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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:

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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

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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;

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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'

administrative and custodial financial statements that are not yet fully corrected. Until resolved, they will continue to prevent us from expressing an opinion on IRS' financial statements in the future. The following sections outline these problems and IRS' improvement plans and progress.

Accounting for Administrative Operations
Has Improved but Problems Remain

Each year, IRS spends billions of dollars in operating expenses to (1) process tax returns, provide taxpayer assistance, and manage tax programs, (2) enforce tax laws, and (3) develop and maintain information systems. For fiscal year 1995, IRS reported $8.1 billion in operating costs, including $5.3 billion for payroll and other personnel costs and $2.8 billion for the cost of goods and services, such as rent, printing, and acquiring and maintaining automatic data processing equipment.

Our initial financial audits identified serious problems in accounting for and reporting on IRS administrative operations, which has resulted in IRS making improvement in these areas. For example, IRS has successfully

implemented a financial management system (which according to
Treasury, conforms to the government's standard general
ledger) to account for its appropriated funds, which has
helped IRS to correct some of its past transaction processing
problems that diminished the accuracy and reliability of its
cost information, and

transferred its payroll processing to the Department of
Agriculture's National Finance Center and, as a result,
improved its accounting for payroll expenses.

These improvements have made IRS' accounting for its administrative operations much better today than it was 4 years ago. For example, we are now able to substantiate IRS' payroll expenses of about $5 billion. However, the following two major problems still need to be fully corrected.

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A significant portion of IRS' reported $3 billion in nonpayroll operating expenses for goods and services could not be verified.

The amounts IRS reported as appropriations available for expenditure for operations could not be reconciled fully with Treasury's central accounting records showing these amounts, and in the past, hundreds of millions of dollars in gross differences had been identified.

Receipt of Goods and Services We found several problems in attempting to substantiate amounts IRS reported as having been spent for goods and services. IRS did not have support for when and if certain goods or services were received and, in other instances, did not have support for reported expense amounts. For example, IRS accepts Government Printing Office (GPO) bills as being accurate and records an expense in its financial records without first verifying that the printing goods and services being billed were actually delivered and accepted. Also, in instances where IRS could provide information showing proper receipt and acceptance of goods and services, expenses were often recorded in the wrong fiscal year. This problem occurs because (1) IRS offices that receive and accept goods and services do not always forward to IRS accounting offices evidence supporting these actions and (2) IRS accounting offices used inconsistent, and in some cases incorrect, policies and procedures for recording expenses.

Ensuring that goods and services have been received and properly accounted for are fundamental accounting steps and controls. Over the past 4 years, we have recommended that IRS

revise its procedures to incorporate the requirements that accurate receipt and acceptance data on invoiced items be obtained prior to payment and that supervisors ensure that these procedures are carried out, and

revise its document control procedures to require IRS units that actually receive goods and services to promptly forward receiving reports to accounting offices so that these transactions can be properly accounted for.

IRS believes the core issue for correcting its receipt and acceptance problems relate to properly accounting for transactions with other federal agencies. IRS' plans to address this issue by

completely and accurately documenting its current accounting systems and control procedures for procuring, receiving. accepting, and paying for goods and services through other federal agencies, such as GPO and the General Services Administration, and recording the related budgetary, expense, and cash disbursement transactions;

identifying and evaluating the reliability of available documentary evidence and systems, which until this point have been developed and utilized primarily to meet operational rather than financial reporting objectives,

working with other federal agencies to explore ways to improve the timeliness, nature, and extent of documentation

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