REPORT OF INDEPENDENT AUDITORS ON INTERNAL CONTROL

Inspector General
U.S. Department of Justice

Director, Asset Forfeiture Management Staff
U.S. Department of Justice

We have audited the accompanying consolidated balance sheets of the Assets Forfeiture Fund and Seized Asset Deposit Fund, a financial reporting component of the U.S. Department of Justice (DOJ) referred to herein as the AFF/SADF, as of September 30, 2003 and 2002, and the related consolidated statements of net cost, of changes in net position and of financing, and the combined statements of budgetary resources, for the years then ended and have issued our report thereon dated January 14, 2004. We conducted our audits in accordance with auditing standards generally accepted in the United States of America; the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States; and Office of Management and Budget (OMB) Bulletin No. 01-02, Audit Requirements for Federal Financial Statements.

Pursuant to the Homeland Security Act of 2002, Public Law 107-296, the operations and funds of the Immigration and Naturalization Service were transferred to the Department of Homeland Security on March 1, 2003. However, legacy INS asset seizure and forfeiture activity remained part of the AFF/SADF for the entire fiscal year. Additionally, the operations and funds of certain programs of the U.S. Department of the Treasury Bureau of Alcohol, Tobacco and Firearms were transferred to the DOJ's newly created Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF) effective January 24, 2003. The AFF/SADF has included ATF seizure and forfeiture activity in its financial statements since January 24, 2003.

Management of the Asset Forfeiture Management Staff (AFMS) is responsible for establishing and maintaining accounting systems and internal control. In fulfilling this responsibility, estimates and judgments are required to assess the expected benefits and related costs of internal control policies and procedures. The objectives of internal control are to provide management with reasonable, but not absolute, assurance that: (1) transactions are properly recorded, processed, and summarized to permit the preparation of reliable financial statements in accordance with accounting principles generally accepted in the United States of America, and to safeguard assets against loss from unauthorized acquisition, use or disposition; (2) transactions are executed in compliance with laws governing the use of budget authority and 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 in Appendix C of OMB Bulletin No. 01-02; and (3) 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. Because of inherent limitations in any internal control, errors or fraud may nevertheless occur and not be detected. Also, projection of any evaluation of internal control to future periods is subject to the risk that procedures may become inadequate because of changes in conditions or that the effectiveness of the design and operation of policies and procedures may deteriorate.

In planning and performing our audits of the AFF/SADF's financial statements, we obtained an understanding of the design of significant internal controls and whether they had been placed in operation, tested certain controls and assessed control risk in order to determine our auditing procedures for the purpose of expressing an opinion on the financial statements. We limited our control testing to those controls necessary to achieve the objectives described above and we did not test all controls relevant to operating objectives as broadly defined by the Federal Managers' Financial Integrity Act of 1982. Our purpose was not to provide an opinion on the AFF/SADF's internal controls. Accordingly, we do not express such an opinion.

With respect to internal control relevant to data that support reported performance measures, 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. Accordingly, we do not provide an opinion on such controls.

We noted certain matters in the AFF/SADF's internal control that we consider to be reportable conditions under standards established by the American Institute of Certified Public Accountants. Reportable conditions involve matters coming to our attention relating to significant deficiencies in the design or operation of internal control that, in our judgment, could adversely affect the entity's ability to meet the internal control objectives described in the second paragraph. Material weaknesses are reportable conditions in which the design or operation of one or more of the internal control elements does not reduce to a relatively low level the risk that errors or fraud in amounts that would be material in relation to the financial statements being audited or material to a performance measure or aggregation of related performance measures may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. Our consideration of internal control would not necessarily disclose all matters in internal control that might be reportable conditions and, accordingly, would not necessarily disclose all reportable conditions that are also considered to be material weaknesses as defined above. We identified the following reportable condition, which we also considered to be a material weakness.

1. Improvements are needed in controls over monitoring, accounting, and reporting of financial transactions. (Updated Condition)

This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the fiscal year 2003 financial statements, and it does not affect our report dated January 14, 2004, on those financial statements. The remainder of this report discusses the condition in more detail. Our recommendations for corrective action are also provided.

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Our audit identified that seizing and custodial agencies and litigation offices (collectively referred to herein as participating agencies), which are integral parts of the seizure and forfeiture process, do not place sufficient emphasis on recording the correct status or valuation of seized/forfeited property or obligations throughout the year. Furthermore, we noted that corrections to the status of obligations are mainly performed at the end of the fiscal year as part of the AFF/SADF's year-end financial closing and audit procedures. Failure to identify and correct errors in the status of seized and forfeited property and obligations throughout the fiscal year increases the risk that errors in financial statement account balances may exist and not be detected by management within established financial reporting timeframes.

In accordance with the OMB's and the DOJ's financial reporting requirements, the AFF/SADF began preparing interim financial statements in fiscal year 2002, and began preparing quarterly financial statements in fiscal year 2003. As a whole, participating agencies have not made adequate progress in establishing effective monitoring, accounting, and financial reporting processes, to ensure the preparation of timely and accurate quarterly and year-end financial statements.

Specifically, we identified the following weaknesses:

• Errors in the valuation and status of seized and forfeited property

At September 30, 2003, the AFF/SADF's financial statements reported 49,639 seized properties with an estimated seizure value of $188 million, and 23,912 forfeited properties with an estimated forfeiture value of $82 million. Participating agencies record all of the transactions that affect these amounts in the Consolidated Asset Tracking System (CATS). In the past four years, participating agencies have made inadequate improvement in the timeliness and accuracy of recording seized/forfeited transactions in CATS. We continue to note that errors exist in seized/forfeited balances throughout the year and are generally identified and corrected only at the end of the fiscal year during management's year-end reporting process, or as a consequence of the audit process. Failure to record seized and forfeited property transactions as they occur or to effectively perform routine procedures designed to identify and correct errors, discrepancies or unrecorded entries adversely affects the AFF/SADF's ability to meet its reporting and overall financial management responsibilities.

During our interim and year-end testing of seized and forfeited properties, we identified a number of status, valuation, category, and substitute res errors for both seized and forfeited property. Status errors occur when properties are entered into CATS by the participating agencies as either seized when they are in fact forfeited, or forfeited when they are in fact disposed. Status errors also occur when properties subject to seizure (i.e. Frozen, Indicted, Restrained or Encumbered Assets (FIRE Assets) are incorrectly entered as seized property prior to actual seizure. Valuation errors consist of seized or forfeited properties that have incorrect or unsupported values entered into CATS by the participating agencies at the time of seizure, forfeiture, or appraisal date as prescribed under program policy. Category errors are misclassifications of assets between cash, financial instruments, real property, personal property, or non-valued categories. Substitute res errors occur when cash is received in lieu of property, and CATS is not updated to recognize the substitution, resulting in overstated property.

As in prior year audits, during our test of controls designed to ensure proper reporting of status, valuation, category classification and substitute res treatment for both seized and forfeited property, we identified an unacceptable level of errors in CATS arising from the failure to perform established procedures. The causes behind these errors include: (a) not recording the change in forfeiture or disposition status, (b) failing to obtain and or correctly enter appraisal information at one or more of the prescribed valuation dates, (c) creating erroneous standard seizure records when properties should be classified as FIRE Assets, and (d) not correctly designating property between the valued and non-valued categories. Our interim and year-end tests of the status and valuation of seized and forfeited property identified the following known misstatements in the sample, which resulted in significant adjustments to the financial statement note disclosures related to seized and forfeited property:

Note: Populations tested for year-end were seized property for the entire fiscal year and fourth quarter forfeitures.

In the past four years, the AFMS has improved coordination among the participating agencies and has developed procedures that have led to the identification and correction of errors in CATS. For example, the AFMS conducts on-site reviews of the underlying data supporting the seizure and forfeiture data in CATS and provides the participating agencies with reports that identify the errors and recommends corrections that should be made in CATS. Our audit revealed that in some cases, corrections of errors identified by AFMS are significantly delayed because of disputes between participating agencies. As the error rates from our interim and year-end tests indicate, participating agencies must take additional steps to improve seized/forfeited property data in CATS including the prompt resolution by the responsible entity of all errors, discrepancies and un-recorded items.

• Errors in the status of undelivered orders and accounts payable

During our interim tests of AFF/SADF's processing of obligations, we noted that there is insufficient on-going emphasis placed on the determination of the proper status of undelivered and delivered orders in the general ledger. Specifically, we noted 5 of 73 undelivered orders (6.85%) and 13 of 88 delivered orders (14.77%) selected for review were incorrect. These errors included the overstatement and understatement of delivered and undelivered amounts, and included the failure to deobligate expired obligations timely. In addition, for 17 out of 73 reimbursable agreements tested (23.94%), AFMS did not record undelivered orders for the entire signed agreement amounts, but instead only recorded the obligated portions as they were incurred by the provider agencies. This resulted in an understatement of undelivered orders for interim financial reporting, but it did not affect the year-end financial statements because most of the agreements were either fully obligated, or excess amounts were deobligated, by year-end.

Guidance in OMB Circular A-11, Preparation, Submission and Execution of the Budget and Statement of Federal Financial Accounting Standards (SFFAS) Number 1, Accounting for Selected Assets and Liabilities, define both undelivered and delivered orders, including the amounts and events required to change the status of obligations between undelivered and delivered. OMB Bulletin No. 01-09, Form and Content of Agency Financial Statements, requires interim financial statements to be prepared on the accrual basis. Under OMB and DOJ reporting requirements, components are required to prepare interim financial statements on a quarterly basis using full accrual accounting. Without improvements in the controls over obligations, there is a risk the AFF/SADF is misstating obligation information on its interim financial statements that are used by management and the OMB.

Because of these control deficiencies, the AFMS and participating agencies performed a review of open obligations on a sample basis at September 30, 2003. As evidenced by the error rates noted during the year-end review, this process of reviewing the status of obligations only at the end of the year increases the risk that errors in obligations will not be detected by management and could result in misstatements in the AFF/SADF's financial statements. In addition, we noted that management was not able to detect and correct all errors in the sample. In fact, management had to conduct subsequent sample reviews of year-end obligations to validate their initial results. 21 of the 34 errors (62%) noted in the Financial Management Information System (FMIS) year-end undelivered and delivered samples related to the Organized Crime and Drug Enforcement Task Force program. Furthermore, 53 of the 80 FMIS and Financial Management System (FMS) year-end undelivered and delivered sample errors (66%) were attributed to the United States Marshals Service (USMS). The statistically projected misstatements of a $2.7 million understatement for FMIS undelivered orders, $5.1 million overstatement in FMIS delivered orders, and $2.2 million understatement of FMS delivered orders resulted in significant adjustments to the AFF/SADF financial statements at September 30, 2003, including an increase in expense of $2.9 million.

As a consequence of these errors and of delays in obtaining supporting documentation from the participating agencies, AFMS was unable to meet their reporting deadlines. The AFF/SADF will not be able to rely primarily on year-end clean-up efforts in future years because the OMB is further accelerating year-end reporting deadlines for fiscal year 2004. Future audit results will depend significantly on effective accounting closings each period and the results of interim internal controls testing.

• Improvements needed in revenue recognition procedures related to forfeited property

During our testing of the year-end HUD-1 real estate sales reconciliation, we noted that information entered on the USMS's HUD-1 spreadsheet was inaccurate, and real estate sales information from the USMS district offices was incomplete and was not submitted in a timely manner. As a result, we noted numerous errors on the HUD-1 spreadsheet for the sales price and third party payment and sales expense amounts for which adjustments of over $1 million were made to these balances. Furthermore, during the interim period, USMS did not reconcile the HUD-1 spreadsheet to real property disposed in CATS, which resulted in a schedule that was not inclusive of all real estate transactions during the interim period. As a result of this control deficiency, we were unable to assess the accuracy of the interim balances related to real estate dispositions.

If complete and accurate real estate sales information is not recorded in both FMS and CATS and provided to AFMS in a timely manner, controls over disposition proceeds are significantly diminished. In addition, misstatements in revenue, expense and forfeited property balances may occur and go undetected.

During our test of the year-end revenue accrual calculation, we determined that AFMS did not include all fiscal year 2004 transactions that related to fiscal year 2003 forfeited revenue activity. We also noted that of our sample of $1.3 million of revenue transactions that occurred after year-end, $633 thousand, or 49% of the sample, should have been reported as a revenue accrual for fiscal year 2003. As a result of the errors identified in our sample, management conducted a further review of its year-end accrual and made additional adjustments to the financial records of $6.8 million to increase the accrued revenue balance.

According to OMB Circular No. A-123, Management Accountability and Control, "transactions should be promptly recorded, properly classified and accounted for in order to prepare timely accounts and reliable financial and other reports. The documentation for transactions, management controls, and other significant events must be clear and readily available for examination." SFFAS Number 3, Accounting for Inventory and Related Property, sets specific criteria for the presentation and disclosure of seized and forfeited property in the financial statement of the AFF/SADF. It states that "Revenue from the sale of property shall be recognized when the property is sold" and "Revenue shall be classified as it arises from the sale or from disposition and this distinction shall be maintained in the entity's accounting records."

• Controls surrounding monitoring of the DOJ Justice Management Division's allocation of the Budget Clearing Account balance to the AFF/SADF need improvement

The AFF/SADF and two other DOJ component agencies share the same Agency Location Code (ALC) and the same budget clearing account (BCA) to record payments that do not have sufficient accounting information to post to the correct fund code. The Justice Management Division Finance Staff (JMD) within the DOJ is responsible for determining the proper allocation of the BCA balance to the various funds. AFMS is responsible for monitoring the allocation of the amounts to the AFF/SADF to ensure they are receiving timely information from JMD to reflect the most accurate activity in their accounts. During year-end testing, we noted JMD did not perform a review of the BCA during the fiscal year, and did not perform the year-end allocation until after the fiscal year end in support of the preparation of the year-end financial statements. Furthermore, although some of the transactions could be specifically identified by schedule type and attributed to the AFF/SADF, there is the risk that the remaining amounts that were allocated among the other component agencies by an overall estimation methodology could belong to the AFF/SADF. Moreover, we noted there is no periodic monitoring performed by the AFMS to ensure any transactions in the BCA that might belong to the AFF/SADF and that might require allocation to the AFF/SADF accounts are being identified and recognized on a timely basis. As a result, timely and accurate information is not being provided from JMD to the AFF/SADF, and this resulted in a material adjustment of $14 million posted to the AFF/SADF accounts at year-end.

According to OMB Circular A-123, " Recording and Documentation; transactions should be promptly recorded, properly classified and accounted for in order to prepare timely accounts and reliable financial and other reports."

Overall Financial Reporting Implications of Internal Control Results

Changes in participating agencies' financial accounting procedures, as they relate to AFF/SADF seized and forfeited property, obligation, revenue, and BCA transactions, must be made as soon as possible to ensure that timely and accurate financial information on seizures and forfeitures and obligation transactions is available to management on an ongoing basis. In addition to timely and accurate information needed to manage the program, acceleration of financial statement reporting deadlines and requirements to prepare quarterly financial statements further highlight the importance of reviewing and correcting errors throughout the year, as opposed to the current once-a-year efforts. Without significant changes to current financial accounting procedures, there is a serious risk that the AFMS will not be able to timely prepare auditable financial statements at the end of the fiscal year or at each fiscal year quarter end.

Recommendations:

    We recommend the Asset Forfeiture Management Staff:

1. Continue monitoring and evaluating participating agencies' efforts to improve CATS data quality and adopt effective processes by which AFMS can enforce compliance with standards designed to ensure that the impact of status, valuation, category and substitute res errors are minimized throughout the fiscal year. This should include establishing effective accounting closing procedures, performing on-site monitoring, resolving disagreements between participating agencies, correcting CATS and the general ledger as needed, and reaffirming with the participating agencies the proper procedures for correcting errors found during physical inventory counts. Moreover, AFMS should enforce procedures to ensure any CATS errors that are not corrected in an effective or timely manner are brought to the attention of senior financial managers at the responsible participating agency.
2. Establish a reporting and monitoring process that communicates and emphasizes the importance of correctly classifying obligations as delivered and undelivered throughout the fiscal year, not just at fiscal year-end. This communication should stress the need for a change in practice for the participating agencies that establish obligations for AFF/SADF to monitor the status of obligations on an on-going basis in accordance with the budgetary and accrual basis of accounting, and to review monthly and quarterly information, in addition to year-end information. The process should include prompt identification and correction of obligation errors to prevent misstatements or delays that adversely affect the AFF/SADF financial statements.
3. Develop and implement procedures within AFMS or JMD to perform frequent validation of obligation status recorded in the financial system and sampling of open obligations throughout the fiscal year. This should include reviewing open obligations and the related supporting documentation to ensure obligations are correctly classified, ensuring documentation supports calculations of undelivered and delivered amounts recorded in the general ledger, and ensuring appropriate adjustments are made to deobligate expired obligations. These procedures should be completed to ensure new processes are being followed throughout the fiscal year, allowing management in each participating agency to correct any problem areas prior to fiscal year-end.
4. Ensure reimbursable agreements are obligated for the appropriate amount for Program Operation Expenses or Investigative Expenses when they are initially entered into the system and ensure the appropriate amount of obligations are included in interim financial statements.
5. Implement procedures to ensure that USMS is properly accounting for real estate dispositions in the financial system and CATS including a review by AFMS of a monthly reconciliation of the real property disposition spreadsheet to CATS and FMS to verify that all real property sale transactions are properly accounted for. In addition, AFMS should require USMS supervisory personnel to review the schedule for any errors in recording sales price, third party payments and sale expenses. The spreadsheet and supporting documentation should be provided to the AFMS in a timely manner so accurate information can be presented in the financial statements.
6. Perform a detailed review of all forfeiture revenue activity at each financial reporting date to ensure transactions are accounted for in the proper period. The AFF/SADF should also verify that the revenue accrual calculation includes all sales that occurred during the fiscal year for which income is received after year-end.
7. Improve the on-going communication and follow-through among participating agencies pertaining to transaction processing standards, errors, exceptions, missing documents, unresolved discrepancies, control matters and other items that impact the timely and accurate preparation of the AFF/SADF financial statements. We also recommend that AFMS establish standard closing procedures and timeframes for all accounting and property information impacting the AFF/SADF's financial statements and enforce those standards vigorously.
8. Establish procedures to monitor JMD's review of BCA transactions to ensure timely and accurate identification of the allocation of BCA balances to the AFF/SADF.

Status of Prior Year Findings and Recommendations

As required by Government Auditing Standards and OMB Bulletin No. 01-02, we have reviewed the status of the AFF/SADF's corrective actions with respect to findings and recommendations from our prior audits of the AFF/SADF. The analysis below provides our assessment of the progress the AFF/SADF has made in correcting the reportable conditions identified during these audits. We also provide the Office of the Inspector General the report number where this condition remains open, our recommendation for improvement, and the status of the condition as of the end of fiscal year 2003:

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We also noted less significant matters involving the AFF/SADF's internal control that we will communicate to management in a separate letter.

This report is intended solely for the information and use of the U.S. Department of Justice Office of the Inspector General, the Asset Forfeiture Management Staff, management of the Department of Justice, the OMB, and Congress. This report is not intended to be and should not be used by anyone other than these specified parties.

January 14, 2004