Why Federal Agencies Fumble Audits

Since they're not penalized for poor bookkeeping, the Defense Department, NASA, and other agencies are unlikely to show much improvement, say gover...
Craig SchneiderJanuary 10, 2005

When it comes to improving the quality of financial reporting by federal government agencies, speed doesn’t seem to be of the essence.

To be sure, federal agencies reported their financials faster last year in order to comply with a new schedule put forth by the Office of Management and Budget. The OMB moved back the financial-statement reporting date to November 15, 2004, for the 10 major agencies and 14 cabinet-level departments governed by the Chief Financial Officers Act, which mandates that those governmental units try to imitate their private-sector counterparts in terms of financial management.

The new timeline, three months earlier than the one set for fiscal year 2003, was met by most of the agencies. Despite the swifter reporting, however, six of the agencies governed by the CFO Act failed to receive a clean audit opinion of their financials.

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Indeed, the OMB officials may have had error detection more than timeliness on their minds when they set up the new schedule. The purpose of faster reporting of audited financials is as much about identifying sooner which government agencies don’t have controls over their financial data as it is about getting the work done sooner, according to Greg Kutz, director of financial management and assurance at the Government Accountability Office.

Some agencies are known for “heroic” efforts to manipulate their books over the year so numbers “look good for a day, and not a day longer,” says Kutz, adding that now they “can’t spend six months massaging numbers or making adjustments.”

Still, five of the six agencies that failed to receive clean audits provided too little information for their independent auditors to render any kind of opinion at all. That group, which received “disclaimers” of opinion, consisted of the Department of Defense, the National Aeronautics and Space Administration, the Department of Homeland Security, the Department of Housing and Urban Development, and the Department of Justice.

Yet even though such disclaimers often signal “problems across the board” in terms of financial reporting, internal controls, and information systems, they aren’t likely to end soon, notes Kutz. That’s because there aren’t any penalties for government officials if an auditor denies an agency a clean opinion or the agency fails to provide accountability or transparency in its financial reporting. At most, an agency will become the target of what Kutz regards as an inconsequential congressional hearing.

In contrast, those at the helm in the private sector, where managers must answer to boards of directors and shareholders, would likely be fired “for much less” than the financial reporting problems of the Defense Department or NASA, says Kutz, who closely follows both agencies.

At the same time, the goal of a federal agency’s financials is not just a clean opinion. “It’s to have information to inform Congress, the president, and the public that taxpayers’ resources are being well spent, handled appropriately, and there’s transparency in the process,” adds Kutz. “If you can’t come up with the statements, what does that say about your accountability?”

But the needed internal cleanup of the agencies is easier said than done. There are “still a lot of growing pains,” he says.

Restatements Galore

One symptom of those aches is a growing tendency on the part of federal units to recast their financial reports. Last year, the increasing number of CFO Act agencies that restated financial statements for fiscal 2003 to correct errors was a trend that “merits concern and close scrutiny,” U.S. Comptroller General David Walker wrote in a December 14, 2004, letter addressed to President Bush and congressional leaders.

At least 10 of the CFO Act agencies restated in 2004, up from at least four such agencies a year earlier; at least two had restatements in both years. “Frequent restatements to correct errors can undermine public trust and confidence in both the entity and all responsible parties,” added Walker.

While he supports the idea of accelerated reporting, Walker noted that federal agencies “may risk incurring additional costs while sacrificing reliability” to get the job done faster.

More than struggling for speed, federal agency managers should continue working toward strengthening the “pervasive and general longstanding material weaknesses” that have been reported at the agency level for the past nine fiscal years, he wrote.

Rep. Todd Platts (R-Pa.), chairman of the House Government Reform Subcommittee on Government Efficiency and Financial Management, feels that department officials should be given a legislative push to do that job. “Congress must exercise oversight responsibility to ensure that these agencies [with material weaknesses] get back on track,” Platts recently stated.

One prime target of criticism has been the Defense Department. Consider the department’s admitted practice of entering material amounts of unsupported accounting entries. The agency’s inspector general, Joseph Schmitz, noted in a recent report that the department’s Indianapolis finance and accounting unit recorded $204.8 billion in unsupported accounting entries, or dollars that could not be accounted for. And that figure excludes more than $59 billion in unsupported adjustments to intra-governmental transactions.

Sometimes, reporting problems can stem from faulty or slow information-technology installation. NASA, for instance, is in the midst of a seven-year agencywide effort ending in 2009 to streamline its financial operations and management information systems.

NASA financial chief Gwendolyn Sykes says the agency’s goal is long-term. “While clean opinions might have resulted from maintaining the old systems and procedures,” she wrote in a response to NASA’s inspector general, Robert Cobb, keeping the status quo would have perpetuated the same systemic challenges. “This is an opportunity to create a solid foundation for the future,” she added.

In preparing and analyzing its 2004 financial statements, however, NASA’s management identified “conversion and data-integrity issues” and significant errors in balances reported on its financials, according to a report by Ernst & Young, the agency’s independent auditor. The errors included departures from generally accepted accounting principles. To the agency’s credit, NASA installed internal controls and beefed up its reporting policies and procedures in the last quarter of fiscal 2004, according to E&Y.

The Department of Defense, the largest U.S. government agency, also believes progress is being made; high-level support for its “Business Management Modernization Program” starts with Defense Secretary Donald Rumsfeld.

“We will get a clean audit in 2007,” said Linda Furiga, comptroller of the Defense Logistics Agency, who cited the success of those reform efforts during an interview with CFO last year. The agency is responsible for much of the Defense Department’s procurement, supplies, and distribution.

But Kutz isn’t holding his breath. “We don’t think the department has a credible plan right now,” he says, citing a lack of consistent leadership and accountability and the challenge of melding thousands of siloed financial-information systems among its divisions. Adds Kutz, “This isn’t going to happen just because of the passage of time.”

Craig Schneider writes frequently about regulatory matters. Contact him at [email protected].