oversight

Internal Revenue Service: Serious Weaknesses Impact Ability to Report on and Manage Operations

Published by the Government Accountability Office on 1999-08-09.

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

                  United States General Accounting Office

GAO               Report to the Commissioner of Internal
                  Revenue



August 1999
                  INTERNAL REVENUE
                  SERVICE

                  Serious Weaknesses
                  Impact Ability to
                  Report on and Manage
                  Operations




GAO/AIMD-99-196
United States General Accounting Office                                                          Accounting and Information
Washington, D.C. 20548                                                                                Management Division



                                    B-282549                                                                                       Letter

                                    August 9, 1999

                                    The Honorable Charles O. Rossotti
                                    The Commissioner of Internal Revenue

                                    Dear Mr. Rossotti:

                                    This report is a follow-on to our report on the results of our audit of the
                                    financial statements of the Internal Revenue Service (IRS) for fiscal year
                                    1998.1 Because of insufficient evidence about the reliability of fund balance
                                    with Department of the Treasury and accounts payable as well as evidence
                                    that led us to conclude that property and equipment was likely materially
                                    understated, we issued a qualified opinion on IRS’ September 30, 1998,
                                    balance sheet. In addition to the balance sheet issues, insufficient evidence
                                    about nonpayroll expenses and budgetary balances also prevented us from
                                    rendering an opinion on the statements of net cost, changes in net position,
                                    budgetary resources, and financing. As we pointed out in the financial
                                    statement report and in subsequent congressional testimony,2 pervasive
                                    weaknesses continue to exist in the design and operation of IRS’ financial
                                    management systems, accounting procedures, documentation,
                                    recordkeeping, and internal controls over its administrative operations.

                                    The matters addressed in this follow-on report relate to IRS’ activities
                                    associated with its fiscal year 1998 appropriations of $7.9 billion—referred
                                    to as IRS’ administrative activities. Issues relating to IRS’ collection of
                                    federal tax revenue, refunding of overpayments of taxes, and unpaid tax
                                    assessments—referred to as IRS’ custodial activities—are covered in a
                                    separate report. The matters in this report deal with IRS’ reconciliations of
                                    fund balance with Treasury accounts, recording certain expenditures
                                    against appropriations, maintaining adequate transaction detail needed to
                                    monitor its liabilities and obligations, accounting for and controlling
                                    property and equipment, and the financial reporting process.




                                    1
                                     Financial Audit: Examination of IRS’ Fiscal Year 1998 Financial Statements (GAO/AIMD-99-75,
                                    March 1, 1999).
                                    2
                                    Internal Revenue Service: Results of Fiscal Year 1998 Financial Statement Audit (GAO/T-AIMD-99-103,
                                    March 1, 1999).




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Results in Brief      Significant financial management system limitations and internal control
                      weaknesses prevented IRS from reliably reporting on the results of its
                      administrative activities for fiscal year 1998 and from having reliable
                      financial information for managing its operations. These deficiencies are
                      long-standing, many being reported in our first financial audit of IRS for
                      fiscal year 1992. We found the following.

                      • Comparable to an individual reconciling his or her checkbook to a bank
                        statement, IRS’ records on its available funds should be reconciled to
                        Treasury records monthly. However, in fiscal year 1998, IRS did not
                        reconcile its administrative fund balance with Treasury accounts.
                        Reconciling these accounts involves identifying differences between
                        IRS and Treasury records, determining the reasons for the differences,
                        and correcting them if needed. Without performing these
                        reconciliations, IRS has no assurance that it is properly controlling and
                        reporting its appropriated funds.
                      • IRS did not promptly record certain types of expenditures against
                        appropriations. IRS’ records show a net of $141 million in its suspense
                        account at the end of fiscal year 1998 that had not been applied to a
                        specific IRS appropriation. According to IRS’ records, the absolute value
                        of items in the suspense account related to fiscal years 1989 through
                        1998 totaled $238 million for government accounts and $170 million for
                        nongovernment accounts with net values of $74 million and $67 million,
                        respectively. Until all these transactions are posted to the proper
                        appropriation accounts and matched with corresponding obligational
                        records, the agency cannot ensure that the activities recorded in these
                        accounts are proper IRS transactions and that its outstanding
                        obligations and disbursements do not exceed appropriated amounts.
                      • IRS’ systems were unable to generate detailed subsidiary records of its
                        accounts payable and outstanding obligations (i.e., undelivered orders).
                        In part this was due to IRS not having adequate transaction-level detail
                        to match related transactions. The lack of subsidiary records for key
                        account balances affects IRS’ ability to provide meaningful and reliable
                        financial information needed to effectively report on and manage its
                        operations. For example, without an accounts payable subsidiary ledger,
                        IRS cannot readily support its accounts payable balance and determine
                        that invalid accounts payable are removed from the account. Also,
                        without comparing outstanding amounts in its undelivered orders
                        accounts to outstanding obligations, IRS cannot readily determine
                        whether the amount for undelivered orders is valid.




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• IRS’ property and equipment was likely materially understated due to a
  number of deficiencies in its recording of property and equipment. IRS’
  financial statements do not reflect the significant assets that IRS has
  purchased as part of tax system modernization. For example, we found
  that major capital expenditures relating to IRS’ mainframe consolidation
  and its new system to process tax returns and remittances (receipts)
  were not included in IRS’ property and equipment account on its
  financial statements. Nearly 69 percent of the gross property and
  equipment in IRS’ detailed records is not included in property and
  equipment on its financial statements either because the items have an
  individual item value of less than Treasury’s $50,000 capitalization
  threshold and do not meet the bulk purchase capitalization threshold or
  because the individual component parts of major computer project
  purchases are not aggregated. Additionally, IRS’ detailed records do not
  accurately keep track of additions and deletions of property and
  equipment. IRS itself has reported every year since 1983, under the
  Federal Managers’ Financial Integrity Act,3 that because it does not have
  a reliable system of accounting for property, it is unable to determine if
  property is being properly used or misappropriated.
• IRS did not have adequate review procedures to oversee and manage
  the accounting and financial reporting process. We found significant
  errors and omissions in IRS’ draft financial statements involving
  millions of dollars and in some cases hundreds of millions of dollars,
  which likely would have been caught and corrected had these
  documents undergone appropriate review by management. For
  example, initially the three major budgetary accounts reflected negative
  available unobligated balances totaling about $200 million. Based on our
  inquiry, IRS performed additional analysis on these accounts and
  subsequently revised them to show positive available unobligated
  balances totaling about $50 million.

IRS has acknowledged these weaknesses and plans to improve its financial
data for its administrative accounts. Past attempts to implement corrective
action plans for these problems have not been effective. Although some
areas, such as fund balance with Treasury reconciliations, improved as
noted in our report on IRS’ fiscal year 1996 financial statements, IRS again
experienced problems in these areas for fiscal year 1998. To correct these
weaknesses, sustained attention by senior IRS management is necessary.


3
The Federal Managers’ Financial Integrity Act requires agencies to annually report on their material
weaknesses.




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             Some of these weaknesses can be addressed in the short-term by making
             improvements in procedures and controls. For example, the fund balance
             with Treasury reconciliation deficiencies can be addressed by ensuring that
             the reconciliations are performed monthly. While some needed
             improvements can be achieved in the short-term, we recognize that for
             other weaknesses long-term systems modernization will be needed. For
             example, in order to properly account for and control its property and
             equipment, IRS will need a fully integrated inventory and accounting
             system. Left uncorrected, the internal control weaknesses identified will
             continue to hinder IRS’ ability to manage its financial operations and
             routinely prepare reliable and timely financial information. This report
             contains a number of recommendations related to these weaknesses for
             which IRS has begun corrective action or has agreed to take action.



Background   IRS is responsible for collecting and accounting for federal tax revenue and
             refunding tax overpayments. In fiscal year 1998, IRS collected almost
             $1.8 trillion in tax revenues, issued $151 billion in tax refunds, and had net
             taxes receivable at year-end of $26 billion. IRS receives the majority of its
             funding for its operations through annual, multiyear, and no-year
             appropriations that are available for use within statutory limits. These
             appropriations include (1) processing, assistance, and management, (2) tax
             law enforcement, and (3) information systems.4 As illustrated in figure 1,
             for fiscal year 1998, IRS reported program expenses of $7.9 billion,
             including $3.5 billion for tax law enforcement, $3.0 billion for processing,
             assistance, and management, and $1.4 billion for information systems.




             4
              These are the main appropriations related to IRS expenditures in fiscal year 1998. IRS also has other
             appropriations, such as technology investment, but expenditures related to these appropriations were
             not material in fiscal year 1998.




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Figure 1: IRS’ Fiscal Year 1998 $7.9 Billion of Operating Expenses by Program
(Dollars in Billions)




Source: Unaudited IRS data.


Appendix I provides details on our scope and methodology and appendix II
includes IRS’ written comments on this report.

Over the past 6 years, we have issued various reports about weaknesses
associated with IRS’ administrative operations. To help IRS correct
weaknesses associated with its administrative activities, we made
numerous recommendations in those reports. Many of these
recommendations, if effectively implemented, would help address the
issues identified in this report. Appendix III summarizes both the previous
years' open recommendations and the recommendations made this year.

In response to our financial statement audit report for fiscal year 1998, IRS
is developing a corrective action plan to address the issues identified. We
will evaluate the actions taken as part of our fiscal year 1999 audit.




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IRS Efforts to          During fiscal year 1998, IRS did not reconcile its administrative fund
                        balance with Treasury accounts. IRS uses over 30 Treasury accounts.5
Reconcile Its Fund      Treasury policy and prudent financial management practices require
Balance With Treasury   agencies to prepare monthly reconciliations of fund balance with Treasury
                        accounts to Treasury's records. Reconciling these accounts involves
Were Ineffective        identifying differences between IRS and Treasury records, determining the
                        reasons for the differences, and correcting them if needed. Differences
                        arise when either IRS or Treasury incorrectly records or delays recording
                        of deposits to and disbursements from IRS appropriation accounts.
                        Correcting such differences should result in adjustments to either
                        Treasury’s or IRS’ records, or both. This process is similar to an individual
                        reconciling his or her checkbook to a monthly bank statement and this
                        reconciliation should occur monthly. Without performing these
                        reconciliations, IRS has no assurance that it is properly controlling the
                        funds appropriated to it and that amounts are being properly recorded.

                        IRS’ inability to reconcile its fund balance with Treasury has been reported
                        as a problem area dating back to 1992, the first year IRS’ financial
                        statements were subject to audit. We have recommended that IRS perform
                        prompt reconciliations, including investigating and resolving the
                        reconciling items. As a result, IRS has implemented corrective actions in
                        the past. For example, during our fiscal year 1996 audit, IRS, with the help
                        of a contractor, reconciled its fund balance with Treasury accounts to
                        Treasury’s records within an immaterial amount. However, we found that
                        IRS’ reconciliation of its fund balance with Treasury accounts was not
                        effective in fiscal year 1998.

                        In fiscal year 1998, IRS did not prepare monthly reconciliations of its over
                        30 fund balances with Treasury accounts. For fiscal year 1998, IRS officials
                        said they relied on a contractor to reconcile IRS’ fund balance with
                        Treasury accounts. In January 1999, IRS’ contractor provided what it
                        considered to be reconciliations of IRS’ fund balance with Treasury for the
                        12 months of fiscal year 1998. However, in addition to these reconciliations
                        not being performed promptly, they were inadequate in that amounts on the
                        reconciliations did not agree with Treasury's and IRS’ records, and
                        reconciling items listed were not investigated and resolved. For example,
                        one reconciliation indicated that the general ledger balance was over


                        5
                         The accounts include individual accounts for fiscal years 1993 through 1998 for each of IRS’ three
                        major annual appropriations—processing, assistance, and management; tax law enforcement; and
                        information systems—as well as accounts for its other appropriations and suspense.




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                       $3 billion, but based on our review of IRS’ general ledger, the balance was
                       $71 million. This reconciliation also reflected what appeared to be over
                       $30 million in reconciling items that were not investigated or resolved. In
                       another example, the reconciliation showed the Treasury balance as
                       $662 million while Treasury's statement reflected a balance of $454 million.

                       Significant unreconciled amounts between Treasury's and IRS’ records for
                       fund balance with Treasury call into question the accuracy of reported
                       amounts for operating expenses, assets, and liabilities. Also, the lack of
                       properly prepared reconciliations affects IRS’ ability to ensure that it
                       complies with the law governing the use of its budget authority since the
                       unresolved differences could significantly affect the status of budget
                       authority available to be obligated and expended. For the future, it will be
                       important for IRS to prepare these reconciliations monthly and promptly
                       resolve any differences. Absent properly prepared reconciliations of fund
                       balance with Treasury, this long-standing problem area for IRS will
                       continue to negatively affect IRS’ ability to produce reliable financial
                       information and properly manage its appropriated funds.



Recommendation         We recommend that the Commissioner of Internal Revenue direct the Chief
                       Financial Officer to ensure that IRS promptly resolves differences between
                       IRS and Treasury records of IRS’ appropriation account balances and
                       adjusts accounts accordingly. For example, reconciliations should be
                       performed promptly every month, with Treasury and IRS amounts in
                       agreement and reconciling items properly resolved.



IRS Did Not Promptly   As was the case in previous years, in fiscal year 1998, IRS did not promptly
                       investigate and resolve amounts in its administrative suspense account. To
Record Certain         obtain assurance that funds were actually used for the purpose
Expenditures Against   appropriated and within prescribed dollar limits, agencies are required to
                       promptly match disbursements against applicable obligations. As of
Appropriations         September 30, 1998, IRS’ records showed that the suspense account had a
                       net outstanding balance of $141 million that had not been researched and
                       posted to the proper appropriation account, including some items dating
                       back to fiscal year 1989 appropriations. As shown in table 1, according to
                       IRS’ records, the absolute value of items in the suspense account related to
                       fiscal years 1989 through 1998 totaled $238 million for government
                       accounts and $170 million for nongovernment accounts.




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Table 1: IRS’ Suspense Account Components as of September 30, 1998
(Dollars in Thousands)

                                                                Government          Nongovernment
1989                                                                         —                           $8
1990                                                                      -$41                        801
1991                                                                         -7                  -5,686
1992                                                                       177                    3,627
1993                                                                        -26                   4,044
1994                                                                       117                   -6,439
1995                                                                    18,294                    4,290
1996                                                                    43,556                  -38,950
1997                                                                   -82,125                  94,277
1998                                                                    93,734                  11,566
Total absolute value                                                 $238,077                 $169,688
Total net value                                                       $73,679                  $67,538
Source: Unaudited IRS data.


Until IRS researches and resolves its suspense items, it will have little
assurance that the amounts recorded in this account are proper IRS
transactions and that its outstanding obligations and disbursements
records do not exceed appropriated amounts.

According to IRS officials, the majority of the dollar value of the suspense
account is related to transactions in which another federal agency charges
IRS for goods or services using Treasury's electronic bill-paying system.6
Although we were not able to obtain a detailed list of items in the suspense
account as of September 30, 1998, from IRS, we did see examples of
suspense transactions during our testing of nonpayroll operating expenses.
Reasons for placing items in suspense include not having received a
breakdown of charges from the billing agency, not having a receipt and
acceptance certification, and not having sufficient funds obligated.7 The
following are examples of items placed in suspense that were reviewed in
our testing of nonpayroll operating expenses and are shown to illustrate
suspense transactions. The first two examples show the length of time it

6
 IRS officials questioned the validity of the large dollar value of items categorized as nongovernment
and said there appeared to be a coding error.
7
 If IRS receives an invoice for over 10 percent above the obligated amount, the transaction will be
posted to suspense until additional funds are obligated.




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can take for items to be cleared from suspense, and the last two examples
show how items are placed in suspense due to insufficient obligation of
funds.

• The General Services Administration (GSA) charged IRS $8.7 million for
  rent on February 18, 1998, and IRS did not clear the transaction out of
  suspense until May 1, 1998, after it resolved questions related to the
  March 23, 1998, receipt and acceptance certification.
• On November 26, 1997, GSA charged IRS about $1 million for payment
  of a leasehold improvement. Because documentation of receipt and
  acceptance had not yet been received by IRS, no expenditure was
  posted. Instead, the entire amount was placed into suspense pending
  certification of receipt and acceptance. Although the receipt and
  acceptance was documented on March 5, 1998, the bill was not posted
  to expenses until June 4, 1998, over 6 months after the GSA charge and
  2 months after certification of receipt and acceptance.
• In another case, GSA charged IRS $9.2 million for telecommunications
  services on May 26, 1998. This $9.2 million was placed into suspense by
  IRS, awaiting receipt and acceptance certification and obligation of an
  additional $2 million. Receipt and acceptance was almost 2 months later
  on July 16, 1998, and the charge was finally removed from suspense on
  July 28, 1998, after a $2 million obligation modification.
• In another telecommunications transaction, GSA charged IRS’ Treasury
  account for $9 million on April 23, 1998. However, the obligation for this
  expenditure was only $5 million. On May 29, 1998, an additional
  $4 million was obligated, and on June 2, 1998, the transaction was
  removed from the suspense account.

While IRS may have to place items in suspense while awaiting supporting
documentation or obligation of funds, it is important that transactions be
cleared from suspense as quickly as possible and that the suspense account
be cleared at the end of the year. As shown above, some items in our
sample of nonpayroll expenses were in suspense for a number of months.
Since IRS was not able to give us a list of amounts in suspense as of
September 30, 1998,8 we do not know how long the items had been in
suspense at that date and if there were old outstanding amounts.
Transactions where sufficient funds have not been obligated are of



8
 IRS relies on a contractor to extract information from its accounting system. The contractor was still
trying to prepare lists of accounts payable and undelivered orders at the end of our audit work and had
not prepared a suspense list as of year-end.




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                          particular concern because until the funds are obligated, IRS does not have
                          an accurate picture of how it has used its budget authority. Also, to the
                          extent that there were outstanding amounts in suspense for which
                          obligations had not been recorded, obligations would be understated.

                          Until the transactions in IRS’ suspense account are posted to the proper
                          appropriation account, the agency will have little assurance that the
                          amounts recorded in this account are proper IRS transactions and that its
                          disbursements do not exceed appropriated amounts. In addition, IRS
                          cannot report reliable budget information until its suspense account is
                          cleared.


Recommendation            We recommend that the Commissioner of Internal Revenue direct the Chief
                          Financial Officer to strengthen control over IRS’ operating funds by
                          promptly investigating and clearing suspense account items. For example,
                          outstanding amounts in the suspense account should be reviewed every
                          month to try to resolve and clear outstanding balances.



IRS Does Not Have         IRS does not have detailed subsidiary records to support certain key
                          account balances, including accounts payable and undelivered orders. As a
Subsidiary Ledgers to     result, for fiscal year 1998, as in past audits, IRS’ support for its accounts
Routinely Track and       payable balance continued to be inadequate. In addition, IRS’ support for
                          its undelivered orders9 balance was inadequate for fiscal year 1998.
Monitor Its Liabilities   According to Federal Financial Management Systems Requirements,10 an
and Obligations           agency's core financial system should be supported by a general ledger
                          account structure that complies with the U.S. Government Standard
                          General Ledger.11 To support the account balances in these Standard
                          General Ledger accounts, the general ledger should be supported by
                          subsidiary ledgers that routinely provide data supporting account balances,


                          9
                           Undelivered orders represent the value of goods and services ordered that have been obligated but that
                          have not been received.
                          10
                            These requirements are included in the Federal Financial Management Improvement Act of 1996 and
                          are detailed in the Federal Financial Management Systems Requirements series issued by the Joint
                          Financial Management Improvement Program, Office of Management and Budget (OMB) circular
                          A-127, Financial Management Systems, and OMB's September 9, 1997, guidance.
                          11
                           The U.S. Government Standard General Ledger establishes a standard chart of accounts, including
                          account titles, definitions, and uses. Its primary purpose is to standardize federal agency accounting to
                          support the external reports and financial statements required by OMB and Treasury, and to provide
                          comparable information for agencies.




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such as accounts payable and undelivered orders. These subsidiary ledgers
would list outstanding amounts by transaction/vendor in accounts payable
and undelivered orders and thus provide IRS with detailed information on
its outstanding obligations. Without such information, IRS cannot routinely
provide meaningful and reliable financial information needed to effectively
manage and report on its operations.

For accounts payable, IRS was only able to generate a transaction history
that included all transactions that had been recorded in accounts payable
since 1991, including amounts that had since been paid and were therefore
no longer payable. As a result, IRS cannot readily determine what its
accounts payable balance consists of and what it owes money for.
Accounts payable was the combination of three general ledger accounts.
For the largest accounts payable account, which, according to IRS totaled
$338 million as of September 30, 1998, we received a computerized list that
netted to this amount. The transaction history included numerous debit
and credit entries of over a billion dollars each (as shown in table 2). The
entries included amounts that had been established as accounts payable
and had subsequently been paid. When inputting transactions into its
accounting system, IRS does not include an indicator code that would
enable it to easily match offsetting entries in order to produce a list of
outstanding amounts. After much manipulation, IRS provided a tape in
which some of the related entries had been removed from the detailed
transaction history, but IRS was not able to give us a list of outstanding
accounts payable as of September 30, 1998, that could be tested for validity
and completeness.




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Table 2: Information on Data Tapes Provided by IRS (Dollars in Millions)

Accounts                                    Debits              Credits Net value—debit (credit)
Accounts payable
 Original                                   $1,317               $1,655                           ($338)
 Revised                                        314                 658                            (344)
Undelivered orders
 Original                                   $3,066               $4,049                           ($983)
 Revised                                        473               1,458                            (985)
Nonpayroll expenses
 Original                                   $2,211                 $861                          $1,350
 Revised                                      1,677                 327                            1,350
Note: Revised figures are the amounts of debits and credits after offsetting entries that could be
identified were eliminated. An example of offsetting entries would be the entries related to establishing
an accounts payable and its subsequent disbursement.
Source: Unaudited IRS data.


Similarly, IRS could not determine the outstanding portion of amounts
ordered from each of its vendors as of September 30, 1998. IRS’ financial
system is unable to generate a list of its outstanding obligations (i.e.,
undelivered orders). For example, if IRS obligates funds for a leasehold
improvement to be performed by GSA, the undelivered order represents
the value of services not yet performed. As of September 30, 1998, IRS
reported undelivered orders, a key component of the obligations incurred
line item on the Statement of Budgetary Resources, at $985 million. This
amount was reported based on a detailed transaction history including
initial obligations along with subsequent liquidations. IRS initially provided
us with a computerized list of about $3 billion in debits and about $4 billion
in credits to support its $985 million in undelivered orders as of
September 30, 1998. The entries included amounts that had been obligated
and subsequently liquidated. However, IRS does not include an indicator
code when inputting transactions into its accounting system that would
enable it to easily match offsetting transactions. As shown in table 2, after
much manipulation, IRS was able to reduce the debit amounts, but IRS was
not able to provide a list of outstanding undelivered orders at year-end.
Knowing what the outstanding undelivered orders are, periodically
reviewing them for validity, and removing invalid amounts are important in
order for IRS managers to know exactly what is left of their appropriated
funds.




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Nonpayroll Operating   As was the case with the accounts payable and undelivered orders areas,
Expenses               we were also unable to obtain a list of IRS’ nonpayroll operating expenses
                       for fiscal year 1998. Instead, IRS provided us with the detailed history for
                       nonpayroll operating expenses, which included many items that were not
                       fiscal year 1998 expenses. The original tape to support a reported
                       $1.3 billion of expenses included $2.2 billion in debits and $861 million in
                       credits. We were able to identify and clear some offsetting entries but not
                       all, as shown in table 2. Many of the debits and credits were offsetting
                       amounts related to prior years' expenses. However, IRS did not have a data
                       field in its accounting system that would facilitate identifying offsetting
                       transactions. We took statistical samples to verify IRS’ fiscal year 1998
                       nonpayroll operating expenses and found significant errors (76 of 208
                       transactions tested were classified as errors). For example, we found
                       (1) property and equipment purchases and leasehold improvements that
                       should have been capitalized, (2) transactions that related to prior years,
                       and (3) credit entries related to prior years. As a result, we were unable to
                       conclude that IRS’ nonpayroll operating expenses for fiscal year 1998 were
                       reliable. Since reliable expense data are the basis for providing good cost
                       information, these problems led us to conclude that IRS is unable to
                       provide reliable cost information or cost-based performance measures.

                       In addition, in our review of expenses, we identified cases of questionable
                       cost allocation. For example, for fiscal year 1998, IRS used its
                       appropriations categories of processing, assistance, and management; tax
                       enforcement; and information systems to categorize costs on its net cost
                       statement. We found that almost all rent was charged to the processing,
                       assistance, and management category. From a financial reporting
                       perspective, rent should be allocated to the various IRS cost categories that
                       benefited from IRS office space.

                       In our March 1998 testimony12 on IRS’ fiscal year 1999 budget request, we
                       stated that IRS included funding requests for similar activities in its tax
                       enforcement as well as its appropriations request for processing,
                       assistance, and management. For example, IRS requested $891.6 million for
                       the “Telephone and Correspondence” budget activity within the processing,
                       assistance, and management appropriation in fiscal year 1999. That activity
                       covers all non-face-to-face contacts between IRS and taxpayers. Such
                       contacts include typical forms of assistance, such as answering telephone


                       12
                         Tax Administration: IRS’ Fiscal Year 1999 Budget Request and Fiscal Year 1998 Filing Season
                       (GAO/T-GGD/AIMD-98-114, March 31, 1998).




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                      calls and correspondence, as well as several enforcement activities, such as
                      correspondence audits and attempts to collect overdue taxes over the
                      telephone. At the same time, however, IRS’ tax law enforcement request
                      included an unspecified amount of money for various forms of assistance,
                      including walk-in service, taxpayer education efforts, and problem
                      resolution. Since IRS uses its appropriation categories to categorize costs
                      for its financial data and on its Statement of Net Costs for its financial
                      statements, this categorization causes misclassification of costs on IRS’
                      financial statements and will affect the validity of cost-based performance
                      measurements.


Recommendations       To effectively manage and report on key balances, we recommend that the
                      Commissioner of Internal Revenue direct the Chief Financial Officer to
                      develop subsidiary records for accounts payable and undelivered orders
                      and a list of current year nonpayroll operating expenses that will provide
                      reliable accounts payable, undelivered orders, and nonpayroll operating
                      expense data. This could include adding an indicator code when inputting
                      transactions into the accounting system that will let IRS identify and
                      eliminate offsetting transactions. In the long-term, it could include
                      enhancements to IRS’ financial systems to include the capability of
                      routinely generating subsidiary records of outstanding accounts payable
                      and undelivered order balances and a reliable list of current year
                      nonpayroll operating expenses.

                      In addition, we recommend that the Commissioner of Internal Revenue
                      direct the Chief Financial Officer to develop the data to support meaningful
                      cost information categories and cost-based performance measures.



IRS Does Not          IRS has historically been unable to reliably account for and control its
                      property and equipment (P&E). Federal property management regulations
Adequately Account    specify that each agency shall establish and maintain control of personal
for and Control Its   property inventories to avoid fraud, waste, and abuse. However, IRS has
                      itself reported deficiencies in its property management controls since 1983.
Property and          In its fiscal year 1998 Federal Managers' Financial Integrity Act (FMFIA)
Equipment             report, IRS reported that it has material weaknesses in property
                      management procedures and controls over the use and accountability of
                      capitalized property. 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. We found that




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                             • IRS materially understated the amount of P&E in its financial
                               statements as of September 30, 1998, and
                             • IRS does not have sufficient control over its P&E due to inaccurate
                               detailed records. In addition, IRS’ P&E detailed records are not
                               integrated with its accounting system, and there were amounts in
                               detailed records substantially different from amounts recorded in IRS’
                               accounting records.


IRS’ Property and            IRS does not have adequate policies and procedures in place to ensure that
Equipment Is Significantly   all P&E purchases are identified and capitalized at the appropriate cost in
                             accordance with federal accounting standards13 and IRS does not review its
Understated                  leases to determine if they meet the criteria for capitalization of leases.
                             According to SFFAS No. 6, agencies should record as P&E all items that
                             meet certain characteristics, such as a useful life of 2 years or more. All
                             costs incurred to bring P&E to a form and location suitable for its intended
                             use should be capitalized and included in the cost of the item, including the
                             design and installation costs and the costs of externally developed
                             software. As of September 30, 1998, IRS reported $164 million, net, of P&E
                             on its financial statements. However, based on our review of detailed
                             records, financial information related to IRS’ computer projects, equipment
                             expenditures, and lease agreements, IRS appears to be materially
                             understating its P&E balance.

                             IRS has expended significant amounts for computer-related projects, such
                             as its new system to process tax returns and remittances (receipts)14 and
                             service center mainframe consolidation. According to IRS’ records, a
                             significant portion of over $100 million in expenditures associated with
                             these two major computer projects in fiscal year 1998 were costs incurred
                             in acquiring computer hardware and software and preparing it for use.
                             Information obtained from both the information systems office and from
                             IRS’ expense data in its accounting records showed that in fiscal year 1998
                             IRS spent over $100 million for these two systems. However, IRS showed
                             P&E additions of only about $30 million for all equipment purchases for
                             fiscal year 1998 and, therefore, most of the over $100 million spent for the



                             13
                              Statement of Federal Financial Accounting Standards (SFFAS) No. 6, Accounting for Property, Plant,
                             and Equipment (effective beginning with fiscal year 1998).
                             14
                               This system is called the Integrated Submission and Remittance Processing System (ISRP) and
                             processes tax returns and tax receipts received directly from taxpayers.




                             Page 15                                      GAO/AIMD-99-196 IRS Administrative Weaknesses
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service center mainframe consolidation and new system to process tax
returns and remittances was inappropriately expensed.

IRS’ use of Treasury’s $50,000 minimum capitalization threshold for
individual items and a $500,000 threshold for bulk purchases of items
costing more than $5,000 each15 also contributed to IRS’ understatement of
P&E. Federal accounting standards allow each agency to establish its own
threshold and guidance on applying the threshold to bulk purchases.
However, agencies should not expense material purchases that have
characteristics requiring capitalization, such as a useful life of 2 years or
more. During our testing, we identified significant purchases meeting
SFFAS No. 6 requirements for capitalization as P&E being charged to
nonpayroll operating expenses. In our expense sample, we noted a
payment of about $300,000 for 10 tape units costing about $30,000 each and
a $100,000 payment for 80 personal computers costing about $1,300 each.
These items were not capitalized because the expenditure did not meet the
$50,000 individual capitalization threshold or the $500,000 threshold for
bulk purchases.

Also, our testing of nonpayroll operating expenses included a $1.3 million
payment related to the purchase of numerous computer workstations for
the mainframe consolidation project. However, none of the individual
pieces of equipment listed on the invoice exceeded $5,000 and thus this
large (bulk) purchase of P&E was expensed. The $50,000 individual item
threshold and bulk purchase threshold far exceed the cost of most of IRS’
P&E items and result in a material distortion of IRS’ reported P&E in its
financial statements. For example, IRS reported equipment-related
expenses of $339 million16 in its fiscal year 1998 financial statements. For
fiscal year 1997, only $46 million in equipment-related purchases was
capitalized as P&E, while $305 million in equipment purchases was
expensed.

As illustrated in figure 2, we found that $1.2 billion (69 percent) of IRS’
gross P&E reported in its detailed records as of September 30, 1998, was


15
  A bulk purchase of general property, plant, and equipment is the single purchase of like items in a lot
(i.e., the items have the same basic utility and are composed of similar parts—furniture, automated data
processing (ADP) hardware, etc.).
16
  Equipment expenses reported on the financial statements for fiscal year 1998 were $339 million,
which included $100 million in depreciation and amortization expense. Equipment expenses reported
on the financial statements for fiscal year 1997 included $99 million in depreciation and amortization
expense.




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not included in P&E in the financial statements either because the items
have an individual item value of less than the $50,000 capitalization
threshold and do not meet the bulk purchase capitalization threshold or
because the individual component parts of major computer project
purchases are not aggregated.



Figure 2: IRS’ September 30, 1998, P&E Detailed Records by Individual Item Dollar
Amount (Gross Amounts)




Source: Unaudited IRS data.


This analysis also reflected that about 46 percent of P&E reported in IRS’
detailed records was in the $0 to $5,000 range, most of which was likely
purchased in bulk. Since IRS specifies that individual items must cost at
least $5,000 each to be subject to the bulk purchase threshold, 46 percent of
IRS’ P&E was automatically expensed. Inappropriate capitalization levels
resulted in understatement of P&E on IRS’ September 30, 1998, balance
sheet and overstatement of nonpayroll operating expenses. Such practices
distort the net cost of operations and understate assets.




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We also analyzed IRS’ purchases of P&E for the last 5 fiscal years17 as
shown in IRS’ detailed records to determine the effect of IRS’ $50,000
capitalization threshold. As shown in table 3, over the last 5 fiscal years
only 33 percent of the P&E recorded in IRS’ detailed records had a
purchase price of over $50,000.



Table 3: IRS’ P&E Purchases for Fiscal Years 1994-1998 (Dollars in Millions)

                                                         P&E additions
                            P&E additions per          over $50,000 per       Percent of additions
Fiscal year                  detailed records          detailed records              over $50,000
1994                                         $207                      $81                         39
1995                                          232                       76                         33
1996                                          216                       81                         38
1997                                          150                       46                         31
1998                                          138                       28                         20
Total                                        $943                    $312                          33
Note: IRS capitalizes P&E with an acquisition amount or price equal to or above $50,000. According to
our and IRS reports, IRS’ detailed records are incomplete.
Source: Unaudited IRS data.


In addition, IRS did not capitalize any lease agreements in fiscal year 1998.
Based on our review of IRS’ detailed records, some lease agreements
appear to meet the criteria in SFFAS No. 6 for capitalization. For example,
in our review of mainframe consolidation costs, we identified $63.5 million
that was budgeted for fiscal year 1998 that was for computer equipment
and software with a 3-year lease to purchase. This would appear to meet
the criteria for capitalization. IRS officials told us that IRS did not evaluate
leases to determine whether any leases met the P&E capitalization criteria.

IRS will be incurring major expenditures to modernize its tax systems and
it will be important for IRS to properly account for these expenditures as
they are made. In December 1998, IRS awarded its prime contract for tax
systems modernization. IRS is partnering with the private sector to make
technology investments in its primary business lines: customer service,
compliance, electronic commerce, submission processing, corporate
systems, and financial reporting. As these investments are made, SFFAS


17
  IRS depreciates a majority of its P&E over a maximum of 5 years. Therefore, all P&E over 5 years old
would have a zero net value on the financial statements.




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                          No. 6 calls for capitalizing the cost of externally developed computer
                          systems, including software. Unless IRS changes its practices, most of
                          these capital costs will not be captured as IRS’ P&E given IRS’
                          capitalization threshold and recognition practices. Thus, IRS' financial
                          statements will not reflect the significant assets that IRS has purchased as
                          part of tax system modernization.



Controls Over Inventory   As previously reported by us,18 IRS internal auditors, and IRS itself, IRS’
Records are Weak          controls over its detailed records are not adequate to ensure that these
                          records provide a reliable record of P&E assets. For example, we found
                          that IRS did not accurately keep track of additions and deletions of P&E in
                          fiscal year 1998. In addition, our work and that of IRS’ internal auditors
                          raised questions about the accuracy of property valuation in IRS’ detailed
                          records.

                          IRS relies entirely on its detailed records and an annual analysis of
                          leasehold improvements to determine its amount of P&E. IRS maintains its
                          detailed records in the Integrated Network and Operations Management
                          System (INOMS) for computer-related P&E and the Property Asset
                          Tracking System (PATS) for noncomputer-related P&E. Although IRS uses
                          a $50,000 threshold for financial reporting, IRS’ offices track P&E in
                          detailed records using a much lower dollar threshold.

                          IRS has several requirements for how physical inventories of property
                          should be performed. For example, IRS’ ADP Property Management
                          Procedural Guide calls for conducting physical inventories annually. IRS’
                          fiscal year 1998 procedures governing non-ADP P&E require that a physical
                          inventory to verify the existence and accuracy of property be taken at
                          regular intervals, but in no case should the interval exceed 3 years. IRS has
                          established procedures whereby each year, one-third of the non-ADP
                          property should be inventoried in order to complete a 100-percent
                          inventory every 3 years. IRS’ internal audit reported that these procedures
                          are not always being followed and, as discussed below, IRS’ detailed
                          records are inaccurate.

                          During our audit of IRS’ fiscal year 1998 financial statements, we tested the
                          reliability of IRS’ detailed records by physically verifying the existence of


                          18
                           Financial Audit: Examination of IRS' Fiscal Year 1996 Administrative Financial Statements
                          (GAO/AIMD-97-89, August 29, 1997).




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selected property items. These limited tests, as well as IRS internal audit
reports and the results of IRS’ own inventories, showed that IRS’ detailed
records were substantially in error. Many of the equipment items on-hand
were not included in the detailed records, items that were no longer in IRS’
possession had not been removed from the records, and information on
other items included in the records were inaccurate, as the following
examples illustrate.

• We found that 10 of 141 items (7 percent) we selected from the floor of
  IRS’ field offices were not included in IRS’ detailed records, including
  items such as a front-end loader, electric pallet jacket, television,
  facsimile machine, and a video cassette recorder.
• IRS was unable to locate 10 of the 153 (7 percent) items we selected for
  review from IRS’ detailed records, including items such as a 1993
  Chevrolet Blazer motor vehicle, a laptop computer, a workstation, a
  microcomputer, and a laser printer which, according to IRS’ records,
  cost over $300,000. After performing additional follow-up, IRS was able
  to determine that the Chevrolet Blazer was leased from GSA in May
  1993, and subsequently returned in July 1998 at the expiration of the
  lease agreement. However, IRS had not updated its property records to
  show that it no longer had the Blazer.
• IRS assigned costs ranging from $300,000 to $1,000,000 to substantially
  identical mail sorting machines.
• For 15 of 294 items, IRS’ detailed records contained inaccurate data
  related to barcodes, serial numbers, manufacturer, and model numbers.

At one office in which we observed IRS staff conducting physical
inventories where they attempted to trace from IRS’ detailed records to the
floor, IRS staff were unable to locate 19 of 130 computer equipment assets
(15 percent), which cost over $50,000 each. In addition, 20 of 443 items
(5 percent) that they attempted to trace from the floor were not included in
IRS’ detailed records. At a different office, we found that 11 of 12
items (92 percent) over $50,000 had been disposed of but had not been
removed from the detailed records.

IRS’ internal auditors have reported significant weaknesses in IRS’ control
over its P&E as illustrated in the following examples.




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• In February 1999,19 the Office of Treasury Inspector General for Tax
  Administration reported that a significant amount of
  telecommunications equipment sampled from the floor of IRS sites
  could not be located on the corresponding detailed records. At the
  Tennessee Computing Center, only 4 of 27 telecommunications
  equipment items identified as physically existing were actually recorded
  by IRS in INOMS. At the Cleveland Customer Service site, only 6 of
  55 items were appropriately recorded in IRS’ detailed records.
• In April 1998,20 IRS’ Internal Audit reported that P&E inventory
  procedures for computer equipment and software were not effective for
  maintaining an accurate inventory or consistently followed by all
  districts in the Northeast Region. For example, an inventory that was to
  be performed for all computer hardware and certain related software
  was not carried out by all districts in the region as some districts were
  unaware of the requirement. Also, a procedure to update the property
  system to reflect the relocation of computer equipment was flawed,
  resulting in the potential for an inaccurate inventory.

The accuracy of IRS’ detailed records is especially important because IRS
uses these records to determine the amount to record as P&E on its
financial statements. This is because IRS inappropriately expenses all P&E
purchases and then once a year computes its ending P&E balance based on
its detailed records. The detailed records are maintained by IRS’ field
offices, which record individual property acquisitions and dispositions in
the detailed records throughout the year. Since IRS’ detailed records are
not integrated with its general ledger accounting system, IRS is compelled
to manually adjust the general ledger P&E account to force it to agree to its
detailed records. To determine the amount of P&E to record on its financial
statements, IRS summarizes information from its detailed records on
assets with individual item dollar values of $50,000 or more. IRS then
adjusts P&E and nonpayroll operating expenses in its accounting records.
In making these adjustments, IRS attempts to eliminate from its expenses
the P&E additions for the fiscal year. However, no analysis is done to
ensure that the detailed records are complete and agree with the dollar
amounts in the accounting records. As shown in table 4, the amount of P&E


19
 Review of the Internal Revenue Service's Year 2000 Efforts to Inventory Telecommunications and
Commercial Off-the-Shelf Products (Office of Treasury Inspector General for Tax Administration Audit
Report No. 092402, February 10, 1999).
20
  Review of INOMS Controls for the Century 2000 Initiative in the Northeast Region (IRS Internal Audit
Report No. 681803, April 24, 1998).




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                  acquired each year according to the detailed records has been much less
                  than the amount shown under equipment-related purchases in IRS’
                  financial statements.



                  Table 4: Differences in Accounting and Detailed Records for P&E Expensed for
                  Fiscal Years 1996-1998 (Dollars in Millions)

                                    P&E expensed per           P&E expensed per            Difference in accounting
                  Fiscal year      accounting records            detailed records              and detailed records
                  1996                               $311                       $216                                 $95
                  1997                                 305                        104                                201
                  1998                                 339                        111                                228
                  Total                              $955                       $431                               $524
                  Note: IRS expensed P&E with an acquisition amount or price below $50,000 for fiscal years 1997 and
                  1998. Depreciation and amortization expenses of $99 million (fiscal year 1997) and $100 million (fiscal
                  year 1998) were not deducted from the reported equipment expense amounts of $305 million (for fiscal
                  year 1997) and $339 million (for fiscal year 1998), because we could not break out amortization from
                  depreciation expense. According to our and IRS reports, IRS’ detailed P&E records are incomplete.
                  Source: Unaudited IRS data.




Recommendations   We recommend that IRS develop and implement procedures and controls
                  to ensure that detailed P&E records are accurately maintained. These
                  procedures and controls would include ensuring that physical inventories
                  at field locations are effectively performed, including prompt resolution of
                  discrepancies found in the inventories and appropriate adjustment of
                  detailed records.

                  Because of inaccuracies in existing detailed P&E records and in order to
                  provide an accurate starting point, we recommend that the Commissioner
                  of Internal Revenue consider directing that a physical inventory of P&E be
                  performed with adjustments being made to IRS’ detailed records
                  accordingly. To ensure that such efforts are not wasted, IRS first needs to
                  establish and implement effective procedures to ensure that the accuracy
                  of detailed P&E records, once corrected, is maintained.

                  In conjunction with or shortly after a physical inventory, we recommend
                  that the Commissioner of Internal Revenue direct that a systematic
                  validation of the P&E amounts (valuation) for items in IRS’ detailed
                  records be performed.




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                        To address the likely understatement of reported P&E and improve the
                        accuracy of information contained in the P&E records, we recommend that
                        the Commissioner of Internal Revenue direct the Chief Financial Officer to

                        • develop a means to capture and capitalize all costs incurred to bring
                          P&E to a form and location suitable for its intended use in accordance
                          with SFFAS No. 6, including the design and installation costs and the
                          costs of externally developed software,
                        • revise the current capitalization policy to ensure that material P&E
                          acquisitions are not expensed, and
                        • review all lease agreements to determine whether they meet the criteria
                          for capital leases and capitalize and properly record any leases that
                          meet the criteria.

                        In the long-term, to address the system deficiencies affecting IRS’ ability to
                        effectively manage and report on its P&E balances, we recommend that the
                        Commissioner of Internal Revenue direct that enhancements be made to
                        IRS’ financial systems to include recording P&E and capital leases as assets
                        when purchased and to generate detailed records for P&E that reconcile to
                        the financial records.



Financial Reporting     We found that IRS’ general ledger for administrative activities cannot
                        routinely generate reliable and prompt financial information. IRS’ basic
Process Is Inadequate   approach to preparing its financial statements was designed specifically for
                        the narrowly defined purpose of preparing auditable amounts and balances
                        only at fiscal year-end. Also, one of the significant challenges facing IRS
                        involves establishing a financial management team with sufficient
                        expertise to ensure that reliable financial information is produced. In order
                        to improve financial management, it will take both a sustained commitment
                        by top management and a sound support team.

                        IRS relies on various costly and time-consuming ad hoc procedures and
                        adjustments to prepare its financial statements at year-end. These include
                        adjustments for P&E and leasehold improvements and numerous other
                        adjustments made at year-end. Therefore, information to measure results is
                        not available throughout the year as a management tool to aid managers in
                        fulfilling their responsibilities for evaluating performance.

                        For fiscal year 1998, adequate supervision of the financial reporting
                        process did not occur. Key financial management positions went unfilled
                        and review of financial and accounting entries was lacking or ineffective.



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For the preparation of IRS’ fiscal year 1998 financial statements, there was
heavy reliance on contractor support to provide the supporting data for the
financial statements without necessary supervision and involvement by IRS
personnel. The Comptroller General's standards for internal controls21
require supervisors to continuously review and approve the assigned work
of their staffs. However, this did not occur at IRS for fiscal year 1998. These
deficiencies contributed to IRS’ inability to adequately support most of its
administrative accounts for its financial statements leading to disclaimers
of opinions for four financial statements and a qualified opinion on its
balance sheet. Several of the deficiencies noted in this report resulted from
inadequate supervision over the accounting and financial reporting
functions, as the following examples illustrate.

• As discussed above, reconciliations of fund balance with Treasury were
  not prompt or successful for fiscal year 1998. The schedules provided to
  us, which were purported to be reconciliations, came directly from IRS’
  contractors with no IRS review. Consequently, we believe that IRS did
  not provide adequate oversight of the contractors to ensure that the
  reconciliations were properly and promptly performed.
• Key personnel with responsibilities for financial systems and reporting
  on IRS’ administrative activities had left IRS by July 1998 and had not
  been replaced by year-end. For example, the Financial Applications
  Support & Technology and Financial Systems section chiefs left IRS and
  were not replaced by February 1999. Also, the head of the Accounting
  Standards & Evaluation Division transferred to a field office in fiscal
  year 1998. Consequently, IRS was compelled to prepare its financial
  statements without managers to properly oversee and review them, as
  well as perform supervisory review on post-closing adjusting and
  reclassification entries.
• Due to the implementation of new federal accounting and reporting
  requirements, IRS prepared four new financial statements, including the
  Statements of Budgetary Resources and Financing. The accountant
  responsible for preparing these budgetary statements had written
  guidance issued only by Treasury and OMB to assist in preparing the
  statements. There was little to no supervisory input provided to the
  accountant preparing the statements nor did the statements undergo a
  detailed review prior to being issued in draft. Consequently, throughout
  our review of the draft statements, we found numerous errors and
  omissions, which should have been caught and corrected had these


21
 Standards for Internal Controls in the Federal Government, U.S. General Accounting Office, 1983.




Page 24                                      GAO/AIMD-99-196 IRS Administrative Weaknesses
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    statements been appropriately reviewed by management. For example,
    in several drafts of IRS’ financial statements, the three major budgetary
    accounts reflected negative available unobligated balances totaling
    about $200 million. A negative balance could indicate the possibility of
    an Anti-Deficiency Act violation. IRS officials told us that IRS did not
    violate the Anti-Deficiency Act and had it performed a more
    comprehensive review, it would have corrected this error prior to
    providing us its draft financial statements. Based on our inquiry, IRS
    performed additional analysis on these accounts and subsequently
    revised its balances to show available unobligated balances totaling
    about $50 million.22 Even after these adjustments, we were unable to
    determine if the revised balances in these accounts were reliable. Table
    5 shows the draft and final numbers for unobligated balances available
    as of September 30, 1998.



Table 5: Unobligated Balances Available as of September 30, 1998
(Dollars in Millions)


                                          December 15, 1998 draft                   Final financial
Appropriation                              of financial statements                     statements
Processing, assistance, and
management                                                        -$23                               $8
Tax law enforcement                                                 -22                               4
Information systems                                               -148                               34
Other                                                              311                          318
Total                                                             $118                         $364
Note: IRS received an appropriation of $295 million for information technology investments. However,
these funds were not available for obligation until September 1, 1998, and were not obligated as of
September 30, 1998.
Source: Unaudited IRS data.


• During fiscal year 1998, a large number of post-closing adjusting and
  reclassification entries were made to correct erroneous entries and
  balances in the accounting records. For example, we questioned the
  reasonableness of the downward adjustment account and upward
  adjustment account of prior year undelivered orders, which were each
  larger than the beginning balance of undelivered orders of $668 million.


22
  Note that we did not give an opinion on IRS’ Statement of Budgetary Resources or test compliance
with the Anti-Deficiency Act due to limitations on the scope of our work.




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                     Based on our inquiry, IRS identified about $580 million worth of
                     transactions that were inappropriately included in each of these
                     adjustment accounts, as shown in table 6.



                  Table 6: Upward and Downward Adjustments of Undelivered Orders
                  (Dollars in Millions)

                                                          Upward adjustments Downward adjustments
                  Original balance                                       -$683                    $727
                  Per IRS, transactions inappropriately                   581                     -577
                  included
                  Revised balance                                        -$102                    $150
                  Source: Unaudited IRS data.


                  IRS subsequently reduced each of these adjustment accounts by about
                  $580 million. Since these accounts are included in five separate line items
                  in the Statement of Budgetary Resources, these errors would have
                  significantly understated some line items while overstating others,
                  resulting in a material distortion of the financial statement. Even after
                  these adjustments, however, we were unable to determine if the revised
                  balances in these accounts were reliable because we were not able to
                  obtain a list of outstanding undelivered orders at the beginning or end of
                  the year.


Recommendations   IRS can improve its financial reporting process by ensuring that
                  appropriate supervisory and management review of its financial statements
                  and operations occurs. We recommend that the Commissioner of Internal
                  Revenue direct that additional knowledgeable staff are employed or that
                  existing staff are appropriately cross-trained to be able to develop IRS’
                  financial statements and perform its accounting and financial functions or
                  are able to perform the necessary supervision needed to obtain reliable and
                  supportable financial data on time.

                  Also, to address IRS’ deficiencies in its accounting and financial reporting
                  processes, we recommend that the Commissioner of Internal Revenue
                  direct the Chief Financial Officer to establish procedures for the financial
                  statements to undergo review at the appropriate levels within the Chief
                  Financial Officer's office, with documented evidence of the reviews.




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Agency Comments and   IRS said it agreed for the most part with the conclusions in this report. IRS
                      said it has already begun implementing many actions to improve its
Our Evaluation        administrative financial operations. For example, IRS said that subsequent
                      to the completion of the fiscal year 1998 financial statement audit, IRS put
                      in place an entirely new management team on the administrative
                      accounting side. IRS noted, however, that several of the issues raised in this
                      report will require fixing and/or replacing the current accounting system as
                      well as integration with the other administrative systems (e.g.
                      procurement, property, and personnel) and cannot be fixed in the
                      short-term.

                      We are pleased to see that IRS has begun taking positive steps towards
                      addressing the recommendations in this report in order to improve its
                      administrative accounting such as hiring needed supervisory personnel.
                      However, it will take sustained senior management attention to resolve
                      IRS’ weaknesses in its administrative accounting area.


                      This report contains recommendations to you. The head of a federal agency
                      is required by 31 U.S.C. 720 to submit a written statement on actions taken
                      on these recommendations. You should send your statements to the Senate
                      Committee on Governmental Affairs and the House Committee on
                      Governmental Reform and Oversight within 60 days after the date of this
                      report. A written statement also must be sent to the House and Senate
                      Committees on Appropriations with the agency's first request for
                      appropriations made more than 60 days after the date of this report.

                      We are sending copies of this report to Senator Ted Stevens, Senator Robert
                      Byrd, Senator Ben Nighthorse Campbell, Senator Byron Dorgan, Senator
                      William Roth, Senator Daniel P. Moynihan, Senator Orrin Hatch, Senator
                      Max Baucus, Senator Fred Thompson, Senator Joseph Lieberman, Senator
                      Pete Domenici, Senator Frank Lautenberg, Representative Bill Young,
                      Representative David Obey, Representative Jim Kolbe, Representative
                      Steny Hoyer, Representative Bill Archer, Representative Charles Rangel,
                      Representative Dan Burton, Representative Henry Waxman,
                      Representative Stephen Horn, Representative Jim Turner, Representative
                      John Kasich and Representative John Spratt in their capacities as Chair or
                      Ranking Minority Member of Senate and House Committees and
                      Subcommittees. We are also sending copies to the Honorable Lawrence H.
                      Summers, Secretary, Department of Treasury; the Honorable Jacob J. Lew,




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Director, Office of Management and Budget, and other interested parties.
Copies will be made available to others upon request.

Please contact me at (202) 512-3406 or Joan Hawkins at (202) 512-8433 if
you have any questions concerning this report. Other key contributors to
this report are listed in appendix IV.

Sincerely yours,




Gregory D. Kutz
Associate Director
Governmentwide Accounting and Financial
 Management Issues




Page 28                          GAO/AIMD-99-196 IRS Administrative Weaknesses
Page 29   GAO/AIMD-99-196 IRS Administrative Weaknesses
Contents



Letter                                                                      1


Appendix I                                                                 32
Scope and
Methodology

Appendix II                                                                33
Comments From the
Internal Revenue
Service

Appendix III                                                               35
Status of GAO
Recommendations on
IRS Administrative
Activities

Appendix IV                                                                39
GAO Contacts and
Staff
Acknowledgments

Related GAO Products                                                       40




                       Page 30   GAO/AIMD-99-196 IRS Administrative Weaknesses
          Contents




Tables    Table 1: IRS’ Suspense Account Components as of
            September 30, 1998 (Dollars in Thousands)                                  8
          Table 2: Information on Data Tapes Provided by IRS (Dollars in
            Millions)                                                                 12
          Table 3: IRS’ P&E Purchases for Fiscal Years 1994-1998 (Dollars
            in Millions)                                                              18
          Table 4: Differences in Accounting and Detailed Records for P&E
            Expensed for Fiscal Years 1996-1998 (Dollars in Millions)                 22
          Table 5: Unobligated Balances Available as of September 30, 1998
            (Dollars in Millions)                                                     25
          Table 6: Upward and Downward Adjustments of Undelivered
            Orders (Dollars in Millions)                                              26
          Table III.1: Status of Open GAO Recommendations on IRS
            Administrative Activities                                                 35



Figures   Figure 1: IRS’ Fiscal Year 1998 $7.9 Billion of Operating Expenses
            by Program (Dollars in Billions)                                           5
          Figure 2: IRS’ September 30, 1998, P&E Detailed Records by
            Individual Item Dollar Amount (Gross Amounts)                             17




          Abbreviations

          ADP        automated data processing
          FMFIA      Federal Managers’ Financial Integrity Act
          GSA        General Services Administration
          INOMS      Integrated Network and Operations Management System
          IRS        Internal Revenue Service
          OMB        Office of Management and Budget
          P&E        property and equipment



          Page 31                           GAO/AIMD-99-196 IRS Administrative Weaknesses
Appendix I

Scope and Methodology                                                                        Appenx
                                                                                                  Idi




             As part of our audit of IRS’ fiscal year 1998 financial statements, we
             conducted an evaluation of IRS’ internal controls. We designed our audit
             procedures to test relevant controls and included tests for proper
             authorization, execution, accounting, and reporting of transactions. Some
             of the key procedures we performed included the following.

             • We selected a statistical sample of nonpayroll operating expense
               transactions and traced sample information to supporting
               documentation, such as invoices, receiving reports, and obligating
               documents, and reconciled total expense transaction data to the general
               ledger and the financial statements.
             • We selected a statistical sample of payroll operating expense
               transactions and traced sample information to supporting
               documentation, such as time and attendance records and personnel
               folders, conducted analytical procedures on year-end payroll expenses,
               and obtained documentation to support IRS personnel liabilities from
               other federal agencies, such as the Department of Labor.
             • We conducted site visits to confirm the physical existence of a
               nonrepresentative selection of property and equipment at several IRS
               service centers and other IRS locations. We also selected items at these
               locations and traced them to IRS’ records to ensure completeness.
             • We observed selected property and equipment inventories taken by IRS.
             • We reviewed IRS’ contractor-provided reconciliations of the fund
               balance with Treasury.

             To assess the reliability of budget information presented in IRS’ financial
             statements, we planned to use a combination of detail testing, analytical
             procedures, and where applicable, rely on our work performed in the
             property and equipment, accounts payable, and operating expenses areas.
             However, IRS was unable to provide us with the necessary data from which
             to select our samples due to IRS’ lack of subsidiary ledgers, and thus we
             were unable to perform the detail tests. Also, due to deficiencies identified
             in our work in a number of areas such as P&E, accounts payable, and
             nonpayroll operating expenses, we were unable to determine whether the
             corresponding budgetary balances were materially correct. We performed
             our work from July 1998 through March 1999 in accordance with generally
             accepted government auditing standards and OMB Bulletin 98-08.




             Page 32                             GAO/AIMD-99-196 IRS Administrative Weakness
Appendix II

Comments From the Internal Revenue Service                            Appe
                                                                         nIx
                                                                           Idi




              Page 33     GAO/AIMD-99-196 IRS Administrative Weaknesses
Appendix II
Comments From the Internal Revenue
Service




Page 34                              GAO/AIMD-99-196 IRS Administrative Weaknesses
Appendix III

Status of GAO Recommendations on IRS
Administrative Activities                                                                                                                      AppeInx
                                                                                                                                                     Idi




                                            As a result of our financial audits of IRS from fiscal years 1992 through
                                            1996, we made a total of 29 recommendations for improving IRS’
                                            administrative accounting and internal controls. Action was completed on
                                            15 of these recommendations as of the end of the fiscal year 1996
                                            administrative financial statement audit, and thus these recommendations
                                            were closed. In fiscal year 1997, IRS’ administrative activities were audited
                                            by the Department of the Treasury Office of Inspector General.1

                                            The following table shows the updated status of the 14 prior administrative
                                            accounting and internal control recommendations that were still open at
                                            the completion of the fiscal year 1996 audit, numbered 1-14 in the table. We
                                            also have added new recommendations we are making in this report as a
                                            result of our fiscal year 1998 audit. They are numbered 15-27 in the
                                            following table.



Table III.1: Status of Open GAO Recommendations on IRS Administrative Activities

Report         Administrative recommendations                                                Description of recommendations
Financial Management: IRS Lacks Accountability Over Its ADP Resources (GAO/AIMD-93-24, August 5, 1993)
               1. Develop and implement standard operating procedures that                   We are closing this recommendation and
               incorporate controls to ensure that detailed records are accurately           replacing it with recommendations 19, 20,
               maintained. Such controls should include (1) establishing specific            21, and 25 to highlight the need for action.
               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, (2) reconciling
               accounting and detailed records monthly as an interim measure until the
               successful integration of inventory and accounting systems is completed
               as planned, and (3) implementing mechanisms for ensuring that annual
               physical inventories at field locations are effectively performed, that
               discrepancies are properly resolved, and that detailed records are
               appropriately adjusted.
               2. Oversee efforts for ensuring that P&E inventory data, including            Open.
               telecommunications and electronic filing equipment, are complete and
               accurate.
               3. Determine what information related to ADP resources, such as               Open.
               equipment 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.




                                            1
                                             See Internal Revenue Service Accountability Report Fiscal Year 1997, Department of the Treasury
                                            (March 1998).




                                            Page 35                                      GAO/AIMD-99-196 IRS Administrative Weaknesses
                                             Appendix III
                                             Status of GAO Recommendations on IRS
                                             Administrative Activities




Report         Administrative recommendations                                               Description of recommendations
               4. Develop an interim means to capture relevant costs related to in-house Open. Beginning with fiscal year 2001,
               software development.                                                     agencies will be required to implement the
                                                                                         provisions of SFFAS No.10, Accounting for
                                                                                         Internal Use Software.
Financial Management: IRS Does Not Adequately Manage Its Operating Funds (GAO/AIMD-94-33, February 9, 1994)
               5. Promptly resolve differences between IRS and Treasury records of          We are closing this recommendation and
               IRS’ cash balances and adjust accounts accordingly.                          replacing it with recommendation 15 to
                                                                                            highlight the need for action.
               6. Promptly investigate and record suspense account items to                 We are closing this recommendation and
               appropriate accounts.                                                        replacing it with recommendation 16 to
                                                                                            highlight the need for action.
               7. Perform periodic reviews of obligations, adjusting the records for        Open. IRS informed us that it has taken
               obligations to amounts expected to be paid and removing expired              corrective action to address this
               appropriation balances from IRS records as stipulated by the National        recommendation. We will evaluate the
               Defense Authorization Act for Fiscal Year 1991.                              actions taken as part of our fiscal year 1999
                                                                                            audit.
               8. Revise procedures to incorporate the requirements that accurate           Open. IRS informed us that it has taken
               receipt and acceptance data on invoiced items be obtained prior to           corrective action to address this
               payment and that supervisors ensure that these procedures are carried        recommendation. We will evaluate the
               out.                                                                         actions taken as part of our fiscal year 1999
                                                                                            audit.
               9. Revise document control procedures to require IRS units that actually     Open. IRS informed us that it has taken
               receive goods or services to promptly forward receiving reports to           corrective action to address this
               payment offices so that payments can be promptly processed.                  recommendation. We will evaluate the
                                                                                            actions taken as part of our fiscal year 1999
                                                                                            audit.
               10. Use the Automated Financial System's enhanced cost accumulation          Open.
               capabilities to monitor and report costs by project in all appropriations.
               11. Require payment and procurement personnel, until the integration of      No action planned. In fiscal year 1996, IRS
               the Automated Financial System and the procurement system is                 officials stated that IRS did not plan to
               completed as planned, to periodically (monthly or quarterly) reconcile       manually reconcile its existing procurement
               payment information maintained in the Automated Financial System to          and payment systems as an interim
               amounts in the procurement records and promptly resolve any                  measure since they expected to integrate
               discrepancies.                                                               the procurement system with the Automated
                                                                                            Financial System. These officials believed
                                                                                            that this new system would ensure that
                                                                                            payment amounts recorded in the
                                                                                            procurement and accounting systems are
                                                                                            equal. During our fiscal year 1999 audit, we
                                                                                            will determine if the issue has been
                                                                                            adequately addressed.
Financial Audit: Examination of IRS’ Fiscal Year 1993 Financial Statements (GAO/AIMD-94-120, June 15, 1994)
               12. Establish a method to continuously monitor and correct actions to        Open.
               ensure that progress is achieved.
               13. Develop reliable detailed information supporting reported accounts       We are closing this recommendation and
               payable balances.                                                            replacing it with recommendation 17 to
                                                                                            highlight the need for action.




                                             Page 36                                    GAO/AIMD-99-196 IRS Administrative Weaknesses
                                             Appendix III
                                             Status of GAO Recommendations on IRS
                                             Administrative Activities




Report        Administrative recommendations                                                 Description of recommendations
              14. Use current information to periodically update estimated future Tax        Open.
              Systems Modernization costs.
Financial Management: Serious Weaknesses Impact Ability to Report on and Manage Operations (GAO/AIMD-99-196, August 9,
1999)
              15. Promptly resolve differences between IRS and Treasury records of           We are making this recommendation, which
              IRS’ appropriation account balances and adjust accounts accordingly. For       replaces recommendation 5, to highlight the
              example, reconciliations should be performed promptly every month, with        need for action on this long-standing
              Treasury and IRS amounts in agreement and reconciling items properly           problem area.
              resolved.
              16. Strengthen control over IRS’ operating funds by promptly                   We are making this recommendation, which
              investigating and clearing suspense account items. For example,                replaces recommendation 6, to highlight the
              outstanding amounts in the suspense account should be reviewed every           need for action on this long-standing
              month to try to resolve and clear outstanding balances.                        problem area.
              17. Develop subsidiary records for accounts payable and undelivered            New recommendation. This
              orders and a list of current year nonpayroll operating expenses that will      recommendation relates to recommendation
              provide reliable accounts payable, undelivered orders, and nonpayroll          13, which we are closing.
              operating expense data.
              18. Develop the data to support meaningful cost information categories         New recommendation.
              and cost-based performance measures.
              19. Develop and implement procedures and controls to ensure that               We are making this recommendation, which
              detailed P&E records are accurately maintained. These procedures and           replaces recommendation 1, to highlight the
              controls would include ensuring that physical inventories at field locations   need for action on this long-standing
              are effectively performed, including prompt resolution of discrepancies        problem area.
              found in the inventories and appropriate adjustment of detailed records.
              20. Consider directing that a physical inventory of P&E be performed with New recommendation. This
              adjustments being made to IRS’ detailed records accordingly. To ensure recommendation relates to recommendation
              that such efforts are not wasted, IRS first needs to establish and        1, which we are closing.
              implement effective procedures to ensure that the accuracy of detailed
              P&E records, once corrected, is maintained.
              21. In conjunction with or shortly after a physical inventory, perform a       New recommendation. This
              systematic validation of the P&E amounts (valuation) for items in IRS’         recommendation relates to recommendation
              detailed records.                                                              1, which we are closing.
              22. Develop a means to capture and capitalize all costs incurred to bring New recommendation.
              P&E to a form and location suitable for its intended use in accordance
              with SFFAS No. 6, including the design and installation costs and the
              costs of externally developed software.
              23. Revise the current capitalization policy to ensure that material P&E       New recommendation.
              acquisitions are not expensed.
              24. Review all lease agreements to determine whether they meet the             New recommendation.
              criteria for capital leases and capitalize and properly record any leases
              that meet the criteria.
              25. Make enhancements to IRS’ financial systems to include recording           New recommendation. This
              P&E and capital leases as assets when purchased and to generate                recommendation relates to recommendation
              detailed records for P&E that reconcile to the financial records.              1, which we are closing.




                                             Page 37                                      GAO/AIMD-99-196 IRS Administrative Weaknesses
                                      Appendix III
                                      Status of GAO Recommendations on IRS
                                      Administrative Activities




Report   Administrative recommendations                                          Description of recommendations
         26. Ensure that additional knowledgeable staff are employed or that        New recommendation.
         existing staff are appropriately cross-trained to be able to develop IRS’
         financial statements and perform its accounting and financial functions or
         are able to perform the necessary supervision needed to obtain reliable
         and supportable financial data on time.
         27. Establish procedures for the financial statements to undergo review at New recommendation.
         the appropriate levels within the Chief Financial Officer’s office, with
         documented evidence of the reviews.




                                      Page 38                                GAO/AIMD-99-196 IRS Administrative Weaknesses
Appendix IV

GAO Contacts and Staff Acknowledgments                                                        Appenx
                                                                                                   di
                                                                                                   IV




GAO Contacts      Greg Kutz, (202) 512-3406
                  Joan Hawkins, (202) 512-8433



Acknowledgments   In addition to those named above, Christina Beck, Craig Feight, David
                  Fisher, Paul Foderaro, Mai Nguyen, Ruth Sessions, and Keith Thompson
                  made key contributions to this report.




                  Page 39                         GAO/AIMD-99-196 IRS Administrative Weaknesses
Related GAO Products


                   Financial Audit: IRS’ Fiscal Year 1998 Financial Statements
                   (GAO/AIMD-99-75, March 1, 1999).

                   Financial Audit: Examination of IRS’ Fiscal Year 1996 Administrative
                   Financial Statements (GAO/AIMD-97-89, August 29, 1997).

                   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).

                   Financial Management: IRS Does Not Adequately Manage Its Operating
                   Funds (GAO/AIMD-94-33, February 9, 1994).

                   Financial Management: IRS Lacks Accountability Over Its ADP Resources
                   (GAO/AIMD-93-24, August 5, 1993).




(919366)   Leter   Page 40                           GAO/AIMD-99-196 IRS Administrative Weaknesses
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