including the 23 CFO Act agencies, to reconcile selected 
intragovernmental activity and balances with their "trading 
partners"[Footnote 22] and to report to Treasury, the agency's 
inspector general, and GAO on the extent and results of 
intragovernmental activity and balances reconciliation efforts. A 
substantial number of the agencies continue to be unable to fully 
perform reconciliations of intragovernmental activity and balances with 
their trading partners, citing reasons such as (1) trading partners not 
providing needed data; (2) limitations and incompatibility of agency 
and trading partner information systems; and (3) lack of human 
resources. Amounts reported for federal agency trading partners for 
certain intragovernmental accounts were significantly out of balance in 
the aggregate for both fiscal years 2003 and 2002.

We reported in previous years that the heart of the intragovernmental 
transactions issue was that the federal government lacked clearly 
articulated business rules for these transactions so that they would be 
handled consistently by agencies. In this regard, at the start of 
fiscal year 2003, OMB issued business rules to transform and 
standardize intragovernmental ordering and billing. To address long-
standing problems with intragovernmental exchange transactions between 
federal agencies, Treasury provided federal agencies with quarterly 
detailed trading partner information during fiscal year 2003 to help 
them better perform their trading partner reconciliations. In addition, 
the federal government began a three-phase Intragovernmental 
Transactions e-gov project to define a governmentwide data architecture 
and provide a single source of detailed trading partner data. On April 
20, 2004, however, OMB announced that it was appropriate to pause and 
evaluate the results of the project to date. OMB estimated that the 
evaluation will take 120 days and will be followed by a phased 
deployment. Resolving the intragovernmental transactions problem 
remains a difficult challenge and will require a commitment by the CFO 
Act agencies and continued strong leadership by OMB.

Preparing the Consolidated Financial Statements:

The federal government did not have adequate systems, controls, and 
procedures to ensure that the consolidated financial statements are 
consistent with the underlying audited agency financial statements, 
balanced, and in conformity with GAAP. In this regard, Treasury is 
developing a new system and procedures to prepare the consolidated 
financial statements beginning with the statements for fiscal year 
2004. Treasury officials have stated that these actions are intended 
to, among other things, directly link information from federal 
agencies' audited financial statements to amounts reported in the 
consolidated financial statements and resolve many of the issues we 
identified in the process for preparing the consolidated financial 
statements. As part of our fiscal year 2004 audit, we will evaluate the 
new system and procedures as they are fully developed and implemented 
and determine the extent of linkage accomplished for the fiscal year 
2004 financial statements. Resolving issues surrounding preparing the 
consolidated financial statements has been a significant challenge and 
will require continued strong leadership by Treasury management.

Truth and Transparency in the Fiscal Outlook:

Our nation's large and growing long-term fiscal imbalance, which is 
driven largely by known demographic trends and rising health care 
costs--coupled with new homeland security and defense commitments--
serves to sharpen the need to fundamentally review and re-examine basic 
federal entitlements, as well as other mandatory and discretionary 
spending, and tax policies. As we look ahead, our nation faces an 
unprecedented demographic challenge with significant implications, 
among them budgetary and economic. Between now and 2035, the number of 
people who are 65 years old or over will double, driving federal 
spending on the elderly to a larger and ultimately unsustainable share 
of the federal budget. As a result, tough choices will be required to 
address the resulting structural imbalance.

GAO prepares long-term budget simulations that seek to illustrate the 
likely fiscal consequences of the coming demographics and rising health 
care costs. Our latest long-term budget simulations reinforce the need 
for change in the major cost drivers--Social Security and health care 
programs. As shown in figure 2, by 2040, absent reform of these 
entitlement programs, projected federal revenues may be adequate to pay 
little beyond interest on the debt.

Figure 2: Composition of Spending as a Share of GDP Assuming 
Discretionary Spending Grows with GDP after 2004 and All Expiring Tax 
Provisions Are Extended:

[See PDF for image] 

Note: Although expiring tax provisions are extended, revenue as a share 
of gross domestic product (GDP) increases through 2014 due to (1) real 
bracket creep, (2) more taxpayers becoming subject to the alternative 
minimum tax, and (3) increased revenue from tax-deferred retirement 
accounts. After 2014, revenue as a share of GDP is held constant.

[End of figure] 

Current financial reporting does not clearly and transparently show the 
wide range of responsibilities, programs, and activities that may 
either obligate the federal government to future spending or create an 
expectation for such spending and provides an unrealistic and even 
misleading picture of the federal government's overall performance and 
financial condition. Few agencies adequately show the results they are 
getting with the taxpayer dollars they spend. In addition, too many 
significant federal government commitments and obligations, such as 
Social Security and Medicare, are not fully and consistently disclosed 
in the federal government's consolidated financial statements and 
budget, and current federal financial reporting standards do not 
require such disclosure.[Footnote 23] Figure 3 shows some selected 
fiscal exposures. The spectrum of these exposures ranges from covering 
only the explicit liabilities that are shown on the consolidated 
financial statements to implicit promises embedded in current policy or 
public expectations. These liabilities, commitments, and promises have 
created a fiscal imbalance that will put unprecedented strains on the 
nation's spending and tax policies. Although economic growth can help, 
the projected fiscal gap is now so large that the federal government 
will not be able to simply grow its way out of the problem. Tough 
choices are inevitable.

Figure 3: Selected Fiscal Exposures: Sources and Examples[A]:

[See PDF for image] 

[A] All figures are as of the end of fiscal year 2003, except Social 
Security and Medicare estimates, which are as of the end of calendar 
year 2003.

[B] This amount includes $774 billion held by military and civilian 
pension funds that would offset the explicit liabilities reported by 
those funds.

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

[End of figure] 

Particularly troubling are the many big-ticket items that taxpayers 
will eventually have to deal with. The federal government has pledged 
its support to a long list of programs and activities, including 
pension and health care benefits for senior citizens, medical care for 
veterans, and contingencies associated with various government-
sponsored entities, whose claims on future spending total trillions of 
dollars. Despite their serious implications for future budgets, tax 
burdens, and spending flexibilities, these unfunded commitments get 
short shrift in the federal government's current financial statements 
and in budgetary deliberations.

The federal government's gross debt as of September 2003 was about $7 
trillion, or about $24,000 for every man, woman, and child in this 
country today. But that number excludes many big-ticket items, 
including the gap between promised and funded Social Security and 
Medicare benefits, veterans' health care, and a range of other 
commitments and contingencies. If these items are factored in, the 
total burden in current dollars is at least $42 trillion. To put that 
number into perspective, $42 trillion is 18 times the current federal 
budget, or 3.5 times our current annual gross domestic product. One of 
the biggest contributors to this total bill will be the new Medicare 
prescription drug benefit, whose estimated current-dollar cost over the 
next 75 years is more than $8 trillion. Stated differently, the current 
total burden for every American is more than $140,000--and every day 
that burden is growing larger. GAO's long-term budget simulations show 
that by 2040, the federal government may have to cut federal spending 
by 60 percent or raise taxes to about 2.5 times today's level to pay 
for the mounting cost of the federal government's current unfunded 
commitments. Either would be devastating.

Proper accounting and reporting practices are essential in the public 
sector. After all, the U.S. government is the largest, most diverse, 
most complex, and arguably the most important entity on earth today. 
Its services--homeland security, national defense, Social Security, 
mail delivery, and food inspection, to name a few--directly affect the 
well-being of almost every American. But sound decisions on the future 
direction of vital federal government programs and policies are made 
more difficult without timely, accurate, and useful financial and 
performance information.

Fortunately, we are starting to see efforts to address the shortcomings 
in federal financial reporting. The President's Management Agenda, 
which closely reflects GAO's list of high-risk government programs, is 
bringing attention to troubled areas across the federal government and 
is taking steps to better assess the results that programs are getting 
with the resources they are given. The Federal Accounting Standards 
Advisory Board is also making progress on many key financial reporting 
issues.

In addition to these efforts, we have published frameworks for 
analyzing various Social Security reform proposals[Footnote 24] and for 
analyzing health care reform proposals.[Footnote 25] We have also 
helped to create a consortium of "good government" organizations to 
stimulate the development of a set of key national indicators to assess 
the United States' overall position and progress over time and in 
comparison to those of other industrialized nations.

Budget experts at the Congressional Budget Office (CBO) and GAO 
continue to encourage reforms to the federal budget process to better 
reflect the federal government's commitments and signal emerging 
problems. Among other things, we have recommended that the federal 
government issue an annual report on major fiscal exposures. The 
President's fiscal year 2005 budget also proposes that future 
President's budgets report on any enacted legislation in the past year 
that worsens the unfunded obligations of programs with long-term 
actuarial projections, with CBO to make a similar report. Such 
reporting could be a good starting point.

Although these are positive initial steps, much more must be done given 
the magnitude of the federal government's fiscal challenge. A top-to-
bottom review of government activities to ensure their relevance and 
fit for the 21st century and their relative priority is long overdue. 
As I have spoken about in the past, the federal government needs a 
three-pronged approach to (1) restructure existing entitlement 
programs, (2) reexamine the base of discretionary and other spending, 
and (3) review and revise the federal government's tax policy, 
including major tax preferences, and enforcement programs. New 
accounting and reporting approaches, budget control mechanisms, and 
metrics are needed for considering and measuring the impact of spending 
and tax policies and decisions over the long term.

Closing Comments:

Our report on the U.S. government's consolidated financial statements 
for fiscal years 2003 and 2002 highlights the need to continue 
addressing the federal government's serious financial management 
weaknesses. With the significantly accelerated financial reporting time 
frame for fiscal year 2004 and beyond, it is essential that the federal 
government move away from the extraordinary efforts many federal 
agencies continue to make to prepare financial statements and toward 
giving prominence to strengthening the federal government's financial 
systems, reporting, and controls. This is the only way the federal 
government can meet the end goal of making timely, accurate, and useful 
financial and performance 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 our nation faces major long-term 
fiscal challenges that will require tough choices in setting priorities 
and linking resources to results.

The Congress and the President face the challenge of sorting out the 
many claims on the federal budget without the budget enforcement 
mechanisms or fiscal benchmarks that guided the federal government 
through the previous years of deficit reduction into the brief period 
of surplus. While a number of steps will be necessary to address this 
challenge, truth and transparency in federal government reporting are 
essential elements of any attempt to address the nation's long-term 
fiscal challenges. The fiscal risks I mentioned earlier can be managed 
only if they are properly accounted for and publicly disclosed. A 
crucial first step will be to face facts and identify the significant 
commitments facing the federal government. If citizens and federal 
government officials come to understand various fiscal exposures and 
their potential claims on future budgets, they are more likely to 
insist on prudent policy choices today and sensible levels of fiscal 
risk in the future. In addition, new budget control mechanisms will be 
required, along with effective approaches to successfully engage in a 
fundamental review, reassessment, and reprioritization of the base of 
federal government programs and policies that I have recommended 
previously.

Public officials will have more incentive to make difficult but 
necessary choices if the public has the facts and comes to support 
serious and sustained action to address the nation's fiscal challenges. 
Without meaningful public debate, however, real and lasting change is 
unlikely. Clearly, the sooner action is taken, the easier it will be to 
turn things around.

I believe that nothing less than a national education campaign and 
outreach effort is needed to help the public understand the nature and 
magnitude of the long-term financial challenge facing this nation. An 
informed electorate is essential for a healthy democracy. Members of 
Generations X and Y especially need to become active in this discussion 
because they and their children will bear the heaviest burden if 
policymakers fail to act in a timely and responsible manner.

We at GAO are committed to doing our part, but others also need to step 
up to the plate. By working together, I believe we can make a 
meaningful difference for our nation, fellow citizens, and future 
generations of Americans.

In closing, Mr. Chairman, I want to reiterate the value of sustained 
congressional interest in these issues, as demonstrated by the 
Congress's annual hearings on the results of our audit of the 
consolidated financial statements and of audits of certain federal 
agencies' financial statements. 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, or Gary T. Engel, Director, 
Financial Management and Assurance, at (202) 512-2600.

[End of section]

Appendix I: Selected Major Federal Agencies: Fiscal Year 2003 Audit 
Results, Principal Auditors, and Number of Other Audit Contractors:

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

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

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

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

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

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

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

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

23 CFO Act agencies: Health and Human Services; 
Audit results: Unqualified; 
Principal auditor: Inspector General; 
Number of: other audit contractors: 4.

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

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

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

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

23 CFO Act agencies: National Aeronautics and Space Administration; 
Audit results: Disclaimer; 
Principal auditor: PricewaterhouseCoopers LLP; 
Number of: other audit contractors: 2.

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

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

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

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

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

23 CFO Act agencies: State; 
Audit results: Unqualified; 
Principal auditor: Leonard G. Birnbaum and Company, LLP; 
Number of: other audit contractors: 2.

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

23 CFO Act agencies: Treasury; 
Audit results: Unqualified; 
Principal auditor: Inspector General; 
Number of: other audit contractors: 6[A].

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

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

Source: GAO.

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

[B] DHS began operations as an agency 5 months after the start of the 
fiscal year, on March 1, 2003. Transfers of funds, assets, liabilities, 
and obligations from 22 existing federal agencies to DHS began on March 
1, 2003. DHS's auditors issued a qualified opinion on the consolidated 
balance sheet and statement of custodial activity as of September 30, 
2003, and disclaimed on the consolidated statement of net cost, 
consolidated statement of changes in net position, combined statement 
of budgetary resources, and consolidated statement of financing for the 
7 months ended September 30, 2003.

[End of table]

[End of section]

Appendix II: Material Deficiencies:

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

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

The federal government could not satisfactorily determine that all PP&E 
and inventories and related property were included in the consolidated 
financial statements, verify that certain reported assets actually 
exist, or substantiate the amounts at which they were valued. Most of 
the PP&E and inventories and related property are the responsibility of 
DOD. As in past years, DOD did not maintain adequate systems or have 
sufficient records to provide reliable information on these assets. 
Other agencies, most notably the National Aeronautics and Space 
Administration, reported continued weaknesses in internal control 
procedures and processes related to PP&E.

Liabilities and Commitments and Contingencies:

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

Cost of Government Operations and Disbursement Activity:

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

With respect to disbursements, DOD and certain other federal agencies 
did not adequately reconcile disbursement activity. For fiscal years 
2003 and 2002 there were unsupported adjustments to federal agencies' 
records and unreconciled disbursement activity, including unreconciled 
differences between federal agencies' and Treasury's records of 
disbursements, totaling billions of dollars, which could also affect 
the balance sheet.

Accounting for and Reconciliation of Intragovernmental Activity and 
Balances:

OMB and Treasury require the CFOs of 35 executive departments and 
agencies, including the 23 CFO Act agencies, to reconcile selected 
intragovernmental activity and balances with their "trading 
partners"[Footnote 26] and to report to Treasury, the agency's 
inspector general, and GAO on the extent and results of 
intragovernmental activity and balances reconciliation efforts. A 
substantial number of the agencies did not fully perform the required 
reconciliations for fiscal years 2003 and 2002, citing reasons such as 
(1) trading partners not providing needed data, (2) limitations and 
incompatibility of agency and trading partner information systems, and 
(3) lack of human resources. For both of these years, amounts reported 
for federal agency trading partners for certain intragovernmental 
accounts were significantly out of balance. Treasury's ability to 
eliminate certain intragovernmental activity and balances is impaired 
by these federal agencies' problems in handling their intragovernmental 
transactions.

Net Outlays:

OMB Bulletin 01-09, Form and Content of Agency Financial 
Statements,[Footnote 27] states that outlays in federal agencies' 
Statements of Budgetary Resources (SBR) should agree with the 
respective agency's net outlays reported in the budget of the U.S. 
government. In addition, Statement of Federal Financial Accounting 
Standards (SFFAS) No. 7, Accounting for Revenue and Other Financing 
Sources and Concepts for Reconciling Budgetary and Financial 
Accounting, requires explanation of any material differences between 
the information required to be disclosed (including net outlays) and 
the amounts described as "actual" in the budget of the U.S. government.

We found material differences between the total net outlays reported in 
selected federal agencies' audited SBRs and the records used to prepare 
the Statement of Changes in Cash Balance from Unified Budget and Other 
Activities (Statement of Changes in Cash Balance),[Footnote 28] 
totaling about $140 billion and $186 billion for fiscal years 2003 and 
2002, respectively.[Footnote 29] Two agencies (Treasury and the 
Department of Health and Human Services (HHS)) accounted for about 83 
percent and 75 percent of the differences identified in fiscal years 
2003 and 2002, respectively. We found that the major cause of the 
differences for the two agencies was the treatment of offsetting 
receipts.[Footnote 30] Some offsetting receipts for these two agencies 
had not been included in the agencies' SBRs, which would have reduced 
the agencies' net outlays and made the amounts more consistent with the 
records used to prepare the Statement of Changes in Cash 
Balance.[Footnote 31] For example, we found that HHS reported net 
outlays for fiscal year 2003 as $596 billion on its audited SBR, while 
the records that Treasury uses to prepare the Statement of Changes in 
Cash Balance showed $505 billion for fiscal year 2003 for this agency. 
Until these differences between the total net outlays reported in the 
federal agencies' SBRs and the records used to prepare the Statement of 
Changes in Cash Balance are reconciled, the effect that these 
differences may have on the U.S. government's consolidated financial 
statements will be unknown. OMB has stated that it plans to work with 
the agencies to address this issue.

Preparation of Consolidated Financial Statements:

The federal government did not have adequate systems, controls, and 
procedures to ensure that the consolidated financial statements are 
consistent with the underlying audited agency financial statements, 
balanced, and in conformity with generally accepted accounting 
principles (GAAP). During our fiscal year 2003 audit, we found the 
following:[Footnote 32]

* The process for compiling the consolidated financial statements does 
not directly link information from federal agencies' audited financial 
statements to amounts reported in the consolidated financial 
statements, and therefore does not ensure that the information in the 
consolidated financial statements is consistent with the underlying 
information in federal agencies' audited financial statements and other 
financial data.

* Internal control weaknesses exist in Treasury's process for preparing 
the consolidated financial statements, such as a lack of (1) 
segregation of duties and (2) appropriate documentation of certain 
policies and procedures for preparing the consolidated financial 
statements.

* The net position reported in the consolidated financial statements is 
derived by subtracting liabilities from assets, rather than through 
balanced accounting entries. To make the fiscal years 2003 and 2002 
consolidated financial statements balance, Treasury recorded a net 
$24.5 billion and a net $17.1 billion decrease, respectively, to net 
operating cost on the Statements of Operations and Changes in Net 
Position, which it labeled "Unreconciled Transactions Affecting the 
Change in Net Position."[Footnote 33] An additional net $11.3 billion 
and $12.5 billion of unreconciled transactions were recorded in the 
Statements of Net Cost for fiscal years 2003 and 2002, respectively. 
Treasury does not identify and quantify all components of these 
unreconciled activities, nor does Treasury perform reconciliation 
procedures, which would aid in understanding and controlling the net 
position balance as well as eliminating the unreconciled transactions 
associated with compiling the consolidated financial statements.

* Significant differences in other intragovernmental accounts, 
primarily related to appropriations, still remain unresolved. 
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 
federal government's inability to determine the impact of these 
differences on amounts reported in the consolidated financial 
statements.

* The federal government did not have an adequate process to identify 
and report items needed to reconcile the operating results, which for 
fiscal year 2003 showed a net operating cost of $665 billion, to the 
budget results, which for the same period showed a unified budget 
deficit of $374.8 billion.

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

* Treasury lacks an adequate process to ensure that the financial 
statements, related notes, Stewardship Information, and Supplemental 
Information are presented in conformity with GAAP. We found that 
certain financial information required by GAAP was not disclosed in the 
consolidated financial statements. Treasury did not provide us with 
documentation of its rationale for excluding this information. As a 
result of this and certain material deficiencies noted above, we were 
unable to determine if the missing information was material to the 
consolidated financial statements.

Other Material Weaknesses:

In addition to the material deficiencies noted above, we found four 
other material weaknesses in internal control as of September 30, 2003: 
(1) several federal agencies continue to have deficiencies in the 
processes and procedures used to estimate the costs of their lending 
programs and value their related loans receivable; (2) most federal 
agencies have not reported the magnitude of improper payments in their 
programs and activities; (3) federal agencies have not yet fully 
institutionalized comprehensive security management programs; and (4) 
material internal control weaknesses and systems deficiencies continue 
to affect the federal government's ability to effectively manage its 
tax collection activities.

Loans Receivable and Loan Guarantee Liabilities:

In general, federal agencies continue to make progress in reducing the 
number of material weaknesses and reportable conditions[Footnote 34] 
related to their lending activities. However, significant deficiencies 
in the processes and procedures used to estimate the costs of certain 
lending programs and value the related loans receivable still remain. 
These deficiencies continue to adversely affect the government's 
ability to support annual budget requests for these programs, make 
future budgetary decisions, manage program costs, and measure the 
performance of lending activities. The most notable deficiencies 
existed at the Small Business Administration (SBA), which, while 
improved from last year, continues to have a material weakness related 
to this area. For example, SBA did not adequately document its 
estimation methodologies, lacked the management controls necessary to 
ensure that appropriate estimates were prepared and reported based on 
complete and accurate data, and could not fully support the 
reasonableness of the costs of its lending programs and valuations of 
its loan portfolio. We are currently assessing SBA's actions to resolve 
certain of these deficiencies related to accounting for previous loan 
sales and cost estimates for disaster loans.

Improper Payments:

Across the federal government, improper payments occur in a variety of 
programs and activities, including those related to health care, 
contract management, federal financial assistance, and tax 
refunds.[Footnote 35] While complete information on the magnitude of 
improper payments is not yet available, based on available data, OMB 
has estimated that improper payments exceed $35 billion annually. Many 
improper payments occur in federal programs that are administered by 
entities other than the federal government, such as states. Improper 
payments often result from a lack of or an inadequate system of 
internal controls. Although the President's Management Agenda includes 
an initiative to reduce improper payments, most federal agencies have 
not reported the magnitude of improper payments in their programs and 
activities.

The Improper Payments Information Act of 2002[Footnote 36] provides for 
federal agencies to estimate and report on their improper payments. It 
requires federal agencies to (1) annually review programs and 
activities that they administer to identify those that may be 
susceptible to significant improper payments, (2) estimate improper 
payments in susceptible programs and activities, and (3) provide 
reports to the Congress that discuss the causes of improper payments 
identified and the status of actions to reduce them. In accordance with 
the legislation, OMB issued guidance for federal agencies' use in 
implementing the act. Among other things, the guidance requires federal 
agencies to report on their improper payment-related activities in the 
Management Discussion and Analysis section of their annual Performance 
and Accountability Reports (PAR). While the act does not require such 
reporting by all federal agencies until fiscal year 2004, OMB required 
44 programs and 14 CFO Act agencies to report improper payment 
information in their fiscal year 2003 PARs. Our preliminary review of 
the PARs found that 12 of the 14 agencies reported improper payment 
amounts for 27 of the 44 programs identified in the guidance. We also 
found that, for the programs where improper payments were identified, 
the reports often contained information on the causes of the payments 
but little information that addressed the other reporting requirements 
cited in the legislation.

Information Security:

Although progress has been made, serious and widespread information 
security weaknesses continue to place federal assets at risk of 
inadvertent or deliberate misuse, financial information at risk of 
unauthorized modification or destruction, sensitive information at risk 
of inappropriate disclosure, and critical operations at risk of 
disruption. GAO has reported information security as a high-risk area 
across government since February 1997. Such information security 
weaknesses could result in compromising the reliability and 
availability of data that are recorded in or transmitted by federal 
financial management systems. A primary reason for these weaknesses is 
that federal agencies have not yet fully institutionalized 
comprehensive security management programs, which are critical to 
identifying information security weaknesses, resolving information 
security problems, and managing information security risks on an 
ongoing basis. The Congress has shown continuing interest in addressing 
these risks, as evidenced by recent hearings on information security 
and enactment of the Federal Information Security Management Act of 
2002[Footnote 37] and the Cyber Security Research and Development 
Act.[Footnote 38] In addition, the administration has taken important 
actions to improve information security, such as integrating 
information security into the Executive Branch Management 
Scorecard.[Footnote 39]

Tax Collection Activities:

Material internal control weaknesses and systems deficiencies continue 
to affect the federal government's ability to effectively manage its 
tax collection activities.[Footnote 40] Due to errors and delays in 
recording activity in taxpayer accounts, taxpayers were not always 
credited for payments made on their taxes owed, which could result in 
undue taxpayer burden. In addition, the federal government did not 
always follow up on potential unreported or underreported taxes and did 
not always pursue collection efforts against taxpayers owing taxes to 
the federal government.

[End of section]

Appendix III: Primary Effects of the Material Weaknesses Described in 
This Report:

Areas Involving Material Weaknesses: Property, plant, and equipment and 
inventories and related property; 
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated 
Financial Statements and the Management of Government Operations: 
Without accurate asset information, the federal government does not 
fully know the assets it owns and their location and condition and 
cannot effectively (1) safeguard assets from physical deterioration, 
theft, or loss, (2) account for acquisitions and disposals of such 
assets, (3) ensure the assets are available for use when needed, (4) 
prevent unnecessary storage and maintenance costs or purchase of assets 
already on hand, and (5) determine the full costs of programs that use 
these assets.

Areas Involving Material Weaknesses: Liabilities and commitments and 
contingencies; 
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated 
Financial Statements and the Management of Government Operations: 
Problems in accounting for liabilities affect the determination of the 
full cost of the federal government's current operations and the extent 
of its liabilities. Also, improperly stated environmental and disposal 
liabilities and weak internal control supporting the process for their 
estimation affect the federal government's ability to determine 
priorities for cleanup and disposal activities and to allow for 
appropriate consideration of future budgetary resources needed to carry 
out these activities. In addition, when disclosures of commitments and 
contingencies are incomplete or incorrect, reliable information is not 
available about the extent of the federal government's obligations.

Areas Involving Material Weaknesses: Cost of government operations and 
disbursement activity; 
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated 
Financial Statements and the Management of Government Operations: 
Inaccurate cost information affects the federal government's ability 
to control and reduce costs, assess performance, evaluate programs, and 
set fees to recover costs where required. Improperly recorded 
disbursements could result in misstatements in the financial statements 
and in certain data provided by federal agencies for inclusion in the 
President's budget concerning obligations and outlays.

Areas Involving Material Weaknesses: Accounting for and reconciliation 
of intragovernmental activity and balances; 
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated 
Financial Statements and the Management of Government Operations: 
Problems in accounting for and reconciling intragovernmental activity 
and balances impair the government's ability to account for billions of 
dollars of transactions between governmental entities.

Areas Involving Material Weaknesses: Net outlays; 
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated 
Financial Statements and the Management of Government Operations: Until 
the differences between the total net outlays reported in federal 
agencies' Statements of Budgetary Resources and the records used by the 
Department of the Treasury to prepare the Statement of Changes in Cash 
Balance from Unified Budget and Other Activities are reconciled, the 
effect that these differences may have on the U.S. government's 
consolidated financial statements will be unknown.

Areas Involving Material Weaknesses: Preparation of consolidated 
financial statements; 
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated 
Financial Statements and the Management of Government Operations: 
Because the federal government did not have adequate systems, controls, 
and procedures to prepare its consolidated financial statements, the 
federal government's ability to ensure that the consolidated financial 
statements are consistent with the underlying audited agency financial 
statements, balanced, and in conformity with U.S. generally accepted 
accounting principles was impaired.

Areas Involving Material Weaknesses: Improper payments; 
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated 
Financial Statements and the Management of Government Operations: 
Without a systematic measurement of the extent of improper payments, 
federal agency management cannot determine (1) if improper payment 
problems exist that require corrective action, (2) mitigation 
strategies and the appropriate amount of investments to reduce them, 
and (3) the success of efforts implemented to reduce improper 
payments.

Areas Involving Material Weaknesses: Loans receivable and loan 
guarantee liabilities; 
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated 
Financial Statements and the Management of Government Operations: 
Weaknesses in the processes and procedures for estimating credit 
program costs affect the government's ability to support annual budget 
requests for these programs, make future budgetary decisions, manage 
program costs, and measure the performance of lending activities.

Areas Involving Material Weaknesses: Information security weaknesses; 
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated 
Financial Statements and the Management of Government Operations: 
Information security weaknesses over computerized operations are 
placing enormous amounts of federal assets at risk of inadvertent or 
deliberate misuse, financial information at risk of unauthorized 
modification or destruction, sensitive information at risk of 
inappropriate disclosure, and critical operations at risk of 
disruption.

Areas Involving Material Weaknesses: Tax collection activities; 
Primary Effects on the Fiscal Years 2003 and 2002 Consolidated 
Financial Statements and the Management of Government Operations: 
Weaknesses in controls over tax collection activities continue to 
affect the federal government's ability to efficiently and effectively 
account for and collect revenue. Additionally, weaknesses in financial 
reporting affect the federal government's ability to make informed 
decisions about collection efforts. As a result, the federal government 
is vulnerable to loss of tax revenue and exposed to potentially 
billions of dollars in losses due to inappropriate refund 
disbursements. 

Source: GAO.

[End of table]

(198304):

FOOTNOTES

[1] In addition, GAO is providing separate statements today on problems 
related to financial and business management systems and processes at 
the Department of Defense and the Department of Homeland Security. See 
U.S. General Accounting Office, Department of Defense: Financial and 
Business Management Transformation Hindered by Long-standing Problems, 
GAO-04-941T (Washington, D.C.: July 8, 2004), and Department of 
Homeland Security: Financial Management Challenges, GAO-04-945T 
(Washington, D.C.: July 8, 2004).

[2] 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.

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

[4] JFMIP is a joint and cooperative undertaking of the Department of 
the Treasury, GAO, the Office of Management and Budget (OMB), and the 
Office of Personnel Management working in cooperation with each other 
and other federal agencies to improve financial management practices in 
the federal government. Leadership and program guidance are provided by 
the four Principals of the JFMIP--the Comptroller General of the United 
States, the Secretary of the Treasury, and the Directors of OMB and the 
Office of Personnel Management.

[5] 31 U.S.C. § 901(b). One of the 24 CFO Act agencies, the Federal 
Emergency Management Agency, was transferred to the new Department of 
Homeland Security effective March 1, 2003. With this transfer, the 
Federal Emergency Management Agency will no longer be required to 
prepare and have audited stand-alone financial statements under the CFO 
Act, leaving 23 CFO Act agencies. 

[6] DHS is not a CFO Act agency and is therefore not subject to CFO Act 
requirements. However, along with most other executive branch agencies 
not covered by the CFO Act, DHS is required to prepare and have audited 
financial statements under the Accountability of Tax Dollars Act of 
2002, Pub. L. No. 107-289, 116 Stat. 2049 (Nov. 7, 2002). For fiscal 
year 2003, the act provided that OMB could grant executive branch 
agencies' requests for waivers from having audited financial statements 
for fiscal year 2003. However, DHS and certain other agencies chose to 
prepare and have their fiscal year 2003 financial statements audited.

[7] At least 4 CFO Act agencies restated certain of their audited 
fiscal year 2002 financial statements to correct misstatements in such 
financial statements. All 4 of the agencies had received unqualified 
opinions on their fiscal year 2002 financial statements. These 
restatements were not material to the consolidated financial 
statements.

[8] DHS began operations as an agency 5 months after the start of the 
fiscal year, on March 1, 2003. Transfers of funds, assets, liabilities, 
and obligations from 22 existing federal agencies to DHS began on March 
1, 2003. DHS's auditors issued a qualified opinion on the consolidated 
balance sheet and statement of custodial activity as of September 30, 
2003, and disclaimed on the consolidated statement of net cost, 
consolidated statement of changes in net position, combined statement 
of budgetary resources, and consolidated statement of financing for the 
7 months ended September 30, 2003. In accordance with Federal 
Accounting Standards Advisory Board Technical Bulletin 2003-1, Certain 
Questions and Answers Related to the Homeland Security Act of 2002, the 
fiscal year 2003 activities that occurred prior to the transfer of 
operations to DHS were to be reflected in the transferring agencies' 
financial statements.

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

[10] We previously reported that material deficiencies prevented us 
from expressing an opinion on the fiscal years 1997, 1998, 1999, 2000, 
2001, and 2002 consolidated financial statements of the U.S. 
government.

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

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

[13] Pub. L. No. 107-107, § 1008, 115 Stat. 1012, 1204 (Dec. 28, 2001).

[14] Although not major DOD components, the Military Retirement Fund 
received an unqualified opinion on its fiscal year 2003 financial 
statements, and the DOD Medicare-Eligible Retiree Health Care Fund 
received a qualified opinion on its fiscal year 2003 financial 
statements.

[15] U.S. General Accounting Office, Military Pay: Army National Guard 
Personnel Mobilized to Active Duty Experienced Significant Pay 
Problems, GAO-04-413T (Washington, D.C.: Jan. 28, 2004).

[16] U.S. General Accounting Office, DOD Travel Cards: Control 
Weaknesses Led to Millions in Fraud, Waste, and Improper Payments, GAO-
04-825T (Washington, D.C.: June 9, 2004).

[17] U.S. General Accounting Office, DOD Business Systems 
Modernization: Limited Progress in Development of Business Enterprise 
Architecture and Oversight of Information Technology Investments, GAO-
04-731R (Washington, D.C.: May 17, 2004). 

[18] U.S. General Accounting Office, DOD Business Systems 
Modernizations: Improvements to Enterprise Architecture Development 
and Implementation Efforts Needed, GAO-03-458 (Washington, D.C.: Feb. 
28, 2003), and DOD Business Systems Modernizations: Important Progress 
Made to Develop Business Enterprise Architecture, but Much Work 
Remains, GAO-03-1018 (Washington, D.C.: Sept. 19, 2003).

[19] U.S. General Accounting Office, Department of Defense: Further 
Actions Needed to Establish and Implement a Framework for Successful 
Financial and Business Management Transformation, GAO-04-551T 
(Washington, D.C.: Mar. 23, 2004), and Department of Defense: Further 
Actions Needed to Establish and Implement a Framework for Successful 
Business Transformation, GAO-04-626T (Washington, D.C.: Mar. 31, 2004).

[20] On September 9, 2002, GAO convened a roundtable of executive 
branch leaders and management experts to discuss the Chief Operating 
Officer concept. For more information, see U.S. General Accounting 
Office, Highlights of a GAO Roundtable: The Chief Operating Officer 
Concept: A Potential Strategy to Address Federal Governance Challenges, 
GAO-03-192SP (Washington, D.C.: Oct. 4, 2002).

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

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

[23] The Federal Accounting Standards Advisory Board has a project 
under way to consider recognition, measurement, and display of social 
insurance obligations.

[24] U.S. General Accounting Office, Social Security Reform: Analysis 
of Reform Models Developed by the President's Commission to Strengthen 
Social Security, GAO-03-310 (Washington, D.C.: Jan. 15, 2003).

[25] GAO's health care framework can be found at www.gao.gov/cghome/
hccrisis/health.pdf. See also Comptroller General's Forum on Health 
Care: Unsustainable Trends Necessitate Comprehensive and Fundamental 
Reforms to Control Spending and Improve Value, GAO-04-793SP 
(Washington, D.C.: May 1, 2004).

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

[27] Office of Management and Budget Bulletin No. 01-09, Form and 
Content of Agency Financial Statements (Washington, D.C.: Sept. 25, 
2001). This bulletin is OMB's official guidance for the form and 
content of federal agencies' financial statements. 

[28] OMB and U.S. generally accepted accounting principles (GAAP) 
require agencies to report net outlays in the SBR. The Statement of 
Changes in Cash Balance also reports unified budget outlays-actual. 
Both are intended to represent the same amount and be consistent with 
the information presented in the budget of the U.S. government. 

[29] In some agencies' fiscal year 2003 financial statements, the 
comparable fiscal year 2002 amounts were restated.

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

[31] These two agencies did not adequately explain their fiscal year 
2002 differences between the net outlays reported on the SBR and the 
budget of the U.S. government in their notes to the fiscal year 2003 
financial statements.

[32] The same issues we identified in fiscal year 2003 existed in 
fiscal year 2002, and some have existed for a number of years. In 
October 2003, we reported in greater detail on the issues we 
identified, in U.S. General Accounting Office, Financial Audit: Process 
for Preparing the Consolidated Financial Statements of the U.S. 
Government Needs Improvement, GAO-04-45 (Washington, D.C.: Oct. 30, 
2003). This report included 44 recommendations to address weaknesses we 
identified. It also included recommendations related to 16 disclosure 
areas that are required by GAAP. We recommended that the 16 disclosures 
that are not included in the consolidated financial statements either 
be included or that the rationale for their exclusion be documented.

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

[34] Reportable conditions are matters coming to our attention that, in 
our judgment, should be communicated because they represent significant 
deficiencies in the design or operation of internal control that could 
adversely affect the federal government's ability to meet the internal 
control objectives relating to financial reporting and compliance with 
laws and regulations.

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

[36] Pub. L. No. 107-300, 116 Stat. 2350 (Nov. 26, 2002). The act's 
reporting requirement on actions taken by agencies to reduce improper 
payments applies only to an agency program or activity with estimated 
improper payments exceeding $10 million.

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

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

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

[40] U.S. General Accounting Office, Financial Audit: IRS's Fiscal 
Years 2003 and 2002 Financial Statements, GAO-04-126 (Washington, D.C.: 
Nov. 13, 2003).