Background

The Army depot maintenance activity group is part of the Army Working  Capital Fund, a revolving fund that relies on sales revenue rather than  direct appropriations to finance its operations. DOD policy requires  working capital fund activity groups to (1) establish sales prices that allow  them to recover their anticipated costs from their customers and (2)  operate on a break even basis over time—that is, to not make a gain nor  incur a loss, which is referred to as a zero accumulated operating result  (AOR). DOD policy also requires the activity groups to establish their sales  prices prior to the start of each fiscal year and to apply these  predetermined or “stabilized” prices to most orders received during the  year—regardless of when the work is actually accomplished or what costs  are actually incurred. For depot maintenance activity groups, DOD policy  also requires that as long as adequate cash balances are maintained,  unbudgeted operating losses or gains of $10 million or more per activity  group will be recouped or returned, as appropriate. This will occur in the  current fiscal year or, in the case of fourth quarter losses or gains, in the  first quarter of the next fiscal year.
Developing accurate sales prices is challenging since the process to  determine the prices begins about 2 years in advance of when the work is  actually ordered and performed. In essence, the activity group’s budget  development has to coincide with the development of its customers’  budgets so that they both use the same set of assumptions. To develop  prices, the activity group estimates (1) labor, material, overhead, and other  costs based on anticipated demand for work as projected by customers; (2) total direct labor hours for each type of work performed, such as  helicopters, tanks, and repairable inventory items; (3) the workforce’s  productivity; and (4) savings due to productivity and other cost-avoidance  initiatives. In order for an activity group to operate on a break even basis, it  is extremely important that the activity group accurately estimate the work  it will perform and the costs of performing the work. Higher-than-expected  costs or lower-than-expected customer demand for goods and services can  cause the activity group to incur losses. Conversely, lower-than-expected  costs or higher-than-expected customer demand for goods and services can  result in gains. With sales prices based on assumptions that are made as  long as 2 years before the prices go into effect, some variances between  expected and actual costs are inevitable.

		New Depot Maintenance System Expected to Improve Financial Data

We have previously reported that DOD has had long-standing problems in  preparing accurate working capital fund financial reports. For example, in  its fiscal years 2003 and 2004 Principal Financial Statements, the Army  acknowledged that its financial management and feeder systems that DOD  relied on to provide evidence supporting the Army Working Capital Fund  financial statements did not comply with federal financial management  system requirements, generally accepted accounting principles, and the  U.S. Government Standard General Ledger at the transaction level. As a  result of such deficiencies, the DOD Inspector General (who is required by  31 U.S.C. sec. 3521(e)(1) to conduct an audit of said financial statements)  was unable to express an opinion on the reliability of the Army Working  Capital Fund’s financial statements for fiscal years 1993 through 2004.
To help improve the Army depot maintenance activity group’s operations,  including financial management, in February 1998, the Army Materiel  Command began an effort to replace systems that are at least 30 years old  that manage inventory and depot maintenance operations with LMP.  According to the Army, LMP is intended to transform the Army Materiel  Command’s logistics operations in six core processes, one being financial  management. LMP is to, among other things, improve accounting and  reporting on billions of dollars worth of Army weapons systems through  fully integrated single-source transaction entry, online/real-time data, and  U.S. Standard General Ledger compliance. Further, LMP is intended to  bring the logistics community to the point of achieving favorable audit  opinions on financial statements. LMP became operational at the U.S. Army  Communications and Electronics Command and Tobyhanna Army Depot in  July 2003. The Army plans to implement LMP at the other four depots. In  May 2004, we reported on the Army’s lack of adequate management  oversight over LMP implementation and the problems being encountered  after it became operational in July 2003. As discussed later in this report,  the Army continued to experience significant LMP implementation  problems at the Tobyhanna Army Depot that inhibited the depot from  accurately reporting on its financial results of operations, which adversely  affected the depot’s ability to accurately set customer sales prices.

		Army Merged Its Depot Maintenance and Ordnance Activity Groups

Beginning with fiscal year 2005 (October 2004), the Army established a new  Army Working Capital Fund activity group by merging its depot  maintenance and ordnance activity groups. The new activity group—the  Industrial Operations activity group—consolidated the existing five Army  depots and the Army ordnance activities. These two activity groups  perform different types of work. The depots repair and overhaul a wide  range of assets such as helicopters and tanks, whereas the ordnance  activities, among other things, manufacture and sell munitions and large  caliber weapons critical to the Army’s execution of its warfighting mission.  The ordnance activity group also provides ammunition stockpile  management for all services within DOD as well as for foreign military  customers. Among the benefits of consolidation cited by the Army is that  the merger of the two activity groups will (1) create a more integrated  business perspective that encourages cooperation and partnership,  (2) eliminate duplication of effort associated with preparing and defending  two separate budget submissions for essentially the same type of service,  and (3) focus capital investments on the good of the business entity rather  than on the good of the individual installations.
We reviewed the Army Working Capital Fund fiscal year 2006/2007 budget  document submitted to the Congress in February 2005. The budget  document does not provide information on the Army depot maintenance  activity group. Instead, the budget document consolidates the information  on the depot maintenance and ordnance activity groups. This consolidation  of information is discussed later in this report.

	Depot Maintenance Prices Increased Due to Increasing Material Costs

Our work showed that the Army depot maintenance activity group’s  average sales price for work increased 31 percent (21 percent if adjusted  for inflation) between fiscal years 2000 and 2005. The activity group’s  budget documents showed that the average price per direct labor hour of  work accomplished (composite sales price) increased from $111.87 per  hour for fiscal year 2000 to $147.07 for fiscal year 2005. We found that  material costs accounted for the majority of the sales price increase from  fiscal year 2000 to fiscal year 2005, accounting for over 100 percent of the  group’s sales price increase. Army depot maintenance officials provided  evidence showing increasing material costs were caused, in part, by  increased (1) material usage to rebuild selected weapon systems to like- new condition under the Army’s recapitalization program and (2) prices  that the activity group pays its suppliers for repair parts. However, Army  depot maintenance officials have not completed a comprehensive analysis  to determine (1) how much of the increase was due to the recapitalization  program versus price increases and (2) whether they have identified all of  the reasons for the material cost increases. As a result, the Army has not  been able to take proactive steps to control rising material costs.

		Factors Causing Army Depot Maintenance Prices to Increase

The composite sales price that the Army depot maintenance activity group  charged its customers increased from $111.87 per direct labor hour in fiscal  year 2000 to $147.07 per direct labor hour in fiscal year 2005 – a $35.20  difference or 31 percent increase. As shown in table 1, our analysis of the  factors that make up the activity group’s composite price showed that  direct material, overhead, and direct labor account for all of the costs  making up the composite price increase charged customers. Table 1 also  shows that   Budgeted material costs were by far the most significant of the factors  ($65.23 per direct labor hour) making up the composite sales price in  fiscal year 2005 (44 percent of the fiscal year 2005 composite sales  price). Additionally, material costs increased by $36.14 and accounted  for over 100 percent of the increase in the group’s sales prices between  fiscal year 2000 and fiscal year 2005 because other cost factors  decreased.
Budgeted overhead costs were the second largest cost factor ($49.47 per  direct labor hour) making up the composite sales price for fiscal year  2005 (34 percent of the fiscal year 2005 composite sales price). However,  the overhead rate increased by only $3.98 during this time period. A  large portion of the budgeted overhead costs is associated with  operating and maintaining the installations.
Budgeted labor costs were the third largest cost factor ($30.84 per direct  labor hour) making up the composite sales price for fiscal year 2005 (21  percent of the fiscal year 2005 composite sales price). The labor costs  were less than half the material costs’ portion of the composite price for  fiscal year 2005. Depot officials noted that the labor cost increases were  primarily due to factors beyond the activity group’s control, such as  mandated cost-of-living annual salary increases for federal employees.  As a result, we did not perform an in-depth review of the labor costs  increases between fiscal year 2000 and fiscal year 2005.
Budgeted direct other costs (costs for contracts and travel) were the  fourth largest cost factor (down $1.84 to $4.99 per direct labor hour)  making up the composite sales price for fiscal year 2005. We did not  perform an in-depth review of these costs since they decreased between  fiscal year 2000 and fiscal year 2005.
All other budgeted cost factors included in developing the composite  sales price decreased from $3.91 in fiscal year 2000 to a negative $3.46 in  fiscal year 2005. The negative amount is due to the return of prior gains  in setting the prices.

		Spiraling Material Costs Are Primary Cause of Price Increases, but Further Analysis Is Needed

Although table 1 shows that several factors contributed to the increase that  occurred in the composite hourly sales price for fiscal years 2000 through  2005, higher budgeted material costs was by far the most significant factor.  Material costs increased 124 percent, from $29.09 per direct labor hour in  fiscal year 2000 to $65.23 per direct labor hour in fiscal year 2005. While  Army depot maintenance officials provided evidence on why the activity  group’s overall material costs have increased, they have not performed a  comprehensive analysis of material costs to determine (1) how much of the  increase was due to the recapitalization program versus price increases  and (2) whether they have identified all of the reasons for the material cost  increases.

			The Army Has Identified Some Causes of Material Cost Increases

Army depot maintenance officials stated that the activity group’s higher  material costs can be attributed, to a large extent, to (1) increased material  usage to rebuild certain weapon systems to like-new condition, as required  by the Army’s recapitalization program; and (2) price growth—what the  activity group pays various suppliers for material and component parts it  uses to repair weapon systems and other items. For example:  Due primarily to the recapitalization program, the depot maintenance  activity group raised the sales price for the repair of the Patriot missile  air defense system antenna mast group from $398,612 in fiscal year 2002  to $744,784 in fiscal year 2004, an increase of $346,172 or 87 percent.  Under this program, the depots automatically replaced more parts than  they did previously under a traditional weapon system overhaul. This  resulted in an increase in material costs. For example, under the fiscal  year 2002 recapitalization pilot program, the Letterkenny Army Depot  automatically replaced 142 parts on an individual antenna mast group.  By fiscal year 2004, the number of parts automatically replaced by  Letterkenny increased to 1,938 or 1,264 percent.
Due to increased prices paid to suppliers for component parts used in  repairs, the cost to repair radar sets used for the Patriot missile has  increased significantly. Depot maintenance officials estimated that for  one Patriot missile radar set, they replace approximately 1,500 of the  5,463 active radar antenna elements when they repair it. In January 2003,  depot maintenance was purchasing the antenna elements for $724  apiece from the supplier. About 15 months later, the purchase price for a  single element increased about 43 percent to $1,038. As a result, the  stabilized sales price for repairing the radar set increased from  $6,450,330 in fiscal year 2003 to $7,284,751 in fiscal year 2004, an  increase of $834,421 or 13 percent in 1 year.
Due to the recapitalization program, the depot maintenance activity  group raised its sales price for the repair of the Chinook helicopter from  $4,431,953 in fiscal year 2003 to $6,754,808 in fiscal year 2005, an  increase of $2,322,855 or 52 percent. The material component of the  sales price increased from $2,661,481 in fiscal year 2003 to $4,060,000 in  fiscal year 2005—an increase of $1,398,519 or 60 percent of the total  sales price increase. Corpus Christi Army Depot officials stated that  material costs increased because under the recapitalization program the  depot is required to (1) replace more parts 100 percent of the time  during maintenance and (2) follow tighter inspection criteria, which  results in parts being repaired or replaced more frequently. For  example, the depot increased the number of helicopter parts required to  be replaced during maintenance by 217 when it implemented the  recapitalization program.
Due primarily to the recapitalization program, the depot maintenance  activity group raised the sales price for the repair of the engine used in  the Armored Vehicle Launch Bridge, a folding portable bridge that is  transported on the top of a tank chassis, and the M88 Hercules Recovery  Vehicle, used to recover tanks. More specifically, the Anniston Army  Depot increased the price for the engine from $58,559 in fiscal year 2003  to $95,451 in fiscal year 2005, an increase of $36,892 or 63 percent.  During this same time period, the materials costs increased by $38,749  or 120 percent from $32,183 to $70,932. Since they anticipate repairing  about 336 of these engines in fiscal year 2005, the impact of the  increased material costs is about $13 million.
Due primarily to increased prices paid to suppliers for component parts,  the cost to overhaul one type of Bradley Fighting Vehicle increased from  $409,964 in fiscal year 2003 to $549,291 in fiscal year 2005, an increase of  $139,327 per vehicle or 34 percent. A major cause of this increase was  the material cost growth of $30,280 per vehicle. One example of a part  contributing to the higher material costs is the price of a gyroscope used  on the vehicle increasing from $11,486 in fiscal year 2003 to $19,381 in  fiscal year 2005. Further, the price of two transmission parts increased  from about $1,300 each to $10,092 each over the same time period.

			Army Has Not Performed a Comprehensive Analysis of Material Cost Increases

One of the primary goals of the working capital fund is to focus the  attention of all levels of management on the total costs of carrying out DOD  business operations such as depot maintenance. That is, working capital  fund operations are intended to operate like a business by developing and  using effective methods to control operating costs. We found that the Army  depot maintenance activity group has not achieved that goal nor attempted  to, at least in part, as it pertains to controlling material costs. Specifically,  the activity group has not performed a comprehensive analysis to  determine (1) how much of the increase was due to the recapitalization  program versus supplier price increases and (2) whether they have  identified all of the reasons for material cost increases. Such an analysis is  frequently used for manufacturing processes, for example, to determine if  material usage has increased and, if so, to determine the impact on material  costs.
We believe that a comprehensive analysis of material costs is warranted  because the activity group’s material costs account for over 44 percent of  the group’s fiscal year 2005 composite sales price and have increased by  124 percent between fiscal year 2000 and fiscal year 2005. Depot  maintenance officials at the five Army depots and the Army Materiel  Command told us that they did not perform such analyses. In fact, officials  at one depot told us it was not necessary for them to perform analyses on  material cost increases because they believe they know what their primary  material cost drivers are: the recapitalization program previously discussed  and increased prices being paid to one of their parts suppliers. We agree  with these two reasons. However, without performing a comprehensive  analysis, the depot cannot quantify the extent to which the causes  contribute to the higher material costs and does not know if all major  causes have been identified. Perhaps most important, absent these data,  DOD does not have the necessary information to try to mitigate costs  related to usage rates, unit prices, or other causes.

		Army Depot Maintenance Overhead Represents the Second Largest Cost Factor Affecting Prices

As illustrated in table 1, our analysis showed that budgeted overhead costs  were the second largest factor making up the fiscal year 2005 composite  sales price. Overhead costs consist of two broad cost categories: base  operations and maintenance mission. Base operations overhead includes  costs necessary to maintain the installations that support the Army depots  and other base tenants and include security, fire protection, building  maintenance, resource management, and personnel and community  activities. Maintenance mission overhead includes indirect costs that can  be directly attributed to supporting the depots’ maintenance mission, such  as supervision, indirect material, general engineering, and mid-level  management and administrative expenses, but cannot be tied to a specific  cost center. Tables 2 and 3 illustrate the breakout of the depots’ base  operations and maintenance mission overhead rates per direct labor hour  as a percentage of the depots’ total overhead rates for fiscal years 2001 and  2005.
As illustrated in tables 2 and 3, base operations overhead costs represented  a significant portion of the depots’ total overhead rate per direct labor hour  for fiscal years 2001 and 2005. In fiscal year 2001, base operations overhead  as a percentage of the total overhead rate ranged from 39 percent at the  Letterkenny Army Depot to 54 percent at the Tobyhanna Army Depot. In  fiscal year 2005, base operations still made up a significant portion of the  individual depots’ total overhead rates: a range of 28 percent at the  Anniston Army Depot to 52 percent at the Red River Army Depot.
Tables 2 and 3 show that maintenance mission overhead was also a  significant cost factor making up the individual depots’ total overhead rate  per direct labor hour for fiscal years 2001 and 2005. In fiscal year 2001,  maintenance mission overhead as a percentage of the total overhead rate  ranged from 46 percent at the Tobyhanna Army Depot to 61 percent at the  Letterkenny Army Depot. By fiscal year 2005, these percentages ranged  from 48 percent at the Red River Army Depot to 72 percent at the Anniston  Army Depot. Some maintenance mission overhead costs involve payments  to organizations external to the depots, such as payments to the Defense  Finance and Accounting Service for accounting and financial services. We  also found that from fiscal year 2001 to fiscal year 2005, the maintenance  mission overhead rate increased at only two of the depots—those that had  the lowest rates in fiscal year 2001. An official at Anniston Army Depot  stated that increased quality assurance operations that required hiring  additional engineers and higher subordinate command management fees  primarily caused the maintenance mission rate increase. An official at  Tobyhanna Army Depot stated that increased LMP, Defense Logistics  Agency, and Defense Finance and Accounting Service fees caused part of  the increase in its maintenance mission rate. Further, in fiscal year 2002,  the Army Materiel Command directed the depots to reclassify certain base  operations costs as maintenance mission to properly allocate overhead  costs to maintenance mission.

	Method of Allocating Gains and Losses Does Not Provide Incentive For Depots to Set Prices Correctly

In setting future prices to break even, the Army spread depot maintenance  reported gains and losses across all depots, rather than allocating reported  losses or gains incurred by a specific depot to that depot. While DOD policy  does not specify how to allocate gains and losses at the depot level, this  practice does not provide the right incentives to the depots to set prices  correctly in the budget. If one depot consistently incurred losses, the Army  would increase the prices at other depots to help recoup the losses. As a  result, the depot incurring the losses is not held accountable for operating  on a break even basis. For example, the Red River Army Depot reported an  accumulated loss for 4 of the past 5 years, including fiscal years 2002, 2003,  and 2004. For these 3 fiscal years, the reported accumulated losses ranged  from $18 million to about $48 million, indicating that Red River’s customers  were not charged enough for the goods and services provided to them.  Because of the continual reported losses, the Tank-automotive and  Armaments Command—the major subordinate command that directs Red  River—sent a team to Red River to determine why the depot reported $29  million of losses during fiscal year 2003. The team found that Red River did  not develop accurate budget estimates and underestimated various costs  that it incurred including salaries, material, and overhead.
On the other hand, the Tobyhanna Army Depot—which had a reported  revenue that ranged from $259 million to $406 million from fiscal years  2000 to 2004—reported an accumulated gain for each fiscal year from fiscal  year 2000 through fiscal year 2004, ranging from $31 million to $169  million. Likewise, the Anniston Army Depot reported an accumulated gain  for fiscal years 2002 through 2004 ranging from $30 million to $123 million,  indicating that it has been charging its customers too much for goods and  services. Tobyhanna officials stated that over the last few years, they  wanted to reduce their prices more than was allowed by the Army Materiel  Command to return these gains to customers. Tobyhanna officials said that  their sales prices were inflated to offset losses at other depots.
Due to its recent business merger of depot maintenance and ordnance  activity groups beginning in fiscal year 2005, it is even more important for  the Army to allocate gains and losses incurred by a specific activity to that  activity. This new activity group is called the industrial operations activity  group. In the past, the depot maintenance activity group did a much larger  business than the ordnance activity group. The Army depot maintenance  activity group received $2.6 billion in new orders in fiscal year 2003, while  the ordnance activity group received $832 million of new orders. These  orders were financed with appropriations in different proportions. For  example, in fiscal year 2003, 41 percent and 7 percent of the depot  maintenance orders were financed with operation and maintenance  appropriations and procurement appropriations, respectively. On the other  hand, 58 percent and 15 percent of the ordnance orders were financed with  operation and maintenance and procurement appropriations, respectively.  If the Army continues its current practice of allocating gains and losses  across all activities, customers of activities that make a gain will continue  to subsidize customers of activities that incur a loss. Further, because  ordnance activities are financed with several appropriations in different  proportions than depot maintenance activities, spreading gains and losses  across all activities could result in an inequitable allocation of the gains and  losses to and from these appropriations.

	Army Has Consistently Exceeded Carryover Threshold

In addition, the Army did not comply with DOD’s carryover policy. We  found that the Army depot maintenance activity group’s actual reported  carryover (1) consistently exceeded DOD’s 3-month carryover standard  from fiscal year 1996 through fiscal year 2001 and (2) continued to exceed  the allowable amount of carryover as calculated under DOD’s revised  carryover policy for fiscal years 2002 and 2003. The activity group’s  reported actual carryover did not exceed the allowable amount for fiscal  year 2004. We reviewed the Army’s fiscal year 2004 carryover calculation  and validated that the Army’s calculation was done in accordance with  DOD’s new carryover policy. Too much carryover could result in an activity  group receiving funds from customers in one fiscal year but not performing  the work until well into the next fiscal year or subsequent fiscal years. In  the past, the Congress has reduced the services’ budgets because of  excessive carryover, including a $48 million reduction in the Army’s fiscal  year 2003 Operation and Maintenance appropriation. Factors contributing  to carryover exceeding the ceilings included depots receiving new orders at  fiscal year-end and depots not being able to obtain material needed to  perform repair work in a timely manner. Furthermore, although the Army’s  reported carryover amount exceeded the ceilings, we found that the Army  understated its reported actual carryover for fiscal years 2002 and 2003.  For example, fiscal year 2003 carryover was understated by $95 million.  According to Army officials, the understatement occurred because DOD’s  verbal guidance was unclear. Based on its interpretation of this guidance,  the Army only included actual carryover on orders received in the current  year but did not include carryover related to orders received in prior years  in calculating its reported actual carryover for fiscal years 2002 and 2003.

		What Is Carryover and Why Is It Important

Carryover is the dollar value of work that has been ordered and funded  (obligated) by customers but not completed by working capital fund  activities at the end of the fiscal year. Carryover consists of both the  unfinished portion of work started but not completed, as well as requested  work that has not yet commenced. Some carryover is necessary at fiscal  year-end if working capital funds are to operate efficiently and effectively.  For example, if customers do not receive new appropriations at the  beginning of the fiscal year, carryover is necessary to ensure that the  working capital fund activities have enough work to ensure a smooth  transition between fiscal years. Too little carryover could result in some  personnel not having work to perform at the beginning of the fiscal year.  On the other hand, too much carryover could result in an activity group  receiving funds from customers in one fiscal year but not performing the  work until well into the next fiscal year or subsequent years. By minimizing  the amount of carryover, DOD can use its resources in the most effective  manner and minimize the “banking” of funds for work and programs to be  performed in subsequent years.
In 1996, DOD established a 3-month carryover standard for all working  capital fund activities except for the contract portion of the Air Force depot  maintenance activity group. In May 2001, we reported that DOD did not  have a basis for its carryover standard and recommended that DOD  determine the appropriate carryover standard for the depot maintenance,  ordnance, and research and development activity groups. According to the  Office of the Under Secretary of Defense (Comptroller) and Army officials,  based on our recommendation, in December 2002, DOD provided verbal  guidance concerning its new carryover policy for working capital fund  activities. Subsequently, DOD included its revised carryover policy in its  DOD Financial Management Regulation 7000.14-R, Volume 2B, Chapter 9,  dated June 2004, which eliminated the 3-month standard for allowable  carryover. Under the new policy, the allowable amount of carryover is to be  based on the outlay rate of the customers’ appropriations financing the  work. This meant that in determining allowable carryover, the first year  outlay rate would be used for new orders received in the current year (first  year of the work order). According to the DOD regulation, this new metric  allows for an analytical-based approach that holds working capital fund  activities to the same standard as general fund execution and allows for  more meaningful budget execution analysis.

		Army Reports Showed That the Depot Maintenance Activity Group Consistently Exceeded Carryover Ceiling

Tables 4 and 5 show that the Army depot maintenance activity group’s  actual reported carryover (1) consistently exceeded DOD’s 3-month  carryover standard from fiscal year 1996 through fiscal year 2001 and  (2) continued to exceed the allowable amount of carryover as calculated  under DOD’s revised carryover policy for fiscal years 2002 and 2003.
Officials at the four depots that exceeded their carryover ceilings informed  us that reported actual year-end carryover exceeded the allowable amount  because some depots received and accepted work late in the fiscal year and  some depots could not obtain the material needed in a timely manner, so  that less work was performed than planned. While other work can be  substituted for items awaiting parts, this shifting of the repair work does  have a negative effect on the amount of work accomplished. The following  examples illustrate these two reasons regarding why work was not  performed by fiscal year-end.
On September 26, 2003—the last week of the fiscal year—the Red River  Army Depot accepted a customer work order for $17.9 million to  overhaul 41 Bradley Fighting Vehicles. Because the depot did not begin  work on this order until October 2003, the entire $17.9 million had to be  carried over into fiscal year 2004 and was included in the depot’s fiscal  year-end 2003 reported actual carryover amount. According to Red River  Army Depot officials, their command told them to accept this order to  enable the obligation of operation and maintenance funds before they  expired at year-end.
In January 2002, the Red River Army Depot accepted a customer work  order financed with about $3.1 million of operation and maintenance  funds to overhaul 25 25-ton cranes. Upon starting the work, depot  officials said they discovered that many of the parts needed for the  overhaul were no longer readily available, thus requiring the depot to  research where the parts could be obtained. This delayed the overhaul  work, which caused about $3.1 million to be included in the depot’s  fiscal year-end 2002 reported actual carryover and was carried over into  fiscal year 2003. At the end of fiscal year 2003, almost $1.4 million of the  work was still not completed and was carried over into fiscal year 2004.
In fact, at the start of fiscal year 2004, none of the 25 cranes had been  completed. In November 2003, the first 2 cranes were completed, with  16 more being completed by the end of fiscal year 2004. The remaining 9  cranes, with about $470,000 of work, were carried over into fiscal year  2005 and finally completed by November 2004. Thus, due to the  unavailability of repair parts, uncompleted work on this order was  included in the depot’s carryover balance at the end of fiscal years 2002,  2003, and 2004.
On September 26, 2003, the Tobyhanna Army Depot accepted an order  for about $2.7 million that was financed by operation and maintenance  funds to repair a ground mobile navigation radar. Since the depot  accepted the order late in the fiscal year, the depot was unable to  schedule and begin the repair work until November 2003. As a result,  this $2.7 million order was carried over into fiscal year 2004. In addition,  because of delays in completing a modification upgrade to a component  on the radar, not all repair work on the radar was completed in fiscal  year 2004, resulting in about $1.2 million of the order, or 44 percent,  being carried over into fiscal year 2005.
In May 2003, the Tobyhanna Army Depot accepted a $3.6 million order  that was financed by operation and maintenance funds to repair three  Firefinder radar antennas. The depot received the radar antennas in  June 2003 but was unable to complete the repair work by the end of the  fiscal year because it did not receive the other necessary repair parts.  For example, the depot did not receive completed sets of sentinel  components and beam steering units from the parts supplier until June  2004. As a result, the depot reported over $3 million in fiscal year 2003  carryover and about $2.3 million in fiscal year 2004 carryover.
On August 24, 2004, the Corpus Christi Army Depot accepted an order  totaling about $3.1 million that was financed by operation and  maintenance funds to repair a Black Hawk helicopter. Even though the  depot did not have the material needed to repair the helicopter, it  accepted the work order late in the fiscal year. In September 2004, the  depot ordered the material to make the repairs. Although the depot  accepted the order and ordered the material in fiscal year 2004, it did  not begin the repair work until November 2004, when it received the  material. As a result, the depot reported almost the entire $3.1 million as  carryover at the end of fiscal year 2004.
On September 5, 2003, the Letterkenny Army Depot accepted a $5  million order that was financed by operation and maintenance funds for  the repair of the Patriot Missile Air Defense System launching stations in  support of the war in Iraq and Afghanistan. During the week of  September 19, 2003, the depot began repairing the stations. Since the  launching stations were received during the last month of the fiscal year,  the depot was unable to complete repairs on the stations by the end of  fiscal year 2003. This resulted in the depot reporting about $3.7 million  as carryover at the end of fiscal year 2003. The depot completed its  repair on the launching stations in September 2004.

		Reported Actual Carryover Was Understated in Fiscal Years 2002 and 2003 Because Prior Year Orders Were Not Included

The Army understated its reported actual carryover for fiscal years 2002  and 2003 because it interpreted DOD’s new carryover guidance as requiring  only the inclusion of customer orders received in the current year when  calculating carryover. As a result, the Army did not include customer  orders received in prior years. For example, the dollar amount of reported  actual carryover was understated by $95 million at the end of fiscal year  2003 because carryover related to orders received in fiscal year 2002 and  prior years was not included. Army officials at headquarters, the Army  Materiel Command, and the depots acknowledged that the actual carryover  figures did not include carryover related to prior year orders. As a result,  the Army reported to the Congress that its actual carryover exceeded the  allowable amount by $127 million in fiscal year 2003 as shown in table 5,  when it actually exceeded the allowable amount by $222 million.
DOD changed its carryover policy in December 2002 and stated that the  revised carryover methodology would be adopted for the first time in the  fiscal year 2004 budget, which affected the way the fiscal year 2002  reported actual carryover amount, as well as the fiscal years 2003, 2004,  and 2005 budgeted amounts, were to be calculated. However, DOD did not  issue detailed written procedures for calculating actual carryover until  June 2004. Army headquarters officials stated that prior to the issuance of  the written guidance in June 2004, the new carryover calculation was based  on verbal instructions that the Army received from the Office of the Under  Secretary of Defense (Comptroller). The Army interpreted the new  guidance to include only actual carryover on orders received in the current  year and instructed the Army Materiel Command to calculate carryover  accordingly. The Army Materiel Command then provided this guidance to  the depots. For example, on March 4, 2003, the Army Materiel Command  provided carryover guidance for the development of the fiscal year 2005  budget and specified that the amount of actual carryover was to be based  on new orders only and not to include actual carryover related to prior year  orders. When DOD issued the revised DOD regulation in June 2004, Army  officials realized that they were not calculating reported actual carryover  correctly and changed their methodology in developing the fiscal year 2006  depot maintenance budget so that the actual carryover calculation would  include prior year orders and be in accordance with DOD’s written  guidance.

		Current DOD Policy on Calculating Allowable Carryover Unclear

In addition to the problem of not including work related to prior year  orders when reporting actual carryover, problems also existed with  determining the amount of allowable carryover. As previously stated, in  June 2004, DOD revised the DOD Financial Management Regulation  7000.14-R, Volume 2B, Chapter 9 to formalize the December 2002 carryover  policy. However, this regulation did not contain specific instructions for  determining allowable carryover for work not completed on prior year  orders. To clarify its June 2004 written guidance, DOD again provided the  Army verbal guidance on calculating the allowable carryover amount for  work not completed on prior year orders. Based on the verbal guidance, the  Army used the first year outlay rate for both (1) current year orders and  (2) work not completed on prior year orders. We questioned this  methodology for calculating allowable carryover with officials from the  Army and the Office of the Under Secretary of Defense (Comptroller), and  why they were applying the first year outlay rates to prior year orders  instead of the applicable second or third year outlay rates. By using only  the first year rates, the Army was allowed more carryover. After discussing  our concerns with Office of the Under Secretary of Defense (Comptroller)  and Army depot maintenance officials, they changed the way they were  calculating allowable carryover. Specifically, the Army calculated the  allowable amount of carryover that was included in the Army Working  Capital Fund fiscal year 2006 budget by applying the first year outlay rate of  the appropriation financing the order for current year orders only. For  illustrative purposes, if the Army depot maintenance activity group  received $100 of new orders in fiscal year 2006 and the outlay rate was 60  percent, then the allowable amount of carryover would be $40.
In discussing this matter with officials from the Office of the Under  Secretary of Defense (Comptroller), they acknowledged that the current  written guidance on calculating allowable carryover was unclear. They  stated that they have since provided verbal guidance to the Army on how to  calculate the allowable amount. Specifically, the allowable amount of  carryover is to be calculated by applying the first year outlay rate of the  appropriation financing the current year orders. The officials also stated  that work not completed in the first year of the order is not to be included  in the calculation because it is expected to be completed by the end of the  second year of the order for the Army depot maintenance activity group.  The officials informed us that they plan to issue written guidance on this  matter.

	Tobyhanna Army Depot Continues to Experience Difficulty With LMP

Since its implementation in July 2003, LMP has not been able to provide  timely and accurate information needed for the economical and efficient  operations of the Tobyhanna Army Depot. As we reported in May 2004,  the Army’s inadequate management of its requirements and system testing  activities before LMP was fielded were the primary contributing factors to  the problems experienced at Tobyhanna since fiscal year 2003. These  problems are continuing to prevent the Tobyhanna Army Depot from  accurately reporting on its financial operations, which, in turn, adversely  impacts the depot’s ability to accurately set customer sales prices. While  the Army developed a reasonable approach that was to be followed in  addressing system problems that must be resolved for LMP to provide the  intended capabilities, the Army has not been able to effectively implement  those processes. As a result, the Army was unable to provide evidence to  show that the corrective actions adequately address the problems  experienced during LMP implementation. Until the Army effectively  implements its stated management processes to address the numerous  problems impeding the efficient and effective operation of LMP at the  Tobyhanna Army Depot, future deployments can expect to experience  similar, significant disruptions in their depot maintenance operations.

		Prior GAO Report Identified LMP Problems

In our May 2004 report, we pointed out that the Army had not effectively  managed its implementation of LMP. This report noted that after LMP was  deployed in July 2003, operational difficulties at the Tobyhanna Army  Depot resulted in inaccurate financial management information. More  specifically, the depot was not (1) producing accurate workload planning  information, (2) generating accurate customer bills, and (3) capturing all  repair costs, which impeded the Army’s ability to calculate accurate future  repair prices. As noted in the report, Army program officials acknowledged  that requirements and testing defects were factors contributing to the  operational problems.
Requirements represent the blueprint that system developers and program  managers use to design, develop, and acquire a system. Improperly defined  or incomplete requirements have been commonly identified as a cause of  system failure, resulting in systems not meeting their costs, schedules, or  performance goals. Further, because requirements provide the foundation  for system testing, requirement defects, such as those noted during our  review relating to specificity and the ability to determine the relationship  between requirements (commonly referred to as traceability), preclude an  entity from implementing a disciplined testing process. That is,  requirements must be complete, clear, and well documented to design and  implement an effective testing program. Absent this, an organization is  taking a significant risk that its testing efforts will not detect significant  defects until after the system is placed into production. Industry  experience indicates that the sooner a defect is recognized and corrected,  the cheaper it is to fix.
In our May 2004 report, we noted that LMP’s requirements (1) lacked the  specific information necessary to understand the required functionality  that was to be provided and (2) did not describe how to determine  quantitatively, through testing or other analysis, whether the systems  would meet the Army’s needs. We continue to believe that one reason that  users have not been provided with the intended systems capabilities is  because of the breakdown in the requirements management process. As a  consequence, the Army has implemented error-prone, time-consuming  manual workarounds as a means to minimize disruption to critical  operations. As discussed in the next section, our current work  demonstrated that Tobyhanna’s financial management operations  continued to be affected by LMP system problems.

		LMP Adversely Affected Tobyhanna Army Depot’s Financial Management Operations

Since the Army has not corrected LMP’s system problems, the Tobyhanna  Army Depot continues to experience financial management challenges.  These system problems include the depot’s inability to (1) report net  operating results that are reliable, (2) properly recognize revenue and bill  customers, (3) reconcile balances that were converted from the depot’s  legacy finance and accounting system, the Standard Depot System (SDS),  to LMP, and (4) produce reliable cost information because LMP contains  incorrect unit prices and unit of issue data. These problems adversely  affected Tobyhanna’s ability to accurately set customer sales prices and  develop reliable budgets for its depot maintenance operations.

			Net Operating Results Reported by LMP Were Not Reliable

According to an Army headquarters budget official, the fiscal year-end 2003  and 2004 net operating results were overstated by $74.7 million and $50  million, respectively, due to problems with the implementation of LMP.  Research performed by Tobyhanna finance and accounting personnel  showed that the fiscal year 2003 net operating result was overstated for a  number of reasons including (1) the recording of $35.2 million of  miscellaneous gains in LMP that did not occur and (2) an overstatement of  $39.5 million of revenue in LMP. For example, the $35.2 million of gains  recorded in LMP should have been reversed because LMP did not correctly  (1) account for material charged to jobs ($10.4 million), (2) process  transactions related to the movement of assets and material at the depot  ($11.8 million), (3) account for inventory variance account balances ($12  million), and (4) account for material returned for credit ($1 million). In the  Army Working Capital Fund budget for fiscal year 2006/2007, the Army  plans to revise the accumulated operating results for fiscal year 2005 by  adjusting it downward by the $124.7 million overstatement. Since the  accumulated operating result is one factor used in developing prices, this  adjustment will affect future prices.

			LMP Did Not Always Properly Recognize Revenue and Bill Customers

Shortly after LMP was implemented in July 2003, Tobyhanna officials began  identifying problems related to the system’s ability to accurately recognize  revenue and bill customers for goods and services provided. As of January  2005, the Army had not corrected the problems associated with revenue  recognition and billing of customers. For example, Tobyhanna officials  identified 837 work orders with accumulated costs for work performed  totaling over $44.8 million in September 2004. However, no revenue was  recognized for the work performed and, as a result, customers were not  billed for the corresponding amount. For one of the 837 work orders, our  analysis showed that the depot began incurring costs in May 2004 and had  total accumulated costs of $2.6 million as of September 2004. Tobyhanna  officials informed the contractor of this problem in September 2004. In  December 2004, the contractor told depot officials that it had corrected the  problem. However, the contractor corrected the problem for the one order  but did not correct the problems with the remaining 836 orders. Further,  the contractor did not determine the root cause of the problem, and the  depot continued to find the same problem with other orders. Once a  problem is identified, it is critical that it be investigated, the root cause  identified in order for a systematic solution to be developed, and that the  solutions be effectively tested to ensure that they address the fundamental  problem and do not introduce additional problems.
Another problem related to billing customers involves the Defense Finance  and Accounting Service (DFAS) and the process used to close customer  work orders. As part of this process, Tobyhanna sends completed work  orders to DFAS to be closed out so DFAS can bill customers for any  authorized funds (customer’s orders) that remain unbilled. DFAS uses LMP  data to perform this final billing. On September 16, 2004, Tobyhanna  identified 38 orders where the work was completed and sent this  information to DFAS for final billing and to close out the orders. However,  DFAS was not able to perform the final billings and close out these orders  because no sales order data (commonly referred to as a customer order)  were recorded in LMP for these 38 orders. In September 2004, the Army  told the contractor and DFAS about the problem of closing out orders.  Rather than fixing the root cause of the problem, DFAS agreed to manually  bill the customers and close the orders. According to Tobyhanna officials,  the problem will continue since the root cause of the problem was not  identified and fixed.

			Account Balances Were Not Reconciled When Tobyhanna Converted to LMP

Tobyhanna Army Depot encountered problems in converting data from the  legacy system to LMP. Specifically, when Tobyhanna converted from its  legacy finance and accounting system, SDS, to LMP in July 2003, the June  30, 2003, ending account balances in SDS did not reconcile to the beginning  account balances in LMP. According to Tobyhanna officials, the account  balances should have been the same. However, the officials did not perform  a detailed analysis to determine why the account balances did not reconcile  because they (1) were too busy identifying other problems with the  implementation of LMP and (2) lacked the detailed information to do the  analysis. Tobyhanna officials informed the contractor that the balances  were not reconciling in September 2003. However, as of January 2005— about 18 months after the implementation of the system—the account  balances in the two systems still could not be reconciled. Table 6 provides  the account balances shown in SDS and LMP for five selected accounts that  should have been the same but were different as of June 30, 2003.
Accurate account balances are important because the amounts are used to  produce official financial reports such as the income statement—which  include revenues, expenses, and annual and accumulated operating  results—that are used to prepare future budgets. For example, the fiscal  year 2004 operating result is one factor used in developing the fiscal year  2006 prices. If the information on revenue, costs, and net operating results  is unreliable, this could adversely affect the reliability of Tobyhanna’s  customer sales prices. Tobyhanna officials told us that in the past, they  were able to reconcile the information contained in SDS to the DFAS  official financial reports, including the income statement. This provided  them some assurance that the financial reports were correct. However,  since the implementation of LMP, they have not been able to reconcile the  data in LMP to the DFAS official reports.
DFAS officials acknowledged that there should not be differences between  ending account balances in SDS and beginning account balances in LMP.  However, because of unreconciled differences between the two systems,  DFAS included a footnote in the depot maintenance activity group’s fiscal  years 2003 and 2004 year-end financial reports and stated that LMP  conversion problems affected revenue earned, orders received from  customers, and billings. As of the end of fiscal year 2004—over 1 year after  conversion—DFAS was still unable to quantify the effect on revenue.

			LMP Contained Erroneous Unit Prices and Unit of Issue

LMP did not always contain the correct unit price or unit of issue for  certain materials, resulting in excess material being ordered and incorrect  prices being charged to jobs. Since LMP contained the wrong values for the  quantity of issue and price, Tobyhanna received quantities of parts and  supplies for use in repairing military assets that were far greater than  intended. Further, these parts and supplies were charged to jobs at higher  prices than the depot officials thought were being charged. Tobyhanna  officials informed us that they have experienced unit-price and unit-of- issue problems with LMP since its implementation in July 2003 and that  these problems continued as of January 2005, causing erroneous cost  information that distorts the depot’s financial reports, including net  operating results. The following are two examples illustrating problems  that Tobyhanna experienced while using LMP to place orders for parts and  supplies.
LMP did not contain the correct price for screws, wing nuts, and locking  washers. According to the officials, if depot maintenance personnel had  not identified these errors, the customer requesting this work would  have been charged over $2.8 million for the wing nuts, screws, and  locking washers, which were actually worth about $400. In fiscal year  2002, Tobyhanna received a work order from the Army to repair High  Mobility Multipurpose Wheeled Vehicles. In reviewing the work on this  order in May 2004, Tobyhanna officials determined that the job had been  assessed with costs totaling $2,846,686 for plain wing nuts, screws, and  locking washers instead of costs totaling $411.04 as shown in table 7.
These officials informed us that they identified the problem with this order  because they knew that the wing nuts, screws, and locking washers could  not possibly cost $2.8 million. The officials stated that they were aware of  only two possible reasons for these errors: (1) the contractor who  developed LMP input incorrect unit-of-issue and/or price data into the  system or (2) the unit-of-issue and/or price data did not transfer correctly  from the SDS legacy system to LMP.
In another case, Tobyhanna officials stated that they did not realize until  June 2004—almost 1 year after LMP was implemented—that LMP  contained the wrong unit of issue for washers, which resulted in the  system multiplying each order for washers placed with DLA by a factor  of 100. This occurred because when the data were converted, the lowest  unit of issue for the item was 100, while the shop floor employees  requisitioned the items by individual item. For example, when a  requisition for 800 washers was processed by the system, the system  converted the 800 to 80,000 by multiplying the number ordered (800)  times the unit of issue applicable for that order (100). Tobyhanna  officials informed us that they had so many flat washers in inventory  that it took about three truckloads to return the excess to the Defense  Logistics Agency.
The Army and the contractor acknowledged that there is a unit-of-issue and  unit-price problem. In January 2005, they identified over 7,600 items in LMP  whose base unit of measure was incorrect. According to the officials,  correcting this problem is not simple in all cases. For example, once the  inventory item has been used in the system, those transactions for the item  need to be reversed before the change can be made in the system that  shows the correct base unit-of-issue value. The officials also noted that  some of these items have literally thousands of transactions against them,  since these problems have been present since the system was deployed in  July 2003.
To avoid the unit-of-issue and unit-price problem that occurred at  Tobyhanna Army Depot, Army and contractor officials stated that it is  critical to clean up the base unit-of-issue problems before the system is  deployed at other sites. Accordingly, they have undertaken a program for  the second deployment sites to help ensure that the items they will be  adding to LMP that are not presently in the system have the proper base  unit-of-issue values. Based on reports provided by the project office, a great  deal of progress has been made on this initiative. For example, between  August and November 2004, the number of items at Corpus Christi Army  Depot with base unit-of-issue problems had dropped by 67 percent from  180 items to 60 items. It will be critical for Army to ensure that this activity  is completed prior to converting the legacy data into LMP.

		Army’s Efforts to Resolve LMP Problems Have Been Ineffective

We found that the significant flaws in requirements and testing  management that adversely affected the initial development and  implementation of LMP also hampered efforts to correct the operational  difficulties experienced at Tobyhanna. To address these recurring  problems, the Army and its contractor, Computer Sciences Corporation  (CSC), developed a reasonable approach that was to be followed in  addressing 722 stabilization items—system problems identified by the  Army that must be resolved for LMP to provide the intended capabilities.  The ability to effectively implement the necessary project management  processes (commonly referred to as disciplined processes) is a key factor  in reducing the project risks to acceptable levels and is the best indicator  of a project’s ability to meet its cost, schedule, and performance objectives.  However, the Army has not been able to effectively implement those  processes. Accordingly, the Army lacks reasonable assurance that  (1) system problems experienced during the initial deployment and causing  the delay of future deployments have been corrected and (2) LMP is  capable of providing the promised system functionality.
The Army and its contractor developed specific steps that were to be  followed in addressing the stabilization items. From an overall perspective,  the Army’s described approach is aligned with steps one would anticipate  to see in a project such as LMP.  For the most part, each corrective action  was to include the following steps:   Developing and documenting the requirements that were needed to  resolve the problem being corrected and the test steps that should be  followed to validate that a corrective action had been properly  implemented, where appropriate.
Requiring an Army and CSC official to sign off on each corrective action.
This sign off was used to help provide assurance that (1) the corrective  action adequately addressed the problem identified in the stabilization  item and was defined in the requirements document and (2) adequate  testing had been performed.
Establishing an oversight board to review the corrective actions and  ensure the stated processes had been followed, such as ensuring  (1) proper documentation had been developed and (2) adequate testing  had been conducted to provide reasonable assurance that the corrective  action addressed the problem. Based on a review of the actions taken to  address the problem, the oversight board would make a decision on  whether the corrective action should be loaded into the production  system. The oversight board included Army and CSC personnel.
To ascertain if the Army’s stated corrective action processes were being  adhered to, we selected 80 of the 276 stabilization items for review that  were shown as completed as of May 2004. Of the 80 items, we found that 32  items had been either merged with another corrective action or  cancelled—meaning they should not have been included in the stabilization  item inventory. For the remaining items, our analysis identified numerous  instances in which the stated processes were not being followed. As a  result, the Army was unable to provide evidence to show us that the  stabilization items had been corrected. Our analysis disclosed the  following:  The requirements documentation was inadequate or nonexistent for 24  items. As previously noted, the lack of adequately defined requirements  was one of the primary reasons LMP experienced problems when it was  initially deployed in July 2003. Further, since requirements represent the  blueprint that system developers and program managers use, it is  unclear how the individuals assigned to correct a given problem would  know exactly what needed to be fixed, e.g., the detailed business rules  that needed to be implemented.
Testing documentation was insufficient for 33 items. In some cases,  while there was documentation related to testing, the requirement had  not been properly defined. Therefore, one could not ascertain if testing  was properly conducted. For example, without documentation defining  the business rules that should be used, a tester cannot develop the types  of tests to ensure those business rules are implemented. As discussed  previously, we found numerous problems with the implementation of  the business rules that should be used for recognizing revenue and  billing.
Documentation is one means available to indicate that the stated processes  are being followed. Without the appropriate documentation, the Army does  not have reasonable assurance that all of the required steps are being  followed and cannot validate that a stabilization item has been corrected.  Further, if a planned corrective action does not resolve a stated problem,  the documentation, particularly for requirements and testing, can be used  to ascertain if the requirement was properly defined. In terms of testing, the  documentation would help indicate if the test was properly designed based  upon the stated requirement and if all of the attributes were tested as  required.
The following are specific examples of cases in which the problem  resolution process was not followed and, therefore, the Army did not have  reasonable assurance and could not demonstrate to us that these  stabilization items were resolved:  One corrective action related to labor charges was shown as completed  in July 2004. However, the Army could not provide documentation to  substantiate that (1) requirements were developed, (2) government  approval was received, and (3) oversight board approval was obtained.  Although a testing document was provided, it was impossible to  determine its adequacy since a corresponding requirements document  was not available for review.
Another corrective action designed to resolve inaccurate entries in the  general ledger was shown as completed on July 30, 2004. However, the  Army could not provide documentation that indicated that the  requirements were developed, testing was performed, and government  approval was received. In addition, we found a note that indicated  approval by the oversight board was not necessary, but no one could  explain why the board’s approval was not needed.
In discussing these issues with Army officials, they acknowledged that  although the problem resolution process was documented in May 2004, it  was not until October 2004 that all items that were submitted to the  oversight board were required to contain the requisite documentation. To  ascertain if the project had effectively implemented the disciplined  processes over other corrective actions subsequent to this later time frame,  we reviewed 14 “trouble tickets”—specific LMP output problems identified  by Tobyhanna users—that were reported as completed from October 2004  through January 2005. These trouble tickets were be resolved with  essentially the same process used for stabilization items discussed  previously. For example, the problems identified by Tobyhanna were  expected to be reviewed to determine the causes and, if the problems were  caused by the system, the following steps should be taken and  documented: (1) identify the cause of the problem and the corrective  action that needed to be taken (requirements), (2) perform adequate  testing to ensure that the problem was fixed and did not adversely affect  other LMP functionality, and (3) obtain approval by the contractor and LMP  staff. In each case, we found that documentation was not available to  validate that the process had been followed and the problem resolved.  Examples are discussed below.
In October 2004, a program was developed and placed into operation to  address billing problems reported by Tobyhanna. However, it did not fix  the problem and generated so many errors that the resulting bills could  not be released to the customers. In fact, because of the number of  errors produced by this “fix,” a stabilization item to clean up the  erroneous data was generated. LMP officials stated they were unsure  why this happened. Because of the large number of errors generated, it  was clear that adequate testing had not been performed on this program  before it was placed into production.
As noted previously, one of the major problems with LMP is its inability  to properly recognize revenue and bill customers. One cause of this  problem is that, in some cases, the system did not include an estimated  value for the planned costs of customer orders that were being  processed by Tobyhanna. When this condition occurred, improper  amounts of revenue were being recognized and improper bills prepared.  The Army recognized this problem early in the LMP deployment and  developed a “fix” in September 2003. However, we found the problem  was still continuing as late as January 2005, and the Army did not know  why the September 2003 corrective action was not working as planned.  If the Army had implemented the necessary disciplined processes, it  would have likely been able to (1) identify the cause of the initial  problem and (2) determine why the September 2003 corrective action  was not working. In one case, this problem generated revenue of over  $2.8 million that should not have been recognized, and in another case a  customer was improperly billed for over $1 million.

	Conclusions

The Army depot maintenance group has not always achieved the goals  envisioned under the working capital fund concept—that is, to operate like  a business by developing and using effective methods to control operating  costs, charging customers prices that result in break-even status at year- end, and ensuring that accurate and timely information is available to  manage and report on financial management operations. Specific examples  of management weaknesses in this area include the lack of proactive steps  to control rising material costs, overcharging certain depot maintenance  customers, and excessive amounts of year-end carryover, which could  result in an activity group receiving funds from customers in one fiscal year  but not performing the work until well into subsequent fiscal years, thus  tying up funds for lengthy periods that could otherwise be put to more  beneficial near-term use. Finally, DOD’s inability to develop and implement  systems solutions on time and with the promised capability appears to be a  critical impediment in the planned transformation of depot operations.  Flaws in the early stages of system development, including inadequate  requirements management and system testing, are now manifested in  significant LMP implementation problems at Tobyhanna. The failure to  resolve these problems will continue to impede operations at Tobyhanna,  and future deployment locations can expect to experience similar  significant disruptions in their operations.

	Recommendations for Executive Action

		Analyzing Cost Increases

We recommend that the Secretary of the Army direct the Commander,  Army Materiel Command, to develop and implement a systematic process  for analyzing the depot maintenance activity group’s material cost  increases due to the price paid for material and material usage that would  enable the Army to specifically identify and quantify all material cost  drivers and take proactive steps to control these rapidly increasing material  costs.

		Allocating Gains or Losses

We recommend that the Secretary of the Army direct the Commander,  Army Materiel Command, to allocate depot gains and/or losses to the  individual depots if a several-year trend shows that an individual depot  consistently realizes gains or incurs losses.

		Reducing Excessive Carryover

We recommend that the Secretary of Defense take the following actions:  Direct the Under Secretary of Defense (Comptroller) to clarify DOD’s  written guidance for calculating carryover so that the actual amount of  carryover associated with current and prior year orders is required to be  included in the reported amount provided to the Congress and DOD.
Direct the Under Secretary of Defense (Comptroller) to issue written  guidance that specifies that only current year orders are used in  calculating the allowable amount of carryover for the Army depot  maintenance activity group.
We recommend that the Secretary of the Army direct the Commander,  Army Materiel Command, to continue to comply with DOD’s policy on not  exceeding the year-end ceilings on the amount of year-end carryover  ceilings.

		Improving LMP Implementation

We recommend that the Secretary of the Army direct the Commander,  Army Materiel Command to take the following actions:  Delay implementation of LMP at the four remaining depots until the  problems encountered by the Tobyhanna Army Depot with the system  are resolved.
Implement the existing management procedures for ensuring the  complete resolution of identified problems resulting from the  implementation of LMP.
Reconcile all general ledger account balances between the legacy  systems and LMP as of the date the Army deploys the system at the four  depots that have not yet implemented the system.
Correct unit of issue and material pricing errors in LMP.

	Agency Comments and Our Evaluation

DOD provided written comments on a draft of this report. While DOD  concurred with all the recommendations, it noted that our report did not  fully address the effects of the Global War on Terrorism and the impact it  had on maintenance workload at the Army depots. According to DOD,  support for the war more than doubled the depot workload driving up  personnel and material costs. As stated in our report, we agree that the war  on terrorism has affected the depots’ workload and impacted material and  personnel costs.  However, the war on terrorism does not affect the Army’s  (1) practice of spreading gains and losses across all depots, (2) calculation  of reported actual carryover and the allowable amount of carryover, and  (3) development of LMP. Regarding increasing material costs, we agree that  the war does affect overall material costs. However, material costs per  direct labor hour more than doubled from $29.09 in fiscal year 2000 to  $65.23 in fiscal year 2005 and accounted for over 100 percent of the sales  price increase that occurred during this same time period. Because of this  significant increase, we still believe that the Army needs to identify all  material cost drivers and take proactive steps to control them.
In its comments, DOD concurred with the nine recommendations in the  draft report. For most of the recommendations, DOD identified specific  actions it will take to implement them. For example, DOD believes the  Army should make every effort to control the growth of material costs.  While DOD believes the increase in material costs are, in part, related to  wartime demand increases, the Army will determine the factors affecting  pricing. Also, the Army indicated that it has updated its budget formulation  guidance stating that gains and losses should be allocated to the individual  industrial installations if a several year trend shows that an installation has  consistently realized gains or losses. Further, the Under Secretary of  Defense (Comptroller) will issue guidance clarifying the present carryover  policy concerning the calculation of actual carryover as well as the  allowable amount of carryover. Finally, the Army concurred with our  recommendations on LMP and recognized that it cannot move forward  with future deployments to other depots until critical problems identified  at the Tobyhanna Army Depot are corrected.
We are sending copies of this report to the Chairmen and Ranking Minority  Members of the Senate Committee on Armed Services; the Subcommittee  on Readiness and Management Support, Senate Committee on Armed  Services; the Subcommittee on Defense, Senate Committee on  Appropriations; the House Committee on Armed Services; the  Subcommittee on Readiness, House Committee on Armed Services; and the  Ranking Minority Member, Subcommittee on Defense, House Committee  on Appropriations. We are also sending copies to the Secretary of Defense,  Secretary of the Army, and other interested parties. Copies will be made  available to others upon request. Should you or your staff have any  questions concerning this report, please contact Gregory D. Kutz, Managing  Director, at (202) 512-9505 or kutzg@gao.gov, or William M. Solis, Director,  at (202) 512-8365 or solisw@gao.gov, or Keith Rhodes, Director, at (202)  512-6412 or rhodesk@gao.gov. Key contributors to this report are listed in  appendix III.

Scope and Methodology

To determine if the prices charged by the Army depot maintenance activity  group have increased and, if so, why, we obtained and analyzed budget  documents that provided information on cost factors such as material  costs, overhead costs, and labor costs used in developing the prices from  fiscal year 2000 to fiscal year 2005. We determined the reasonableness of  the figures by reviewing and analyzing the cost factor data at each depot  and the Army Materiel Command. We determined which factors caused the  prices to increase the most and discussed the reasons for the price  increases with officials at the Army Materiel Command and the five Army  depots. In addition, we met with Army Materiel Command and depot  officials to determine what actions they were taking to identify the causes  for increasing material costs—a significant factor causing the majority of  the prices to increase from fiscal year 2000 to fiscal year 2005. We also  obtained information on the impact of increasing material costs on  repairing certain weapon systems such as the Patriot missile, Chinook  helicopter, and Bradley fighting vehicle. To assess the reliability of the data,  we (1) reviewed and analyzed the factors used in determining the prices  and (2) interviewed Army officials knowledgeable about the data. We  determined that the data were sufficiently reliable for the purposes in this  report.
To determine how the Army depot maintenance activity group allocated  reported gains or losses from fiscal year 2000 through fiscal year 2004, we  obtained and analyzed budget documents and accounting reports that  provided information on prices, revenue, costs, annual operating results,  and accumulated operating results for the depot maintenance activity  group as well as the individual depots. When the activity group or depots  reported gains or losses, we met with officials to determine (1) why the  prices charged customers resulted in a reported gain or a loss and (2)  whether the activity group allocated reported gains or losses incurred by a  specific depot to that depot. When reported gains or losses were not  allocated to the specific depot incurring them, we met with Army officials  to determine why not.
To determine if the Army depot maintenance activity group exceeded its  carryover ceilings in the past and the reasons for exceeding the ceiling, we  obtained and analyzed (1) the allowable amount of carryover for fiscal  years 1996 through 2004 and (2) reported actual year-end carryover data for  fiscal years 1996 through 2004. We also reviewed our prior report (GAO-01- 559) on carryover, which provided information on the allowable amount of  carryover as well as reported actual year-end carryover data. When the  reported actual carryover exceeded the carryover ceiling, we met with  responsible budgeting and/or accounting officials at the Army depots and  the Army Materiel Command to ascertain why. We also reviewed customer  orders to determine why the work was not completed on these orders by  the end of the fiscal year. Further, through a review of documentation and  discussions with officials at Army headquarters, the Army Materiel  Command, the depots, and the Office of the Under Secretary of Defense  (Comptroller), we determined (1) whether the Army was implementing  DOD’s new carryover policy and (2) how allowable carryover and actual  reported carryover were being calculated under the new carryover policy.
To determine if the Army encountered problems with the implementation  of LMP at the Tobyhanna Army Depot, we (1) identified problems reported  by system users at the Tobyhanna Army Depot to the system developers  and implementers (Army Materiel Command and CSC), (2) analyzed  actions taken by the Army and its contractor to resolve reported system  problems, (3) analyzed system stabilization plan to determine whether  system problems were sufficiently identified and understood to allow  proper problem resolution, (4) analyzed Army’s project management  processes to determine whether underlying root causes of system  problems were identified and appropriate system solutions were developed  to resolve reported system problems, and (5) analyzed Tobyhanna’s  financial reports produced by the legacy system and LMP at the time of  conversion to LMP to determine whether differences in account balances  were identified and reconciled. We also met with officials from Tobyhanna  Army Depot, Defense Finance and Accounting Service, CSC, and Army  Materiel Command to discuss LMP problems we found with the  implementation of LMP. We also reviewed our prior report (GAO-04-615),  which provided information on problems found with LMP’s development  and implementation at Tobyhanna and at the Communications and  Electronics Command.
We performed our work at the headquarters, Office of the Under Secretary  of Defense (Comptroller) and the Office of the Secretary of the Army,  Washington, D.C.; Army Materiel Command, Virginia; the Tobyhanna Army  Depot, Tobyhanna, Pennsylvania; the Letterkenny Army Depot,  Chambersburg, Pennsylvania; the Corpus Christi Army Depot, Corpus  Christi, Texas; the Anniston Army Depot, Anniston, Alabama; and the Red  River Army Depot, Texarkana, Texas. We also visited Computer Sciences  Corporation, Moorestown, New Jersey, the contractor responsible for  developing and implementing LMP, to discuss with company officials the  problems being experienced with the implementation of LMP at the  Tobyhanna Army Depot. Most of the financial information in this report is  budget data obtained from official Army budget documents. The  accounting data used in this report were obtained from official Army  accounting reports. We conducted our work from June 2004 through April  2005 in accordance with U.S. generally accepted government auditing  standards. We requested comments on a draft of this report from the  Secretary of Defense or his designee. DOD provided written comments,  and these comments are presented in the Agency Comments and Our  Evaluation section of this report and are printed in appendix II.

Comments from the Department of Defense

GAO Contacts and Staff Acknowledgments

	GAO Contacts

	Acknowledgments

Staff who made key contributions to this report were Richard Cambosos,  Francine DelVecchio, Chris Martin, Keith McDaniel, Mike Peacock, Janine  Prybyla, Greg Pugnetti, Chris Rice, Hal Santarelli, Darby Smith, and Ron  Tobias.

Summary:
Why GAO Did This Study

The Army depot maintenance activity group received about $2.6 billion of orders in fiscal year 2004 to repair helicopters, combat vehicles, and air defense systems. To perform this work, the group operates under the working capital fund concept, where customers are to be charged the anticipated costs of providing goods and services to them. GAO was asked to determine (1) if prices charged by the group have increased and, if so, why; (2) how the group allocates gains or losses incurred at the individual depot level; and (3) if the group exceeded its allowable carryover ceilings and the reasons for exceeding the ceilings. GAO was also asked to determine if the Army encountered problems implementing a new system, the Logistics Modernization Program (LMP), at the Tobyhanna Army Depot.

What GAO Found

GAO identified four management weaknesses that are impairing the efficiency and effectiveness of Army depot maintenance operations. The activity group's average sales price increased from $111.87 per hour for fiscal year 2000 to $147.07 per hour for fiscal year 2005--a 31 percent increase (21 percent if adjusted for inflation). An increase in material costs was the major driver of the sales price increase. The Army has identified some causes of the higher material costs such as increased material usage to rebuild certain weapon systems under the Army's recapitalization program and higher prices that it pays suppliers for parts, but it has not completed a comprehensive analysis of material cost increases. As a result, the Army has not been able to take proactive steps to control rising material costs. GAO analysis showed that in setting future prices, the Army spread depot maintenance reported gains and losses across all depots rather than allocating them to the individual depot that incurred the gains or losses. While DOD policy does not specify how to allocate gains and losses at the depot level, this practice does not provide the right incentives to the depots to set prices correctly in the budget. If one depot consistently incurred losses, the Army would increase the prices at other depots to help recoup its losses. As a result, the depot incurring the losses is not held accountable for operating on a break-even basis. The end result of this practice is that customers of depots with consistent losses are, in effect, subsidized by customers of depots with consistent gains. GAO analysis also showed that the reported carryover (work not completed at fiscal year end) exceeded DOD's carryover ceilings from fiscal year 1996 through fiscal year 2003. Too much carryover could result in an activity group receiving funds from customers in one fiscal year but not performing the work until subsequent fiscal years. Factors contributing to carryover exceeding the ceilings include depots receiving new orders at fiscal year-end and not being able to obtain parts needed in a timely manner. Finally, the Army continued to encounter problems implementing a new system intended to improve depot operations. GAO previously reported on these problems in May 2004, and noted that the Army's inadequate requirements management and system testing were primary contributing factors to the problems. These problems are preventing the Tobyhanna Army Depot from accurately reporting on its financial operations, which, in turn, adversely impacts the depot's ability to accurately set prices. GAO's current review found that the Army has not put into place an effective management process to help ensure that the problems with the system are resolved. While the Army developed a process that identified the specific steps that should be followed in addressing the problems identified, the process was not followed. Until the underlying causes of the problems are corrected, other depots implementing LMP will encounter similar problems.