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supporting interagency payments that would allow IRS to properly account for these interagency transactions, and developing both short- and long-term improvements to its accounting systems and control procedures, including modifications to its automated systems to allow for direct interfaces between its operating systems and its general

ledger accounting system. IRS is now beginning to deal with this problem in a comprehensive way. To that end, IRS has engaged an accounting firm to assist it in carrying out this plan. We are closely monitoring IRS' and its contractor's progress because, only through an intense concerted effort, will the proposed solutions be implemented on time for the fiscal year 1996 audit.

Fund Balance Reconciliation Issues Also, we could not verify the accuracy of IRS' Fund Balance with Treasury accounts that are related to IRS' appropriation accounts for its operations. The Fund Balance accounts are used to record cash receipts and cash disbursements for these appropriations. These accounts are much like checking accounts with a bank, and their balances represent the amount of appropriations available to IRS for expenditure. Accordingly, like bank checking accounts, each month, these accounts must be reconciled with the bank's records, and any differences reported to the bank. In this case, the banker is Treasury and the differences are great.

These accounts have been unreconciled in each of the years we have audited IRS' financial statements. The net reconciling differences are made up of gross differences in the hundreds of millions of dollars. For example, we reported last year that IRS was researching $13 million in net differences that consisted of $661 million of increases and $674 million of decreases. We have recommended that IRS

promptly resolve differences between IRS and Treasury records of IRS' cash balances and adjust accounts accordingly, and promptly investigate and record suspense account items to

appropriate appropriation accounts. In fiscal year 1995, IRS hired a contractor to provide information on the differences between IRS and Treasury records through fiscal year 1995 and established a task force to resolve the differences the contractor identified. IRS found that documentation was no longer available to resolve prefiscal year 1993 differences, which resulted in $10 million of net positive cash reconciling differences being written off. IRS has not yet completed the research necessary to resolve fiscal year 1993, 1994, and 1995

differences. Further, additional research is required to resolve differences held in IRS' Suspense Accounts and Budget Clearing Accounts at Treasury.

To this end, IRS has developed plans to

complete its posting of adjustments to its appropriation accounts for fiscal year 1995 based on our review of these adjustments, and

engage a contractor to assist in completing its reconciliation of balances remaining in its Budget Clearing Accounts and Suspense Accounts.

IRS plans to complete the necessary adjustments to its records and Treasury's records prior to the closing of its books for fiscal year 1996.

In addition to completing this research, IRS must ensure that effective processes and procedures are in place to routinely reconcile its Fund Balance with Treasury accounts. In this regard, IRS has created a unit to manage the reconciliation of these accounts on an ongoing basis.

Overall, IRS' success in resolving the basic accounting and control issues involving its administrative operations will be indicative of its commitment and ability to resolve larger and more complex issues involving accounts receivable and revenue accounting.

Accounts Receivable Could Not Be Verified

We could not verify the validity of either the $113 billion of accounts receivable or the $46 billion of collectible accounts receivables that IRS reported on its fiscal year 1995 financial statements. In our audit of IRS' fiscal year 1992 financial statements, 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 was valid for financial reporting purposes and that only $19 billion of the valid receivables was collectible. At the time, IRS had reported that $66 billion of the $105 billion was collectible.

In our audit of IRS' fiscal year 1992 financial statements, we
recommended that IRS take steps to ensure the accuracy of the
balances reported in its financial statements by, in the long-
term,

identifying which assessments currently recorded in the
masterfile represent valid receivables, and

designating new assessments that should be included in the

receivables balance as they are recorded. We recommended also that, until these capabilities are implemented, IRS should rely on statistical sampling to determine what portion of its assessments represent valid receivables. Subsequently, we helped IRS develop a statistical sampling method that, if properly applied, would allow it to reliably estimate and report valid and collectible accounts receivable on its financial statements. We evaluated and tested IRS' use of the method as part of our succeeding financial audits and found that IRS made errors in carrying out the statistical sampling procedures, which rendered the sampling results unreliable. For the fiscal year 1995 audit, for the first time, IRS tried, also without success, to specifically identify its accounts receivable. Further, IRS' accounting and reporting for accounts receivable is hampered by the limitations of its financial management system. IRS' system is not designed to specifically identify and separately track from detailed taxpayer records those owing taxes reportable as accounts receivable. To mitigate this system's limitation in fiscal year 1995, IRS reported accounts receivable by using the uncollected assessment information from its computer system's master files, which were automatically sorted into either compliance assessments or financial receivables. In this way, IRS planned to identify the amount specifically related to financial receivables and report it as valid accounts receivable as of September 30, 1995. However, when we tested a sample of the automated sorting results, we found cases in which the financial management system's data were incorrect, and thus, did not properly segregate compliance assessments from financial receivables. We identified instances in which compliance assessments were classified as financial receivables, and thus, incorrectly included as accounts receivable; and other cases in which financial receivables were classified as compliance assessments, and thus, improperly excluded from accounts receivable. Based on the testing results, we concluded that the process IRS used in 1995 was unreliable for projecting the total inventory of outstanding assessments. Consequently, the accounts receivable reported on the fiscal year 1995 financial statements could not be relied on. IRS' plans call for improving accounts receivable reporting in the short term by

analyzing, by September 30, 1996, its inventory of uncollected assessments to determine ways to resolve issues

concerning the financial management system's underlying data limitations, and

reliably determining, by January 6, 1997, the estimated
amount of accounts receivable that is collectible.

Also, IRS needs to review and update current policies and procedures for maintaining documentation supporting accounts receivable, and where necessary, train employees to properly record detailed taxpayer transactions. Currently, IRS is reviewing its policies for retaining documentation supporting accounts receivable. In addition, IRS will be challenged to fully meet the federal accounting standards for accounting for accounts receivable, which become effective for fiscal year 1998. IRS will need to

design its financial management system to analyze all outstanding amounts to properly identify and report valid accounts receivable and the amount expected to be collected; track all activity affecting IRS' accounts receivable balance, including collections as a result of enforcement efforts, tax abatements, and aging of receivables; and provide dollar information about its compliance assessments.

Accounting for Revenue

Our audit of IRS' fiscal year 1995 financial statements found that

the amounts of total revenue (reported to be $1.4 trillion for fiscal year 1995) and tax refunds (reported to be $122 billion for fiscal year 1995) could not be verified or reconciled to accounting records maintained for individual taxpayers in the aggregate, and

the amounts reported for various types of taxes collected
(social security, income, and excise taxes, for example)
could not be substantiated.

Our financial audits have found that IRS' financial statement amounts for revenue, in total and by type of tax, were not derived from its revenue general ledger accounting system or its master files of detailed individual taxpayer records. The revenue accounting system does not contain detailed information by type of tax, such as individual income tax or corporate tax, and the master file cannot summarize the taxpayer information needed to support the amounts identified in the system. As a result, IRS relied without much success on alternative sources, such as

Treasury schedules, to obtain the summary total by type of tax needed for its financial statement presentation. To substantiate the Treasury figures, our audits attempted to reconcile IRS' master files--the only detailed records available of tax revenue collected--with Treasury records. For fiscal year 1994, for example, we found that IRS' reported total of $1.3 trillion for revenue collections taken from Treasury schedules was $10.4 billion more than what was recorded in IRS' master files. Because IRS was unable to satisfactorily explain, and we could not determine the reasons for this difference, the full magnitude of the discrepancy remains uncertain. In addition to the difference in total revenues collected, we also found large discrepancies between information in IRS' master files and the Treasury data used for the various types of taxes reported in IRS' financial statements. For fiscal year 1994, for example, some of the larger reported amounts in IRS' financial statement for which IRS had insufficient support were $615 billion in individual taxes collected--this amount was $10.8 billion more than what was recorded in IRS' master files; $433 billion in social security insurance taxes collected--this amount was $5 billion less than what was recorded in IRS' master files; and $148 billion in corporate income taxes--this amount was $6.6 billion more than what was recorded in IRS' master files. Thus, IRS did not know and we could not determine if the reported amounts were correct. These discrepancies also further reduce our confidence in the accuracy of the amount of total revenues collected.

Causes of IRS' Revenue Accounting Problem Contributing to these discrepancies is a fundamental problem in the way tax payments are reported to IRS. About 80 percent, or about $1.1 trillion, of total tax payments are made by businesses and typically include (1) taxes withheld from employees' checks for income taxes, (2) Federal Insurance Compensation Act (FICA) collections, and (3) the employer's matching share of FICA. IRS requires business taxpayers to make tax payments using federal tax deposit coupons.

The payment coupons identify the type of tax return to which they relate, such as a Form 941, Quarterly Wage and Tax Return, but do not specifically identify either the type of taxes being paid or the individuals whose tax withholdings are being paid. For example, a payment coupon indicating that a deposit relates to a Form 941 return can cover payments for employees' tax withholding, FICA taxes, and employers' FICA taxes. Because only the total dollars being deposited are indicated on the coupon, IRS knows that the entire amount relates to a Form 941 return but does not know how much of the deposit relates to the different kinds of taxes covered by that type of return.

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