Financial Management: Financial Management Weaknesses at the Department of Education

Published by the Government Accountability Office on 1999-12-06.

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

                          United States General Accounting Office

GAO                       Before the Subcommittee on Oversight and Investigations,
                          Committee on Education and the Workforce,
                          House of Representatives

For Release on Delivery
Expected at
12:30 p.m.                FINANCIAL
December 6, 1999          MANAGEMENT

                          Financial Management
                          Weaknesses at the
                          Department of Education
                          Statement of Gloria Jarmon
                          Director, Health, Education, and Human Services
                          Accounting and Financial Management Issues
                          Accounting and Information Management Division

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss our review of the independent
auditors’ reports1 on the Department of Education’s financial statements
covering fiscal year 1998. The Department’s financial statements are
important to the federal government because Education is the primary
agency responsible for overseeing the more than $73 billion annual federal
investment in support of educational programs for U.S. citizens and
eligible non-citizens. The Department is also responsible for tracking
approximately 93 million student loans and 15 million grants as well as
collecting more than $150 billion owed by students. In fiscal year 1998,
more than 8.5 million students received over $48 billion in federal student
financial aid through programs administered by Education.

As you know, audit results of agency financial statements are key
indicators of the quality of the underlying agency financial data and the
related systems used to compile that information. In March of this year, we
reported on the results of our financial statement review of the fiscal year
1998 consolidated financial statements of the U.S. government.2 Because
of serious deficiencies in the government’s systems, recordkeeping,
documentation, financial reporting, and controls, we found that amounts
reported in the governmentwide financial statements do not provide a
reliable source of information for decision-making by the government or
the public.

Similar outcomes were identified at Education. The results of the effort to
audit the fiscal year 1998 financial statements for Education reveal that
serious internal control and financial management system issues continue
to plague the agency. Pervasive weaknesses in the design and operation of
Education’s financial management systems, accounting procedures,
documentation, recordkeeping, and internal controls, including computer
security controls, prevented Education from reliably reporting on the
results of its operations. Education’s independent auditors were unable to
express an opinion (called a disclaimer of opinion) on Education’s fiscal
year 1998 consolidated financial statements. The reasons cited for the
disclaimer for fiscal year 1998, also described as material internal control

1Department of Education, Fiscal Year 1998 Consolidated Financial Statements, Ernst & Young LLP,
November 1999.
2Financial Audit: 1998 Financial Report of the United States Government (GAO/AIMD-99-130,
March 31, 1999).

Page 1                                                                        GAO/T-AIMD-00-50
             weaknesses in the report,3 were (1) weaknesses in the financial reporting
             process and (2) inadequate reconciliations of financial accounting records.
             In addition, the independent auditors cited inadequate controls over
             information systems as a third material internal control weakness.4 These
             deficiencies prevented the independent auditors from being able to form
             an opinion on the reliability of the financial statements and represent
             material weaknesses in internal control. Similar deficiencies concerning
             financial reporting, reconciliations, and systems controls were reported by
             Education’s Inspector General (IG) for fiscal year 1997.5 In addition,
             vulnerabilities in the Department’s student financial assistance programs
             have led us since 1990 to designate this a high-risk6 area for waste, fraud,
             abuse, and mismanagement. As we reported in our high-risk series update
             in January 1999, audits by GAO and the Department’s IG have found
             instances in which students fraudulently obtained grants and loans.

Background   Federal decisionmakers need reliable and timely financial information to
             ensure adequate accountability, manage for results, and make timely and
             well-informed decisions. However, historically, such information has not
             been available across the government. Agencies’ independent auditor
             reports, IG reports, as well as our own work, have identified persistent
             limitations in the availability of quality financial data for decision-making.
             Major reforms, such as the Chief Financial Officers (CFO) Act of 1990, and
             later the Government Management Reform Act of 1994 and the Federal
             Financial Management Improvement Act of 1996 (FFMIA), set
             expectations for federal agencies to develop and deploy more modern
             financial management systems to routinely produce sound cost

             3A material internal control weakness is a reportable condition that precludes the entity’s internal
             controls from providing reasonable assurance that material misstatements in the financial statements
             or material noncompliance with applicable laws or regulations will be prevented or detected on a
             timely basis.
             4In addition to these material internal control weaknesses, the independent auditors also reported four
             reportable conditions. Reportable conditions are matters coming to the auditors’ attention that, in their
             judgment, should be communicated because they represent significant deficiencies in the design or
             operation of internal controls that could adversely affect the organization’s ability to meet the
             objectives of reliable financial reporting and compliance with applicable laws and regulations.
             5U.S. Department of Education, Office of Inspector General Audit of Fiscal Year 1997 Consolidated
             Financial Statements, June 15, 1998.
             6High-Risk Series: An Update (GAO/HR-99-1, January 1999).

             Page 2                                                                             GAO/T-AIMD-00-50
Toward that end, 24 CFO Act agencies have been required to annually
prepare financial statements and have them audited beginning with those
for fiscal year 1996. These audits have shown that many agencies face
major challenges in generating reliable year-end financial information. Of
the 24 CFO Act agencies, 12 agencies received unqualified audit opinions
on their fiscal year 1998 financial statements, indicating that their financial
statements were reliable in all material respects; 4 agencies received
qualified opinions, indicating that at least one significant item on the
financial statements was unreliable; 6 agencies, including Education,
received disclaimers of opinion, meaning that the auditors were unable to
determine on an overall basis if the financial statements were reliable; and
2 agencies received mixed opinions.7 Education, the last CFO Act agency
to issue its fiscal year 1998 financial statements, released them on
November 18, 1999, over 8 months later than the March 1, 1999, due date
for audited statements.

For some agencies, like Education, the preparation of financial statements
requires considerable reliance on ad hoc programming and analysis of
data produced by inadequate financial management systems that are not
integrated or reconciled. These systems problems often require significant
adjustments to the financial statements. While obtaining unqualified or
“clean” opinions on federal financial statements is an important objective,
it is not an end in and of itself. The key is to take steps to continuously
improve underlying financial and management information systems and
internal controls as a means to ensure accountability, increase the
economy, improve the efficiency, and enhance the effectiveness of
government. The ultimate goal is for these systems to generate timely,
accurate, and useful information on an ongoing basis, not just as of the
end of the fiscal year.

More fundamentally, FFMIA requires that agency financial management
systems substantially comply with (1) financial management systems
requirements,8 (2) federal accounting standards, and (3) the U.S.
Government Standard General Ledger9 at the transaction level. Of the 24

7One of these agencies received an unqualified opinion on its balance sheet and a disclaimer on the
rest of its statements. The other agency did not prepare consolidated statements and received
unqualified opinions on three of its components and disclaimers on the remaining two of its
8The financial management systems requirements have been developed by the Joint Financial
Management Improvement Program, which is a joint and cooperative undertaking of the Department
of the Treasury, Office of Management and Budget (OMB), GAO, and the Office of Personnel
9The Standard General Ledger provides a standard chart of accounts and standardized transactions
that agencies are to use in all their financial systems.

Page 3                                                                           GAO/T-AIMD-00-50
                          CFO Act agencies, financial management systems for 21 agencies,
                          including Education, were found by auditors to be in substantial
                          noncompliance with FFMIA’s requirements during fiscal year 1998.

                          Education’s fiscal year 1998 audit effort was conducted by Ernst & Young
                          LLP, independent auditors contracted for by the Education Inspector
                          General. We reviewed the independent auditors’ reports during the last
                          half of November 1999 and their workpapers on information systems.
                          However, we did not review key workpapers supporting other material
                          internal control weaknesses because they have not yet been made
                          available to us. We shared a draft of this statement with Education
                          officials, who provided technical comments. We have incorporated their
                          comments where appropriate. Our work was conducted in accordance
                          with generally accepted government auditing standards.

Education’s Reporting     The independent auditors found that the Department does not have
                          adequate internal controls over its financial reporting process to provide
Controls Are Inadequate   reasonable assurance that its principal financial statements are reliable. As
and Its Financial         a result, Education (1) was unable to prepare reliable statements and
                          (2) could not support material amounts reported on its financial
Management Systems        statements, including obligations, grant expenditures, and net position.
Do Not Comply With        These limitations in the financial reporting process of the Department’s
                          new accounting system10 contributed to the disclaimer of opinion on its
FFMIA                     fiscal year 1998 financial statements. The system’s reported weaknesses
                          included its inability to perform an automated year-end closing process
                          and directly produce consolidated financial statements as would normally
                          be expected from such systems. Because of these weaknesses, Education
                          had to resort to a costly, labor-intensive and time-consuming process
                          involving extensive and complex analyses and ad hoc procedures to
                          prepare financial statements for fiscal year 1998. These system limitations
                          contributed to the delay in Education submitting financial statements to
                          the auditors and OMB.

                          The amounts produced by these efforts involved over 700 adjustments to
                          develop the balances for the financial statements. The auditors reported
                          that one of these adjustments, erroneously posted for $550 million, would
                          have resulted in a net difference in expenditures of $1.1 billion if not
                          corrected. In another instance, a $400 million adjustment made by the
                          Department was deemed to be unnecessary and needed to be reversed.
                          The Department’s inability to prepare reliable, year-end financial

                          10ED operated under a new accounting system—Education’s Central Automated Processing System
                          (EDCAPS)—in fiscal year 1998.

                          Page 4                                                                    GAO/T-AIMD-00-50
                        statements after extraordinary efforts is evidence that Education cannot
                        provide reliable information about its operations on a day-to-day basis.
                        Thus, decisionmakers, such as agency management and the Congress,
                        cannot be assured that the information they are using is reliable.
                        Department officials stated that they have recognized the seriousness of
                        these problems and are working with a contractor to resolve them.

                        For fiscal year 1998, the independent auditors found that Education was
                        not in compliance with FFMIA because it lacked adequate financial
                        management systems, reports, and oversight to prepare timely and
                        accurate financial statements. The independent auditors also reported that
                        the Department did not comply with all of the requirements included in
                        the Chief Financial Officers Act of 1990, as expanded by the Government
                        Management Reform Act of 1994. Specifically, the Department did not
                        submit fiscal year 1998 audited financial statements to OMB by March 1,
                        1999, the statutory deadline.

Education’s Financial   The independent auditors reported that Education did not properly or
                        promptly reconcile its financial accounting records during fiscal year 1998.
Accounting Records      An adequate reconciliation provides assurance that processed transactions
Were Not Reconciled     are properly and promptly recorded in accounting records and financial
                        statements, which in turn facilitates management’s ability to routinely
Properly or Promptly    analyze its financial condition and results of operations and to use that
                        data in the course of daily operations. However, the Department did not
                        adequately perform reconciliations and could not provide sufficient
                        documentation to support its financial transactions.

                        For example, as indicated in fiscal year 1997 and again in fiscal year 1998,
                        Education has not been able to identify and resolve differences between
                        its accounting records and cash transactions reported by the Treasury for
                        several years. Such reconciliations are required by Treasury policy and are
                        analogous to companies or individuals reconciling their checkbooks to
                        monthly bank statements. In fiscal year 1998, Education reported about
                        $45 billion in Fund Balance with Treasury accounts, but the independent
                        auditors could not determine whether the amount was correct.

                        For the grantback account,11 which is part of Education’s Fund Balance
                        with Treasury, Education’s new accounting system showed a balance of
                        almost $400 million, some portion of which Education owed the Treasury,

                        11The grantback account holds funds paid to recipients under a grant or cooperative agreement that
                        were recovered from a recipient following a determination of a violation of law or of the grant or
                        cooperative agreement. A portion of these funds is to be returned to the recipient when the violation
                        has been corrected. Any amounts not returned to the grantee should revert to the Treasury.

                        Page 5                                                                            GAO/T-AIMD-00-50
as of September 30, 1998. Of this balance, over $386 million represented
several adjustments that had been accumulating since fiscal year 1993 that
Education could not identify with any specific program or reconcile. When
Education attempted to resolve the differences and determine what
amount it should return to the Treasury, its estimates ranged from about
$15.4 million to over $221 million. According to Department officials,
Education is in the process of resolving these differences.

The independent auditors also determined that the transactions Education
reported to the Treasury routinely differed from those reported in
Education’s general ledger throughout fiscal year 1998. The auditors found
that Education made large adjustments, which it did not research or
support, merely to force the records into agreement. In addition,
Education did not reconcile its general ledger balance with its subsidiary
debt collection system. Instead, Education made unsupported adjustments
to the general ledger to align these records with amounts reported in its
debt collection system. Furthermore, Education did not reconcile between
the loans reported by its guaranty agencies12 as assigned13 to Education
and those recorded in its debt collection system. As a result, Education
could not be assured that amounts reported for assigned loans receivable
were accurate. Such practices are severely at odds with established
financial management practices and reporting standards.

Many of these differences result from a lack of supporting documentation
for proprietary accounts (such as cash) and budgetary balances, the
failure to regularly perform formal reconciliations, and the serious
problems with Education’s accounting system. The lack of timely,
thorough reconciliations makes it difficult if not impossible for Education
to determine if operating funds have been properly spent or if reported
amounts for operating expenses, assets, and liabilities are reliable. Without
performing such reconciliations, Education has no assurance that its
financial accounting records are accurate. The lack of appropriate
reconciliations also affects Education’s ability to ensure that it complies
with the laws governing the use of its budget authority. Errors in these
accounts may also affect the accuracy of various Education financial
reports, including budget execution reports and information reported to
the Congress.

12These agencies act as intermediaries between the government and the lender. They are responsible
for reviewing student applications and approving loans, reviewing and paying claims to lenders when
defaults occur, and collecting on defaulted loans.
13Under the Federal Family Education Loan Program, when the guaranty agencies have exhausted
their collection efforts or a loan meets specific Education criteria (34 CFR § 682.409), all rights and
title of the loan are permanently assigned to Education.

Page 6                                                                              GAO/T-AIMD-00-50
Information Systems       In connection with their review of Education’s fiscal year 1998 financial
                          statements, the independent auditors also conducted a review of
Controls Are Inadequate   information systems controls over Education’s accounting and financial
                          reporting systems. The Department places significant reliance on its
                          financial management systems to perform basic functions, such as making
                          payments to grantees and maintaining budget controls. Consequently,
                          weaknesses in information systems controls could render Education
                          unable to perform these vital functions or place Education’s sensitive
                          grant and loan data at risk of loss or misuse.

                          The independent auditors reported information systems controls as a
                          material internal control weakness in Education’s fiscal year 1998 financial
                          statement report. Specifically, the independent auditors reported
                          deficiencies in (1) authorizing and revalidating user access to Education’s
                          systems and effectively managing user identification and passwords,
                          (2) providing adequate physical security for its computer facility,
                          (3) monitoring and reviewing access to sensitive computer resources,
                          (4) documenting the approach and methodology for the design and
                          maintenance of information technology architecture, and (5) developing
                          and testing disaster recovery plans to ensure the continuity of critical
                          system operations in the event of disaster.

                          Continued weaknesses in these information system control areas place
                          critical Education operations, such as financial management and sensitive
                          loan and grant systems, at increased risk of unauthorized access and
                          disruption. In addition, sensitive financial transaction data are vulnerable
                          to inadvertent or deliberate misuse, fraudulent use, improper disclosure,
                          or destruction, possibly occurring without detection. For example, given
                          the high volume of transactions that flow through Education’s Grant
                          Administration and Payment System (GAPS)–over $20 billion a year—
                          these weaknesses in the information systems controls increase the risk of
                          misuse or loss of grant data. Effective information systems controls
                          contribute greatly to the reduction of such risks.

                          The need to strengthen information system security in both the
                          government and the private sector has been recognized over the past
                          several years by a number of entities. Since 1994, we have issued dozens of
                          reports on individual agency computer security weaknesses and made
                          scores of related recommendations. In September 1996, we reported that
                          poor information security was a widespread federal problem.14

                          14Information Security: Opportunities for Improved OMB Oversight of Agency Practices (GAO/
                          AIMD-96-110, September 24, 1996).

                          Page 7                                                                       GAO/T-AIMD-00-50
                           Subsequently, in February 1997, in a series of reports to the Congress, we
                           designated information security as a new governmentwide high-risk area.15
                           More recently, we reported16 that the nation’s computer-based critical
                           infrastructures are at increasing risk of severe disruption from varying
                           sources. We also reported on cooperative efforts underway across federal
                           agencies and among public and private sector entities and other nations to
                           address this substantial risk.

Significant Efforts Will   Education continues to be plagued by serious internal control and system
                           deficiencies that hinder its ability to achieve lasting financial management
Be Needed To Resolve       improvements. While Education has planned and begun implementing
Education’s Financial      many actions to resolve its financial management problems, it is too early
                           to tell whether they will be successful. We recognize that Education’s
Management Issues          newly acquired financial management system does not meet current
                           systems and financial reporting needs, that its financial management
                           problems did not occur overnight, and that the task ahead of Education to
                           fully correct these deficiencies will take a great deal of commitment and
                           effort. We do, however, believe that serious internal control issues can be
                           addressed in the near term through continued dedicated effort on the part
                           of Education’s management. It is critical that Education rise to the
                           challenges posed by these financial management issues, because its
                           success in achieving all aspects of its strategic objectives depends in part
                           upon reliable financial management information and effective internal
                           controls. It is also important to recognize that several of the financial
                           management issues that have been raised in reports emanating from
                           reviews of Education’s financial statements directly or indirectly affect
                           Education’s ability to meet its obligations to its loan and grant recipients
                           and responsibilities under law.

                           Mr. Chairman, this concludes my testimony. I would be happy to answer
                           any questions you or other Members of the Subcommittee may have.

                           15High-Risk Series: Information Management and Technology (GAO/HR-97-9, February 1997).

                           16Critical Infrastructure Protection: Comprehensive Strategy Can Draw on Year 2000 Experiences
                           (GAO/AIMD-00-1, October 1, 1999).

                           Page 8                                                                        GAO/T-AIMD-00-50
Contact And       For information about this statement, please contact Gloria Jarmon at
                  (202) 512-4476 or at jarmong.aimd@gao.gov. Individuals making key
Acknowledgement   contributions to this statement included Chinero Thomas, Cheryl Driscoll,
                  Anh Dang, and Meg Mills.


                  Page 9                                                    GAO/T-AIMD-00-50
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