   
                  FIRST FINANCIAL AUDITS OF IRS
             AND CUSTOMS REVEALED SERIOUS PROBLEMS

       ------------------------------------------------------
              UNITED STATES GENERAL ACCOUTING OFFICE

       Testimony before the Committee on Governmental Affairs
      United States Senate; Released Wednesday, August 4, 1993.

       Statement of Charles A. Bowsher, Comptroller General
       of the United States.
       ------------------------------------------------------

 Mr. Chairman and Members of the Committee:

 We are pleased to be here today to discuss the results of our
 recently completed financial statement audits at the Internal
 Revenue Service (IRs) and the customs Service and the need to
 accelerate governmentwide financial management reform through the
 full and effective implementation of the Chief Financial Officers
 (CFO) Act of 1990.

 Our financial audits at IRS and Customs show that serious financial
 management problems exist at the Department of the Treasury. The
 results of these audits and our work at the Department of Defense,
 on which I testified before you on July 1, 1993, [1] I demonstrate the
 necessity of preparing and auditing annual financial  statements.

 The CFO Act's pilot program of agency-level audited financial
 statements has proven that this process pinpoints problems and
 provides the road map needed to establish financial accountability
 and control. The audits are demonstrating that there are specific
 flaws in budget execution needing correction, that particular steps
 should be taken to improve the efficiency and effectiveness of
 government, and that better accountability measures will protect
 against unnecessary losses. It is my hope that the requirement for
 audited financial statements will be expanded to all major agencies
 and departments and implementation of the CFO Act will be
 strengthened. We also believe that the time has come to arrange
 for audited governmentwide financial reports that will tell the
 American public where its government stands financially.

 Through the CFO Act's pilot financial statement audits , IRS and
 Customs management have begun the process of improving their
 financial reporting and the quality of the underlying financial and
 program performance data. Also, they have gained a greater insight
 into the areas needing improvement and are now better able to focus
 on solutions to fundamental problems for which a number of
 corrective actions are already underway* Further, the Congress has
 a better idea of how these. organizations are actually functioning.
 Among the results of these financial audits are the following.

 -- The Congress now has reliable estimates of IRS' receivables and
  the related collectible amount, which are tens of billions of
  dollars less than what had been reported by the agency in the
  past. Also, management efforts of the IRS to address the
  collection function can now be better focused.

   Revenue information at IRS and Customs, covering over 99 percent
   of the government's total revenues, has undergone an; audit for
   the first time, highlighting for management's attention a wide
   range of problems with the quality of the information and with
   internal controls over billions of dollars. For
   instance, IRS will need to overcome a problem whereby its
   system cannot provide details as to amounts of specific excise
   taxes collected. As a result, general tax revenues
   inappropriately subsidized excise tax trust funds, perhaps by
   billions of dollars. This condition has important management
   implications and may have some effect on excise tax policy.

   IRS is presently focusing on fixes to problems involving
   unauthorized access to taxpayer information and serious
   weaknesses regarding the use of its appropriated operating funds
   that have led to (1) unreconciled differences between its
   records and Treasury's cash records, (2) unresolved
   discrepancies and transactions in suspense accounts, and
   (3) duplicate and other inappropriate payments to contractors.

   At Customs we noted many opportunities for seized drugs,
   weapons, and currency to be stolen or misappropriated without
   detection. The audit has provided additional impetus to address
   serious control weaknesses evident throughout the seized
   property process, from the time property is seized until
   disposed of, that could result in financial loss to the
   government or danger to the general public.

   Information has been provided to Customs management and the
   Congress about the great reliance Customs places on importers
   and brokers to voluntarily assess and honestly report the amount
   of duties, taxes, and fees owed on imported merchandise.
   Customs and the Congress can now better address the potential
   for additional revenue through an increase in the level of
   inspection and monitoring.

 Other civilian agencies, including those participating in the CFO
 Act's pilot program, likewise have received important benefits from
 the audited financial statement process. For the Committee's
 benefit, I have attached to my testimony a summary of the results
 of financial statement audits of (1) the student loan program at
 the Department of Education and (2) the Social Security
 Administration (SSA). (See attachment I.) Some examples follow:

 -- Insights into the costs and operating problems of Education's
   guaranteed student loan program were disclosed by our recently
   completed financial audit and are being considered in pending
   legislation. The Department's use of overly optimistic
   projections of loan defaults has contributed to a nearly
   $3 billion shortfall in Education's budgetary estimates of
   program costs for fiscal years 1992 and 1993. There is now
   additional emphasis to address misplaced incentives and
   conflicts of interest that are built into the present student
   loan program.

-- Six years ago, SSA, much like IRS and Customs this year, began
   the challenge of preparing financial statements that could
   withstand audit scrutiny. Through a sustained effort, this year
   the audited financial statements were available in February
   1993 -- in time to be useful for appropriation hearings and budget
   deliberations -- and included extensive performance information
   tied to many of SSA's strategic goals and objectives.

 In my July 1 testimony, I spoke to you about the need for
 leadership at the Secretary of Defense level to address long-
 standing financial management weaknesses. The problem we
 identified at IRS and Customs, coupled with our findings at
 Defense, demonstrate not only the need for agency leadership but
 also for strong leadership at the Presidential, Office of
 Management and Budget (OMB), and Treasury levels. Governmentwide
 implementation of the CFO Act must be greatly accelerated and made
 a top priority of the administration. While important progress has
 been made in the 2-1/2 years since the passage of the act to set a
 foundation for change and to better identify problems', a greater
 sense of urgency is needed to solve a range of problems that
 pervade government.

 Decisive action is needed now to reform federal financial
 management by

  -- selecting an OMB Controller with proper credentials as a
     financial management leader and a team of highly qualified
     agency CFOs who can work together to solve difficult common
     problems;

  -- drastically overhauling existing processes, controls, and
     systems and, in the interim while new system-41 are being
     developed, increasing discipline over basic accounting functions
     such as transaction processing and reconciliations;

  -- attracting and retaining qualified financial management
     personnel;

  -- expeditiously developing generally accepted accounting,
     financial reporting, cost, and systems standards to guide the
     agencies' improvement efforts; and

  -- fostering a strong program of financial Statement preparation
     and auditing.

 Our financial audits at IRS and Customs represent the first such
 audits of these organizations, requiring a major effort by these
 agencies. Before discussing our specific audit findings, 1 would
 like to recognize both agencies for their cooperation and strong
 efforts to implement the CFO Act. In contrast to the concerns I
 raised to the Committee on July 1 regarding the Department of
 Defense's response to its serious financial management weakmesses,
 both IRS and Custom management have been very responsive to our
 audit findings and have made progress toward developing reliable
 information and establishing financial control.

 Nevertheless, we were unable to express an opinion on the
 reliability of IRS' and Customs, fiscal year 1992 financial
 statements because critical supporting information for billions of
 dollars was either not available or was unreliable. Preparation of
 financial statements presented a substantial challenge to IRS and
 Customs. This undertaking was made especially difficult because
 their existing systems were not designed to provide meaningful and
 reliable financial information needed to effectively manage and
 report on their operations. Compounding this problem, internal
 controls were not designed and implemented to effectively safeguard
 assets, provide a reasonable basis for determining material
 compliance with certain laws and regulations, and assure that there
 were no material misstatements in the financial statements.

 IRS and Customs have begun the process of rebuilding their
 financial management processes and systems. Continued strong
 implementation of the CFO Act by these agencies can result in a
 tremendous payoff through an improved ability to safeguard assets,
 manage operations, and collect revenues. But the job will not be
 easy. Using audited financial statements as an important
 foundation to improve financial management, IRS and Customs will
 have to overcome the broad range of very serious problems that our
 financial audits have identified. This will require sustained,
 high priority management attention and congressional support.

 I will now highlight the results of our IRS and Customs audits.

 SERIOUS WEAKNESSES EXIST IN IRS' FINANCIAL MANAGEMENT OPERATIONS
 AND CONTROLS, AND MANAGEMENT IS ACTING TO ADDRESS THESE PROBLEMS
 ----------------------------------------------------------------

 First, I would like to discuss some of the more severe problems we
 identified in our audit of IRS' financial statements. [2]

 IRS Significantly Overstated Its Accounts Receivable
 ----------------------------------------------------

 After performing a detailed analysis of IRS, receivables as of
 June 30, 1991, we estimated that only $65 billion of about
 $105 billion in gross reported receivables that we reviewed were
 valid and that only $19 billion of the valid receivables were
 collectible. At the time, IRS had reported that $66 billion of the
 $105 billion was collectible.

 Historically, IRS reports have significantly overstated its
 receivables primarily because IRS included duplicate and
 insufficiently supported assessments that it had recorded as part
 of of efforts to identify and collect taxes due. While IRS may have a
 need to maintain such recards for enforcement purposesp these and
 many erroneous assessments were not valid receivables for financial
 reporting purposes and should not have been included in the
 reported balances. In additions IRS' estimates of the
 collectibility of its receivables have been unreliable because, in
 addition to including invalid receivables, IRS relied solely on
 collection experience and did not group assessments according to
 their collection risk or consider the taxpayer's current ability to
 pay. This unreliable information on IRS' accounts receivable has
 affected decisions about the (1) impact of increased collections on
 the deficit, (2) evaluation of enforcement and collection
 performance, (3) determination of staffing levels, and
 (4) allocation of resources.

 Based upon the methods that we recommended in our May 1993 report, [3]
 IRS developed and reported an estimate of $22 billion for
 collectible receivables as of September 30, 1992. Ultimately,
 though, systems must be developed to keep an accurate running
 record of IRS' receivables.

 Important Revenue Information Is Unavailable or Unreliable
 ----------------------------------------------------------

 We were able to determine that IRS' total reported revenues of
 about $1.1 trillion were actually collected and deposited into
 Treasury accounts. [4] Although we were able to audit total revenue
 collections, we were not able to audit the components of revenue
 because IRS' systems could not provide the detailed transactions
 supporting the revenue balance, which is a serious limitation.
 IRS systems also did not maintain and, thus, could not report the
 amounts of specific excise and social security taxes collected.

 As a result, IRS could not provide Treasury the information needed
 to distribute excise taxes among the general revenue fund and the
 various excise tax trust funds based on collections, as required by
 law. Instead, IRS reported to Treasury the amounts of excise taxes
 assessed, and Treasury distributed revenue based on these amounts.
 Since total assessments exceed total collections, this practice, in
 effect, results in subsidies to the excise tax trust funds from
 general tax revenues. Over the past several years, such subsidies
 may have totaled several billion dollars. Also, the reported
 information given the impression to decision     that the excise
 taxes are generating more revenue than they actually do.

 Similarly, IRS cannot determine the general revenue fund's subsidy
 to the social security trust fund. This subsidy occurs because,
 amounts distributed, which are by law to be based on wages earned,
 generally exceed social security taxes collected. However, IRS,
 cannot precisely determine the subsidy amount because it does not
 account for the specific amounts of social security taxes
 collected. As a result, IRS cannot provide information on the
 subsidy to congressional committees and others who may be
 interested in monitoring the financial condition of the social
 security program. [5]

 We identified additional fundamental deficiencies in IRS' analysis
 and summarization of its revenue-related records and in controls
 over the reliability, of this information. Some examples follow.

 -- IRS' reports did not include transactions that were in process
    at the and of reporting periods because IRS did not analyze such
    transactions to determine which needed to be reported. As of
    September 30, 1992, in-process transactions, which could have
    affected IRS' reported accounts receivable, refunds payable, and
    other noncash accounts, exceeded $150 billion.

 -- IRS' current paper-based Federal Tax Deposit system for
    collecting payment data from businesses allowed numerous errors,
    primarily because the payment data and the related tax data were
    collected separately. Resolving such errors was both time-
    consuming and costly to IRS and taxpayers.[6]

 To address problems in revenue accounting, IRS is expanding the
 role of the CFO and is either studying, planning, or implementing
 various improvements to its systems and processes. Many of these
 improvement efforts, however, have not yet been defined or are not
 expected to be complete until well past the year 2000 because they
 are part of IRS' long-term Tax Systems Modernization effort.

 Unreliable Records for Automated Data Processing Properly
 ---------------------------------------------------------

 Inventory records for IRS' automated data processing (ADP) property
 were unreliable for managing and reporting on computer hardware and
 software. IRS had not instituted basic procedures to ensure that
 this information was current and aceurate. SpecificallY, IRS
 (1) had not developed procedures to record acquisitions and
 disposals accurately and promptly, (2) did not effectively perform
 physical inventories, and (3) did not properly value computer
 resources. For example, a video display terminal costing $752 was
 valued in  the ADP inventory records at $5.6 million, and
 telecommunications and electronic filing equipment, which IRS
 valued at a total of $84.2 million, was omitted altogether.

 As a result of unreliable and incomplete records, IRS did not
 readily have the information it needed to (1) make computer support
 staffing decisions, (2) support development of budget requests,
 procurement decisions, and performance measurement information
 related to the use of computer assets, or (3) effectively manage
 maintenance contracts. For example, we found that IRS paid $36,000
 for a maintenance contract for a minicomputer that had not been
 used for 3 years, because maintenance contract officers could not
 readily determine what equipment was still in use. Further, IRS
 did not maintain records of the costs of in-house software
 development which, when combined with ADP inventory information,
 would provide more complete accountability for ADP costs and assist
 in planning decisions.

 For the last 3 fiscal years, IRS had budgeted acquisitions of
 property and equipment totaling $453 million. Planned future
 expenditures for ADP assets, approaching $9 billion under IRS' Tax
 Systems Modernization effort, increase the importance of accurate
 ADP asset records to IRS.

 Inadequate Controls Over Computerized Taxpayer Data
 ---------------------------------------------------

 Though heavily dependent on automated systems to process and
 safeguard taxpayer data, IRS did not adequately control access
 authority given to computer support personnel or adequately monitor.
 employee access to this information. Further, controls did not
 provide reasonable assurance that only approved versions of
 computer programs were implemented.

 Such weaknesses increase the risk of unintentional errors and fraud
 and may compromise the confidentiality of taxpayer information.
 For example, IRS' internal reviews found that some employees had
 used their access to monitor their own fraudulent returns, to issue
 fraudulent refunds, and to inappropriately browse taxpayer
 accounts. IRS is in the process of implementing new systems to
 monitor employee activities relating to computerized taxpayer
 information.

 Inadequate Managment of Operating Funds
 ---------------------------------------

 For years, IRS' systems used to process and account for spending of
 operating funds could not provide accurate and timely information
 needed to manage these funds. We were unable to audit
 approximately $4.3 billion, or 64 percent, of the reported spending
 of $6.7 billion from IRS, operating appropriations because IRS
 could not reconcile the total of detailed spending information in
 its outdated systems with summary amounts reported in such systems.
 The remaining $2.4 billion of reported spending in fiscal year
 1992, which we audited, was processed by a new system installed in
 fiscal year 1992 in IRS' National Office and one region. This new
 system was implemented throughout IRS on October 1, 1992.

 For the spending we were able to audit, IRS' systems and controls
 did not provide (1) a reasonable basis for determining compliance
 with laws governing the use of budget authority and (2) reasonable
 assurance that its disbursements were appropriate.

 We found, for instance, that IRS had several billion dollars in
 unresolved cumulative gross differences between its records and
 Treasury's cash records at the end of the fiscal year. Also, as of
 September 30, 1992, IRS had not resolved $53 million in unmatched
 expenditures which were in a suspense account. To clear the
 account, IRS arbitrarily charged the $53 million to three of its
 appropriations (each appropriation was allocated one-third of the
 amount), causing IRS' reports to show that it had exceeded the
 budget authority for one of its appropriations. However, to
 eliminate the appearance that it exceeded such authority for this
 appropriation, IRS recorded an unsupported receivable from another
 appropriation.

 Further, some disbursements were inappropriately processed because
 supporting documents were not adequately reviewed, related
 processing guidance was insufficient, and procurement and payment
 systems were not designed to automatically exchange information.
 In a random sample of 280 payments, for example, we found
 (1) 32 duplicate and overpayments totaling $0.5 million, 4 of which
 were part of our sample and 28 that were discovered in related
 documentation and (2) 112 payments totaling $17.2 million, for
 which complete supporting documentation could not be provided. As
 a result of these problems, IRS made improper payments, and reports
 used by its managers, Treasury, OMB, and the Congress to manage and
 oversee IRS' operations were unreliable.

 IRS expects that its new system will provide up-to-date information
 that would enable it to better monitor available appropriations and
 determine whether funds are available before they are obligated--
 two problems identified during our financial audit. But even if
 the new system is successful, additional changes are needed to
 solve a number of the weaknesses we identified which were not
 intended to be addressed by the new system.

 IRS' FMFIA Reporting
 --------------------

 IRS did not disclose the overall severity of its internal control
 and accounting system weaknesses in its fiscal year 1992 report to
 Treasury under the Federal Managers' Financial Integrity Act
 (FMFIA) of 1982. Without adequate disclosure the Congress and
 other users of the FMFIA report will not be aware of the extent of
 IRS' weaknesses and the efforts needed to correct them. We
 identified material weaknesses that IRS either did not include or,
 in our view, did not adequately disclose. For example, the serious
 problems we noted in the revenue area were largely undisclosed as
 were the problems in the management of operating funds.

 In addition, some previously identified material weaknesses that
 were reported as corrected still exist because IRS did not address
 the fundamental causes of those weaknesses or ensure that
 corrective actions were effective. IRS' FMFIA process for
 identifying, disclosing, and correcting material weaknesses must be
 improved if IRS is to produce reliable information that top
 management can use to control costs and improve operations.

 Actions by IRS to Improve Financial Management
 ----------------------------------------------

 Prior to fiscal year 1989, IRS had put neither substantial effort
 nor resources into rectifying the poor state of its financial
 management operations and no one at. IRS was responsible for
 ensuring the integrity and efficiency of financial management and
 accounting systems agencywide. Responding to a recommendation in
 our 1988 report [7] on our general management review of IRS, which was
 a joint effort with the agency, and the mandate of the CFO Act, IRS
 established financial leadership through the appointment of a CFO
 and an Assistant Commissioner (Finance)/Controller. These
 individuals and the support of IRS' top management have been key to
 the progress to date.

 Among the actions IRS has taken are to (1) significantly increase
 its CFO staff, (2) implement agencywide, in fiscal year 1993, a new
 integrated accounting and budget system, and (3) begin development
 of a cost management system to enable better performance
 measurement and reporting on operating performance. Also, IRS is
 studying, planning, or implementing various additional improvements
 to its systems and processes.

 IRS will continue to face major challenges in developing meaningful
 and reliable financial management information and in providing
 effective internal control as envisioned by the CFO Act. It will
 take a significant and sustained commitment by IRS management,
 particularly by the CFO and CFO staff, to successfully implement
 the improvement initiatives now under way.

 We believe IRS is making progress because it has had a sustained
 commitment to improving the management of its operations. The past
 several IRS Commissioners adopted a consistent management
 improvement agenda that we helped IRs initially frame as part of
 our 1988 general management review. Management's response to the
 findings of the general management review, similar to IRS' work to
 address the findings of our financial audit, has been most
 encouraging and signifies an organization willing to recognize its
 problems and attempt to do something about them. My hope is that
 we will see this type of management involvement and commitment
 across government. In my view, only in this way will agencies
 achieve the level of improvement that is needed to successfully
 implement the CFO Act and to improve overall management of agency
 programs and operations.

 SERIOUS WEAKNESSES EXIST IN CUSTOMS' FINANCIAL MANAGEMENT
 OPERATIONS AND CONTROLS, AND MANAGEMENT IS ACTING TO ADDRESS THESE
 PROBLEMS
 ------------------------------------------------------------------

 I will now discuss some of the more serious problems we identified
 through our financial audit of the Customs Service.[8]

 Weak Accountability for Seized Property and Special operations
 Documents
 ---------------------------------------------------------------

 Customs reported $542 million in Seizures during fiscal year 1992
 and an ending balance of $489 million in seized property in its
 financial statements. The policies and procedures the agency
 established to control seized property, though, were not
 consistently and effectively implemented. We identified weaknesses
 in internal controls throughout Customs, seizure process, from the
 time property was seized to the time of its disposal. Seized
 property was vulnerable to theft or loss, which could result in
 financial loss to the government or danger to the public.

 The following are examples of control breakdowns.

 -- The transfer of seized property from seizing officers to seizure
    custodians for safeguarding was often delayed. Over 50 percent
    of the 118 items we tested were not transferred within Customs'
    prescribed 2-day maximum--the average was 35 days. In one
    instance, about one-half pound of heroin was held by a seizing
    officer from August 11, 1992, the date of the seizure, until
    March 16, 1993, when we visited the Customs' district involved.
    No one could explain the reason for the delay.

 -- Seized drugs were not properly weighed and tested, creating an
    environment where drugs could be stolen without detection. For
    instance, although Customs had established procedures to weigh
    drug seizures, we found a case where a shortage of 1,850 pounds
    of seized marijuana could not be accounted for. Customs was
    unable to explain the discrepancy other than to state that the
    initial weight assigned to the marijuana was probably an
    estimate and that the seizure had not been weighed as required
    at the time of receipt.

  Storage facilities were not properly protected. At 14 of the 20
  Customs' seized property storage facilities we visited, we
  observed that unaccompanied seizure custodians had access to
  vaults. None of the 20 Customs districts we visited had
  security cameras in their vaults, and 2 sites containing large
  bulk quantities of drugs had open physical access in full public
  view.

 Further, Customs did not adequately control millions of dollars in
 funds advanced to its agents for special operations, such as
 undercover work and payments to informants, or the sensitive
 documents related to these advances. For advances, Customs'
 accounting records had to be adjusted from $37. million to
 $19 million to show the correct balance at year-end. More serious
 though, sensitive documents supporting special operations
 transactions were not adequately safeguarded. At Customs' National
 Finance Center, sensitive documents were routinely stored in an
 open filing cabinet in an unlocked room or were left unattended on
 a desk. Failure to adequately protect these documents could
 threaten the safety of informants and Customs, agents, compromise
 important relationships with informants, and undermine Customs'
 credibility.

 Inadequate Accounting for and Controlling of Accounts Receivable
 ----------------------------------------------------------------

 The $828 million Customs reported as accounts receivable as of
 September 30, 1992, was inaccurate and incomplete. Customs'
 internal controls over accounts receivable were so poor that we
 could not gain assurance that all valid receivables were included
 in its reported amounts. Further, Customs, reported amount did not
 include certain valid receivables, included some receivables at a
 net amount instead of gross, and included some receivables which
 could not be supported. For example, the reported accounts
 receivable included only $26 million for fines and penalties cases.
 In a relatively small sample, we found fines and penalties cases
 with an assessed value of $78.7 million which should have been
 included but were not.

 Also, Customs had not developed a reliable methodology for
 estimating the amount of its receivables that is likely to be
 collected. Customs' methodology was flawed because it considered
 primarily historical collection experience but did not consider the
 debtor's current ability to pay. our review of $403 million of
 valid receivables as of June 30, 1992, showed that Customs'
 estimate of the uncollectible amount of these accounts receivable
 was understated by about $41 million.

 In addition, efforts to collect delinquent debt were hampered by
 missing documents. In our sample of 966 cases, Customs could not
 locate 144 key documents, involving 127 cases, needed to support
 its claims against the importer or surety. In addition, Customs
 did not effectively monitor bond coverage which gave rise to
 delinquent and, in some cases, uncollectible accounts receivables.
 In one instance, a petroleum importer, with 15 outstanding bills
 totaling about $3.1 million, had a continuous surety bond of only
 $400,000. Customs pursued collection from the surety and collected
 the bond amount. However, the remaining $2.7 million was not
 covered by the bond and is most likely uncollectible as the
 importer is more than 4 years delinquent in paying this debt.

 Finally, large differences existed between the amounts of fines and
 penalties assessed, mitigated, and collected. overall, Customs
 collected pennies on a dollar of assessed fines and penalties.
 Violators, who are aware of these differences and Customs' practice
 of mitigating most assessments, may routinely petition for
 mitigation, requiring Customs to devote large amounts of resources
 to the mitigation process. While Customs does not routinely report
 data that correlate individual assessments to collections, we found
 that only a small fraction is being collected. As a measure of the
 potential difference, during the past 2 fiscal years, Customs
 assessed fines and penalties totaling approximately $7.9 billion
 and collected only about $87 million for various fines and
 penalties cases, including cases opened in earlier years.

 According to Customs' officials, such differences result primarily
 from (1) the statutory requirements that Customs assess fines and
 penalties in large amounts and (2) Customs' practice of mitigating
 most accounts to nominal amounts. We found that some assessments
 are mitigated because Customs did not have sufficient documentation
 at the time of assessment and later mitigated the assessment to
 reflect documentation provided by the importer. For example,
 Customs assessed a penalty amount of about $4.4 million to an
 importer for allegedly fraudulently undervaluing merchandise being
 imported. The importer filed a petition with Customs and provided
 additional information, and the penalty was reduced to $150,000.

 Weaknesses Over Import and Drawback Verification Create
 Opportunities for Lost Revenue and Fraud
 -------------------------------------------------------

 Customs relies to a great extent on importers and brokers to
 voluntarily report and assess the amount of duties, taxes, and fees
 owed on imported merchandise. We found no significant internal
 controls to ensure that merchandise entering the United States was
 identified and the proper duty assessed. Based on certain audit
 tests, we were able to conclude that Customs' reported revenues of
 $20.2 billion for fiscal year 1992 approximate revenues collected
 from imparters who voluntarily reported and paid amounts owed.
 However, because of the potential for goods to enter and not be
 identified, we cannot give any assurance that the $20.2 billion
 represents all revenues which Customs should have collected for
 fiscal year 1992. Customs recognizes this problem and has
 established a project to improve importer compliance and target
 inspections for trade enforcement purposes. It will, though, take
 a significant effort to adequately address the broad scope of
 problems in this area.

 Furthermore, our review of Customs' duty refund (drawback) policies
 and procedures showed that serious control weaknesses existed
 throughout the process. Customs makes refunds to claimants for
 99 percent of duties paid when the related imported merchandise is
 subsequently exported or destroyed. Customs reported that it made
 almost half a billion dollars in drawback payments during fiscal
 year 1992. However, we found that procedures were inadequate to
 prevent excessive or duplicate payments or detect fraudulent
 claims. Specifically, Customs did not (1) adequately assess the
 validity of a drawback claim and track the amount of drawback paid
 against an import entry, (2) establish sufficient review procedures
 to ensure that a claim was accurate, (3) ensure that required bonds
 were adequate, and (4) ensure that only authorized claimants
 received accelerated drawback payments. [9]

 In the absence of appropriate controls, Customs' extensive reliance
 on voluntary compliance of the trade community to accurately report
 duties owed and drawbacks claimed creates an environment where the
 federal government could lose substantial amounts of revenue.

 Customs Lacked Adequate Accountability for Property
 ---------------------------------------------------

 Customs lacked adequate accountability for property which it valued
 at $710 million at September 30, 1992. About 85 percent of this
 amount consisted of equipment such as aircraft, vehicles, and
 vessels. For years, Customs was unable to reconcile its accounting
 records with the related detailed subsidiary property records. In
 fiscal year 1992, Customs made a substantive effort to reconcile
 these records, which resulted in net adjustments that totaled
 $115 million. Some of these adjustments, though, were not
 supported by identifiable transactions and were made to force. these
 records to agree. Customs did not know whether the adjustments
 represented property that was simply incorrectly accounted for or,
 was lost, misappropriated, or stolen.

 Also, Customs* fiscal year 1992 physical inventory of equipment was
 ineffective. We found, for example, $6.2 million of computer
 equipment on hand which was not included in the property records.
 Further, Customs was unable to support the values assigned to over
 50 percent of the 650 property items we sampled and tested. The
 value assigned to many items appeared to be estimates. In the
 cases where Customs was able to provide documentation, 12 percent
 of the property items were improperly valued, resulting in an
 estimated net understatement of at least $4.7 million.

 Customs' FMFIA Reporting
 ------------------------

 Similar to IRS, Customs did not report the overall severity of its
 internal control and accounting system weaknesses in its fiscal
 year 1992 FMFIA report. Its report did not include or did not
 adequately disclose the seriousness of the problems identified in
 our audit. Customs' FMFIA process for identifying, disclosing, and
 correcting material weaknesses must be improved if the agency is to
 produce reliable information that top management can use to control
 costs and improve operations.

 Actions by Customs to Improve Financial Management
 --------------------------------------------------

 Customs has made strides in addressing long-standing financial
 management problems. For years, until the passage of the CFO Act,
 Custom, like IRS, lacked financial management leadership with
 sufficient expertise, responsibility, and authority to ensure that
 its financial systems, processes, and internal controls fully
 supported its financial information needs. Over the last
 2 years, through the strong support of the Commissioner and
 Customs' top management, the agency has put in place a CFO
 structure and given the CFO the authority and responsibility
 necessary to begin to correct many of the problems identified in
 our audit. During 1992, for instance, the agency installed a new
 core general ledger system which became effective October 1, 1992.

 Customs is either studying, planning, or implementing various
 improvements to its systems and processes. It is in the process of
 redesigning its Automated Commercial System, which was developed to
 automate information on Customs' program operations and is used to
 account for revenue collected, and it has begun development of a
 new cost accounting system. Customs has also begun to modify its
 methodology for estimating the collectibility of its accounts
 receivable and has made positive strides towards addressing its
 debt collection problems. Further, Customs has taken steps to
 resolve long-standing problems in its property records and is
 planning additional efforts.

 The success of Customs' ongoing ADP modernization efforts and
 planned procedural improvements will be critical to improving its
 financial management systems and internal control structure. Many
 of these efforts, though, are not expected to be complete for
 several more years. As a result, it will take a significant and
 sustained commitment by Customs' management, particularly by the
 CFO and the CFO staff, to build on efforts now under way to develop
 now systems and put proper controls in place.

 REACHING FOR FINANCIAL MANAGEMENT REFORM: SUCCESSFUL
 IMPLEMENTATION OF THE CFO ACT MUST BE A HIGH PRIORITY
 ------------------------------------------------------

 This leads me to the broader issue of ensuring successful
 goverrmentwide implementation of the CFO Act. As discussed in our
 December 1992 transition series report on Financial Management
 Issues (GAO/OCG-93-4TR), widespread financial management weaknesses
 are crippling the ability of our leaders to effectively run the
 federal government. Reducing the federal deficit requires
 monumentally difficult decisions. If our government is to make
 these decisions in an informed manner, it must have better
 financial information. Also, our citizens should be provided
 meaningful information that allows them to judge the performance of
 their government and controls that help guarantee fundamental
 accountability. Because credible financial data are not available
 today, public confidence in the federal government as a financial
 steward has been severely undermined.

 There is no magical formula to solve the federal government's
 financial management problems. The issues are very complex, deeply
 rooted, and involve the largest entities in the world, which have
 no counterparts in the private sector -- the federal government is
 clearly different. Nevertheless, successful financial management
 reform can and must be achieved.

 The CFO Act, enacted under the leadership of this Committee and the
 House Committee on Government Operations, provided the needed
 foundation. This landmark legislation is the most comprehensive
 financial management reform package in 40 years--but it must be
 fully and effectively implemented. The CFO Act is now 2-1/2 years
 old. Many important initiatives are under way and planned, and I
 am most pleased that the basic concepts are taking root. But a
 much greater sense of urgency is essential to successfully
 implement needed reforms and to ensure that the huge potential
 savings to the taxpayer from the resulting improvements in the
 efficiency and effectiveness of government are realized as promptly
 as possible. I would now like to highlight these critical actions.

 Ensuring Sustained High-Level Priority Attention to Resolve
 Problems
 -----------------------------------------------------------

 Only through consistent and continuous attention from the highest
 levels of government and the Congress, including agency CFOs with
 requisite skills and experience and the needed powers and authority
 to got the job done, will we see the results that are possible.
 Without decisive action by the new administration and strong
 oversight and support by the Congress, efforts to reform financial
 management will falter. There must be a sense of urgency.
 Changing a government culture that has not always seen financial
 management as important is difficult, especially if there is not a
 continuity of effort or if this change is not perceived as
 important.

 Essential to success will be the President making financial
 management reform a high priority in the administration, and I am
 hopeful this will emerge as one of the top action items of the
 National Performance Review. The President must hold agency heads
 accountable for successfully implementing the CFO Act. There has
 to be an increased emphasis on professional management. In my
 view, the success of financial management reform is critical to any
 effort to reinvent government.

 Agencies must give high-level attention to financial management
 improvements. For example, the recent announcement by the
 Department of Defense that it had established a senior management
 steering committee, chaired -by the Deputy Secretary, to bring
 together financial, program, and information management, was
 encouraging. Agency leadership has to provide an appropriate
 framework for integrating accounting, program, and budget systems
 and data in order to develop more useful and relevant information
 for decision-making and to break down traditional barriers between
 program and financial management. Further, the central financial
 management agencies.--OMB, Treasury, and GAO--must expedite sorely
 needed accounting, financial reporting, cost, and systems
 standards.

 The CFO Act established a Controller in OMB to provide overall
 leadership and CFOs to direct and control financial management
 activities in major departments and agencies. A highly qualified
 Controller is needed to steer this effort, with the authority to
 lead the CFOs in the major departments and agencies and the
 resources to do the job. The administration must also appoint
 agency CFOs who are highly qualified financial management
 professionals, with the right mix of properly defined duties and
 full authority for traditional financial management functions,
 including budgeting. At most agencies, the CFO has not yet been
 appointed.

 Expanding Audited Financial Statements to the Entire Federal
 Government
 -------------------------------------------------------------

 As I have stated on many occasions, I am firmly convinced of the
 value of audited financial statements. As I discussed earlier, the
 results of the pilot financial audits at Defense and the civilian
 agencies further reinforce this belief.

 On June 25, 1993, OMB Bulletin 93-18 extended the Pilot Program for
 audited financial statements at 10 agencies for 3 years and
 established March 1 as the new due date for the issuance of all
 audited financial statements. In issuing this new bulletin, the
 Director of OMB stated:

   "The preparation and audit of financial statements has
   provided significant. financial and related information,
   identified and stimulated correction of deficiencies in
   the agencies' financial systems, and improved
   understanding of the agencies' financial condition and
   results. Accordingly, it is beneficial to continue and.
   expand the audited financial reporting process."

 I fully support the OMB Director's extension of the pilots and
 establishment of a March 1 reporting date to tie in with the budget
 cycle. OMB's continuing strong support of audited financial
 statements and the leadership of its office of Federal Financial
 Management have been very important to the success of this program.

 To further build on this success, it is now time to expand the
 requirements for agency level audited financial statements beyond
 the 10 pilots to cover all the agencies identified in the CFO Act.
 This could be phased in over the next 3 years and would ultimately
 enable preparation of financial statements for the government as a
 whole, which GAO would audit. For the first time, the American
 public would be given an accountability report from its government.

 We believe it would be best for this requirement to be anchored in
 legislation. The legislative mandate in the CFO Act for audited
 financial statements has been a catalyst for the important results
 we have seen to date in moving agencies to a higher level of
 financial accountability. While administrative requirements to
 prepare financial reports date back to the 1950s, the legal force
 of the CFO Act, together with the interest and involvement of this
 Committee and the House Committee on Government Operations, is what
 finally moved this effort ahead.

 Also, the preparation of audited financial statements, including
 required performance information on the results of operations,
 would support the implementation of the Government Performance and
 Results Act of 1993. In my view, implementation of this important
 new legislation can be greatly aided with good cost and operating
 performance information that audited financial statements under the
 CFO Act are intended to provide.

 Making Wise Investments in Systems and Personnel to Rebuild
 Financial Management Infrastructures

 Today, it is well acknowledged that current financial systems
 across government are in extremely poor condition, despite spending
 billions of dollars over the years on improvement efforts. IRS and

 Customs, for example, struggled in preparing reliable financial
 statements primarily because of severely weak system. This has to
 be overcome through wise investments in modern systems that onable
 streamlined operations and have a dollar pay-off in term of better
 information and better efficiency. While investment in new systems
 is essential, billions of dollars are already being spent on
 systems every year--the money just has to be better invested in
 carefully developed systems that will meet government information
 needs.

 The CFO Act calls for integrated systems, meaning financial and
 operating systems that are interconnected to support both agency
 business plans and management information needs. There must be
 increased emphasis on using information resource management to
 facilitate agency reengineering projects. Reform cannot be viewed
 merely as further automating existing processes. Rather, those
 processes must be simplified, redirected, and reengineered.

 An equally important step is breaking down traditional barriers
 between program and financial management so that financial
 management supports programs, missions, and business lines. For
 example, the serious problems IRS faced in accounting for its
 receivables stemmed in large part from a system that was designed
 to capture information for enforcement and collection activities
 and was not properly tied to financial reporting. Further,
 efficiencies could be gained through more standard systems and more
 "cross servicing" in which one agency provides accounting services
 (such as payroll and disbursing) to another agency. The
 development and use of governmentwide systems development standards
 to better guide system design and implementation efforts would be a
 vital component in such efforts.

 The federal government must address immediately the serious problem
 of attracting and retaining well-qualified financial management
 personnel. Agencies reported a significant need to upgrade their
 financial management staff capabilities. In our financial audits,
 we have found that bad systems are made even worse because people
 do not properly process transactions. We have identified tens of
 billions of dollars of accounting errors that could have been
 avoided if there had been more discipline in following existing
 policies and procedures. Financial managers must upgrade their
 training efforts to increase professional skills.

 Implementation of new systems that eliminate the duplicative and
 manual processes that agency systems require today should enable
 agencies to decrease the size of their financial management staffs.
 But, they may need more skilled professionals such as financial
 analysts and cost and systems accountants. Further, to ensure a
 cadre of professional financial managers for a government that is
 the largest financial entity in the world, we support mandatory
 continuing professional education for all financial managers
 similar to the requirement now in place for auditors.

 Fostering Reforms Through Strong Congressional Oversight and
 Support
 -------------------------------------------------------------

 I have spoken many times about the importance I place on annual
 congressional oversight hearings of agency management. Managers
 must be held accountable for results. The annual agency CFO
 report, which includes the audited financial statements, together
 with the reporting required under FMFIA, can provide a baseline for
 such hearings.

 In the case of FMFIA, these reports have to be meaningful and must
 be used or else they will not be taken seriously. As I testified
 on July 1, we had major problems with the Department of Defense's
 most recent FMFIA report, and earlier I cited the problems we
 identified with IRS' and Customs' FMFIA reporting. Greater
 accountability can be established through reporting that combines
 the agency CFO and FMFIA reports and focuses on outcomes and
 results which are scrutinized by annual congressional oversight
 hearings.

 Finally, in difficult budget times, and where the pay-off may not
 be immediate, funding for financial management improvements will
 need to be viewed as investments. For the CFO Act to succeed, the
 Congress will have to provide the necessary funding support through
 investments in modern systems, personnel staf f ing and development,
 and expanded financial reporting and auditing.

 In closing, I want to emphasize that the CFO Act has had an
 important impact in changing perceptions about the need for good
 financial management, and agencies have made improvements and are
 working in response to the act to significantly strengthen their
 financial processes and systems. But it will take a great deal of
 commitment and hard work to achieve the full potential and
 objectives of the act and turn around long-standing neglect of
 financial management. Our financial audits at IRS and Customs, for
 example, have identified major problems that will need management' s
 continuing top-level attention and their support of the CFO. Top
 management's recognition that they have serious problems and
 efforts to establish a viable CFO structure in their agencies are
 an important beginning to a difficult challenge.

 Shifting now to a governmentwide perspective, an intensified sense
 of urgency will be needed. We are at a critical juncture in
 implementation of the CFO Act. Financial management reform must be
 a high priority of the President and the Congress. Changing a
 government culture that has not always seen financial management as
 important is difficult, especially if there is not a continuity of
 effort or if this change is not perceived as critical. We stand
 ready to work with the Committee in any way we can. Attached to my
 statement is a summary of the needed actions which were included in
 our Financial Management issues transition series report. (See
 attachment II.) I view-implementation of the CFO Act as essential
 to establishing accountability in the federal government, which has
 been one of my fundamental goals as Comptroller General.

 Mr. Chairman, this concludes my statement. I will be glad to
 answer any questions that you or the other Members of the Committee
 may have at this time.


 FOOTNOTES:
 ----------

 [1] Financial Management: DOD Has Not Responded Effectively to
     Serious, Long-standing Problems (GAO/T-AIMD-93-1).

 [2] Financial Audit: Examination of IRS' Fiscal Year 1992 Financial
     Statements (GAO/AIMD-93-2, June 30, 1993).

 [3] Financial Audit: IRS Significantly Overstated Its Accounts
     Receivable Balance (GAO/AFMD-93-42, May 6, 1993).

 [4] Our financial audit for fiscal year 1992 was not designed to
     address IRS' information on (1) the impact of tax policies on
     revenue, often referred to as "tax expenditures," and the process
     used by IRS to determine this information or (2) potential tax
     revenues, often referred to as "the tax gap."

 [5] In or report entitled "Social Security: Reconciliation Improved
     SSA Earnings Records, But Efforts Were Incomplete" (GAO/HRD-92-81,
     September 1, 1992), we suggested that the Congress consider
     amending the Social Security Act to requre that revenues
     credited to the social security trust funds be based on social
     security taxes collected.

 [6] Federal Tax Deposit System: IRS Can Improve the Federal Tax
     Deposit System (GAO/AFMD-93-40, April 28, 1993).

 [7] Managing IRS: Actions Needed to Assure Quality Service in the
     Future (GAO/GGD-89-1, October 14, 1988).

 [8] Financial Audit: Examination of Customs' Fiscal Year 1992
     Financial Statements (GAO/AIMD-93-3, June 30, 1993).

 [9] Accelerated drawback payments were made to authorized claimants
     prior to Customs reviewing and verifying the validity and
     accuracy of the claim. Nonaccelerated claims are paid after
     Customs reviews them. Therefore, accelerated payments represent
     a greater risk than nonaccelerated payments.

