oversight

Fiscal Year 2011 U.S. Government Financial Statements: The Federal Government Faces Continuing Financial Management and Long-Term Fiscal Challenges

Published by the Government Accountability Office on 2012-03-01.

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

                             United States Government Accountability Office

GAO                          Testimony
                             Before the Subcommittee on Government
                             Organization, Efficiency and Financial
                             Management, Committee on Oversight and
                             Government Reform, House of Representatives

                             FISCAL YEAR 2011
For Release on Delivery
Expected at 10:00 a.m. EST
Thursday, March 1, 2012

                             U.S. GOVERNMENT
                             FINANCIAL STATEMENTS
                             The Federal Government
                             Faces Continuing Financial
                             Management and Long-
                             Term Fiscal Challenges
                             Statement of Gene L. Dodaro
                             Comptroller General of the United States




GAO-12-444T
                                              March 1, 2012

                                              FISCAL YEAR 2011 U.S. GOVERNMENT
                                              FINANCIAL STATEMENTS
                                              The Federal Government Faces Continuing Financial
Highlights of GAO-12-444T, a testimony
                                              Management and Long-Term Fiscal Challenges
before the Subcommittee on Government
Organization, Efficiency and Financial
Management, Committee on Oversight and
Government Reform, House of
Representatives

Why GAO Did This Study                        What GAO Found
GAO annually audits the consolidated          Three long-standing major impediments continued to prevent GAO from
financial statements of the U.S.              expressing an opinion on the federal government’s accrual-based consolidated
government. The Congress and the              financial statements: (1) serious financial management problems at the
President need reliable, useful, and          Department of Defense (DOD) that have prevented DOD’s financial statements
timely financial and performance              from being audited, (2) federal entities’ inability to adequately account for and
information to make sound decisions           reconcile intragovernmental activity and balances, and (3) the federal
and conduct effective oversight of            government’s ineffective process for preparing the consolidated financial
federal government programs and               statements. GAO also reported material weaknesses involving billions of dollars
policies.
                                              in improper payments, information security, and tax collection activities. Also,
However, over the years, certain              GAO was prevented from expressing opinions on the 2011 and 2010 Statements
material weaknesses in internal control       of Social Insurance and the 2011 Statement of Changes in Social Insurance
over financial reporting have prevented       Amounts because of significant uncertainties primarily related to the achievement
GAO from expressing an opinion on             of projected reductions in Medicare cost growth reflected in the statements.
the accrual-based consolidated
financial statements. Unless these            GAO is encouraged by the commitment of DOD leaders to improving DOD’s
weaknesses are adequately                     financial management and achieving auditiability and by the congressional
addressed, they will, among other             attention being given to this important matter. The Congress set statutory
things, continue to (1) hamper the            deadlines for DOD auditability, convened a congressional panel to focus on the
federal government’s ability to reliably      issue, and held several hearings on DOD financial management. The Secretary
report a significant portion of its assets,   of Defense accelerated the timeline for DOD auditability, setting a 2014 deadline
liabilities, costs, and other related         for audit readiness of the Statement of Budgetary Resources, and DOD has
information; and (2) affect the federal       issued a plan for meeting that date, which GAO is in the process of reviewing.
government’s ability to reliably              The plan emphasizes the importance of leadership, including senior leaders and
measure the full cost as well as the          field commanders, to achieving DOD’s goals, and it links accountability to
financial and nonfinancial performance        performance appraisals. To meet their financial management and auditability
of certain programs and activities.           goals, DOD and its components will need to overcome significant challenges,
This testimony presents the results of        including implementation of its financial improvement plan, deployment of
GAO’s audit for fiscal year 2011 and          supporting automated systems, and assessment and resolution of gaps in
discusses certain of the federal              workforce skills.
government’s significant long-term
                                              The Department of the Treasury (Treasury) furthered its commitment to resolve
fiscal challenges.
                                              unreconciled differences between federal entities regarding intragovernmental
What GAO Recommends                           activity and balances, which included several short- and long-term initiatives. In
                                              addition, Treasury, in coordination with the Office of Management and Budget
Over the years, GAO has made                  (OMB), implemented corrective actions during 2011 to address certain
numerous recommendations directed             deficiencies regarding the preparation of the consolidated financial statements.
at improving federal financial
                                              Fully addressing the numerous issues in these areas will require a strong and
management. The federal government
                                              sustained commitment by federal entities and leadership by Treasury and OMB.
has generally taken or plans to take
actions to address GAO’s                      The 2011 Financial Report of the United States Government included
recommendations.                              comprehensive long-term fiscal projections for the U.S. government, which
                                              provides a much needed perspective on the federal government’s long-term
                                              fiscal position and outlook. These, like GAO’s simulations, include the savings
                                              provided by the Budget Control Act of 2011. While assuming that the savings as
                                              a share of gross domestic product continue beyond the decade leads to an
                                              improvement in the long-term fiscal path, it does not make the path sustainable.
View GAO-12-444T. For more information,       Addressing the long-term fiscal imbalance is made more difficult by the need to
contact Robert F. Dacey or Gary T. Engel at   balance achieving the goals of sustaining economic growth in the near term,
(202) 512-3406.
                                              while producing a plan to change the federal government’s long-term fiscal path.
                                                                                      United States Government Accountability Office
Mr. Chairman, Ranking Member Towns, and Other Members of the
Subcommittee:

I appreciate the opportunity to be here today to discuss our report on the
U.S. government’s consolidated financial statements for fiscal years 2011
and 2010. During fiscal year 2011, the federal government continued to
face economic and fiscal challenges in a slow growth economy with high
unemployment. Dealing with the government’s long-term fiscal challenges
will require sustained attention and difficult decisions to address serious
deficit and debt issues. These fiscal issues further highlight the need for
the federal government to operate as effectively and efficiently as
possible. Therefore, the Congress, the administration, and federal
managers must have ready access to reliable and complete financial and
performance information for individual federal entities and the federal
government as a whole. Even though significant progress has been made
in federal financial management since the enactment of key reforms in
the 1990s, our report on the U.S. government’s consolidated financial
statements illustrates that much work remains to improve federal financial
management. I would like to commend you, Mr. Chairman, and this
Subcommittee, for continuing the annual tradition of oversight hearings on
this important subject. Your involvement is critical to assuring continued
progress.

Our testimony today discusses the following major issues relating to the
consolidated financial statements for fiscal years 2011 and 2010: (1) the
results of our audit, including continued major impediments to an opinion
on the accrual-based consolidated financial statements 1 and certain
significant uncertainties that prevented us from expressing opinions on



1
  The consolidated financial statements other than the Statement of Social Insurance and
the Statement of Changes in Social Insurance Amounts are referred to as the accrual-
based consolidated financial statements. Most revenues reported in the accrual-based
consolidated financial statements are recorded on a modified cash basis. In fiscal year
2011, the federal government adopted Statement of Federal Financial Accounting
Standards No. 37, “Social Insurance: Additional Requirements for Management’s
Discussion and Analysis and Basic Financial Statements,” which calls for a new basic
financial statement, the Statement of Changes in Social Insurance Amounts, that is
included, along with the related notes, in the consolidated financial statements. The
Statement of Changes in Social Insurance Amounts presents the components of the
changes of the open group measure (total present value of future expenditures in excess
of future revenue), presented in the 2011 and 2010 Statements of Social Insurance.
Neither the Statement of Social Insurance nor the Statement of Changes in Social
Insurance Amounts interrelate with the accrual-based consolidated financial statements.




Page 1                                                                      GAO-12-444T
the 2011 and 2010 Statements of Social Insurance, 2 as well as on the
2011 Statement of Changes in Social Insurance Amounts; (2) the effects
of the last economic recession and the federal government’s actions to
stabilize financial markets and promote economic recovery on the federal
government’s financial condition; and (3) challenges posed by the federal
government’s long-term fiscal outlook.

Both the consolidated financial statements and our related audit report
are included in the fiscal year 2011 Financial Report of the United States
Government (Financial Report). 3 We performed sufficient audit work to
provide our report on the consolidated financial statements, internal
control, and compliance with selected provisions of laws and regulations.
We considered the limitations on the scope of our work in forming our
conclusions. We conducted our audit in accordance with U.S. generally
accepted government auditing standards. Our audit report would not be
possible without the commitment and professionalism of inspectors
general throughout the federal government who are responsible for
annually auditing the financial statements of individual federal agencies.
The Financial Report is available at
http://www.gao.gov/financial/fy2011financialreport.html and through the
Department of the Treasury (Treasury) at
http://www.fms.treas.gov/fr/index.html.




2
 Social insurance programs included in the Statement of Social Insurance are Social
Security, Medicare, Railroad Retirement, and Black Lung.
3
  Also, see GAO, Understanding the Primary Components of the Annual Financial Report
of the United States Government, GAO-09-946SP (Washington, D.C.: September 2009).




Page 2                                                                     GAO-12-444T
                        The federal government was unable to demonstrate the reliability of
Results of Our Audit    significant portions of the U.S. government’s accrual-based consolidated
of the U.S.             financial statements for fiscal years 2011 and 2010, principally resulting
                        from limitations related to certain material weaknesses in internal control
Government’s            over financial reporting. As a result, we were unable to provide an opinion
Consolidated            on such statements. Further, significant uncertainties, primarily related to
                        the achievement of projected reductions in Medicare cost growth 4
Financial Statements    reflected in the 2011 and 2010 Statements of Social Insurance, prevented
for Fiscal Years 2011   us from expressing opinions on those statements, 5 as well as on the 2011
and 2010                Statement of Changes in Social Insurance Amounts. Given the
                        importance of social insurance programs, such as Medicare and Social
                        Security to the federal government’s long-term fiscal outlook, the
                        Statement of Social Insurance is critical to understanding the federal
                        government’s financial condition and fiscal sustainability.

                        The federal government did not maintain adequate systems or have
                        sufficient, reliable evidence to support certain material information
                        reported in the U.S. government’s accrual-based consolidated financial
                        statements. The underlying long-standing material weaknesses in internal
                        control6 contributed to our disclaimers of opinion on the U.S.
                        government’s accrual-based consolidated financial statements for the
                        fiscal years ended 2011 and 2010. 7 Those material weaknesses relate to
                        the federal government’s inability to

                        •     satisfactorily determine that property, plant, and equipment and
                              inventories and related property, primarily held by the Department of




                        4
                            These uncertainties are discussed in Note 26 to the consolidated financial statements.
                        5
                          We expressed unqualified opinions on the 2009, 2008, and 2007 Statements of Social
                        Insurance.
                        6
                          A material weakness is a deficiency, or combination of deficiencies, in internal control
                        such that there is a reasonable possibility that a material misstatement of the entity’s
                        financial statements will not be prevented, or detected and corrected on a timely basis. A
                        deficiency in internal control exists when the design or operation of a control does not
                        allow management or employees, in the normal course of performing their assigned
                        functions, to prevent, or detect and correct misstatements on a timely basis.
                        7
                          A more detailed description of the material weaknesses that contributed to our
                        disclaimer of opinion, including the primary effects of these material weaknesses on the
                        accrual-based consolidated financial statements and on the management of federal
                        government operations, can be found on pages 224 through 228 of the Financial Report.




                        Page 3                                                                          GAO-12-444T
    Defense (DOD), were properly reported in the accrual-based
    consolidated financial statements;
•   reasonably estimate or adequately support amounts reported for
    certain liabilities, such as environmental and disposal liabilities, or
    determine whether commitments and contingencies were complete
    and properly reported;
•   support significant portions of the reported total net cost of operations,
    most notably related to DOD, and adequately reconcile disbursement
    activity at certain federal entities;
•   adequately account for and reconcile intragovernmental activity and
    balances between federal entities;
•   ensure that the federal government’s accrual-based consolidated
    financial statements were (1) consistent with the underlying audited
    entities’ financial statements, (2) properly balanced, and (3) in
    conformity with U.S. generally accepted accounting principles
    (GAAP); and
•   identify and either resolve or explain material differences between (1)
    certain components of the budget deficit reported in Treasury’s
    records that are used to prepare the Reconciliation of Net Operating
    Cost and Unified Budget Deficit, the Statement of Changes in Cash
    Balance from Unified Budget and Other Activities, and the Fiscal
    Projections for the U.S. government (included in the Supplemental
    Information section of the Financial Report) and (2) related amounts
    reported in federal entities’ financial statements and underlying
    financial information and records.
These material weaknesses continued to (1) hamper the federal
government’s ability to reliably report a significant portion of its assets,
liabilities, costs, and other related information; (2) affect the federal
government’s ability to reliably measure the full cost as well as the
financial and nonfinancial performance of certain programs and activities;
(3) impair the federal government’s ability to adequately safeguard
significant assets and properly record various transactions; and (4) hinder
the federal government from having reliable financial information to
operate in an efficient and effective manner.

In addition to the material weaknesses that contributed to our disclaimer
of opinion on the accrual-based consolidated financial statements, we




Page 4                                                             GAO-12-444T
found the following three other material weaknesses in internal control. 8
These other material weaknesses were the federal government’s inability
to

•     determine the full extent to which improper payments occur and
      reasonably assure that appropriate actions are taken to reduce
      improper payments, 9
•     identify and resolve information security control deficiencies and
      manage information security risks on an ongoing basis, and
•     effectively manage its tax collection activities.
Since the enactment of key financial management reforms in the 1990s,
significant progress has been made improving financial management
activities and practices. For fiscal year 2011, 21 of 24 Chief Financial
Officers (CFO) Act agencies were able to attain unqualified audit opinions
on their accrual-based financial statements 10 within an accelerated
reporting time frame, up from 6 CFO Act agencies for fiscal year 1996.
Also, the preparation and audit of financial statements have identified
numerous deficiencies, leading to actions to strengthen controls and
systems. However, many of the CFO Act agencies continue to struggle
with financial systems that are not integrated and do not meet the needs
of management for reliable, useful, and timely financial information. Often,
federal entities expend major time, effort, and resources to develop
financial information that their systems should be able to provide on a
daily or recurring basis. Therefore, it is important for the individual federal
entities to remain committed to maintain the progress that has been
achieved in obtaining positive audit results and to build upon that
progress to make needed improvements.




8
  A more detailed discussion of these weaknesses, including the primary effects of the
material weaknesses on the accrual-based consolidated financial statements and on the
management of federal government operations, can be found on pages 229 and 230 of
the Financial Report.
9
  Federal entities reported estimates of improper payment amounts that totaled $115.3
billion for fiscal year 2011, which represented approximately 4.7 percent of about $2.5
trillion of reported outlays for the associated programs.
10
     See app. I for the fiscal year 2011 audit results for the 24 CFO Act Agencies.




Page 5                                                                           GAO-12-444T
Addressing Impediments   Three long-standing major impediments continued to prevent us from
to an Opinion on the     expressing an opinion on the U.S. government’s accrual-based
Accrual-Based            consolidated financial statements: (1) serious financial management
                         problems at DOD that have prevented DOD’s financial statements from
Consolidated Financial   being auditable, (2) the federal government’s inability to adequately
Statements               account for and reconcile intragovernmental activity and balances
                         between federal entities, and (3) the federal government’s ineffective
                         process for preparing the consolidated financial statements. In addition,
                         while improvements were made, financial management issues at the
                         Department of Homeland Security (DHS) also contributed to our inability
                         to express an opinion on the U.S. government’s accrual-based
                         consolidated financial statements. Extensive efforts by DOD and other
                         entity officials and cooperative efforts between entity chief financial
                         officers, Treasury officials, and Office of Management and Budget (OMB)
                         officials will be needed to resolve these obstacles to achieving an opinion
                         on the U.S. government’s accrual-based consolidated financial
                         statements.

Improving Financial      DOD leadership has, with oversight and reinforcement from Congress,
Management at DOD        committed DOD to the long-term goal of full financial statement
                         auditability. The National Defense Authorization Act for Fiscal Year 2010,
                         as amended, requires that DOD’s financial statements be validated as
                         ready for audit by September 30, 2017, 11 a date that has been DOD’s
                         stated goal since 2008. DOD’s Financial Improvement and Audit
                         Readiness (FIAR) Plan and semiannual status reports define the
                         activities, corrective actions, and interim milestones necessary to achieve
                         auditability and the availability of reliable, useful, and timely information
                         for management decision making. The most recent update of the plan
                         also emphasizes the importance of leadership, including senior leaders
                         and field commanders, to achieving DOD’s goals, and it links
                         accountability to performance appraisals.

                         Under its FIAR Plan, DOD is focusing on improving controls and
                         processes relied on to provide financial information in two areas it says
                         are most critical to managing its operations: (1) budgetary information and
                         (2) accountability over its military equipment. With respect to budgetary
                         information, in October 2011, the Secretary of Defense directed the DOD



                         11
                            National Defense Authorization Act for Fiscal Year 2010, Pub. L. No. 111-84, § 1003(a),
                         (b), 123 Stat. 2190, 2439-40 (Oct. 28, 2009).




                         Page 6                                                                       GAO-12-444T
Comptroller to provide him with a plan to achieve audit readiness for the
Statement of Budgetary Resources (SBR) by the end of 2014. The SBR
is important because it is intended to show the flow of money in and out
of DOD consistent with the budgetary information reported in the Budget
of the United States Government. 12 The Secretary’s directive also called
for increased emphasis on accountability for assets, a full review of
DOD’s financial controls over the next 2 years and the establishment of
interim goals, mandatory training for audit and key financial efforts, and
establishing a pilot certification program for financial managers by the end
of calendar year 2012.

DOD recently updated its FIAR Guidance, which provides a standardized
methodology for DOD components to follow in planning and carrying out
their FIAR efforts aimed at achieving audit readiness. However, as we
reported in September 2011, we found that the Air Force and the Navy
were not always effectively implementing the FIAR Guidance, presenting
a risk of not achieving DOD’s overall FIAR goals. 13 Specifically, we found
that although the Air Force asserted audit readiness for its military
equipment and the Navy asserted audit readiness for its civilian pay,
neither of these areas were audit-ready because the Air Force and Navy
had not fully carried out FIAR Guidance procedures. We recommended
actions for improving the development, implementation, documentation,
and oversight of DOD’s financial management improvement efforts. In
addition, the Marine Corps’ attempt to achieve an audit opinion on its
SBR is still in process. In that regard, we recently recommended that the
Marine Corps develop a risk-based remediation plan and confirm that its
actions fully respond to auditor recommendations and that DOD direct
other military services to consider key lessons learned in their audit
readiness plans as appropriate.

The Navy and Marine Corps also continue to address a key element
necessary to achieve an auditable SBR—the reconciliation of their
balance of funds with the balance on Treasury’s books, or Fund Balance
with Treasury (FBWT). (The process is similar in concept to reconciling a



12
  According to DOD officials, the goal of achieving SBR audit readiness by 2014 will only
apply to the department’s general funds, but not to its working capital funds.
13
   GAO, DOD Financial Management: Improvement Needed in DOD Components’
Implementation of Audit Readiness Effort, GAO-11-851 (Washington, D.C.: Sept. 13,
2011).




Page 7                                                                       GAO-12-444T
checkbook with a bank account.) Because of the fundamental importance
of the reconciliation, GAO reviewed the processes used by the Navy,
Marine Corps, and the Defense Finance and Accounting Service, which
processes much of DOD components’ financial data, including
transactions that affect FBWT.14 We recommended that the Navy and
Marine Corps improve policies and procedures that guide the FBWT
reconciliation process, provide training to communicate these policies and
procedures to staff, and resolve system deficiencies.

The effective implementation of Enterprise Resource Planning (ERP)
systems will be critical to the success of all of DOD’s planned long-term
financial improvement efforts. ERP systems are integrated, multifunction
systems that perform business-related tasks such as general ledger
accounting and supply chain management. DOD considers their
implementation essential to transforming its business operations.
However, DOD continues to encounter difficulties in implementing its
planned ERP systems on schedule and within budget. For example, in
October 2010, we reported that six of nine critical DOD ERPs
experienced schedule delays ranging from 2 to 12 years. 15 We also
reported that five of these ERPs incurred cost increases totaling an
estimated $6.9 billion. We made eight recommendations to DOD aimed at
improving schedule and cost practices and the development of
performance measures to evaluate whether the ERPs’ intended goals are
being accomplished.

Another key to effectively transforming DOD’s financial management will
be its ability to ensure that it has sufficient staff with the appropriate skills
necessary to carry out financial and budgetary accounting duties. To that
end, DOD is establishing a Financial Management Certification Program
to be mandatory for its personnel in financial management positions.
However, DOD has not yet performed a competency gap analysis for its
financial management workforce as we reported in July 2011. 16 Further,


14
  GAO, DOD Financial Management: Ongoing Challenges with Reconciling Navy and
Marine Corps Fund Balance with Treasury, GAO-12-132 (Washington, D.C.: Dec. 20,
2011).
15
   GAO, DOD Business Transformation: Improved Management Oversight of Business
System Modernization Efforts Needed, GAO-11-53 (Washington, D.C.: Oct. 7, 2010).
16
   GAO, DOD Financial Management: Numerous Challenges Must Be Addressed to
Improve Reliability of Financial Information, GAO-11-835T (Washington, D.C.: July 27,
2011).




Page 8                                                                      GAO-12-444T
                                the House Armed Services Committee (HASC) Panel on Defense
                                Financial Management and Auditability Reform, which held several
                                hearings on DOD financial management, recently reported that DOD
                                personnel in other functional areas, such as logistics and acquisition,
                                should also have the skills necessary to maintain appropriate controls and
                                ensure that financial-related information is accurately recorded. 17 The
                                HASC Panel made several recommendations about DOD’s workforce,
                                including recommending that DOD assess its financial management
                                workforce with respect to existing skills and the critical skills and
                                competencies that will be needed over the next decade.

                                While we are encouraged by DOD’s recent plans and efforts to
                                fundamentally transform its financial management operations, several
                                DOD business practices, including financial management, remain on
                                GAO’s list of high-risk programs designated as vulnerable to waste, fraud,
                                abuse, and mismanagement or in need of transformation. 18 Given the
                                size, complexity, and interrelated nature of DOD’s financial management
                                and other business process control deficiencies, the sustained
                                commitment by DOD’s leaders will be critical to effectively building on
                                DOD’s initial momentum to transform its financial management operations
                                and ultimately achieve auditability. Further, we agree with the
                                recommendation by the HASC Panel on Defense Financial Management
                                and Auditability Reform that strong congressional oversight must
                                continue. 19 To assist Congress in its oversight efforts, we plan to
                                reassess the FIAR Plan, associated guidance, and DOD’s related actions
                                as they continue to evolve.

Reconciling Intragovernmental   Since the first audit of the U.S. government’s fiscal year 1997
Activity and Balances           consolidated financial statements, we have reported a material weakness
                                related to the federal government’s inability to adequately account for and
                                reconcile intragovernmental activity and balances between federal
                                entities, as well as between federal entities and the General Fund.
                                Consolidated financial statements are intended to present the results of
                                operations and financial position of the components that make up the


                                17
                                  House Armed Services Committee, Panel on Defense Financial Management and
                                Auditability Reform Findings and Recommendations (Jan. 24, 2012).
                                18
                                     GAO, High-Risk Series: An Update, GAO-11-278 (Washington, D.C.: February 2011).
                                19
                                  House Armed Services Committee, Panel on Defense Financial Management and
                                Auditability Reform Findings and Recommendations (Jan. 24, 2012).




                                Page 9                                                                    GAO-12-444T
reporting entity as if the entity were a single enterprise. Therefore, when
preparing the consolidated financial statements, intragovernmental
activity and balances between federal entities and between federal
entities and the General Fund should be in agreement and must be
subtracted out, or eliminated, from the financial statements. If the two
federal entities engaged in an intragovernmental transaction do not both
record the same intragovernmental transaction in the same year and for
the same amount, the intragovernmental transactions will not be in
agreement, resulting in errors in the consolidated financial statements.

Treasury has grouped intragovernmental activity and balances into the
following five categories and established focus groups to work with
federal entity personnel to identify and resolve reported unreconciled
differences.

•   Fiduciary activities include investments in Treasury securities with
    the Bureau of the Public Debt (BPD), borrowing from BPD and the
    Federal Financing Bank and related interest receivable and payable,
    interest expense and revenue, and federal loans receivable and
    payable.
•   Benefit activities include contributions by federal entities into
    employee benefit programs (retirement, life insurance, workers’
    compensation, and health benefits) administered by the Office of
    Personnel Management and the Department of Labor.
•   Buy/Sell activities between entities include buy and sell costs and
    revenues, accounts receivable and payable, and advances to and
    from others.
•   Transfers of funds include transfers payable and receivable, and
    transfers in and out without reimbursement.
•   General Fund transactions and balances include fund balance with
    Treasury, appropriations received and warrants, and custodial and
    non-entity collections.
The federal government has made progress in reconciling
intragovernmental differences and the degree of progress varies by
category. However, the federal government continues to be unable to
adequately account for and reconcile intragovernmental activity and
balances. For both fiscal years 2011 and 2010, amounts reported by
federal entity trading partners for certain intragovernmental accounts
were not in agreement by significant amounts. OMB and Treasury require
the CFOs of 35 significant federal entities to reconcile, on a quarterly
basis, selected intragovernmental activity and balances with their trading
partners. A substantial number of the entities did not adequately perform
the required year-end reconciliations for fiscal years 2011 and 2010.


Page 10                                                           GAO-12-444T
                             Further, there continue to be hundreds of billions of dollars of
                             unreconciled differences between the General Fund of the U.S.
                             government and federal entity trading partners related to appropriation
                             and other intragovernmental transactions. Currently, federal entities
                             report their activity with the General Fund; however, the General Fund
                             activity is not centrally accounted for, and therefore, there is no existing
                             reporting process for which entities can confirm and reconcile all of their
                             activity and balances with the General Fund. As a result of these
                             circumstances, the federal government’s ability to determine the impact of
                             the unreconciled differences between trading partners on the amounts
                             reported in the accrual-based consolidated financial statements is
                             significantly impaired.

                             Over the years, we have identified and reported on numerous
                             intragovernmental activities and balances issues and have made several
                             related recommendations to Treasury. Treasury has taken or plans to
                             take actions to address these recommendations. During fiscal year 2011,
                             Treasury furthered its commitment to resolve differences in
                             intragovernmental activity and balances, which included several short-
                             and long-term initiatives. For example, Treasury expanded focus groups’
                             monitoring and outreach efforts that included quarterly analysis and
                             ongoing collaboration with entities to resolve intragovernmental
                             differences. 20 Such focus groups made significant progress in
                             understanding reasons for material differences and determining corrective
                             actions to be taken, which resulted in adjustments to eliminate certain
                             differences. Also, Treasury identified deficiencies in the intragovernmental
                             process and is planning to develop governmentwide systems to improve
                             intragovernmental transactions data. Further, Treasury is currently
                             working to develop a complete set of financial statements for the General
                             Fund, including intragovernmental transactions that will be audited.
                             Resolving the intragovernmental transactions problem remains a difficult
                             challenge and will require a strong and sustained commitment by federal
                             entities, as well as continued strong leadership by Treasury and OMB.

Preparing the Consolidated   While Treasury, in coordination with OMB, implemented corrective
Financial Statements         actions during fiscal year 2011 to address certain internal control
                             deficiencies detailed in our previously issued report, the federal


                             20
                                Beginning in 2008, Treasury established three focus groups to work with federal entity
                             personnel to identify and resolve reported differences related to benefits, transfers, and
                             buy/sell transactions.




                             Page 11                                                                        GAO-12-444T
government continued to have inadequate systems, controls, and
procedures to ensure that the consolidated financial statements are
consistent with the underlying audited entity financial statements, properly
balanced, and in conformity with GAAP. 21 For example,

•    Treasury’s process did not ensure that the information in certain of the
     accrual-based consolidated financial statements was fully consistent
     with the underlying information in 35 significant federal entities’
     audited financial statements and other financial data.
•    To make the fiscal years 2011 and 2010 consolidated financial
     statements balance, Treasury recorded net increases of $15.6 billion
     and $0.8 billion, respectively, to net operating cost on the Statement
     of Operations and Changes in Net Position, which it labeled
     “Unmatched transactions and balances.” 22 Treasury recorded an
     additional net $6.0 billion and $3.8 billion of unmatched transactions in
     the Statement of Net Cost for fiscal years 2011 and 2010,
     respectively.
•    Treasury’s reporting of certain financial information required by GAAP
     continues to be impaired, and will remain so until federal entities, such
     as DOD, can provide Treasury with complete and reliable information
     required to be reported in the consolidated financial statements.
Until these and other internal control deficiencies 23 have been fully
addressed, the federal government’s ability to ensure that the
consolidated financial statements are consistent with the underlying
audited federal entities’ financial statements, properly balanced, and in
conformity with U.S. GAAP will be impaired. Resolving some of these
internal control deficiencies will be a difficult challenge and will require a




21
   Most of the issues we identified in fiscal year 2011 existed in fiscal year 2010, and
many have existed for a number of years. Most recently, in May 2011, we reported the
issues we identified to Treasury and OMB and provided recommendations for corrective
action in GAO, Management Report: Improvements Needed in Controls over the
Preparation of the U.S. Consolidated Financial Statements, GAO-11-525 (Washington,
D.C.: May 26, 2011).
22
   Although Treasury was unable to determine how much of the unmatched transactions
and balances, if any, relate to net operating cost, it reported this amount as a component
of net operating cost in the consolidated financial statements.
23
   A detailed discussion of additional control deficiencies regarding the process for
preparing the consolidated financial statements can be found on pages 226 through 228
of the Financial Report.




Page 12                                                                       GAO-12-444T
                              strong and sustained commitment from Treasury and OMB as they
                              continue to execute and implement their corrective action plans.

Improving Financial           Improvements in DHS’s financial management during fiscal year 2011
Management at DHS             contributed to DHS receiving a qualified opinion on its Balance Sheet and
                              Statement of Custodial Activity for the fiscal year. 24 These statements
                              were qualified because of certain matters related to property, plant, and
                              equipment; environmental liabilities; and other related balances. This
                              qualified opinion represents a significant achievement for DHS. However,
                              the remainder of its financial statements for fiscal year 2011 were not
                              subjected to audit by the agency auditors, and the auditor was unable to
                              form an opinion on DHS’s internal control over financial reporting due to
                              pervasive material internal control weaknesses over key financial
                              reporting processes. It will be important that DHS continues to resolve its
                              internal control deficiencies and build upon the progress it has
                              accomplished as it moves forward to expand the audit to all financial
                              statements and achieve its ultimate goal of obtaining a clean audit opinion
                              on the full set of financial statements and on internal control over financial
                              reporting.


Significant Uncertainties     Significant uncertainties, primarily related to the achievement of projected
Result in Disclaimers of      reductions in Medicare cost growth reflected in the 2011 and 2010
Opinion on the 2011 and       Statements of Social Insurance, prevented us from expressing opinions
                              on the 2011 and 2010 Statements of Social Insurance, as well as on the
2010 Statements of Social     2011 Statement of Changes in Social Insurance Amounts. 25 The
Insurance as well as on the   Statement of Social Insurance presents the actuarial present value of the
2011 Statement of Changes     federal government’s estimated future revenue to be received from or on
in Social Insurance           behalf of participants and estimated future expenditures to be paid to or
Amounts                       on behalf of participants, based on benefit formulas in current law and




                              24
                                   For fiscal year 2010, these two statements were not auditable.
                              25
                                About $24.6 trillion and $22.8 trillion, or 73 percent and 74 percent, of the federal
                              government’s reported total present value of future expenditures in excess of future
                              revenue for 2011 and 2010, respectively, relate to the Department of Health and Human
                              Services’ 2011 and 2010 Statements of Social Insurance, which received disclaimers of
                              opinion.




                              Page 13                                                                     GAO-12-444T
using a projection period sufficient to illustrate the long-term sustainability
of the social insurance programs. 26

The significant uncertainties, discussed in further detail in Note 26 to the
consolidated financial statements, include:

•    Medicare projections in the 2011 and 2010 Statements of Social
     Insurance were based on full implementation of the provisions of the
     Patient Protection and Affordable Care Act, as amended (PPACA), 27
     including a significant decrease in projected Medicare costs from the
     2009 Statement of Social Insurance related to (1) reductions in
     physician payment rates (totaling almost 30 percent in January 2012)
     and (2) productivity improvements for most other categories of
     Medicare providers. However, there are significant uncertainties
     concerning the achievement of these projected decreases in Medicare
     costs.
•    Management has noted that actual future costs for Medicare are likely
     to exceed those shown by the current-law projections presented in the
     2011 and 2010 Statements of Social Insurance due to the likelihood of
     modifications to the scheduled reductions. 28 The extent to which
     actual future costs exceed the projected current-law amounts due to
     changes to the physician payments and productivity adjustments
     depends on both the specific changes that might be legislated and on




26
   The projection period used for the Social Security, Medicare, and Railroad Retirement
social insurance programs is 75 years. For the Black Lung program, the projections are
through September 30, 2040.
27
  Patient Protection and Affordable Care Act, Pub. L. No. 111-148, 124 Stat. 119 (Mar.
23, 2010), as amended by the Health Care and Education Reconciliation Act of 2010,
Pub. L. No. 111-152, 124 Stat. 1029 (Mar. 30, 2010).
28
   The Medicare and Medicaid Extenders Act of 2010, Pub. L. No. 111-309, § 101, 124
Stat. 3285, 3286 (Dec. 15, 2010) overrode the scheduled reductions in physician
payments through December 2011 and reduced non-Medicare outlays by limiting a health
insurance tax credit. Subsequent to the date of our 2011 report, (1) the Temporary Payroll
Tax Cut Continuation Act of 2011, Pub. L. No 112-78, § 301, 125 Stat. 1280, 1283-1284
(Dec. 23, 2011) overrode the scheduled reductions in physician payments through
February 29, 2012 and (2) the Middle Class Tax Relief and Job Creation Act of 2012, Pub.
L. No. 112-96, § 3003 (Feb. 22, 2012) overrode the scheduled reductions in physician
payments through December 31, 2012.




Page 14                                                                      GAO-12-444T
     whether legislation would include other provisions to help offset such
     costs. 29
•    Management has developed an illustrative alternative projection
     intended to provide additional context regarding the long-term
     sustainability of the Medicare program and to illustrate the
     uncertainties in the Statement of Social Insurance projections. The
     present value of future estimated expenditures in excess of future
     estimated revenue for Medicare included in the illustrative alternative
     projection exceeds the $24.6 trillion estimate in the 2011 Statement of
     Social Insurance by $12.4 trillion.
Projections of Medicare costs are sensitive to assumptions about future
decisions by policymakers and about the behavioral responses of
consumers, employers, and health care providers as policy, incentives,
and the health care sector change over time. For example, behavioral
responses of health care providers could affect Medicare beneficiaries’
access to care. Such secondary impacts are not reflected in the
Statement of Social Insurance projections but could be expected to
influence the excess cost growth rate used in the projections. 30 Key
drivers of uncertainty about the excess cost growth rate include the future
development and deployment of medical technology, the evolution of
personal income, and the cost and availability of insurance, as well as
federal policy change, such as the PPACA. In August 2010, the Secretary
of the Department of Health and Human Services, working on behalf of
the Board of Trustees, established an independent panel of expert
actuaries and economists to review the assumptions and methods used
by the Trustees to make projections of the financial status of the trust
funds. The work of the 2010 Technical Review Panel on the Medicare
Trustees Report could provide additional guidance to management
concerning ways to incorporate secondary impacts into future Statement
of Social Insurance projections and related disclosures.

As noted in our audit report, in preparing the Statements of Social
Insurance, management considers and selects assumptions and data that



29
  Public law 112-96 offset the physician payment reductions through various cuts under
certain health care laws (public laws 111-148 and 111-152), as well as to Medicare
payments to hospitals, skilled nursing facilities and clinical labs.
30
   The excess cost growth rate is the increase in health care spending per person relative
to the growth of gross domestic product per person after removing the effects of
demographic changes on health care spending.




Page 15                                                                       GAO-12-444T
                         it believes provide a reasonable basis for the assertions in the statement.
                         The statement is not a forecast or prediction, but is intended to illustrate
                         the potential impact of the continuation of current scheduled benefits and
                         financing. The Financial Report includes a summary of the assumptions
                         used by management and unaudited information concerning how
                         changes in various key assumptions, such as health care cost growth,
                         would affect the Statement of Social Insurance. Both the Statement of
                         Social Insurance projections and the illustrative alternative estimate
                         summarized in Note 26 in the Financial Report indicate that the Social
                         Security and Medicare programs are not sustainable under current
                         financing arrangements.


                         The federal government’s financial condition continued to be significantly
Effects of the Last      affected by the last economic recession and the federal government’s
Economic Recession       actions to stabilize financial markets and promote economic recovery,
                         among other factors. For fiscal year 2011, the federal government
and Stabilization        reported a net operating cost of about $1.3 trillion and a unified budget
Efforts on the Federal   deficit of approximately $1.3 trillion. In addition, federal debt held by the
Government’s             public increased to about 68 percent of gross domestic product (GDP) as
                         of September 30, 2011. 31
Financial Condition
                         The federal government undertook an array of unprecedented actions to
                         help stabilize the financial markets and promote economic recovery. As of
                         September 30, 2011, the federal government reported assets of over
                         $295 billion, which is net of about $95 billion in valuation losses, as a
                         result of these actions. In addition, the federal government reported
                         incurring significant liabilities resulting from these actions as of
                         September 30, 2011, including approximately $316 billion of liabilities for
                         future payments to the Federal National Mortgage Association (Fannie
                         Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac).
                         Because the valuation of these assets and liabilities is based on
                         assumptions and estimates that are inherently subject to substantial


                         31
                            Federal debt held by the public relative to GDP is a function of the federal government’s
                         fiscal policy as well as overall economic conditions. The Congress and the President have
                         enacted laws to establish a limit on the amount of federal debt that can be outstanding at
                         one time. Federal debt subject to the limit includes both debt held by the public and debt
                         held by government accounts (intragovernmental debt holdings). In February 2011, we
                         reported on the debt limit in GAO, Debt Limit: Delays Create Debt Management
                         Challenges and Increase Uncertainty in the Treasury Market, GAO-11-203 (Washington,
                         D.C.: Feb. 22, 2011).




                         Page 16                                                                        GAO-12-444T
                   uncertainty arising from the uniqueness of certain transactions and the
                   likelihood of future changes in general economic, regulatory, and market
                   conditions, actual results may be materially different from the reported
                   amounts.

                   Actions taken to stabilize financial markets—including aid to the
                   automotive industry—increased the government’s costs and contributed
                   to growing federal debt held by the public. The economic downturn and
                   the nature and magnitude of the actions taken to stabilize the financial
                   markets and to promote economic recovery, as well as challenges in the
                   housing market, will continue to affect the federal government’s near-term
                   budget and debt outlook. In addition, the future structure of Fannie Mae
                   and Freddie Mac and the roles they will serve in the mortgage markets
                   may also affect the federal government’s financial condition.

                   The ultimate cost of the federal government’s actions to stabilize the
                   financial markets and promote economic recovery will not be known for
                   some time as these uncertainties are resolved and further federal
                   government actions are taken in fiscal year 2012 and later. Looking
                   ahead, the federal government will face the challenge of determining the
                   most expeditious manner in which to bring closure to its financial
                   stabilization initiatives while optimizing its investment returns.


                   The 2011 Financial Report includes comprehensive long-term fiscal
Long-Term Fiscal   projections for the U.S. government that, consistent with GAO
Challenges         simulations, show that without changes in current policy, the federal
                   government continues to face an unsustainable fiscal path. 32 Such
                   reporting provides a much needed perspective on the federal
                   government’s long-term fiscal position and outlook. The projections
                   included in the Financial Report and our simulations both reflect an
                   improvement resulting from provisions of the Budget Control Act of 2011
                   (BCA). 33 The BCA set limits on discretionary spending for fiscal years
                   2012-2021 and created the Joint Select Committee on Deficit Reduction.
                   Under the enacted discretionary spending limits, discretionary spending
                   as a share of the economy in 2021 would be lower than any level seen in


                   32
                     GAO, The Federal Government’s Long-Term Fiscal Outlook: Fall 2011 Update,
                   GAO-12-28SP (Washington, D.C.: Oct. 23, 2011).
                   33
                        Pub. L. No. 112-25, 125 Stat. 240 (Aug. 2, 2011).




                   Page 17                                                                GAO-12-444T
                   the last 50 years. The fact that the Joint Select Committee did not reach
                   agreement on a package triggered automatic procedures that would lead
                   to additional spending reductions. Together, the provisions of the BCA
                   would reduce deficits over the 2012-2021 decade by $2.1 trillion—largely
                   through reductions in discretionary spending. Both the Financial Report
                   and GAO’s simulations assume these reductions occur, and that the
                   savings as a share of GDP continue beyond the decade. Even with the
                   reductions from the BCA, the government continues to face a significant
                   structural imbalance between revenues and spending, driven on the
                   spending side largely by rising health care costs and the aging of the U.S.
                   population. We have already begun to see the impact of this structural
                   imbalance—Social Security is now in a negative cash flow position. The
                   growing gap between revenues and spending that is built into the current
                   structure of the budget leads to continued growth in debt held by the
                   public as a share of GDP; this is not sustainable. Changing this path will
                   not be easy, and it will likely require difficult decisions affecting both
                   federal spending and revenue. While delay increases the size of the
                   changes that must be made, it is also important to recognize current
                   economic conditions. Addressing the long-term fiscal imbalance is made
                   more difficult by the need to balance achieving the goals of sustaining
                   economic growth in the near term, while producing a plan to change the
                   federal government’s long-term fiscal path.


                   In closing, even though progress has been made in improving federal
Closing Comments   financial management activities and practices, much work remains given
                   the federal government’s long-term fiscal challenges and the need for the
                   Congress, the administration, and federal managers to have reliable,
                   useful, and timely financial and performance information to effectively
                   meet these challenges. Sound decisions on the current and future
                   direction of vital federal government programs and policies are more
                   difficult without reliable, useful, and timely financial and performance
                   information. DOD, in particular, faces many difficult challenges in this
                   area. We are encouraged by DOD’s efforts toward addressing its long-
                   standing financial management weaknesses and its efforts to achieve
                   auditability. However, sustained and diligent DOD top management
                   oversight toward achieving financial management capabilities, including
                   audit readiness, will be critical going forward. Moreover, in addition to
                   annual financial statements that can pass the scrutiny of a financial audit,
                   the civilian CFO Act agencies must continue to strive toward routinely
                   producing reliable, useful, and timely financial and performance data to
                   help guide decision makers on a day-to-day basis. Federal entities’



                   Page 18                                                           GAO-12-444T
                   improvement of financial management systems will be essential to
                   achieve this goal for their agency and the government as a whole.

                   The last economic recession and the federal government’s actions to
                   stabilize financial markets continued to significantly affect the federal
                   government’s financial condition. Continued focus and attention is needed
                   to ensure (1) that sufficient internal controls and transparency are
                   established and maintained for all financial stabilization efforts; and (2)
                   that all related financial transactions are reported on time, accurately, and
                   completely. In addition, the federal government will face the challenge of
                   determining the most expeditious manner in which to bring closure to its
                   financial stabilization initiatives while optimizing its investment returns.

                   Further, of utmost concern are the federal government’s long-term fiscal
                   challenges that result from large and growing structural deficits that are
                   driven on the spending side primarily by rising health care costs and
                   known demographic trends. This unsustainable path must be addressed
                   by policymakers.

                   Finally, I want to emphasize the value of sustained congressional interest
                   in federal financial management issues, as demonstrated by this
                   Subcommittee’s leadership. It will be key that, going forward, the
                   appropriations, budget, authorizing, and oversight committees continue to
                   support improvement efforts and to hold the top leadership of federal
                   entities accountable for resolving the remaining problems.


                   Mr. Chairman and Ranking Member Towns, this concludes my prepared
                   statement. I would be pleased to respond to any questions that you or
                   other members of the Subcommittee may have at this time.


                   For further information regarding this testimony, please contact Robert F.
GAO Contacts and   Dacey, Chief Accountant, or Gary T. Engel, Director, Financial
Acknowledgments    Management and Assurance, at (202) 512-3406. Key contributions to this
                   testimony were also made by staff on our Consolidated Financial
                   Statement audit team.




                   Page 19                                                           GAO-12-444T
Appendix I: Chief Financial Officers (CFO)
                                       Appendix I: Chief Financial Officers (CFO) Act
                                       Agencies: Fiscal Year 2011 Audit Results and
                                       Principal Auditors


Act Agencies: Fiscal Year 2011 Audit Results
and Principal Auditors

                                                                   Agency auditor-reported
                                       Opinion expressed           material weaknesses or
                                                                                 a
CFO Act agencies                       by agency auditor           noncompliance                       Principal auditor
Agency for International Development   Unqualified                 √                                   Office of Inspector General (OIG)
Agriculture                            Unqualified                 √                                   OIG
Commerce                               Unqualified                                                     KPMG LLP
Defense                                Disclaimer                  √                                   OIG
Education                              Unqualified                 √                                   Ernst & Young LLP
Energy                                 Unqualified                                                     KPMG LLP
Environmental Protection Agency        Unqualified                 √                                   OIG
General Services Administration        Unqualified                                                     KPMG LLP
                                       b
Health and Human Services                                          √                                   Ernst & Young LLP
                                       c
Homeland Security                                                  √                                   KPMG LLP
Housing and Urban Development          Unqualified                 √                                   OIG
Interior                               Unqualified                 √                                   KPMG LLP
Justice                                Unqualified                                                     KPMG LLP
Labor                                  Unqualified                 √                                   KPMG LLP
National Aeronautics and Space         Unqualified                                                     PricewaterhouseCoopers LLP
Administration
National Science Foundation            Unqualified                                                     Clifton Gunderson LLP
Nuclear Regulatory Commission          Unqualified                                                     Clifton Gunderson LLP
Office of Personnel Management         Unqualified                 √                                   KPMG LLP
Small Business Administration          Unqualified                 √                                   KPMG LLP
Social Security Administration         Unqualified                                                     Grant Thornton LLP
                                       d
State                                                              √                                   Kearney & Company
Transportation                         Unqualified                 √                                   Clifton Gunderson LLP
Treasury                               Unqualified                 √                                   KPMG LLP
Veterans Affairs                       Unqualified                 √                                   Clifton Gunderson LLP
                                       Source: GAO.
                                       a
                                        Reported noncompliance with applicable laws and regulations and/or substantial noncompliance with
                                       one or more of the Federal Financial Management Improvement Act requirements.
                                       b
                                        The auditors expressed an unqualified opinion on the Department of Health and Human Services’
                                       fiscal year 2011 accrual-based financial statements, but were unable to express opinions on the
                                       department’s 2011 Statement of Social Insurance and 2011 Statement of Changes in Social
                                       Insurance Amounts.
                                       c
                                        For fiscal year 2011, only the Consolidated Balance Sheet and the related Statement of Custodial
                                       Activity of the Department of Homeland Security were subject to audit. The auditors expressed a
                                       qualified opinion on these two financial statements.
                                       d
                                        The auditors of the Department of State’s fiscal year 2011 financial statements issued a qualified
                                       opinion because of the effect of certain matters related to after-employment actuarial liabilities and
                                       benefit plan assets and net position balances.




(198708)
                                       Page 20                                                                                   GAO-12-444T
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