David M. Walker: Transforming Federal Financial Reporting and Auditing
David M. Walker, former Comptroller General of the United States from 1998 to 2008 and a member of the Committee for a Responsible Federal Budget, wrote a commentary that appeared in Government Executive. It is reposted here.
Although The U.S. Constitution stipulated that “a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time,” it took more than 200 years to pass a law that was intended to vigorously meet that intent.
The Chief Financial Officers Act of 1990 represented a significant leap forward for federal financial management, reporting and auditing.
It authorized two new positions in the Office of Management and Budget – Deputy Director for Management and Controller – and also created Chief Financial Officer posts within major federal agencies.
It required annual accrual-based financial statements for certain federal funds and accounts and required that they be audited. Reporting requirements have been expanded over the years, and at last count some 151 different agencies and accounts were included in the consolidated financial statements of the U.S. Government. Today, most federal agencies issue their audited financial reports within 45 days of fiscal year end and the government’s consolidated financial report is targeted for issuance 30 days later.
Most of the departmental and agency financial statements are audited by their inspector generals (IGs) or an independent public accounting firm hired by the IG. The U.S. Government Accountability Office (GAO) currently audits the Internal Revenue Service, the Bureau of Public Debt, the Federal Deposit Insurance Corporation and the consolidated financial statements of the U.S. Government.
The Act also established a CFO Council chaired by the new Deputy Director for Management at OMB. To facilitate effective adoption of the Act, a new nine-member Federal Accounting Standards Advisory Board (FASAB) was established in 1990 and charged with proposing generally accepted accounting principles for the federal government.
Twenty one of the 24 CFO Act agencies achieved an unmodified opinion on their financial statements for fiscal 2014. To date, GAO has been unable to express an opinion on the consolidated financial statements, largely because the Defense Department hasn’t been able to pass an audit.
In annual reports, GAO notes numerous weaknesses in financial controls, and since 2003 it has also remarked that the U.S. government is on an unsustainable fiscal path that will ultimately require major spending and tax reforms.
Federal financial reporting has markedly improved since passage of the CFO Act. But it’s time to ask what kinds of new reforms make sense in the realm of financial reporting and auditing. Based on my experience as U.S. Comptroller General and in dealing with officials in government, the media, business, labor, the social sector and the general public, I believe that the following 10 transformational reforms should be seriously considered.
If adopted, they would result in more meaningful information and a much more cost-effective approach to federal auditing.
Financial and Performance Reporting
1. Federal financial statement reporting should focus on financial assets that have an expected and realizable economic value.
Current federal financial reporting excludes certain types real estate, capital and other assets owned and controlled by the federal government that have significant potential value. Specifically, “Heritage Assets,” such as The Capitol, the White House, the Washington Monument and national parks, are excluded, but the list needs to be expanded to include weapons systems and related military support inventory. The federal government has no intention of disposing of or realizing any meaningful economic value for these items. The costs associated with obtaining and retaining historical cost and related depreciation information for these assets exceed the benefits.
2. Federal financial statements should recognize additional liabilities and unfunded obligations: thus a new “Statement of Financial Assets, Liabilities and Obligations” would replace the current Balance Sheet.
In the Social Security and Medicare programs, the federal government spent “excess” payroll tax receipts on other government expenses, and replaced them with government bonds that are not readily marketable but are backed by the full faith and credit of the U.S. Government. The resulting obligations should be acknowledged and represented as a liability on the face of this new balance-sheet-style statement.
The new statement would include Assets, Liabilities and Unfunded Social Insurance Obligations. Government bonds held in various trust funds (e.g., Social Security, Medicare, Railroad Retirement and Black Lung), currently characterized as intra-governmental debt and disclosed in the footnotes to the financial statements, would be shown as a liability in this new financial statement.
The discounted present value of unfunded obligations relating to Social Security and Medicare should also be displayed under a new category of “Unfunded Obligations.” They should not be deemed a liability particularly because the Supreme Court has ruled that promised benefits are not protected by the Constitution and can be changed at any time and in any way the Congress deems appropriate.
3. There should be a new “Statement of Fiscal Sustainability and Intergenerational Equity.”
As CBO, GAO and others have noted, current fiscal policy is unsustainable. It also has serious intergenerational implications. So a separate statement is needed to show implied tax and spending levels in the longer term as a percentage and as a share of gross domestic product.
4. There should be a new ‘Statement of Key Performance Indicators.”
Current annual reporting focuses primarily on financial and activity-based information. Much greater attention needs to be placed on reporting outcome-based information based on key performance indicators of federal activities in such important categories as economic health, safety/security, energy/environment, transportation/infrastructure, education/training, health, housing, income security. This information could be hugely helpful in assessing the results achieved with the resources and authorities provided to the federal government.
5. There should be additional financial statement disclosures about major classes of military assets and supplies, major tax preferences/expenditures, budget categories, and key financial metrics.
Quantity and condition of military assets and supplies is much more meaningful than historical cost and accumulated depreciation information, and clearly passes a cost/benefit test.
Tax preferences/expenditures, including individual and business deductions, exemptions, credits and exclusions, aggregated to about $1.2 trillion in fiscal 2015--about $100 billion greater than total discretionary spending. They represent indirect spending and need to be subjected to additional transparency and accountability. As a result, all individual and corporate tax preferences that amount to 5 percent or greater of total tax preferences should be disclosed in the notes to the financial statements.
Reporting by major budget category component and/or programs acknowledges the reality that OMB and the Congress focus most of their management and oversight activities at these levels rather than at the consolidated Department level. Budgets are typically built from the bottom up rather than the top down. As a result, there should be additional disclosure of financial information by major component such as sub-department level agencies.
Most people have difficulty relating to numbers in the billions and trillions. As a result, given the size and scope of the U.S. Government, we should provide additional information for major revenue, expenditure and debt levels on a per-capita basis and as a percent of the economy, or GDP. This information can be compared with other major industrialized countries, such as those included in the Organization for Economic Development and Cooperation (OECD), providing a clearer picture of U.S. performance.
6. Financial statement audits below the Department-wide level should not be required, including in the Defense Department.
The hard truth is very few people take the time to read the consolidated financial statements of the federal government much less the financial statements of major departments and agencies. Sub-departmental or segment financial statement audits can be costly and are of little use to the public. As a result, they should be eliminated as a requirement.
7. GAO should assume responsibility for auditing the Defense Department.
DoD is the largest and most complex entity in the federal government. It is also the largest single obstacle to GAO’s ability to express an opinion on the consolidated financial statements of the U.S. Government. GAO should assume the principal auditor role and use the IG and independent public audit firms (IPAs) as it deems appropriate. DoD should assume the full cost of the audit.
8. After all major departments and agencies have achieved unqualified opinions on their financial statements, the annual financial statement audit requirement should only apply for the consolidated financial statements of the U.S. Government and federal entities that are intended to be self-supporting (e.g., Federal Reserve, Social Security, Medicare, Federal Deposit Insurance Corporation, Pension Benefit Guaranty Corporation, U.S. Postal Service, Securities and Exchange Commission).
Savings from eliminating other audits could be applied to improving internal controls, information systems, cost accounting and performance management activities in the federal government.
9. GAO should continue to perform the audit of the Consolidated Financial Statements of the U.S. Government.
GAO remains best positioned to perform the audit of the consolidated financial statements of the U.S. Government, and it should be able to use the Inspectors General and select IPAs as needed. To the extent that auditing is needed for departments or agencies, they should pay the costs.
10. Audit report language should be revised to reduce expectation gaps, require an expression of opinion on internal controls over financial and performance reporting, and encourage appropriate use of “emphasis paragraphs.”
Too many people still believe that an unmodified opinion on an entity’s financial statements means that it is operating in an economical, efficient and effective manner, and in compliance with all major laws and regulations. Such is not the case--and the auditor’s report should make that clear. And external auditors for federal government entities should be required to express an opinion on the quality of internal controls over both financial reporting, as is required by federal law with audits of public companies, and performance reporting. They should also be encouraged to use “emphasis paragraphs,” as appropriate.
"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the Committee.