In planning and performing our audit, we considered the internal control over financial reporting and compliance at the Agencies comprising HTF. We did this to determine our procedures for auditing the financial statements and to comply with OMB audit guidance, not to express an opinion on internal control. Accordingly, we do not express an opinion on internal control over financial reporting and compliance.

The objectives of an effective internal control system are the following:

• Financial Reporting: Transactions are properly recorded, processed, and summarized to permit the preparation of financial statements and stewardship information in conformity with generally accepted accounting principles, and assets are safeguarded against loss from unauthorized acquisition, use, or disposition.
• Compliance With Laws and Regulations: Transactions are executed in accordance with laws governing the use of budget authority and with other laws and regulations that could have a direct and material effect on the financial statements and any other laws, regulations, and government-wide policies identified by OMB audit guidance.
• Reliability of Performance Reporting: Transactions and other data that support reported performance measures are properly recorded, processed, and summarized to permit the preparation of performance information in accordance with criteria stated by management.

Our consideration of the internal control over financial reporting would not necessarily disclose all matters in the internal control over financial reporting that might be reportable conditions. Under standards issued by the American Institute of Certified Public Accountants, reportable conditions are matters coming to our attention relating to significant deficiencies in the design or operation of the internal control that, in our judgment, could adversely affect HTF Agencies' ability to record, process, summarize, and report financial data consistent with the assertions by management in the financial statements. Material weaknesses are reportable conditions in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements caused by error or fraud in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their duties. Because of inherent limitations in internal controls, misstatements, losses, or noncompliance may nevertheless occur and not be detected.

The following sections detail the continuing weaknesses noted during the audit involving the internal control and its operation that we consider to be reportable conditions or material weaknesses. Such matters are summarized as follows:

Material Weaknesses

• Financial Accounting Processes Do Not Fully Support Financial Management or Facilitate The Timely Preparation of Accurate Financial Statements;
• Reconciliation Procedures;
• Grants Financial Management Oversight; and
• Information Technology Control Weaknesses.

Other Reportable Condition

• Federal Lands Highway Program Transaction Processing and Reconciliations.

 

MATERIAL WEAKNESSES

Background

As noted on page 1 of this report, the HTF financial statements are comprised of certain accounts of several operating divisions of the U.S. Department of Transportation (DOT). The Federal Highway Administration (FHWA) comprises over ninety-five percent of the costs reflected in the HTF financial statements. In addition to its own responsibilities for financial statement preparation and analysis, FHWA is also responsible for preparing the consolidated financial statements of HTF. The overall accounting system, Delphi, is maintained and operated by another DOT operating administration not included in the HTF financial statements. Even though the examples given in this report mostly relate to FHWA, many of the issues affect the other HTF Agencies as well.

Our report on the audit of the financial statements of HTF for FY 2003, dated January 13, 2004, noted material deficiencies in basic internal control policies and procedures. These deficiencies, along with the difficulties management experienced converting to a new accounting system for its largest Agency (FHWA) in FY 2003, resulted in significant delays in producing accurate financial statements at September 30, 2003. Accordingly, the audit of the financial statements of HTF for FY 2003 was not completed until late January 2004. Our FY 2003 report noted Material Weaknesses in Financial Statement Preparation and Analysis, Reconciliation Procedures, Conversion To New Accounting System, and Computer Security.

After the FY 2003 audit was complete, management immediately began implementing changes in accounting policies and procedures to correct these weaknesses going forward. Management also needed to “cleanup” the errors that occurred during the first several months of FY 2004 while most accounting resources were focused on completing the FY 2003 audit. The difficulty of completing this task was compounded by the mandate from OMB to complete the FY 2004 audit by November 15, 2004, only nine months after the FY 2003 audit was completed. Management allocated resources (internally and through use of contractors) to address these issues and implement appropriate changes in its accounting policies and procedures. Such policies and procedures needed to be designed and implemented to ensure that current transactions were accounted for properly.

The changes management implemented assisted them in correcting some of the deficiencies reported in prior years. These changes allowed them to prepare financial statements more timely than during the FY 2003 audit. Some of the more significant improvements are described below:

• Reconciling key accounts monthly, specifically FBWT, Grants and Reimbursable Agreements. However reconciling items were not resolved in a timely manner;
• Performing accounting analysis as part of the monthly financial statements preparation process;
• Promptly clearing activity in suspense accounts, including old outstanding items;
• Automating certain aspects of the financial statement preparation process that reduced the extent of manual processes used in prior years; and
• Recruiting more qualified/experienced personnel to perform a variety of accounting functions.

However, due to the time restrictions and magnitude of changes needed, the improvements were not adequate to correct the internal control problems existing at September 30, 2003. As a result, even though management was able to prepare the HTF financial statements at September 30, 2004 much earlier than in prior years, significant errors and omissions were noted and not resolved until several weeks after the financial statements were provided for audit. The resolution of many of these discrepancies resulted in material adjustments to amounts reflected in the HTF financial statements and note disclosures.

As noted in Appendix A, Management Response to Auditor's Report, DOT Agencies plan to continue implementing improvements in their systems and processes during FY 2005.

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1. Financial Accounting Processes Do Not Fully Support Financial Management or Facilitate The Timely Preparation of Accurate Financial Statements
   

   Condition: In our FY 2003 report, we noted the following specific deficiencies in “Financial Statement Preparation and Analysis:”

   1. Financial Statements Preparation Process is Manually Intensive
   2. Accounting Records Were Not Corrected Until the End of the Year
   3. Material Adjustments Were Required To The Statements of Budgetary Resources(SBR)
   4. Lack of Understanding and Analysis By Agencies of Amounts Reflected in TheirFinancial Statements
   5. Financial Statements Were Not Initially Prepared in Accordance with OMB BulletinNo. 01-09
   6. System is Not in Place to Properly Track Intragovernmental Transaction

   Some procedural improvements have been made (i.e. monthly reconciliations and financial analysis procedures) to address the several recommendations detailed in our FY 2003 report. However, the improvements have not been sufficient, or in certain cases in effect long enough, to overcome the problems that existed nine months ago to meet the accelerated reporting deadlines imposed by OMB. Extraordinary efforts to “cleanup” the accounting records for the audit of the financial statements were needed at September 30, 2004.

   The rest of this section of the report, provides a status of the specific deficiencies noted in our prior year report along with examples of the effect that continued internal control deficiencies has had on the financial statements provided for audit at September 30, 2004. The accounting and reporting concepts of all the matters identified in our FY 2003 report continue to contribute to a material weakness in financial reporting in FY 2004.

   1. Financial Statements Preparation Process Is Manually Intensive

      For the first three quarters of FY 2004, the same process was used by management to produce its financial statements. A new financial statement preparation process was used at September 30, 2004 that better integrates the data from Delphi into the financial statements. However this new process is not yet capable of producing the Statement of Budgetary Resources or the Statement of Financing. These statements were still prepared manually from reports generated by Delphi.

   2. Accounting Records Were Not Corrected Until The End Of The Year

      This situation continued to be a major problem in FY 2004. By the time the FY 2003 audit was complete, and management's attention could be redirected to correcting the deficiencies noted during the audit, four months had passed. During that time, transactions continued to be processed in error and differences between subsidiary records and data in Delphi were not investigated.

      This situation continued for several more months as management attempted to implement new procedures to prevent transactions from being entered initially into the system in error. Due to the lack of reliability of the data in Delphi, and FHWA not being caught up with account reconciliations, the consolidated financial statements of HTF at March 31, 2004 were deemed unreliable.

      Management was able to produce consolidated financial statements at June 30, 2004; however, it was only after extensive adjustments were made to the accounting records throughout the first three quarters of FY 2004. The absolute value (sum of debits) of these adjustments was approximately $135 billion through June 30, 2004.

      Prior to preparing the consolidated financial statements at September 30, 2004, an additional $195 billion was needed in the last quarter to further adjust amounts reflected in the general ledger. This brought the total adjustments for the year up to $330 billion. The volume and amount of these adjustments suggest that the system is not working properly to accurately capture all transactions.

      Even though some of these adjustments are considered “normal cleanup” entries, many were a result of manually intensive analysis and reconciliation procedures needed to correct longstanding problems identified in the FY 2003 that carried over into FY 2004. We commend management for its efforts in identifying these errors in its general ledger; however, the volume and type of adjustments made were excessive. This situation indicates that significant manual effort was needed to “get the numbers” right before the data was good enough to conclude that there is relatively low risk that further misstatements would be material in relation to the financial statements being submitted for audit. The time required to do all of this “cleanup” delayed management in getting its financial statements ready for audit. It also hindered management in adequately reviewing the results reflected in such statements in a timely manner.

      HTF Agencies continued to have significant difficulty in providing complete and accurate documentation to support certain transactions processed by its accounting system in a timely manner (i.e. a time frame conducive to meeting the new OMB reporting directives). In addition, HTF Agencies were, at times, unable to provide adequate explanations for certain amounts reported in their financial statements (both at June 30 and September 30) in a timely manner.

   3. Material Adjustments Were Required To The Statements Of Budgetary Resources (SBR)

      In FY 2003 material adjustments were made to the FY 2003 SBR. The specific error identified in our FY 2003 audit did not occur in FY 2004. However, a different type of error was noted in the SBR at September 30, 2004 relating to a misinterpretation by management of information being reported by the Bureau of Public Debt (BPD) involving un-invested tax collection/receipts unavailable for obligation. The error resulted in both the “Total Budgetary Resources” and the “Total Status of Budgetary Resources” being reduced by $16 billion for the year ended September 30, 2004.

      In addition, four weeks after the end of the year, FHWA adjusted a variety of budgetary account balances at September 30, 2004. The adjustments had an absolute value of $10 billion.

   4. Lack Of Understanding and Analysis By Agencies of Amounts Reflected In Their Financial Statements Could Result In Errors In Financial Statements

      During the FY 2003 audit we noted that management did little financial analysis of the amounts reflected in its financial statements, and there was limited oversight by DOT management of the financial statements prepared by the individual agencies.

      Prior to the commencement of the FY 2004 audit, Agency management did not have a system in place to adequately analyze its financial statements at the quarter end or at year-end. We provided management with potential formats, along with evaluation criteria, to consider in performing their research/analysis. In certain cases, the initial analyses performed at June 30 and again at September 30 by management were inaccurate. Based on the extent of errors noted in the financials statements provided for audit, it appeared that the financial statements were not reviewed thoroughly by someone other than the preparer.

      After several attempts, FHWA was unable to produce a reasonable analysis of its program costs for the year ended September 30, 2004. One of FHWA's attempts at explaining fluctuations in its Net Cost note disclosure resulted in a conclusion that costs needed to be increased by over $2 billion. This conclusion was erroneous and indicated a lack of understanding of basic accounting principles. In another attempt, FHWA proposed to change individual program line items aggregating to an absolute value of $8 billion. After further review, management later concluded that total costs were accurate as originally stated. However, FHWA management still changed individual program lines, and such changes had an absolute value of $5 billion compared to that originally reflected in its financial statements.

   5. Financial Statements Were Not Initially Prepared In Accordance With OMB Bulletin No. 01-09

      Improvement was noted since last year's audit. However, the review of HTF and related Agencies' stand-alone financial statements and fluctuation analyses did not appear to be effective in ensuring the accuracy of amounts reflected in the financial statements and related note disclosures. As a result of the audit of the consolidated financial statements of HTF at September 30, 2004, several corrections were needed. Some of the more significant corrections are noted below:

      • Four weeks after the end of the year, FHWA proposed over 40 adjustments to its financial statements adjusting a variety of accounts as follows:
        • entries to increase in costs by approximately $760 million;
        • adjustments for recipient allocation related accounts. The absolute value of the adjustments was approximately $3 billion. Such adjustments were necessary because FHWA did not periodically reconcile recipient accounts during the year and at year-end, prior to preparing the financial statements. In addition, several entries were recorded in error because of a lack of understanding of parent/recipient accounting, and the absence of a reconciliation of the non-expenditure transfers that took place during FY04. After obtaining the account balances from the recipient entities, FHWA did not perform an analysis to ensure that amounts reported by the recipients were correct, and that amounts included in its financial statements were reasonable;
        • adjustment to reduce intragovernmental Accounts Payable by over $500 million; and
        • adjustment to Transfers in the Statement of Net Position by $ 2.1 billion.
      • Appropriate estimates of amounts that would be reported by third parties (i.e. BPD) to FHWA after the end of the year were not reflected in the financial statements. For example, Fund Balance With Treasury was increased by $2.3 billion relating to the two-week time lag for BPD to process the excise tax collections and allocations for the general fund.
      • A $1 billion adjustment was needed relating to a transfer made to the HTF because of the passage of a new law effective for FY 04. This matter was communicated to FHWA by BPD on October 3, 2004, prior to the submission of its financial statements for audit.
      • Certain other information in the financial statements provided was incomplete or clearly inaccurate (i.e. note disclosure information, required supplementary information, and other accompanying information) in the financial statements provided for audit.
      • The Department of Treasury (Treasury) provides DOT with an estimate of tax collections for each quarter. Such estimate is recorded in the general ledger; however, such estimate is adjusted when actual receipts data is reported by Treasury (six months later). During FY 2004, the Treasury estimates were overstated by approximately $1 billion through June 30, 2004. This situation raised a concern that the estimate provided for the quarter ended September 30, 2004 may also be overstated. FHWA Management did not attempt to quantify this potential error to determine the need for an adjustment to their financial statements.
      • Since HTF Agencies did not have a cost accounting system in place to properly allocate costs to their programs, management was unable to produce a Statement of Net Cost in compliance with OMB requirements. OMB Bulletin No. 01-09 requires the reporting entity to report the full cost of each program output, which should consist of both direct and indirect costs, including the cost of identifiable supporting services. Management did not adequately identify programs for disclosure in its financial statements. The line items detailed in Note 10 (“Net Program Cost”) to the financial statements were not consistent with OMB's definition of a program, “a specific activity or project as listed in the program and financing schedules of the annual budget of the U.S. Government.” In addition, without a cost accounting system, HTF Agencies do not appear to have sufficient information to identify and eliminate wasteful spending, hold or reduce operating costs, or better evaluate the effectiveness of programs.
         
   6. System Is Not In Place To Properly Track Intragovernmental Transactions

      Management has made some progress in this area, but more is needed. Agencies are responsible for accumulating intra-DOT, intra-HTF and intergovernmental activity during the year and providing such trading partner information to DOT and to Treasury (which is responsible for government-wide financial statements). Reconciliations for eliminations were not performed consistently by all Agencies throughout FY 2004. The Agencies were unable to confirm the accuracy of the information disclosed in the“Trading Partner” schedule included with the HTF financial statements. After several attempts, the HTF Trading Partner schedule was finalized four weeks after the end of the year. Significant changes were made to amounts initially provided for audit.

   7. Other Matters – Facts II Preparation Process Needs To Be Linked To Financial Statement Preparation Process - The U.S. Treasury requires that cash and budgetary information be reported via the FACTS II system on a quarterly basis. The report should be prepared using the same trial balance data that is used in preparing the basic financial statements. In reviewing amounts reflected in certain Agencies' (FHWA, FMCSA, FTA and NHTSA) fiscal 2004 FACTS II transmission, we noted differences with amounts reflected in its September 30, 2004 trial balance of accounts (used to prepare its financial statements). Such differences related to FBWT and certain budgetary accounts on the FACTS II submission, with an aggregate absolute value of approximately $50 billion (net of $276 million). HTF Agencies do not have a process in place to ensure the erroneous accounts were reviewed and corrected prior to the financial statements being prepared.

   Condition Summary: The level of effort and the amount of manual intervention needed by management to “get the numbers right” has been extraordinary again this year. We applaud management's effort in its attempts to achieve an unqualified opinion. However, the level of manual intervention needed to “cleanup” their accounting records and “get the numbers right” inherently confirms that the Material Weakness criteria, “…the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur”, is met in this circumstance. In addition, the level of effort noted above also inherently confirms that the efforts by DOT employees and contractors are not considered to be in “the normal course of performing their duties.”

   The basic systems (both electronic and user based) currently in place are not adequate to effectively produce reliable financial statements in a timely manner. Timely is defined by the need to submit reliable quarterly financial statements to OMB within 45 days after quarter end, and for DOT to be able to obtain an audit of its financial statements by November 15th without expending extraordinary efforts to “cleanup” the data used in preparing and auditing such financial statements.

   Given the volume of adjustments made to the basic accounting records during the year and during the audit at September 30, 2004, the accuracy of financial statements submitted to OMB during the year is uncertain. The situation noted during the FY 2004 audit clearly indicates that the current internal control structure does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected promptly by employees in the normal course of performing their duties. Currently it appears that extraordinary efforts are needed to compensate for these weaknesses.

   Finally, we noted that management relied too heavily on certain amounts provided to them by third parties (i.e. BPD, OPM, etc.) and accepted the amounts from these third parties without questioning the impact such amounts had on its financial statements. Management is responsible for the fair presentation of the amounts reported in its financial statements. Regardless of the source of the data used by management to prepare its financial statements, it is ultimately the responsibility of management to identify and correct errors.

   Recommendations: Accounting and financial reporting practices of all agencies must be improved to assist DOT in complying with the OMB reporting requirements for FY 2005 and beyond. We hereby provide the following recommendations for HTF Agencies and DOT management:

   1. The remaining manual aspects of the financial statement preparation process (i.e. Statement of Budgetary Resources or Statement of Financing) should be automated. The adequacy of the resources assigned to the financial statement preparation and analysis process should be evaluated. All financial statement preparation processes should be consolidated within one accounting department at DOT, relieving the Agencies of the physical preparation process, and focusing their efforts on financial statement analysis. Personnel responsible for the preparation and analysis of the financial statements should be adequately trained in basic accounting principles and federal financial reporting requirements.
   2. The reasons for the manual “cleanup” needed to the accounting records for FY 2004 transactions reflected in Delphi should be evaluated. DOT management must determine if systemic processing and report generation problems are preventing the Agencies from utilizing Delphi to its fullest capability. Policies and procedures should be developed, in coordination with DOT management, to ensure that the Delphi system is used correctly so that data is posted accurately at the initiation of a transaction. Reassess controls over the processing of transactions to ensure that only valid transactions are recorded in the general ledger accounts.
   3. Additional training should be provided for all Agency personnel involved in processing accounting transactions in Delphi, as well as in accessing reports relevant to their evaluation of the reasonableness of amounts reflected in the financial statements.
   4. Management must critically review all amounts reflected in the HTF financial statements, including those provided by third parties. They must develop methodologies to determine the reasonableness of such third party amounts, and estimate balances that third parties cannot provide prior to the preparation of the HTF financial statements, as necessary.
   5. Financial analysis techniques must be refined to ensure comparison from month to month and year-to-year for the actual amounts. A comparison of actual and budgeted amounts, and actual and management expectations, should also be performed. This should help management identify and follow up on anomalies and emerging trends in reported balances. Some of the analysis (i.e. Statement of Net Cost by Program) should be performed in conjunction with the Division/Regional offices' input. In such cases, information should be available at the Division/Regional level to facilitate the field offices' analyses.
   6. Consistent methods should be established to accumulate “Trading Partner” information for inclusion in the financial statements. Procedures should be developed to properly classify transactions as Governmental or Non-governmental when they are initially recorded in the accounting system. These new methods could avoid the time consuming task of making manual adjustments during the financial statement preparation process.
   7. Policies and procedures should be established to fully and consistently implement Managerial Cost Accounting in accordance with the Statement on Federal Financial Accounting Standards No. 4. The results of such policies and procedures will assist management in complying with the requirements of the Presidential Management Agenda relating to linking allocated resources used by program objectives to actual program results.

       

2. Reconciliation Procedures
   

   Condition: In our FY 2003 report we noted that reconciliations had not been performed during the year, and when reconciliations were ultimately completed at September 30, 2003 they still contained significant differences that resulted in adjustments. It was also noted that Fund Balance With Treasury (FBWT) and Grants reconciliations were particularly troublesome.

   Substantial improvements were made in this area, and many reconciliations were being done in FY 2004. Reconciling items were being researched, and the general ledger accounts were not being arbitrarily adjusted. However, we noted that account reconciliations were not performed consistently during the year, and research and resolution of the differences were not performed timely. Accordingly, such improvements have not been sufficient to overcome the problems that existed for a number of years and were reported in the FY 2003 audit report issued nine months ago.

   Even though most accounts were ultimately reconciled and the general ledger adjusted as of September 30, 2004, many were completed several months after the month-end. Even when the reconciliations were complete, the process used to determine the cause of the differences was not always adequately documented. In addition, research and resolution of the differences was not performed timely to ensure the correct data was included in Delphi's general ledger. FBWT and Grants accounts were particularly troublesome and, accordingly, further details are provided below:

   1. FBWT Reconciliations - We noted the following deficiencies:
      • Child allocation accounts were erroneously excluded from the general ledger during FY 2004 and were not properly identified as reconciling items. Adjustments with an absolute value of $1.1 billion were needed to correct this problem.
      • Agencies are not promptly reconciling unmatched transactions identified on the Treasury Statement of Differences for deposits and disbursements. At September 30, the absolute value of deposit and disbursement differences was $186 million. Of that amount, nearly $60 million had been outstanding for more than 90 days.
      • Payroll differences ($ 32 million) between the general ledger and the amount paid by Treasury were not adjusted in the general ledger in a timely manner. Some differences have remained for over nine months.
      • Erroneous adjustments ($ 58 million) were made to FBWT in an attempt to reclassify adverse balances without adequate research.
      • Non-224 entries were used in error.
      • SF 224 data was not properly reviewed prior to its submission to Treasury.
      • A Supplemental 224 submitted to Treasury was not recorded in the general ledger.
        
   2. Grant Reconciliations - Although daily and monthly reconciliations were prepared, we continued to note material differences between the subsidiary ledger and amounts reported in Delphi at month end throughout the year. Many of the differences related to periods prior to the system conversion in FY 2003. Due to the lack of reconciliation in past years, FHWA is having difficulty in clearing up these differences.

      Grant account reconciliations at September 30, 2004 still contained significant differences that resulted in material adjustments. These adjustments could only be done at the summary level since the details for certain of these transactions were not available. The differences noted at September 30, 2004 were most significant at FHWA, and are summarized as follows:

      Grant Account Reconciliation Differences for FHWA at September 30, 2004

      OA	ABS1 (Net) Difference FMIS and PO Module	ABS 1 (Net) Difference FMIS and GL Module	ABS 1 (Net) Difference PO and GL
      FHWA	$ 675 million ($181 million)	$ 1.3 billion ($237 million)	$ 679 million ($56 million)
      Notes: (1) Absolute value represents the sum of all differences between the amount in the general ledger and that reflected in the subsidiary ledger.(Back to text)

      Even though the differences were not as significant as those noted at FHWA, FTA and other Highway Trust Agencies also had differences between its subsidiary ledgers and amounts reported in Delphi.

   3. Accounting For Federal Lands Transactions and Related Reconciliations – FHWA has a program titled Federal Lands Highway Program (Fed Lands) whose mission is to plan design, construct and rehabilitate roads and bridges providing access to, through and within Federal and Indian lands. FY 2004 funding for Fed Lands was approximately $700 million.

      FHWA management has not reconciled assets, liabilities, obligations, expenditures and available funds at the project level throughout the year or at year-end. Based on our testing of transactions during the year, we noted significant differences between amounts supported by source documentation and that reflected in Delphi. Since reconciliations between the data in the project module and Delphi had not been performed, management was unable to readily determine the reason for differences. In response to these results, management performed extensive research to determine that the amount in Delphi at September 30, 2004 was reasonably stated in total. The research included an analysis of funds activity during the year, sample validation of project amounts reported in Delphi, fluctuation analysis of program cost, and analysis of the accrual for Federal Lands at September 30, 2004.

   4. Suspense Account – Suspense accounts are routinely used to record transactions for which the proper accounting was not readily determinable. Many transactions in these accounts remained unresolved for several months, and in certain cases over several years. Consequently, suspense account balances were not adequately cleared out and recorded in the proper accounts on a timely basis throughout the year.

      Even though the net balances in the suspense accounts were not material, the absolute value of the composition (i.e. debits and credits) of the net balances was significant. Only after extensive research was it determined that the items in the suspense account did not have a material impact on the financial statements at June 30 or September 30. At September 30, 2004, the absolute value (ABS) of balances in suspense accounts of HTF agencies was $2.8 billion ($647 million after elimination offsets).

      In addition, there was improper reporting of suspense accounts in several financial statement line items by FHWA, and improper classification of transactions between HTF and non-HTF accounts by NHTSA.

   5. Subsidiary Reports - Certain financial statement line items lacked subsidiary reports to facilitate management's performance of monthly reconciliations throughout the year and at September 30, as follows:
      • Federal Lands open projects obligations and disbursements;
      • Federal Lands advances to and from other agencies;
      • Eliminations trading partner reports at the trading partner and agreement level;
      • Allotment status report for all active allotments; and
      • Suspense Account Aging Report.

      Even though a suspense aging report was available, it included historic activities that were not relevant to current outstanding items. This made reconciliation of the suspense accounts cumbersome and needlessly time consuming. While this was noted during the interim phase of the audit, the historic items were not purged prior to yearend, again making the reconciliation process cumbersome and needlessly time consuming.

      Due to continued reconciliation problems noted during the FY 2004 audit, we believe that the implementation of new reconciliation procedures has not been as effective as necessary to support the preparation of accurate financial statements in a time frame conducive to meeting the accelerated reporting deadlines.

   Recommendations:

   1. Implement procedures to ensure periodic reconciliations for all major financial balances and maintain supporting documentation for reconciling items that explain management's understanding of the composition and fluctuation of the accounts. Refine the financial management process by routinely reviewing the Agency's subsidiary accounts to ensure that subsidiary details and the general ledger are analyzed as an ongoing part of financial management. Differences identified should be researched and resolved in a timely manner. More specifically we recommend that management implement the following actions:
      1. Continue to implement policies and procedures included in the Treasury Financial Manual (TFM) and those recommended by GAO relating to FBWT, including Suspense Accounts. Such procedures should include the complete and timely reconciliations of FBWT on a monthly basis, resolving differences between the Agency FBWT balances with those reported by the Treasury in a timely manner, and making adjustments to the general ledger balance after thorough research has been performed and supporting documentation is reviewed by supervisory personnel. Additional discipline, oversight and coordination are needed between the Agency and DOT's Cash Operation division in Oklahoma City in posting transactions during the year and reconciling accounts at month and year-end.
      2. Resolve grant related differences identified in the reconciliation process that relate to prior years.
      3. Use the suspense account sparingly, and clear out transactions within thirty days of entry into the account. Suspense account activity should be monitored throughout the year including maintaining records of resolved items and aging of outstanding amounts reflected in the account. In addition, in accordance with the SGL, suspense amounts should only be reported in SGL account numbers 1010 and 2400.
   2. In coordination with DOT management, relevant Agencies must develop accurate subsidiary detail of the account balances for Federal Lands Highway Program, allotment status, and eliminations at the transaction/project level to facilitate their reconciliation to the general ledger.
   3. Develop written procedures for Federal Lands to assist staff in preparing reconciliations, including the review of such reconciliations by someone in authority. A complete reconciliation to the source documentation should be performed for all open projects to ensure the accuracy and reliability of the data in Delphi. Policies should be established indicating individuals authorized to make adjustments to the general ledger as a result of the reconciliation and to communicate such adjustments to appropriate individuals (i.e., those involved in the reconciliation process.)

    

3. Grants Financial Management Oversight
   

   Condition: In our prior internal control audit report, we noted FHWA's deficiency in the financial management oversight on highway projects. FHWA disbursed approximately $30 billion to grantees and others in FY 2004. However, FHWA has not implemented new procedures to improve controls currently in place to ensure that such funds are safeguarded against fraud, waste and abuse. New matters have come to our attention that increases the risk of improper payments and, accordingly, this matter has been elevate to a Material Weakness.

   The DOT OIG has reported a number of times in recent years that financial stewardship over billions of dollars in grants to states and municipalities must be improved. In addition, the DOT OIG has reported that FHWA must improve its ability to identify hundreds of millions of dollars of idle funds on completed, canceled, or modified projects, and use the funds more productively on active projects. Because of the large amounts of funds that are involved, and the inherent risk of making improper payments when dealing with large transportation project contracts, FHWA has a responsibility to maintain reasonable assurance that states spend Federal funds properly. Our work continues to raise substantial doubts that FHWA has adequate safeguards in place to minimize improper payments to grantees.

   The majority of FHWA's grant payments are processed on a Payment Request Voucher through the Rapid Approval State Payment System (RASPS). The payment request details expenditures by project at the summary level. The Division Financial Manager typically reviews the payment requests submitted in RASPS for unusual items. Such reviews are based on the Financial Manager's knowledge and expertise in the project expenditures, coupled with discussions with the Division Engineer, Project Manager, etc. However, support for the payment request is maintained by the grantee. Many of FHWA's Division Offices relied on the Single Audit process alone to provide assurance that the grantees' billing was accurate in FY 2004; however, Single Audit procedures are not designed to support that type of assurance.

   FHWA does not have a systematic process in place to ensure that the grant payments made were supported by systems and processes to capture the full costs of the project, in accordance with acceptable accounting standards and practices. The disbursement approval process was flawed for much of the year. FHWA management realized in June 2004 that RASPS had a default approval feature that automatically approved the grantees' payment requests. Prior to FHWA management disabling this feature, the formal approval of the Financial Manager, or other officials with delegated authority, was not always required. Approximately $4 billion in payments were processed in FY 2004 with this automatic approval process. However, as noted above, since the current system in place is not conducive to reviewing supporting documents for such payments, management decided not to go back to reevaluate the authenticity of payments made under this automatic approval process. Although this does not mean that all payments were improper, it does raise significant questions about the potential magnitude of improper disbursements.

   In June 2001, FHWA issued the “Policy on Stewardship and Oversight of the Federal Highway Programs.” This policy requires each Division Office to perform a risk/benefit analysis or similar prioritization process to identify appropriate oversight activities. In addition, Division Offices are required to document oversight activities performed in their annual performance plans and submit such plans to FHWA headquarters for review. This policy has not been consistently followed by the FHWA Division Offices. We also noted that the Division Offices have not been performing the risk assessments reviews consistently. Such reviews should have included periodic procurement system and billing process reviews to ensure grant disbursements were properly supported. FHWA headquarters has historically relied on its Division Offices to determine the extent and frequency of conducting risk assessment and oversight activities on the grantees. Consequently, there is no mechanism in place to determine if the Division offices are following the policy.

   During our audit, we selected 45 grant projects for testing. The following summarizes some of the key exceptions noted in this testing:

   • In 41 of 45 grant projects sampled, required financial management risk assessment and associated reviews of grantees were not performed. Our testing included inquiries of the Division Offices regarding the documentation of the grantees' billing processes as well as whether the financial management assessments and reviews were complete. In many cases, we were informed that these reviews had not been done.
   • In 34 projects, Division Offices did not provided details of their current bill review.
   • In 3 current year disbursements, adequate documentation to support the payments was not available from Division Offices.

   In June 2003, the OIG reported that controls over construction payments were generally not effective. In reviewing a random sample of construction payments ($98 million), the OIG found that $7 million (7 %) of these payments were not adequately documented. Although this does not mean that all seven percent were improperly paid, it raises significant questions about the potential magnitude of improper payments.

   The DOT OIG has also reported a significant number of fraud cases (brought to OIG's attention via the hotlines) related to FHWA programs. There have been 128 convictions in the past five years, 29 of which occurred in 2004. This further indicates the significant potential for abuse and, accordingly, the need for revised oversight policies in the financial management oversight area of FHWA's operation.

   Federal Grant Systems are required to provide complete and accurate funds control over grantee payments. RASPS, FHWA's grant payment system, lacks edits to properly document payment approval actions, and under certain circumstances, fails to properly verify funds availability. The available funds balance can be changed between the time of the fund approval process and the time the funds are disbursed.

   Given the concern over adequate documentation to support disbursements made by HTF Agencies, DOT management performed a study of the risk associated with grant payments. However, the study concluded that it was difficult to identify improper payments given the level of electronic payments made. The study results also noted that the limited data supporting electronic payments did not allow for the review of specific costs charged to the award. The study also acknowledged that the Agencies rely on the Single Audit process and closeout reports to identify improper payments. We do not believe there is a basis for this reliance.

   Due to little or no review of supporting documentation by management for grant disbursements there is increased risk of improper payments. Management has indicated that they agree with this assessment and, accordingly, has hired a consultant to perform specific testing for improper payments in FY 2005, including determining an error rate.

   In September 2004, FHWA drafted a new financial oversight and review policy entitled, “Financial Accountability and Integrity Review” (FAIR). We were informed that FHWA management intends to finalize and implement FAIR in FY 2005. Until the policy is implemented and proven to be effective, this Material Weakness will likely be repeated in future years.

   Even though the weaknesses are not as significant as those noted at FHWA, FTA is also weak in the financial management oversight area of its operations.

   Recommendations:

   1. We commend FHWA management for its plan to implement the new FAIR program. We have briefly read the draft and are impressed with the overall spirit of the document. The draft program must be implemented immediately to close the loophole that currently exists in the grants payment approval process.

      However, the key to the success of this or any new program is for the implementation plan to be mandated by top management, with accountability consequences established. In addition, the implementation of these new policies and procedures must be reviewed and monitored closely to ensure compliance by the Division offices. Such monitoring should include:

      • Tracking risk assessment and review results issued by the Division Offices to assess the overall impact of these results on the grant programs;
      • Follow up on findings and potential issues in a timely manner to ensure that grantees implement necessary changes; and
      • Update FAIR procedures as necessary to address specific weakness in the policies noted during the program's implementation.
   2. We recommend that FHWA provide necessary training for headquarters and Division Office personnel to be involved in the implementation and monitoring of FAIR. This is necessary to ensure that they understand the purpose of the program and the processes related to its successful implementation.
   3. Develop appropriate edits in RASPS to validate funds availability prior to approval of payments.
   4. FTA must develop procedures to enhance its current system of financial management oversight over funds provided to grantees.

    

4. Information Technology Control Weaknesses
   

   Condition: We noted weaknesses in several aspects of the information technology (IT) systems in both the general and specific applications used by HTF Agencies to prepare the financial statements of HTF. Because of the sensitivity of matters mentioned below, a separate report (“Limited Use Management Letter”) has been issued to management describing in detail, the specific deficiencies identified and recommendations to correct these deficiencies.

   The IT weaknesses noted directly impact the ability of the users to rely on data being generated by the systems and, accordingly, require the users to employ extended financial analysis of such information to ensure its accuracy. Without effective users controls, the data being generated from the information systems cannot be relied upon to produce accurate financial statements. The breadth of weaknesses noted in the IT area of the audit, and the lack of compensating controls to mitigate these weaknesses, collectively indicates a material weakness in internal control. In addition, the ineffectiveness of the users to process and analyze data generated from these systems in a timely matter without extraordinary efforts increases the risk for even more errors in the HTF financial statements than those identified in the audit of the financial statements (Material Weakness No. 1).

   The following is a summary of the systems reviewed in connection with the FY 2004 audit of the HTF financial statements, along with a general discussion of weaknesses noted and described in more detail in the aforementioned “Limited Use Management Letter”:

   1. Delphi – Delphi is the referred to as the Central System for Financial Accounting and Reporting. It is used by all HTF agencies and is more commonly known as the general ledger accounting system. The last Agency was converted to Delphi in FY 2004. Significant problems were noted during most Agencies' conversions over the years, some of which are still having an impact on the data in reports generated by the system.
      • The DOT OIG issued a report on general controls related to Delphi. The OIG found that the control environment surrounding this application was not sufficient to provide for adequate security, confidentiality and integrity of financial information processed. Compensating controls were not evident to offset these deficiencies.
   2. Specific Feeder Systems Applications - Grants related activity represents over ninety percent of activity reflected in the HTF financial statements. Accordingly, reliance on data being generated from these systems by the systems users is critical to their ability to prepare reliable financial statements in a timely manner. In addition, weaknesses noted could have a material effect on the amounts reflected in the HTF financial statements at September 30, 2004.
      • In particular, weaknesses were noted in the grant management and payment systems used by FHWA relating to agency-wide security program planning and management, logical access controls, business continuity planning and application controls.
      • During our audit, we tested general information technology controls and application controls over the following key systems in support of Highway Trust Fund's financial transactions and reporting:

      1. FHWA only - Rapid Approval and State Payment System (RASPS), and Fiscal Management Information System (FMIS)
      2. All HTF Agencies - User Profile and Access Control System (UPACS) and DELPHI Interface Management System (DIMS).

      With respect to general controls, we found weaknesses in financial system certification and accreditation, risk assessments, system testing and evaluation, background checks for financial system contractors, managing user profiles, logical access controls over financial applications and databases, financial systems access for separated employees, backup tape management and alternate processing facility.

      With respect to application controls in these feeder systems, we noted that certain applications needed improvement related to compliance with the Federal Financial Management Improvement Act (FFMIA), compliance with OMB Circular NO. A-127 “Financial Management Systems”, unsupported operating system/application platforms, grant approval and payment edit features, application auto log-off (standby) feature, sufficient documented procedures for user account management and documentation to support management of sensitive output (media and reports).

      We also performed tests of two grant feeder systems used by FTA: the Electronic House Operation System (ECHO) and the Transportation Electronic Award Management System (TEAM). Even though the data processed in such systems is primarily used in other DOT activities; the weakness noted do have some impact on certain amounts reported in the HTF financial statements. Weaknesses noted in these feeder systems are not as significant as those used by FHWA but are also described in the aforementioned “Limited Use Management Letter” and need management's attention.

   Recommendation:We recommend HTF Agencies work with DOT management to improve their information technology environment by implementing the specific recommendations provided in the aforementioned separate report. We have been informed that management has made changes to address many of the weaknesses noted during the audits (both by the OIG and us). However, management must test the effectiveness of these changes during FY 2005, at which time they will be evaluated during the FY 2005 audit.

 

REPORTABLE CONDITION

1. Federal Lands Highway Program Transaction Processing And Reconciliations
   

   Condition: FHWA has a program titled Federal Lands Highway Program (Fed Lands) whose mission is to plan design, construct and rehabilitate roads and bridges providing access to, through and within Federal and Indian lands. Direct TEA-21 funding for Fed Lands was approximately $700 million in FY 2004.

   As stated in Material Weakness No. 2 above, Federal Lands has not performed a complete reconciliation for all open projects in Delphi since its conversion in FY 2003. In addition, Federal Lands management has not determined the specific reports its needs from Delphi to assist them in this effort.

   In connection with our tests of the Fed Lands accounting process used by FHWA, we selected a sample of twenty-five Federal Lands transactions with payments aggregating $1 million and obligations aggregating $14 million. Our examination included a review of source documentation to ensure the transactions were properly authorized and complete. The sample was randomly selected to represent the characteristics of the population as a whole. The results of our testing are summarized below:

   Results of 25 Randomly Chosen Federal Lands Transactions

   No. Of Items From Sample	Dollar Value Of Items Examined	Description Of Exception
   5	Differences ranging from $206,516 to ($223,926)	Obligation differences existed between Delphi and the project contracts due to the lack of reconciliations performed by the Federal Lands Division Offices. Federal Lands Financial Managers did not reconcile obligations from the contract to the amounts recorded in Delphi.
   3	$30,082	Expenditure amounts recorded in Delphi that exceeded the obligation amounts.
   6	$378,492	Source documentation for the payment was not provided or the payment was made without proper approval.
   1	$35,000	A contract officer's delegation of authority to obligate funds was not documented.
   2	$51,920	A contract officer exceeded the obligation authority in executing the contracts.
   3	$179,620	Invitation to Bid documentation was not available.
   1	$5,976,812	The Contracting Officer did not properly sign the award letter examined.
   2	$1,705,254	Documentation for Transportation Improvement Program (TIP)/Statewide Transportation Improvement Program (STIP) was not available.
   3	$19,004	Noncompliance with Prompt Payment Act provisions.
   18	$1,150,787	The Object Class Code used to record the Federal Lands transactions was not appropriate. The Delphi Object Class Code, 25305, Contract Services Other – Other Services, was used to record Federal Lands disbursements the majority of the time. This “Other” category should not aggregate to a material amount. During fiscal 2004, over $170 million was classified using that Object Class Code.

   In addition, the Statement on Federal Financial Accounting Standards (SFFAS) No. 7, Accounting for Revenue and Other Financing Sources, states that earned revenue should be recognized at the time a Government entity provides goods or services to the public or another Government entity. Federal Lands collect advance payments from other Federal Agencies prior to providing services. It also makes advance payments to other Federal Agencies prior to receiving services outlined in the inter-agency agreements. Earned revenues and expenses were not recorded at the transaction level based on when the service was provided or received, but recorded instead when cash was received or paid. As a result, some earned revenue and expense balances at year-end were inaccurately reported in the financial statements.

   Recommendations: We recommend the following:

   1. Establish reconciliation policies and procedures to ensure that obligation and disbursement amounts are recorded in Delphi on all open projects. Source documentation should be reviewed to ensure the accuracy of data in Delphi. Discrepancies should be researched and necessary adjustments made in Delphi in a timely manner. This recommendation is also included with Material Weakness No. 1.
   2. Implement absolute fund control procedures in Delphi to prevent payments exceeding obligation amounts. Projects with negative Undelivered Orders situations should be identified and resolved immediately.
   3. Implement procedures to ensure that source documentation supporting the payments is properly approved and maintained so that payments recorded in Delphi can be adequately supported.
   4. Close completed contracts immediately after the contractor has met contract deliverables. FHWA management should review Delphi reports of open contract to determine the status of old contracts.
   5. Provide necessary training/oversight to all relevant personnel to ensure transaction documentation, contract authority, procurement and approval procedures are followed.
   6. Routinely update signature authority lists and document proper approval on all purchase orders/contracts prior to the purchase commitment being made.
   7. Strengthen procedures to ensure payments are made within 30 days of invoice receipt.
   8. Develop appropriate Object Class codes for Federal Lands transactions in Delphi, and implement procedures to ensure that all Federal Lands transactions are assigned to the proper object class.
   9. Establish correct transaction codes in Delphi to properly record advance payments made to and collected from other agencies. Such recording should be based upon when services are received or provided.

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   We considered the Agencies internal control over Required Supplementary Stewardship Information by obtaining an understanding of the agency's internal control, determined whether these internal controls had been placed in operation, assessed control risk, and performed tests of controls as required by OMB Bulletin No. 01-02 and not to provide assurance on these internal controls. Accordingly, we do not provide an opinion on such controls.

   Finally, with respect to internal control related to performance measures reported in the Management Discussion and Analysis, we obtained an understanding of the design of significant internal controls relating to the existence and completeness assertions, as required by OMB Bulletin No. 01-02. Our procedures were not designed to provide assurance on internal control over reported performance measures and, accordingly, we do not provide an opinion on such controls.

   In summary, the Material Weaknesses in internal control described above may adversely affect any decision by management that is based, in whole or in part, on information that is inaccurate because of the deficiencies. Unaudited financial information reported by HTF Agencies, including budget information, also may contain misstatements resulting from these deficiencies.

   In addition to the reportable conditions described above, we noted certain matters involving internal control and its operations that we reported to the management of HTF Agencies in a separate letter dated November 8, 2004.