oversight

Financial Audit: Examination of IRS' Fiscal Year 1996 Administrative Financial Statements

Published by the Government Accountability Office on 1997-08-29.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 United States General Accounting Office

GAO              Report to the Congress




July 1997
                 FINANCIAL AUDIT
                 Examination of IRS’
                 Fiscal Year 1996
                 Administrative
                 Financial Statements




GAO/AIMD-97-89
      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      Comptroller General
      of the United States

      B-276920

      July 31, 1997

      To the President of the Senate and the
      Speaker of the House of Representatives

      In accordance with the Chief Financial Officers (CFO) Act of 1990, as
      expanded by the Government Management Reform Act of 1994, this report
      presents the results of our audit of the Administrative Financial
      Statements of the Internal Revenue Service (IRS) for fiscal year 1996. The
      IRS Administrative Financial Statements report the financial position and
      results of operations related solely to the administration of IRS as funded
      by appropriations and reimbursements from other agencies, state and
      local governments, and the public.

      Accordingly, these Administrative Financial Statements do not report on
      activities related to IRS’ custodial responsibilities for implementing federal
      tax legislation, including collecting federal tax revenues, refunding
      overpayments of taxes, and pursuing collection of amounts owed. The
      annual financial results relating to these custodial responsibilities are
      reported separately in IRS’ Custodial Financial Statements. We will report
      the results of our audit of those financial statements for fiscal year 1996 at
      a later date.

      Our report contains our opinions on (1) IRS’ Administrative Financial
      Statements and (2) IRS management’s assertion about the effectiveness of
      internal controls, along with information regarding our efforts to test
      compliance with laws and regulations and a description of our audit
      objectives, scope, and methodology. Also, appendix I describes the status
      of IRS’ efforts to implement our prior recommendations related to the
      Administrative Financial Statements.

      We are sending copies of this report to the Acting Commissioner of
      Internal Revenue; the Secretary of the Treasury; the Director of the Office
      of Management and Budget; the Chairmen and Ranking Minority Members
      of the Senate Committee on Governmental Affairs, the House Committee
      on Government Reform and Oversight and its Subcommittee on
      Government Management, Information and Technology; and other
      interested congressional committees. Copies will be made available to
      others upon request.

      This report was prepared under the direction of Gregory M. Holloway,
      Director, Governmentwide Audits, with the support of IRS’ Internal Audit




      Page 1                                         GAO/AIMD-97-89 IRS Financial Audit
B-276920




staff and staff from the Accounting and Information Management
Division’s Governmentwide Audits Group and Audit Support and Quality
Assurance Group. If you have any questions, please contact Mr. Holloway
at (202) 512-9510.




James F. Hinchman
Acting Comptroller General
of the United States




Page 2                                     GAO/AIMD-97-89 IRS Financial Audit
Page 3   GAO/AIMD-97-89 IRS Financial Audit
Contents



Letter                                                                                             1


Opinion Letter                                                                                     6


Financial Statements                                                                              20


Appendix I                                                                                        35

Reports Issued as a
Result of GAO’S Audit
of IRS’ Fiscal Year
1992, 1993, 1994, and
1995 Financial
Statements and Status
of Recommendations
Related to
Administrative
Accounting
Operations
Appendix II                                                                                       38
                        FINANCIAL STATEMENTS                                                      38
Comments From the       Overview of the Financial Statements (Administrative)                     39
Internal Revenue        Statement of Operations and Changes in Net Position                       40
                          (Administrative)
Service                 Notes to Financial Statements (Administrative)                            41




                        Abbreviations

                        ADP       automated data processing
                        BCA       budget clearing
                        CFO       Chief Financial Officer
                        FMFIA     Federal Managers’ Financial Integrity Act of 1982
                        IRS       Internal Revenue Service
                        OMB       Office of Management and Budget
                        SFFAS     Statement of Federal Financial Accounting Standard


                        Page 4                                     GAO/AIMD-97-89 IRS Financial Audit
Page 5   GAO/AIMD-97-89 IRS Financial Audit
          United States
GAO       General Accounting Office
          Washington, D.C. 20548

          Comptroller General
          of the United States

          B-276920



          To the Commissioner of Internal Revenue

          In accordance with the Chief Financial Officers (CFO) Act of 1990, as
          expanded by the Government Management Reform Act of 1994, this report
          presents the results of our audit of the Administrative Financial
          Statements of the Internal Revenue Service (IRS) for fiscal year 1996. The
          IRS Administrative Financial Statements report the financial position and
          results of operations related solely to the administration of IRS as funded
          by appropriations and reimbursements from other agencies, state and
          local governments, and the public.

          Accordingly, these Administrative Financial Statements do not report on
          activities related to IRS’ custodial responsibilities for implementing federal
          tax legislation, including collecting federal tax revenues, refunding
          overpayments of taxes, and pursuing collection of amounts owed. The
          annual financial results relating to these custodial responsibilities are
          reported separately in IRS’ Custodial Financial Statements. We will report
          the results of our audit of those statements for fiscal year 1996 at a later
          date.

          In our audit of IRS’ fiscal year 1996 Administrative Financial Statements,
          we found the following:

      •   The Statement of Administrative Financial Position was reliable in all
          material respects, except that evidence about the composition and validity
          of administrative accounts receivable as of September 30, 1996, was not
          available. Accordingly, we could not determine the reliability of the
          accounts receivable balances shown and the effect any adjustment
          required to correct the accounts receivable balances might have on net
          position. In addition, because property and equipment have not been
          capitalized and reported, we cannot determine the effect capitalization
          would have on net position.
      •   We are unable to give an opinion on the Statement of Administrative
          Operations and Changes in Net Position because of limitations on the
          scope of our work. Specifically, IRS did not attempt to fully restate its fiscal
          year 1996 opening account balances to address problems identified in our
          prior year audit, and inadequacies in the recordkeeping and control
          systems affected our ability to determine whether reported fiscal year 1996
          operating expenses and revenues related to services that were actually
          provided in fiscal year 1996. Furthermore, in the absence of reliable




          Page 6                                         GAO/AIMD-97-89 IRS Financial Audit
                           B-276920




                           information on property and equipment, we are unable to determine the
                           effect on the Statement of Administrative Operations and Changes in Net
                           Position of IRS’ not recording depreciation. Thus, the Statement of
                           Administrative Operations and Changes in Net Position may be unreliable.
                       •   We agree with management’s assertion that internal controls were
                           ineffective in (1) safeguarding assets, such as administrative accounts
                           receivable and fund balances with Treasury, from material loss,
                           (2) assuring material compliance with laws governing the use of budget
                           authority and with other relevant laws and regulations, and (3) assuring
                           that there were no material misstatements in amounts reported in the
                           financial statements, such as administrative accounts receivable and
                           operating revenues and expenses. However, IRS failed to report the
                           material weaknesses we found in our review of its computer security
                           controls at its Detroit Computing Center.
                       •   Material weaknesses in internal control and recordkeeping systems, which
                           are discussed later in this report, precluded the test necessary to provide a
                           basis for any report on compliance with pertinent laws and regulations.


                           Because IRS could not provide us with supporting documentation for its
Qualified Opinion on       reported administrative accounts receivable balances, we cannot
Statement of               determine if the Statement of Administrative Financial Position’s
Administrative             presentation of accounts receivable and net position is reliable. In
                           addition, because property and equipment have not been capitalized and
Financial Position         reported, we cannot determine the effect capitalization would have on net
                           position. Otherwise, in our opinion, the Statement of Financial Position,
                           including the related accompanying notes, presents fairly, in all material
                           respects, in conformity with a comprehensive basis of accounting other
                           than generally accepted accounting principles, as described in note 1, IRS’
                           administrative assets, liabilities, and net financial position.

                           Without key documentation concerning the basis for IRS’ accounts
                           receivables, including whether IRS had provided the specific services by
                           fiscal year-end, we could not determine whether the amounts reported
                           represent valid unpaid claims for reimbursement for services provided to
                           other entities during or prior to fiscal year 1996. In addition, we could not
                           determine the effect any adjustment required to correct the reported
                           balances might have on net position. Most of IRS’ administrative accounts
                           receivable represent amounts due from other federal agencies for services
                           provided to them by IRS. Proper accounting and reporting of
                           intergovernmental accounts receivable and payable is a problem across
                           the federal government.



                           Page 7                                        GAO/AIMD-97-89 IRS Financial Audit
                        B-276920




                        Department of the Treasury and IRS policies require capitalization of
                        property and equipment. However, because of inherent weaknesses in IRS’
                        systems, which are discussed later in this report, IRS did not capitalize its
                        property and equipment and report it on the Statement of Administrative
                        Financial Position for fiscal year 1996. IRS stated that it is developing
                        procedures which will enable it to capitalize and depreciate its property
                        and equipment.

                        In August 1993, we reported that IRS officials had concluded that the
                        information in IRS’ automated data processing system was so unreliable
                        that it could not be used for the fixed asset balance in its fiscal year 1992
                        financial statements.1 We noted in our report on our audit of IRS’ fiscal year
                        1993 financial statements that as a result of its first nationwide physical
                        inventory of automated data processing property and equipment, IRS had
                        made significant improvements in the recording and valuation of its
                        property and equipment.2 However, we also reported that IRS did not have
                        an interface between the general ledger and the property and equipment
                        systems or reconcile the two. In IRS’ notes to its fiscal years 1993 through
                        1996 financial statements, IRS reported that because of this nonintegration
                        of its systems, the acquisition cost of all property and equipment is
                        expensed in the Statement of Administrative Operations and Changes in
                        Net Position rather than capitalized and depreciated. IRS’ plans for
                        addressing this issue are discussed later in this report.


                        We are unable to give an opinion on the Statement of Administrative
Disclaimer of Opinion   Operations and Changes in Net Position for fiscal year 1996 because of
on Statement of         limitations on the scope of our work. Specifically, IRS did not attempt to
Administrative          fully restate its fiscal year 1996 opening account balances to address
                        problems identified in our prior year audit. In addition, the following
Operations and          inadequacies in the recordkeeping and control systems affected our ability
Changes in Net          to determine whether reported fiscal year 1996 operating expenses and
                        revenues related to services that were actually provided in fiscal year 1996.
Position                Furthermore, in the absence of reliable information on property and
                        equipment, we are unable to determine the effect on the Statement of
                        Administrative Operations and Changes in Net Position of IRS not
                        recording depreciation.



                        1
                         Financial Management: IRS Lacks Accountability Over Its ADP Resources (GAO/AIMD-93-24, August
                        5, 1993).
                        2
                         Financial Audit: Examination of IRS’ Fiscal Year 1993 Financial Statements (GAO/AIMD-94-120,
                        June 15, 1994).



                        Page 8                                                     GAO/AIMD-97-89 IRS Financial Audit
                          B-276920




                      •   As noted above, IRS was unable to provide us with documentation to
                          support its reported administrative accounts receivables. Consequently,
                          we could not determine whether the related revenue for fiscal year 1996
                          attributable to reimbursable work agreements was correct and reported in
                          the period the services were actually provided to other entities.
                      •   IRS’ financial management system, as implemented, records accounts
                          payable only when both an invoice has been received and the goods or
                          services have been received and accepted. Therefore, liabilities for goods
                          or services received and accepted are not routinely recorded until an
                          invoice has also been received and processed. This practice, along with
                          internal control weaknesses for the receipt and acceptance of goods and
                          services, affected our ability to audit the fiscal year 1996 Statement of
                          Administrative Operations and Changes in Net Position in two ways. First,
                          we could not determine the reliability of the reported fiscal year 1996
                          operating expenses because IRS did not determine what portion of these
                          expenses pertained to goods or services actually received in the previous
                          fiscal year. Thus, the reported balance for operating expenses is
                          overstated to the extent that it includes such amounts. Second, in order to
                          establish an accounts payable amount as of September 30, 1996, special
                          procedures were used, including statistical sampling techniques, to
                          estimate the amount. While this effort resulted in a reasonable estimate for
                          the liability, it did not enable IRS to identify all of the specific transactions
                          and the related operating expense classifications (tax law enforcement,
                          information systems, etc.) relating to this estimated balance.
                      •   Although IRS was able to reconcile its September 30, 1996, Fund Balance
                          with Treasury accounts to Treasury’s records within an immaterial
                          amount, IRS did not attempt to completely determine what portion of the
                          adjustments made as a result of the reconciliation process pertained to
                          goods or services actually received in prior fiscal years. Consequently, we
                          could not determine the reliability of the reported fiscal year 1996
                          operating expenses, since they are overstated to the extent they include
                          such amounts.


                          We evaluated management’s assertion about the effectiveness of its
Opinion on                internal controls designed to
Management’s
Assertion About the   •   safeguard assets against loss from unauthorized acquisition, use, or
                          disposition;
Effectiveness of      •   assure the execution of transactions in accordance with laws governing
Internal Controls         the use of budget authority and with other laws and regulations that have a
                          direct and material effect on the Administrative Financial Statements or



                          Page 9                                          GAO/AIMD-97-89 IRS Financial Audit
    B-276920




    are listed in Office of Management and Budget (OMB) audit guidance and
    could have a material effect on the Administrative Financial Statements;
    and
•   properly record, process, and summarize transactions to permit the
    preparation of reliable financial statements and to maintain accountability
    for assets.

    IRS management fairly stated, except it did not report weaknesses we
    found in its computer security controls at its Detroit Computing Center,
    that because of the material weaknesses in internal controls described
    later in this section, internal controls do not provide reasonable assurance
    that

•   unauthorized acquisition, use, or disposition of assets, such as
    administrative accounts receivable and fund balances with Treasury, that
    could lead to losses;
•   noncompliance with laws governing the use of budget authority and with
    other relevant laws and regulations; and
•   misstatements in amounts reported in the financial statements, such as
    administrative accounts receivable and operating revenues and expenses
    material in relation to the financial statements would be prevented or
    detected.

    Management made this assertion based upon criteria established under the
    Federal Managers’ Financial Integrity Act of 1982 (FMFIA) and the Office of
    Management and Budget Circular A-123, Management Accountability and
    Control. A material weakness is a condition in which the design or
    operation of one or more of the internal control structure elements does
    not reduce to a relatively low level the risk that errors or irregularities in
    amounts that would be material to the financial statements may occur and
    not be detected promptly by employees in the normal course of
    performing their duties. Our internal control work would not necessarily
    disclose material weaknesses not reported by IRS.

    The following material weaknesses, most of which we also found in our
    prior audits of IRS, were reported in IRS’ FMFIA report for fiscal year 1996.
    These deficiencies in internal controls may adversely affect any decision
    by management that is based, in whole or in part, on information that is
    inaccurate because of the deficiencies. Unaudited financial information
    reported by IRS, including budgetary information, may also contain
    misstatements resulting from these deficiencies.




    Page 10                                        GAO/AIMD-97-89 IRS Financial Audit
                     B-276920




Fund Balances With   Treasury regulations and prudent cash management practices require an
Treasury             agency to periodically reconcile its Fund Balance with Treasury accounts
                     to Treasury’s records. Such reconciliations allow agencies to promptly
                     detect and resolve any differences between agency and Treasury records.
                     Significant unreconciled accounts make it impossible, or at best difficult,
                     for an agency or anyone else to know whether operating funds have been
                     properly spent and call into question the accuracy of reported operating
                     expenses, assets, and liabilities. Also, such unreconciled accounts affect
                     an auditor’s ability to render an opinion.

                     Prior to the advent of the CFO Act, IRS’ Fund Balance with Treasury
                     accounts historically were not being reconciled. For the most part, IRS’
                     personnel were only tracking the gross differences between IRS’
                     accounting records and what Treasury (the equivalent of its bank)
                     reported to them for its administrative receipts and disbursements. This
                     material weakness resulted in years of accumulated unreconciled amounts
                     that were not regularly researched and were difficult to research and
                     resolve when the amounts were required to be audited. In addition, this
                     problem contributed significantly to our inability to render an opinion on
                     IRS’ financial statements for fiscal years 1992 through 1995.


                     Over the past 3 years, IRS has developed and implemented procedures for
                     reconciling and reducing the backlog of hundreds of millions of dollars
                     posted to budget clearing (BCA) and suspense accounts.3 These procedures
                     included hiring a contractor to assist in identifying the reason amounts
                     were posted to the BCA or suspense account and determining adjustments
                     necessary to post amounts to the appropriate disbursement or collection
                     account for those transactions that could be verified. At the completion of
                     our fieldwork, IRS had reconciled its September 30, 1996, Fund Balance
                     with Treasury accounts to Treasury’s records within an immaterial
                     amount.

                     For the future, it will be important that IRS ensure that (1) reconciliations
                     are prepared monthly on a timely basis (a goal of 30 to 60 days from
                     month-end is a reasonable target), (2) sufficient resources are available to
                     perform the necessary research for any differences, and (3) it identifies
                     and corrects any underlying systems problems.




                     3
                      Budget clearing accounts include items that are more than 6 months old that remain unreconciled.
                     Suspense accounts are used as holding accounts for transactions that are pending decisions by IRS as
                     to their validity.



                     Page 11                                                     GAO/AIMD-97-89 IRS Financial Audit
                          B-276920




Administrative Accounts   Most of IRS’ administrative accounts receivable represent amounts due
Receivable                from other federal agencies for services IRS provided to them. Information
                          recorded in IRS’ core financial management system for these receivables is
                          maintained by the specific project being worked on and not by federal
                          agency. As such, this system cannot readily provide a detailed record of
                          the amounts by debtor constituting the recorded administrative accounts
                          receivable balances. In an effort to identify specific unpaid items
                          constituting its reported administrative gross accounts receivables, IRS
                          performed ad hoc routines to match recorded billed reimbursable services
                          with collections. However, IRS was unable to support the unpaid claims
                          making up its reported balances. When information underpinning
                          significant amounts reported in the financial statements is not available for
                          audit, neither the auditor nor management can determine whether (1) the
                          information presented in the financial statements is correct, (2) all
                          significant internal controls through which the information was managed
                          and processed were effective, and (3) the agency complied with laws and
                          regulations.

                          IRSstated that it has efforts underway to address this financial
                          management problem. Details relating to this problem, along with our
                          assessment of IRS’ efforts and recommendations for improvements, will be
                          more fully communicated in a separate report.


Accounts Payable          IRS’financial management system, as implemented, records accounts
                          payable only when both an invoice has been received and the goods or
                          services have been received and accepted. Therefore, liabilities were
                          routinely not recorded for goods or services received and accepted until
                          an invoice was also received and processed. In addition, the invoice is
                          submitted directly by the vendor to IRS payment processing offices, while
                          receipt and acceptance are performed by personnel located throughout
                          the country. As a result, IRS is unable to readily determine who it owes and
                          how much it owes at any given point. Consequently, trying to accurately
                          determine year-end accounts payable and the related operating expense
                          accounts requires an extremely labor-intensive process to identify the
                          goods and services received prior to fiscal year-end but paid for
                          subsequent to that date. IRS’ problems accounting for its accounts payable
                          did not materially affect the propriety of its accounting for its budgetary
                          accounts.

                          In addition to this weakness, IRS continues to experience documentation
                          problems for receipt and acceptance of goods and services for significant



                          Page 12                                       GAO/AIMD-97-89 IRS Financial Audit
                         B-276920




                         portions of its nonpayroll operating expenses. As we reported in our prior
                         year audit report,4 IRS’ lack of effective control over receipt and
                         acceptance of goods and services, combined with its problems in linking
                         the controls over goods and services purchased to the payment for them,
                         makes IRS vulnerable to vendors, both federal and commercial, billing it for
                         goods and services not provided or for amounts in excess of what was
                         provided.

                         IRS stated that it has efforts underway to address these financial
                         management problems. Details relating to them along with our assessment
                         of IRS’ efforts and recommendations for improvements will be more fully
                         communicated in a separate report.


Property and Equipment   IRS  has historically been unable to reliably account for its property and
                         equipment because the systems containing its detailed subsidiary records
                         for fixed assets and its summary-level general ledger accounts are not
                         integrated. In its fiscal year 1996 FMFIA report, IRS reported that property
                         management procedures and controls over the accountability for its
                         automated data processing (ADP) and non-ADP property need improvement.
                         IRS also reported that without a reliable system of accounting for property,
                         it is unable to determine if property is being properly used or
                         misappropriated.

                         IRShas taken or is taking steps to address this weakness. For instance, it
                         implemented a property tracking system for non-ADP property and plans to
                         conduct agencywide physical inventories for both ADP and non-ADP
                         property. In addition, IRS stated that it is developing procedures that will
                         enable it to comply with the Statement of Federal Financial Accounting
                         Standard (SFFAS) No. 6, Accounting for Property, Plant, and Equipment.
                         SFFAS No. 6 requires the capitalization and depreciation of certain property
                         and equipment and becomes effective in fiscal year 1998.


Computer Security        IRS relies on computerized information systems to process and account for
                         its administrative data. These systems should include controls to prevent
                         or detect unauthorized access and intentional or inadvertent unauthorized
                         modifications to the data and related computer programs. The IRS
                         computing center which processes the administrative data also processes
                         tax data. Our review of controls over this computing center, done to


                         4
                          Financial Audit: Examination of IRS’ Fiscal Year 1995 Financial Statements (GAO/AIMD-96-101,
                         July 11, 1996).



                         Page 13                                                    GAO/AIMD-97-89 IRS Financial Audit
    B-276920




    support our fiscal year 1996 audits, found that such controls were
    ineffective. IRS did not adequately control access authority given to
    computer support personnel or adequately monitor their access to
    administrative and taxpayer data and related programs. Also, IRS did not
    adequately control external access to its computer resources. We consider
    computer security a material weakness because data or programs at the
    computing center could be added, altered, or deleted and not detected in a
    timely manner.

    Specific weaknesses include the following:

•   An excessive number of computer support personnel were granted the
    ability to change sensitive system files. This access gives them the ability
    to implement programs not controlled by the security software;
    accordingly, they can change, alter, or delete both administrative and
    taxpayer data and associated programs. Access to such data files, which
    include the basic operating system software, should be limited to the
    minimum number of computer support personnel needed for maintenance
    and review, substantially fewer than the 88 currently having access.
•   An employee responsible for computer security functions was granted
    access to programs and data beyond that needed to perform the
    employee’s routine duties. As a result, this employee had unneeded access
    to sensitive system files.
•   Computer support personnel’s access to system resources was not
    adequately monitored. The activities of the computer support personnel
    were not adequately reviewed for inappropriate or unauthorized access to
    programs and administrative and taxpayer data. Proper supervision of
    employee actions, especially those having broader access privileges,
    requires routine assurance concerning the propriety of their activities.
•   Computer support personnel were granted excessive or inappropriate
    access, including the ability to (1) alter the automated audit trail that
    identifies who entered or changed data, (2) control the processing
    environment, including relevant security controls, and (3) gain access to
    the security file containing passwords for staff authorized to record or
    alter financial data for IRS’ administrative costs. The inherent risk in these
    privileges, especially when combined, is that data or programs can be
    added, modified, or deleted without any indication that a change occurred.

    Additionally, IRS did not adequately control external access to its systems.
    This weakness, combined with the other weaknesses described
    previously, could allow access to IRS administrative and taxpayer data by
    other than authorized users.



    Page 14                                       GAO/AIMD-97-89 IRS Financial Audit
                       B-276920




                       These computer security problems compounded the weaknesses
                       previously discussed in this report and could effect the security and
                       reliability of IRS’ administrative accounting operations, including the
                       systems that account for procurement, payroll, and property and
                       equipment activity. The office of the CFO has undertaken actions to attempt
                       to mitigate the effect of these problems. Specifically, CFO officials told us
                       that they frequently monitor certain data files used to control and prepare
                       administrative financial information reports. IRS has plans to correct the
                       external access issue, including encryption and other controls, and the
                       access privileges granted to the computer security staff member have been
                       reduced. IRS also told us that it is expanding its monitoring of system
                       activity by computer support personnel. While these are meaningful steps,
                       actions are needed by management of the computing center in order to
                       fully correct these computer security problems.


                       Because of the limitations on the scope of our work in the administrative
Compliance With        accounts receivable, revenues and operating expenses areas, as described
Laws and Regulations   above, we were unable to determine whether operating expenses and
                       revenues were valid and test for compliance with laws deemed significant
                       to the financial statements.5 Accordingly, we are unable to report on IRS’
                       compliance with laws and regulations.

                       When sufficient evidence to support information reported in the financial
                       statements is not available for audit, we cannot determine whether IRS
                       complied with laws and regulations deemed significant to the financial
                       statements. For example, after several efforts to research differences
                       between its Fund Balance with Treasury accounts and Treasury’s records,
                       IRS made millions of dollars of net adjustments to its accounting records to
                       write off unreconciled amounts. In addition, because of IRS’ weaknesses in
                       accounting for accounts payable, the liability as of fiscal year-end was
                       estimated using statistical sampling techniques. While this effort resulted
                       in a reasonable estimate for the liability, it did not enable IRS to identify all
                       of the specific transactions constituting this estimated balance. Thus, in
                       both of these cases, neither we nor IRS could examine supporting
                       documentation to determine whether the transactions recorded in IRS’
                       accounting records complied with laws and regulations.




                       5
                        These laws govern the use of budget authority and other laws and regulations that have a direct and
                       material effect on the Administrative Financial Statements or that are listed in OMB audit guidance
                       and could have a material effect on the Administrative Financial Statements.



                       Page 15                                                      GAO/AIMD-97-89 IRS Financial Audit
                         B-276920




                         In our prior reports, we made 29 recommendations aimed at improving IRS’
IRS’ Progress in         administrative accounting operations.6 In our assessment this year, we
Implementing GAO         determined that, to date, IRS had completed action on 15 of these
Recommended              recommendations, including 5 actions that were completed since our audit
                         of the fiscal year 1995 financial statements. IRS has actions planned or in
Improvements             progress to address all but 1 of the remaining 14 recommendations.
                         Appendix I details why no actions have been taken on this 1
                         recommendation along with the status of IRS’ implementation efforts on
                         the other recommendations.

                         Progress has been made and actions are underway by IRS to try to resolve
                         the material weaknesses in internal controls and financial management
                         problems reported in our prior year audits, including those identified
                         previously. Additional corrective actions are still needed, and IRS continues
                         to state its intention to commit the necessary resources and management
                         oversight to resolve these weaknesses. We will continue to advise IRS on
                         how to resolve these long-standing financial management problems.


                         Management is responsible for
Objectives, Scope,
and Methodology      •   preparing the annual Administrative Financial Statements in conformity
                         with the basis of accounting described in note 1;
                     •   establishing, maintaining, and assessing the internal control structure to
                         provide reasonable assurance that the broad control objectives of FMFIA
                         are met; and
                     •   complying with applicable laws and regulations.

                         We are responsible for obtaining reasonable assurance about whether
                         (1) the Administrative Statement of Financial Position is reliable (free of
                         material misstatements and presented fairly, in all material respects, in
                         conformity with the basis of accounting described in note 1), and
                         (2) management’s assertion about the effectiveness of internal controls is
                         fairly stated, in all material respects, based upon criteria established under
                         the Federal Managers’ Financial Integrity Act of 1982 and the Office of
                         Management and Budget Circular A-123, Management Accountability and
                         Control.



                         6
                          See Financial Audit: Examination of IRS’ Fiscal Year 1995 Financial Statements (GAO/AIMD-96-101,
                         July 11, 1996); Financial Audit: Examination of IRS’ Fiscal Year 1994 Financial Statements
                         (GAO/AIMD-95-141, August 4, 1995); Financial Audit: Examination of IRS’ Fiscal Year 1993 Financial
                         Statements (GAO/AIMD-94-120, June 15, 1994); and Financial Audit: Examination of IRS’ Fiscal Year
                         1992 Financial Statements (GAO/AIMD-93-2, June 30, 1993).



                         Page 16                                                     GAO/AIMD-97-89 IRS Financial Audit
                         B-276920




                         In order to fulfill these responsibilities, we

                     •   examined, on a test basis, evidence supporting the amounts in the
                         Administrative Statement of Financial Position and related disclosures;
                     •   assessed the accounting principles used and significant estimates made by
                         management in the preparation of the Administrative Statement of
                         Financial Position;
                     •   evaluated the overall presentation of the Administrative Statement of
                         Financial Position;
                     •   obtained an understanding of the internal control structure related to
                         safeguarding assets, compliance with laws and regulations including
                         execution of transactions in accordance with budget authority, and
                         financial reporting, except in the above noted areas for which there was a
                         limitation on the scope of our work; and
                     •   tested relevant internal controls over safeguarding, compliance, and
                         financial reporting and evaluated management’s assertion about the
                         effectiveness of internal controls, except in the above-noted areas for
                         which there was a limitation on the scope of our work.

                         We did not evaluate all internal controls relevant to operating objectives as
                         broadly defined by FMFIA, such as those controls relevant to preparing
                         statistical reports and ensuring efficient operations. We limited our
                         internal control testing to those controls necessary to achieve the
                         objectives outlined in our opinion on management’s assertion about the
                         effectiveness of internal controls.

                         We attempted to perform audit procedures on the limited information IRS
                         provided; however, for the reasons stated above, we were unable to
                         perform the necessary audit procedures to opine on IRS’ Administrative
                         Statement of Operations and Changes in Net Position or report on IRS’
                         compliance with laws and regulations.

                         Except for the limitations on the scope of our work on (1) the
                         Administrative Financial Statements, (2) internal controls, and
                         (3) compliance with laws and regulations described above, we did our
                         work in accordance with generally accepted government auditing
                         standards and OMB Bulletin 93-06,”Audit Requirements for Federal
                         Financial Statements.”


                         Gregory M. Holloway
Agency Comments          Director,
and Our Evaluation

                         Page 17                                          GAO/AIMD-97-89 IRS Financial Audit
B-276920




Accounting and Information Management Division/
Governmentwide Audits

April 11, 1997




Page 18                                  GAO/AIMD-97-89 IRS Financial Audit
Page 19   GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




              Page 20   GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 21                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 22                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 23                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 24                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 25                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 26                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 27                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 28                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 29                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 30                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 31                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 32                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 33                GAO/AIMD-97-89 IRS Financial Audit
Financial Statements




Page 34                GAO/AIMD-97-89 IRS Financial Audit
Appendix I

Reports Issued as a Result of GAO’S Audit of
IRS’ Fiscal Year 1992, 1993, 1994, and 1995
Financial Statements and Status of
Recommendations Related to
                The results of our efforts to audit ’ fiscal year 1992, 1993, 1994, and 1995
                                                                                       IRS
Administrative Accounting                     Operations
                Administrative Financial Statements  were presented in our reports entitled
                Financial Audit: Examination of ’ Fiscal Year 1992 Financial Statements
                                                                                   IRS
                                              (GAO/AIMD-93-2, June 30, 1993), Financial Audit: Examination of IRS’ Fiscal
                                              Year 1993 Financial Statements (GAO/AIMD-94-120, June 15, 1994), Financial
                                              Audit: Examination of IRS’ Fiscal Year 1994 Financial Statements
                                              (GAO/AIMD-95-141, August 4, 1995), and Financial Audit: Examination of IRS’
                                              Fiscal Year 1995 Financial Statements (GAO/AIMD-96-101, July 11, 1996).

                                              In these prior reports, we made numerous recommendations to improve
                                              IRS’administrative accounting operations. We determined the status of
                                              these recommendations based on our audit work on IRS’ fiscal year 1996
                                              Administrative Financial Statements and on our discussions with IRS
                                              officials. Our assessments of IRS’ actions for the most significant
                                              recommendations are discussed in the report. However, we have not fully
                                              assessed the effectiveness of all of the responses identified in the
                                              following table.


                                                                                                           Action in
                                                                                                           planning      No specific
                                                                            Action           Action        or planning   action
Reports/recommendations                                                     complete         in progress   complete      planned
Financial Management: IRS’ Self-Assessment of Its Internal Control
and Accounting Systems Is Inadequate
(GAO/AIMD-94-2, October 13, 1993)
The Senior Management Council should coordinate, monitor, or oversee         X
activities to (1) establish and implement proper written procedures that
provide for the identification, documentation, and correction of material
weaknesses, (2) provide classroom training and guidance materials to all
review staff, (3) develop effective corrective action plans that address the
fundamental causes of the weaknesses, and (4) verify the effectiveness of
corrective actions before removing reported weaknesses from IRS’
records.
Financial Management: IRS Does Not Adequately Manage Its
Operating Funds
(GAO/AIMD-94-33, February 9, 1994)
Monitor whether IRS’ new administrative accounting system effectively       X
provides managers up-to-date information on available budget authority.
Promptly resolve differences between IRS and Treasury records of IRS’                        X
cash balances and adjust accounts accordingly.
Promptly investigate and record suspense account items to appropriate                        X
appropriation accounts.
Perform periodic reviews of obligations, adjusting the records for                           X
obligations to amounts expected to be paid, and removing expired
appropriation balances from IRS records as stipulated by the National
Defense Authorization Act for Fiscal Year 1991.
                                                                                                                           (continued)


                                              Page 35                                               GAO/AIMD-97-89 IRS Financial Audit
                                               Appendix I
                                               Reports Issued as a Result of GAO’S Audit
                                               of IRS’ Fiscal Year 1992, 1993, 1994, and
                                               1995 Financial Statements and Status of
                                               Recommendations Related to
                                               Administrative Accounting Operations




                                                                                                         Action in
                                                                                                         planning      No specific
                                                                             Action        Action        or planning   action
Reports/recommendations                                                      complete      in progress   complete      planned
Monitor compliance with IRS policies requiring approval of journal           X
vouchers and enforcing controls intended to preclude data entry errors.
Review procurement transactions to ensure that accounting information        X
assigned to these transactions accurately reflects the appropriate fiscal
year, appropriation, activity, and sub-object class.
Provide (1) detailed written guidance for all payment transactions,          X
including unusual items such as vendor credits, and (2) training to all
personnel responsible for processing and approving payments.
Revise procedures to require that vendor invoices, procurement orders,       X
and receipt and acceptance documentation be matched prior to payment
and that these documents be retained for 2 years.
Revise procedures to incorporate the requirements that accurate receipt                    X
and acceptance data on invoiced items be obtained prior to payment and
that supervisors ensure that these procedures are carried out.
Revise document control procedures to require IRS units that actually                      X
receive goods or services to promptly forward receiving reports to
payment offices so that payments can be promptly processed.
Monitor manually computed interest on late payments to determine             X
whether interest is accurately computed and paid.
Enforce existing requirements that early payments be approved in             X
accordance with OMB Circular A-125.
Require payment and procurement personnel, until the integration of AFS                                                Xa
and the procurement system is completed as planned, to periodically
(monthly or quarterly) reconcile payment information maintained in AFS to
amounts in the procurement records and promptly resolve noted
discrepancies.
Require the description and period of service for all invoiced items to be   X
input in AFS by personnel responsible for processing payments, and
enhance the edit and validity checks in AFS to help prevent and detect
improper payments.
Establish procedures, based on budget categories approved by OMB, to         X
develop reliable data on budget and actual costs.
Use AFS’ enhanced cost accumulation capabilities to monitor and report                     X
costs by project in all appropriations.
Financial Management: IRS Lacks Accountability Over Its ADP
Resources
(GAO/AIMD-93-24, August 5, 1993)
Provide the agency’s CFO with the authority to ensure that data              X
maintained by IRS’ ADP inventory system meet its management and
reporting needs.
Provide that any software purchases, development, or modifications           X
related to this system are subject to the CFO’s review and approval.
                                                                                                                         (continued)




                                               Page 36                                            GAO/AIMD-97-89 IRS Financial Audit
                                               Appendix I
                                               Reports Issued as a Result of GAO’S Audit
                                               of IRS’ Fiscal Year 1992, 1993, 1994, and
                                               1995 Financial Statements and Status of
                                               Recommendations Related to
                                               Administrative Accounting Operations




                                                                                                                   Action in
                                                                                                                   planning          No specific
                                                                                 Action           Action           or planning       action
Reports/recommendations                                                          complete         in progress      complete          planned
Develop and implement standard operating procedures that incorporate                              X
controls to ensure that inventory records are accurately maintained. Such
controls should include
—establishing specific procedures to ensure the prompt and accurate
recording of acquisitions and disposals in IRS’ ADP fixed asset system,
including guidance addressing the valuation of previously leased assets;
—reconciling accounting and inventory records monthly as an interim
measure until the successful integration of inventory and accounting
systems is completed as planned; and
—implementing mechanisms for ensuring that annual physical inventories
at field locations are effectively performed, that discrepancies are properly
resolved, and that inventory records are appropriately adjusted.
Oversee IRS efforts for ensuring that property and equipment inventory                            X
data, including telecommunications and electronic filing equipment, is
complete and accurate.
Determine what information related to ADP resources, such as equipment                            X
condition and remaining useful life, would be most useful to IRS managers
for financial management purposes and develop a means for accounting
for these data.
Develop an interim means to capture relevant costs related to in-house                            X
software development.
Financial Audit: Examination of IRS’ Fiscal Year 1993 Financial
Statements
(GAO/AIMD-94-120, June 15, 1994)
Monitor its systems and controls to regularly identify problems as they    X
occur by establishing clear lines of responsibility and communication from
top management to the lowest staff levels,
Develop action plans that are agreed upon by all affected groups and             X
individuals to correct problems identified, and
Continuously monitor corrective actions to ensure that progress is                                X
achieved.
Periodically compare information in payroll records to supporting                X
personnel information,
Use current information to periodically update estimated future TSM costs,                        X
and
Develop reliable detailed information supporting its reported accounts                            X
payable balances.

                                               a
                                                IRS officials stated that IRS does not plan to manually reconcile its existing procurement and
                                               payment systems as an interim measure since they expect implementation of an integrated
                                               procurement system by October 1997. These officials believe that this new system will ensure
                                               payment amounts recorded in the procurement and accounting systems are equal.




                                               Page 37                                                      GAO/AIMD-97-89 IRS Financial Audit
Appendix II

Comments From the Internal Revenue
Service

Financial Statements




                       Page 38   GAO/AIMD-97-89 IRS Financial Audit
                                           Appendix II
                                           Comments From the Internal Revenue
                                           Service




Overview of the Financial Statements (Administrative)




                                           Page 39                              GAO/AIMD-97-89 IRS Financial Audit
                                          Appendix II
                                          Comments From the Internal Revenue
                                          Service




Statement of Operations and Changes in Net Position (Administrative)




                                          Page 40                              GAO/AIMD-97-89 IRS Financial Audit
                                            Appendix II
                                            Comments From the Internal Revenue
                                            Service




Notes to Financial Statements (Administrative)




(901702)                                    Page 41                              GAO/AIMD-97-89 IRS Financial Audit
Ordering Information

The first copy of each GAO report and testimony is free.
Additional copies are $2 each. Orders should be sent to the
following address, accompanied by a check or money order
made out to the Superintendent of Documents, when
necessary. VISA and MasterCard credit cards are accepted, also.
Orders for 100 or more copies to be mailed to a single address
are discounted 25 percent.

Orders by mail:

U.S. General Accounting Office
P.O. Box 6015
Gaithersburg, MD 20884-6015

or visit:

Room 1100
700 4th St. NW (corner of 4th and G Sts. NW)
U.S. General Accounting Office
Washington, DC

Orders may also be placed by calling (202) 512-6000
or by using fax number (301) 258-4066, or TDD (301) 413-0006.

Each day, GAO issues a list of newly available reports and
testimony. To receive facsimile copies of the daily list or any
list from the past 30 days, please call (202) 512-6000 using a
touchtone phone. A recorded menu will provide information on
how to obtain these lists.

For information on how to access GAO reports on the INTERNET,
send an e-mail message with "info" in the body to:

info@www.gao.gov

or visit GAO’s World Wide Web Home Page at:

http://www.gao.gov




PRINTED ON    RECYCLED PAPER
United States                       Bulk Rate
General Accounting Office      Postage & Fees Paid
Washington, D.C. 20548-0001           GAO
                                 Permit No. G100
Official Business
Penalty for Private Use $300

Address Correction Requested