Accounts Receivable

Another area that has caused concern is converting our inventory of

assessments to an accounting definition for accounts receivable. Like businesses, the IRS has accounts receivable. Unlike private businesses, however, our customers are not purchasing products, and their credit-worthiness is not determined prior to a transaction. In short, we do not choose our customers. Furthermore, the law

prescribes how long we must keep accounts receivable on the books -- 10 years. Thus, unlike private sector businesses, the IRS' accounts receivable cannot be written off for 10 years even when we know that they are not collectible.

It is also very important to realize that we start with an inventory of accounts, not

a true accounts receivable like a business that sells a product or service. Let me explain what makes up the total amount of the inventory. When taxpayers either do not file returns or file inaccurate returns, we make assessments based on the tax laws irrespective of collection potential. We record these unpaid assessments and keep them on our books for as long as they are legally collectible. While we attempt to collect these debts, some accounts are obviously uncollectible for various reasons for example, the taxpayer has died or is insolvent. In other words, we know at the outset that some of these assessments will not be collected. But beyond unpaid taxes, our gross accounts receivable also include the ever-increasing interest and penalties related to those unpaid taxes.

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To overcome this problem for financial reporting purposes, the GAO and IRS have agreed to a common definition of financial receivables. Starting with the FY1995

statements, we classified amounts as financial receivables (the amounts that taxpayers have agreed to pay or courts have set, and we believe are collectible), financial writeoffs (financial receivables that have subsequently been determined to have no further collection potential), and compliance assessments (those amounts that taxpayers have not agreed to or on which the courts have not acted).

We will continue to make changes to the present inventory system to meet our financial reporting requirements. This involves correcting some deficiencies in the present systemic process, requesting some additional Master file reports, and continuing to evaluate and analyze the procedures and policies for how the data is entered into our current systems. We believe these steps will provide us the best means of defining and reporting on our accounts receivable in accordance with applicable accounting standards, at least in the near term.

Progress Toward Correcting the Five Major Problems Cited by GAO

Although I have briefly described what we are doing to address the five major issues cited by GAO, let me summarize what we are doing on each issue.

1.

The amounts of total revenue and tax refunds cannot be verified or

reconciled to accounting records maintained for individual taxpayers.
We have devised a new approach to provide GAO with detailed revenue and
refund data. Instead of starting with summary amounts in the Revenue
Accounting and Control System (RACS), the Service's Master File records were
used as the basis to support revenue receipts and refunds reported on our

financial statements. Our revenue system was then reconciled to the Master File

2.

3.

records. To support our financial statement information for the FY 1996 audit, with concurrence of the GAO, we have pulled interim (six month) detailed

transactions from the Master File and are reconciling it to RACS. I believe that

GAO will verify our extract process and begin their testing for 1996 much earlier
than in prior years.

Amounts reported for various types of taxes collected (social security,
income, and excise tax, for example) cannot be substantiated.

In preparing our FY1995 financial statements, we made great progress in
developing methods to substantiate the revenue collected. For Social Security,
we developed an extract that enables us to report and match assessment and
collection information. As stated earlier, we are also using the Master File to
provide all detailed transactions to support income tax collected. Finally, for
excise taxes, we will continue to perform analysis of monies assessed and
collected to determine if there are significant differences. Additionally, to prepare
for the FY 1997 statements, we are developing programming that will enable us

to have detailed assessment and collection information as we do with Social

Security.

The reliability of reported estimates for $113 billion in accounts receivable

and $46 billion for collectible receivables cannot be determined.
During the prior audit, initial testing by GAO resulted in its conclusion that the
Service's systemic program that classified receivables as compliance

assessments, financial receivables, and financial write-offs was, in fact, flawed,

4.

thus putting our entire reported accounts receivable portfolio amount in question. The GAO curtailed its audit at that point prior to reviewing any detailed source documentation for the selected cases. Based on its review of cases this year to determine the validity of our categorizations, GAO has indicated that the systemic process is more accurately segmenting our portfolio of receivables. Their next step, scheduled for October-November of this year, is to review the supporting source documentation for the selected cases to verify they are

accurate.

A significant portion of IRS' reported $3 billion in nonpayroll operating
expenses cannot be verified.

This is a receipt and acceptance issue related to goods and services received
from other federal agencies paid via the government's Online Payment and
Collection (OPAC) system. The basic question is: "Did we get what we paid
for?" The bulk of these payments are made to the Government Printing Office
(GPO) for tax and other publications, and to the General Services Administration
(GSA) for rent and other reimbursable services. We have been working closely
with GAO to define the problem areas and to propose interim and long-term
solutions to the receipt and acceptance issues. We are also working with the
program areas in IRS--e.g., Publishing Services and Real Estate--on the
development of new procedures for receipt and acceptance and with the other
agencies themselves to resolve ongoing OPAC payment issues. Additionally,

we are working with our procurement office on the development of new

procedures for interagency agreements to ensure that all other interagency

payments will be accounted for properly and timely.

5. Amounts reported as appropriations available for expenditure for

operations cannot be reconciled fully with Treasury's central accounting

records.

To address this issue and ensure that future cash balances would be reconciled timely, we instituted an automated cash reconciliation program, with contractor assistance, during FY1995. This program included all of the Service's operational appropriations. Adjustments to cash balances were identified and will be posted to correct the FY1995 balances. The adjustments are currently being reviewed by GAO for appropriateness and accuracy. During FY1996, we completed the cash reconciliation process by reconciling with Treasury the remaining cash balances, which consisted of Budget Clearing Accounts and Suspense Accounts. Required adjustments are being identified and will be recorded to the accounts prior to closing the books for FY1996.

Status of the 59 recommendations

The GAO has made 59 supporting recommendations through its financial statement audits for the last four fiscal years. Of the 59 recommendations, the IRS and GAO agree that we have implemented and thus closed 17 of them. Of the remaining 42, the IRS believes that we have met the requirements to close 22. Before we actually close these, we will work with GAO to get agreement. Of the remaining 20, 11 are scheduled to be completed by January 1, 1997; five by September 30, 1997; and the