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Mr. HORN. So Mr. Dodaro, please begin. This is the first time I have ever been in this hearing room and I think I need a Hubbell telescope to see you down there. But I will say the podium is terrific, you can spread out, it is the only sensible podium, but this is strange, to be charitable.

So proceed, Gene. STATEMENT OF GENE L. DODARO, ASSISTANT COMPTROLLER

GENERAL, ACCOUNTING AND INFORMATION MANAGEMENT DIVISION, GENERAL ACCOUNTING OFFICE, ACCOMPANIED BY DIANE GUENSBERG AND GREGORY HOLLOWAY, GENERAL ACCOUNTING OFFICE

Mr. DODARO. Good morning, Mr. Chairman. We are pleased to be here today to talk about the progress IRS is making in addressing its financial management problems.

Mr. HORN. Excuse me, I might, for the record, say we now have a quorum. Go ahead.

Mr. DODARO. Good morning, Congresswoman Maloney, it is nice to see you again.

Mrs. MALONEY. Good morning. It is good to see you again.

Mr. DODARO. We are pleased to be here today to give you a status report on IRS' actions to correct its financial management problems.

As you pointed out in your opening statement, we have been auditing the IRS since fiscal year 1992 and I might point out that those audits have covered two different sets of financial statem ts to account for IRS. One is the administrative operations of the Internal Revenue Service, which are about $8 billion that IRS gets in appropriated funds to carry out its various activities. And then there is another set of financial statements that cover IRS' custodial responsibilities for the Government to collect the $1.3 to $1.4 trillion in revenue on behalf of the Federal Government.

Now, in the administrative statements, those covering the $8 billion that IRS uses to manage its own operations, it is in that area that we have seen the greatest progress so far. When we started back in 1992 there were several different administrative systems, accounting systems, that they had in place. They had problems even with controls over payroll operations.

Since then they have replaced those systems with one administrative accounting system that we think is good and an effort to better account for their funds. They have also worked with the National Finance Center at the Department of Agriculture to transfer their payroll functions there. So as a result, in the last year we were able to substantiate that about $5 billion of their $8 billion in appropriations that go for payroll were valid.

We have two remaining problems on the administrative area that need to be addressed. One is in documenting the receipt and acceptance of goods and services, particularly those services that IRS procures from the Government Printing Office, for example, all the tax forms that are mailed out, as well as rent and other activities that involve transactions among Federal agencies. There are difficulties capturing that accurately.

Second, as you pointed out, reconciling their cash accounts with the Treasury Department. In both of these areas, based on our suggestions and discussions with the IRS, they have brought in some outside contract support to help. We are monitoring their activities closely and I would hope in the next year we can see some progress on those two areas. So I think in the administrative accounting area for IRS appropriation we are beginning to see some progress in that area.

Now, on the revenue side, I think that is a different story. The revenue responsibilities, collection responsibilities, are enormous. There are deep problems with the accounting systems over there in terms of their capability to keep track of this. But part of the problem is rooted in how tax receipts come into the Treasury Department and IRS in terms of their not being adequately distinguished. About 80 percent of the taxes are collected from businesses and they send in lump sums, which include income tax, Social Security taxes, and they are not really designated by type of tax at the point of collection, and this creates a massive reconciliation problem for the IRS. Now, they should be able to do this but their current systems do not permit that. Also, in the accounts receivable area, as you pointed out, we have had trouble substantiating the balances there. Again, there are not good detailed subsidiary records that distinguish valid accounts receivable from other compliance assessments that IRS has levied on people as a means to try to get them to pay their taxes, so there is no sorting out of what is valid, what is not, and what is collectible.

We have worked with them to come up with a good statistical sampling approach in the short run to take some of these accounts and to accurately assess and come up with a good figure so the Congress and others know how much delinquent taxes there are and, more importantly, how much is really collectible in the long

Now, we have worked with the IRS and they have developed some short-term fixes in this revenue accounting area, but the longer term fixes are going to be dependent upon their ability to put in place new and enhanced accounting and information systems, and this is a very important issue.

This is an area we have some concern about the Service's ability in. As we talked to this committee about in March, IRS' ability in their tax system modernization effort to develop systems is not at an adequate level yet. As you recall, I mentioned that they were considered to be a level I organization in terms of their ability to develop software, which was not a level commensurate with the task that they had. We made about a dozen recommendations in that area. They are beginning to put in place the right processes and tools, but it is going to take a while before they are able to move up.

As you recall, level I meant that the system-development efforts were at the very initial level, and that was distinguished by ad hoc and oftentimes chaotic development, which means that some of the systems that they develop work well, many others do not. They need to get to a process where they can produce that on an acceptable basis.

Their ability to develop their tax system modernization capabilities is very much an integral part of their ability to fix their financial management problems as well.

run.

Obviously there is also more at stake here in terms of the CFO requirements unfolding. The Department of the Treasury, for the first time for fiscal year 1996 we will have financial statements that cover the entire Department of Treasury. IRS is such a large part of the Department that the problems at IRS will affect the ability of auditors to render an opinion on Treasury's departmentwide statements.

Likewise, we, GAO, as auditors of the consolidated financial statements of the Federal Government, will be it will be difficult to render an opinion on the governmentwide statements. IRS collects virtually all of the major revenue sources of the Government, most of the receivables about two-thirds of the reported receivables in the Government come from delinquent taxes--so it has an enormous impact on both the Treasury statements as well as the governmentwide statements.

Now, in order to get remedies for these problems and not as auditors just pointing out these problems, we have been working with the IRS to develop an action plan. I was concerned in the early years that we did not have a good detailed plan to make progress. In the last year, and particularly in the last 6 months, I see where we have made more progress. I think we have a good plan now.

The question is whether IRS can execute that plan. We are monitoring and working with them very carefully. I am encouraged by the fact that finally, I think, IRS understands the depth of their problems and is moving to begin to put in place strategies. I think these hearings that have been held by this committee have been very helpful in that regard and I would encourage the committee to continue to provide oversight in this area.

My colleagues and I would be pleased to answer any questions. [The prepared statement of Mr. Dodaro follows:)

Mr. Chairman and Members of the Subcommittee:

We are pleased to be here today to discuss IRS' efforts to prepare reliable financial statements, as required by the expanded Chief Financial Officers (CFO) Act of 1990, and to make fundamental financial management improvements. Our recent reports and testimonies, including our March 1996 testimony before the Subcommittee, detailed the substantial problems IRS has in accounting for over $1 trillion in monies collected from American taxpayers and billions of dollars in delinquent taxes owed to the government. Until resolved, these weaknesses will continue to affect the credibility of information used to report the results of IRS' financial operations and measure its performance. While serious problems have been identified, the CFO requirements have provided the impetus for efforts to improve IRS operations. They have:

led to IRS top managers having a much better understanding than ever before of IRS' serious accounting and reporting problems,

provided information on the magnitude of IRS' tax receivables collection problems, and

identified the need for stronger controls over such areas as payroll operations.

IRS has made some progress in responding to the problems we have identified. Over the past 4 years, we have made 59 recommendations to improve IRS' financial management systems and reporting. IRS agreed with these recommendations and has been working to implement them and correct its financial management systems and information problems. In our assessment this year, we determined that IRS had completed 17 of these recommendations and efforts are underway to address the remaining areas. As part of our audit of IRS' fiscal year 1996 financial statements, we will examine additional actions IRS has taken to complete other recommendations we have made.

However, many difficult problems remain to be corrected before we would be able to express an opinion on IRS' financial statements. With our assistance, IRS is working on a plan of interim strategies to solve these problems, with a goal of having these matters resolved in time for the fiscal year 1996 financial statement audit. For some areas, especially in accounting for revenue, IRS will need to make more sweeping changes to fully

Our recent reports and testimonies detailing IRS' financial management problems are listed in attachment I.

address systems problems. In these cases, longer-term solutions involving reprogramming software for IRS' antiquated systems and developing new systems will be required.

Follow-through by IRS is essential to ensure that its short- and long-term plans are carried out and effectively solve financial management problems. In the past, IRS has not always provided the follow-through needed to complete necessary corrective measures. Solving these problems is essential to provide reliable financial information and ensure taxpayers that their tax dollars are properly accounted for in accordance with federal accounting standards. The accuracy of IRS' financial statements is also key to both IRS and the Congress for (1) ensuring adequate accountability for IRS programs, (2) assessing the impact of tax policies, and (3) measuring IRS' performance and cost effectiveness in carrying out its numerous tax enforcement, customer service, and collection activities.

Today, we will focus on

the status of IRS' efforts to implement our recommendations and develop a detailed plan with explicit, measurable goals and a set timetable for actions to correct its financial management weaknesses;

IRS' progress in addressing the major problems that have
prevented us from expressing an opinion on its financial
statements;

the impact that IRS' problems in developing Tax Systems Modernization have on improving financial information; and

the significant adverse affect that delays in resolving IRS' financial management weaknesses could have on preparing and auditing Treasury's agencywide financial statements and the financial statements for the entire government.

ADDRESSING SERIOUS FINANCIAL
MANAGEMENT PROBLEMS

IRS prepares separate sets of financial statements showing the results of its operations for (1) administrative operations, which include $8 billion in payroll and other expenses, and (2) custodial functions, which reflect $1.4 trillion in tax collections. IRS began preparing these annual statements starting with those for fiscal year 1992 as part of a pilot program under the CFO Act of 1990.

We have been unable to express an opinion on the reliability of these financial statements for any of the 4 fiscal years from 1992 through 1995. We identified fundamental problems with IRS'

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