For Release on Delivery

Expected at

10 a.m.

Thursday,

July 20, 2000

GAO/T-AIMD/NSIAD-00-264

DEPARTMENT OF

DEFENSE

Implications of Financial

Management Issues

Statement of Jeffrey C. Steinhoff

Assistant Comptroller General

Accounting and Information Management Division

Testimony

Before the Task Force on Defense and International

Relations, Committee on the Budget, House of

Representatives

United States General Accounting Office

GAO
Page 1 GAO/T-AIMD/NSIAD-00-264

Mr. Chairman and Members of the Task Force:

I appreciate the opportunity to discuss financial management issues at the

Department of Defense (DOD) and their implications for the budget

process. We recently testified1 before the House Subcommittee on

Government Management, Information and Technology on the status of

DOD’s efforts to address its long-standing pervasive weaknesses in

financial management systems, operations, and controls. Material financial

management deficiencies identified at DOD, taken together, continue to

represent the single largest obstacle that must be effectively addressed to

achieve an unqualified opinion on the U.S. government’s consolidated

financial statements. DOD’s vast operations—with an estimated $1 trillion

in assets, nearly $1 trillion in reported liabilities and a reported net cost of

operations of $378 billion in fiscal year 1999—have a tremendous impact

on the government’s consolidated reporting.

To date, no major part of DOD has yet been able to pass the test of an

independent audit; auditors consistently have issued disclaimers of

opinion because of pervasive weaknesses in DOD’s financial management

systems, operations, and controls. Such problems led us in 1995 to put

DOD financial management on our list of high-risk areas vulnerable to

waste, fraud, abuse, and mismanagement, a designation that continued in

last year’s update.2 Lacking such key controls and information not only

hampers the department’s ability to produce timely and accurate financial

information, but also significantly impairs efforts to improve the economy

and efficiency of its operations. Unreliable cost and budget information

affects DOD’s ability to effectively measure performance, reduce costs,

and maintain adequate funds control, while ineffective asset accountability

and control adversely affect DOD’s visibility over weapons systems and

inventory.

DOD has made genuine progress in many areas throughout the

department, both larger steps forward and smaller incremental

improvements. We have seen a strong commitment by the DOD

Comptroller and his counterparts in the military services to address the

department’s serious financial management problems. At the same time,

DOD has a long way to go. Major problems remain—problems that are

1Department of Defense: Progress in Financial Management Reform (GAO/T-AIMD/NSIAD-00-163,

May 9, 2000).

2High-Risk Series: An Overview (GAO/HR-95-1, Feb. 1995), High-Risk Series: Defense Financial

Management (GAO/HR-97-3, Feb. 1997), and Major Management Challenges and Program Risks: A

Governmentwide Perspective (GAO/OCG-99-1, Jan. 1999).
Page 2 GAO/T-AIMD/NSIAD-00-264

pervasive, long-standing, deeply rooted, and complex in nature. Our

previous testimony outlined DOD’s most difficult financial management

challenges and described the many initiatives that are under way or

planned to address them.

Today, I will highlight certain of those ongoing challenges, with a focus on

those that affect the reliability of budget execution data as well as other

areas where accurate and complete financial management information

could provide a useful perspective to decisionmakers related to budget

requests, performance measures, costs, and other key decision points.

Finally, I will discuss DOD’s plans and actions to develop an integrated

financial management system that complies with federal system standards.

To achieve what the Comptroller General has referred to as the “end

game”–systems and processes that routinely generate good financial

information for day-to-day management purposes—will require a major

systems and reengineering effort. Integrated financial management

systems, along with marshaling the human capital needed to achieve

results, have long been cited as major components to the final resolution

of DOD’s financial management problems. The successful Year 2000 effort

demonstrated that DOD can resolve complex, entitywide problems

through top management leadership working across functional lines.

Applying the Year 2000 lessons learned to the department’s financial

management system integration effort will require similar leadership and

commitment to a disciplined systems development approach.

As an integral part of an effective budget execution system, an agency is

responsible for determining and maintaining its available fund balance.

Treasury also has information about activity in the agency’s accounts, and

Treasury’s and the agency’s records must be periodically reconciled to

determine the actual amount of funds available. This is analogous to

reconciling one’s personal checking account with the monthly bank

statement. DOD weaknesses in accounting for its funds include (1) the

inability to reconcile its balances to Treasury’s, (2) frequent adjustments

of recorded payments from one appropriation to another appropriation

account, including to canceled appropriations, (3) problem

disbursements—disbursements that are not properly matched to specific

obligations recorded in the department’s records, and (4) obligated

balances that are incorrect or unsupported.

As a result of these weaknesses, auditors have been unable to verify

DOD’s Fund Balance With Treasury and its major components—obligated

and unobligated balances. This means that DOD does not know with

Reliability of Budget

Execution Data

Impaired
Page 3 GAO/T-AIMD/NSIAD-00-264

certainty the amount of funding that is available. This information is

essential for DOD and the Congress to be able to determine the status of

funds and if unobligated balances are available that could be used to

reduce current funding requirements or that could be reprogrammed to

meet other critical program needs.

Although DOD has made some improvements in its accountability over its

fund balance with Treasury, the amount of funds available at DOD remains

questionable because (1) significant differences between DOD’s and

Treasury’s records remain, (2) the reduction in differences between

Treasury’s and DOD’s recorded fund balances may be, in part, a result of a

change in policy rather than an actual reduction, and (3) items in suspense

accounts, which cannot be identified with a specific appropriation

account, may not be DOD transactions.

DOD made the reduction of differences a high priority in its short-term

improvement plans last year. There was a drop in the amount of the

unresolved differences from $9.6 billion at September 30, 1998, to

$7.3 billion at September 30, 1999. Although some of the differences may

be due to the timing of transaction processing at Treasury versus DOD, an

aging of the difference suggests that significant reconciliation issues

remain. For example, of the $7.3 billion difference, $2.5 billion is 60 days

or older. Differences over 60 days old are generally not attributable to

timing.

At least some of the decrease in the total differences as of September 30,

1999, can be attributed to the practice of some Defense Finance and

Accounting Service (DFAS) center staff to routinely adjust their records

each month to match those at Treasury without first identifying whether

the adjustment is proper. This practice results in fewer differences on the

reports but does not necessarily mean that the reconciliation process has

actually improved or that the causes of the differences, such as Treasury

or DOD errors in recording transactions, have been addressed and

resolved. For example, one Army disbursing station recorded $608 million

in differences to a suspense account.3 At year-end, DOD charged the

differences to Army’s Operations and Maintenance appropriation, without

documentation to support that these transactions should be recorded to

this account. This resulted in financial reports to the Congress and OMB

that show a reduction in the obligated balance in that account available for

3A suspense account is a temporary holding account for problem transactions involving both

collections and disbursements—for example, those rejected because of system edit controls.

Significant Differences

Between DOD’s and

Treasury’s Records
Page 4 GAO/T-AIMD/NSIAD-00-264

disbursement. However, DOD has little assurance that the charge should

not have been properly assessed against, for example, some other Army

appropriation or even to another entity’s appropriation. Further, at the

beginning of the next fiscal year, DOD reversed the Operations and

Maintenance charges and returned the amounts to suspense accounts.

Finally, DOD records show that an estimated $1.6 billion of transactions

held in suspense accounts at the end of fiscal year 1999 have not been

properly reported to Treasury and may also affect the fund balance with

Treasury amount. Until suspense account transactions are posted to the

proper appropriation account, the department will have little assurance

that appropriation balances are accurate, and that it has a right to any

collections, that adjustments are valid, and that the disbursements do not

exceed appropriated amounts. Moreover, the reported amounts in

suspense accounts represent the offsetting (netting) of collections and

adjustments against disbursements, thus understating the magnitude of

the unrecorded amounts in suspense accounts. To illustrate the magnitude

of this issue, we previously testified4 that audit work for fiscal year 1997

found that while the Navy had a net balance of $464 million in suspense

accounts recorded in its records, the individual transactions—collections

as well as disbursements—totaled about $5.9 billion.

DOD frequently adjusts recorded payments to transfer the payment to

another appropriation account, including to canceled appropriations.

These adjustments raise questions about the reliability of amounts

reported as obligated and available for disbursement in specific

appropriations. In March 2000, we reported5 that about one of every two

dollars in fiscal year 1997 contract payment transactions processed was

for adjustments to previously recorded disbursement transactions.

Although DOD reported that the number of adjustments has declined, it

remains significant. During fiscal year 1999, DFAS data showed that

almost one of every three dollars in contract payment transactions was for

adjustments to previously recorded payments—$51 billion in adjustments

out of $157 billion in transactions. Adjustments were often made to

original entries that were recorded years earlier. A number of the

adjustments selected during our review were made to canceled accounts.

4Department of Defense: Status of Financial Management Weaknesses and Actions Needed to Correct

Continuing Challenges (GAO/T-AIMD/NSIAD-99-171, May 4, 1999).

5Financial Management: Differences in Army and Air Force Disbursing and Accounting Records

(GAO/AIMD-00-2-, Mar. 7, 2000).

Frequent Adjustments

Affect Reliability
Page 5 GAO/T-AIMD/NSIAD-00-264

In the National Defense Authorization Act for Fiscal Year 1991, the

Congress changed the government’s account closing procedures. The

intent of the changes was to impose the discipline of the Antideficiency

Act6 and the bona fide needs rule7 to expired appropriations and to ensure

that expired appropriations do not remain open on the government’s

books indefinitely.8

Subsequent to the amendment of the account closing law, DOD requested

that Treasury reopen hundreds of closed accounts to permit the posting of

adjustments. Treasury asked us whether it had authority to correct

reporting or accounting errors in closed accounts. In 1993, we determined

that Treasury had authority to correct these errors.9 The decision

concluded that Treasury may adjust the records of canceled

appropriations to record disbursements that were in fact made before the

cancellation. However, Treasury can make these adjustments only if DOD

can establish that a disbursement was a liquidation of a valid obligation,

recorded or unrecorded, that was properly chargeable against the account

before it closed.10

Adjusting disbursements previously recorded to current accounts by

moving those transactions to canceled accounts can increase balances

available for obligation in the current accounts. Since the 1991 account

closing law was enacted, DOD has requested that Treasury reopen 333

closed accounts, totaling $26 billion. These accounts remained open as of

September 30, 1999. By comparison, all other federal agencies combined

have requested that Treasury reopen 21 closed accounts, totaling

$5 million. According to Treasury’s records, DOD made $576 million in net

6The Antideficiency Act provides that an officer or employee of the United states Government may not

“make or authorize an expenditure or obligation exceeding an amount available in an appropriation or

fund” or enter into a contract or other obligation for payment of money “before an appropriation is

made.” (31 U.S.C. 1341 (a)).

7The bona fide needs rule, based on 31 U.S.C. 1502(a), requires that agencies use appropriations

available for obligation for a limited period of time to meet the legitimate needs of the agency arising

during that period of time.

8Under the account closing law, 31 U.S.C. 1551-1558, agencies must continue to account for the

obligated and unobligated balances of their appropriations for 5 years after the expiration of their

period of availability. At the end of 5 years, appropriation balances, both obligated and unobligated,

are canceled. After that time, they are no longer available for obligation, obligation adjustment, or

expenditure for any purposes. Because these accounts are no longer available for disbursement, they

are not reported as part of DOD’s Fund Balance with Treasury or in the department’s Status of Funds

reports to OMB or the Congress.

972 Comp. Gen. at 343 (1993).

1072 Comp. Gen. at 347 (1993).
Page 6 GAO/T-AIMD/NSIAD-00-264

adjustments to canceled accounts in fiscal year 1999. DOD has indicated

that it has controls in place to ensure that adjustments to canceled

accounts are proper. Chairman Kasich and Chairman Horn recently asked

us to review DOD’s practice of making adjustments to canceled accounts,

and our work has just begun.

Problem disbursements—disbursements that are not properly matched to

specific obligations recorded in the department’s records—continue to

impede the department’s efforts to improve its budgetary data. This

situation can misstate DOD’s reported obligated balances, undermining

this important budgetary control. For example, when disbursements are

not matched to specific obligations, an understatement of obligations and

an overdisbursement of an account can occur. This situation occurs if the

disbursement is for an item for which an obligation has not been recorded

or if the amount of the recorded obligation is less than the recorded

disbursement. Obligations are also understated in the case of in-transits, in

which a disbursement has been made but documentation is insufficient to

determine how the transaction should be recorded in the accounting

records. The elimination of problem disbursements is one of the

department’s highest financial management priorities. DOD has reported

progress in resolving problem disbursements. As of September 30, 1999,

DOD reported11 $10.5 billion in problem disbursements, including intransits, as compared with about $17.3 billion in problem disbursements

reported at the end of fiscal year 1998.

Of the $10.5 billion, DOD reported that about $1.5 billion were problem

unmatched disbursements and negative unliquidated obligations

(NULOs)12 over 180 days old. DOD’s problem disbursement policy requires

that obligations be recorded for amounts paid that are unmatched to a

recorded obligation or exceed recorded obligated balances after 180 days.

However, the policy makes an exception if sufficient funds are not

available for obligation. In that case, DOD’s policy permits the department

to delay recording an obligation or adjustment until the funds cancel—up

to 5 years after expiration of the account. DOD believes that by delaying

the recording of the obligation, funds will become available—for example,

through de-obligation–thus permitting the obligation to be recorded

11Defense Finance and Accounting Service reports to the DOD Comptroller on problem disbursements

and in-transits as of September 30, 1999.

12Negative unliquidated obligations (NULOs) are disbursements that have been received and posted to

specific obligations by the accounting station, but the recorded disbursements exceed the recorded

obligations.

Disbursements Not

Properly Recorded
Page 7 GAO/T-AIMD/NSIAD-00-264

without raising an Antideficiency Act concern and ensuing investigation. If

DOD had recorded this $1.5 billion after the transactions remained

unmatched for 180 days, the related account balances would have

reflected potential Antideficiency Act violations and required an

investigation and report to the Congress if the appropriation is ultimately

determined to be overobligated or overspent.

An agency may not avoid the requirements of the Antideficiency Act,

including its reporting requirements, by failing to record obligations or to

investigate potential violations. To ensure sound funds control and

compliance with the Antideficiency Act, an agency’s fund control system

must record transactions as they occur. We and the DOD IG have

previously reported13 on this issue and recommended that DOD revise its

problem disbursement policies and procedures to ensure that accurate

and reliable balances are maintained.

Finally, the process and control problems that result in the problem

disbursement issues previously discussed also contribute to improper

payments by the department. For example, our work continues to identify

problems with overpayments and erroneous payments to contractors. For

fiscal years 1994 through 1999, according to DFAS records, defense

contractors returned over $5.3 billion to the DFAS Columbus Center,

including about $670 million during fiscal year 1999, due to contract

administration actions and payment processing errors. However, these

amounts do not reflect the true magnitude of this problem because many

overpayments are returned through billing offsets. We are currently

working to estimate the scope of the overpayment problem, including

these offsets.

In their testing of obligated balances, DOD auditors found evidence of

unsupported obligations and poor internal controls over obligations, as

illustrated by the following examples.

• The Army Audit Agency found14 that internal controls over the recording

of obligations were not adequate to ensure that reported obligated

13Financial Management: Problems in Accounting for Navy Transactions Impair Funds Control and

Financial Reporting (GAO/AIMD-99-19, Jan. 19, 1999) and Recording Obligations in Official Accounting

Records (DOD IG Report No. D-2000-030, Nov. 4, 1999).

14Army’s General Fund Principal Financial Statements for Fiscal Year 1999, Financial Reporting of

Budgetary Resources (U.S. Army Audit Agency Report No. AA 00-223, Apr. 28, 2000).

Obligated Balances Were

Incorrect and Unsupported
Page 8 GAO/T-AIMD/NSIAD-00-264

balances were accurate. In a sample of 60 1999 transactions, the auditors

found that 21 could not be supported.

• For fiscal year 1999, audit results15 show that the Air Force Working

Capital Fund had $211 million of obligations out of approximately

$1 billion tested, that is 700 out of 2,526 transactions that were incorrect,

inadequately supported, or not supported. In addition, Air Force’s general

fund audit continued to identify inaccurate or unsupported obligated

balances as of September 30, 1999. Specifically, Air Force auditors

identified an estimated $1.3 billion in inaccurate or unsupported obligated

balances, a significant improvement over the prior year when an estimated

$4 billion in obligated balances were inaccurate or unsupported.

In addition to auditors’ reports, the Department of the Navy identified its

unliquidated and invalid obligations as a material management control

weakness in its fiscal year 1999 annual assurance statement issued

pursuant to the Federal Managers’ Financial Integrity Act. 16 For example,

the Navy reported that within the Operation and Maintenance-Navy

appropriation, some activities were not verifying that only valid

obligations were entered into the accounting system. As a result, funding

may have been available but not used. In addition, the Navy had more than

$1 billion in expired budget authority that was allowed to cancel at the end

of fiscal year 1999, including more than $750 million that had been

obligated but not disbursed. According to Treasury data, at the end of

fiscal year 1999, the department had $3.8 billion in expired budget

authority that canceled.

Accurate and reliable information would permit the Congress to review

DOD year-end unobligated and unexpended balances and identify

opportunities for possible funding reductions. For example, as a result of

our analysis of unobligated balances in the military personnel

appropriation, the House Appropriations Committee recommended a

reduction of $96 million in the fiscal year 2001 request for this account.

Since the military services’ account data have shown a pattern of not

spending all of their appropriated funds, the Committee concluded that the

fiscal year 2001 military personnel budget request is overstated and can be

reduced.

15Opinion on Fiscal Year 1999 Air Force Working Capital Fund Financial Statements (Air Force Audit

Agency Report No. 99068011, Feb. 9, 2000).

16The Federal Managers’ Financial Integrity Act of 1982 requires federal agencies to annually assess

controls and report on internal control and accounting system deficiencies, along with the status of

related corrective actions.
Page 9 GAO/T-AIMD/NSIAD-00-264

Under federal, state, and international law, DOD faces a major funding

requirement associated with environmental cleanup and disposal. These

environmental costs result from the production of weapons systems and

prior and current operations. Even when current operations are carried

out in full compliance with existing environmental regulations, future

cleanup costs for certain operations will still result due to the nature of

these DOD activities. DOD has taken important steps to implement the

federal accounting standards17 requiring recognition and reporting of these

liabilities and has made noteworthy progress. For example, DOD’s

reported estimated liabilities increased from $34 billion in its fiscal year

1998 financial statements to $80 billion in fiscal year 1999. However, the

full magnitude and timing of these costs are not yet known because (1) all

potential liabilities were not considered in the reported estimates,

(2) estimates were not based on the consistent application of assumptions

and methodologies across the services, and (3) support for the basis of

reported estimates continues to be inadequate.

A reliable estimate of DOD’s environmental liability would be an important

factor in determining the cost of its operations and specific programs and

for resource planning. To effectively, efficiently, and economically manage

DOD’s programs, its managers and oversight officials need reliable cost

information for the following key decision points.

Evaluating programs—Long-term liabilities that affect program costs

must be accurately measured and considered in evaluating the status of

programs. For example, the liability for disposal activity is part of the

overall life-cycle cost of weapon systems and can contribute to the

ongoing dialogue on funding comparable weapons. The National Defense

Authorization Act for Fiscal Year 1995 required that the Secretary of

Defense analyze the environmental costs of major defense acquisitions as

part of the life-cycle costs of the programs. However, recent IG audits of

several major weapons systems programs, including the Black Hawk

helicopter and F-15 aircraft, have found that life-cycle cost estimates did

not include costs for demilitarization, disposal, and associated cleanup.18

17Statements of Federal Financial Accounting Standards No. 5, Accounting for Liabilities of the

Federal Government and No. 6, Accounting for Property, Plant, and Equipment.

18Hazardous Material Management for the Black Hawk Helicopter Program (DOD IG Report No. 99-

242, Aug. 23, 1999) and Hazardous Material Management for the F-15 Aircraft Program (DOD IG Report

No. 00-012, Oct. 15, 1999).

Improved Data on

Environmental/

Disposal Liability

Would Be an

Important Oversight

Tool
Page 10 GAO/T-AIMD/NSIAD-00-264

In addition, the Senate Committee on Appropriations has required that

DOD develop disposal cost estimates for munitions.19

Making current economic choices—DOD’s decisions on whether to

outsource specific functions require accurate and complete supporting

cost data. Yet DOD, as well as other government agencies, has historically

been unable to provide actual data on the costs associated with functions

to be considered for outsourcing. For example, environmental and

disposal costs must be considered in the department’s plans to analyze its

more than 2,000 utility systems for privatization. If these costs prove

significant to DOD, they should be considered in any cost-benefit analyses

developed by the department in deciding to retain or privatize these

functions.

Resource planning—Reliable information on the full extent of the

environmental liability that DOD faces under current law and the likely

timing of funding requests would enable DOD and the Congress to make

informed judgments about DOD’s ability to carry out those requirements.

As the Comptroller General recently testified20 before the Senate Budget

Committee, although we are currently enjoying a period of budget surplus,

it does not signal the end of fiscal challenges. Long-term cost pressures

from programs such as Social Security and Medicare will consume an

ever-larger share of the economy and squeeze the resources available for

other commitments and contingencies, such as federal insurance

programs and cleanup costs from federal operations known to result in

hazardous waste, including defense facilities and weapons systems.

Accurate and complete information on the magnitude and timing of DOD’s

environmental liability would permit DOD and the Congress to

strategically plan for this long-term liability and set realistic priorities

among the competing challenges that we will face in the future. Further,

quantifying this enormous liability and providing a breakdown of the costs

by the approximate time periods the disposal costs are expected to be

incurred would add an important context for congressional and other

decisionmakers on the timing of resource needs, including those that are

19Report on the Fiscal Year 1995 Defense Appropriations Bill (Senate Committee on Appropriations,

Senate Report 103-321, July 29, 1994).

20Budget Issues: Effective Oversight and Budget Discipline Are Essential—Even in a Time of Surplus

(GAO/T-AIMD-00-73, Feb. 1, 2000).
Page 11 GAO/T-AIMD/NSIAD-00-264

more near-term. For example, we estimated21 that approximately

$1.6 billion of the $5.6 billion estimate for the disposal of nuclear powered

submarines was for submarines that are already decommissioned and

awaiting disposal.

In summary, the most significant issues faced by the department in

determining and verifying its environmental/disposal liability include

incomplete estimates, inconsistent methodologies, and inadequate

documentation.

Incomplete estimates—To date, DOD has focused on what it expects

will be its most significant liabilities, those associated with nuclear

weapons and training ranges. It has not yet considered the magnitude of

costs associated with other weapon systems, conventional munitions, or

its ongoing operations, although these costs may also be billions of dollars.

For example, the department’s costs to dispose of conventionally powered

ships would be at least $2.4 billion, based on applying the Navy’s estimated

average cost of $500 per ton of displacement used to estimate disposal

costs for its inactive fleet. In addition, we previously estimated that the

conventional munitions disposal liability for Army alone could exceed

$1 billion.

Also, the costs of cleaning up and disposing of assets used in ongoing

operations may be significant. Significant environmental and disposal

costs are required to be recognized over the life of the related assets to

capture the full cost of operations. We are working with DOD to assess

whether operations, such as landfills and utilities (including wastewater

treatment and power generation facilities), will ultimately have significant

environmental costs associated with closure. For example, Edwards Air

Force Base officials provided us with a landfill closure cost estimate of

approximately $8 million. This estimate excluded post-closure

maintenance costs (such as monitoring) which are estimated to exceed

$200,000 annually over 30 years. To provide some perspective on the

potential scope of these operations, the Army alone reported 65 landfills

that, based on the Air Force estimated cost data, could cost nearly

$1 billion to close and monitor.

21The Department of the Navy reported an estimated disposal liability for all nuclear submarines, both

active and inactive and awaiting disposal, of $5.6 billion as of September 30, 1999. To determine the

portion of the total reported $5.6 billion liability that applied to inactive submarines awaiting disposal,

we divided the $5.6 billion by the total number of active and inactive submarines reported in the Naval

Vessel Register to arrive at an estimated disposal cost per submarine of about $49 million. Applying

this average cost to the reported number of inactive submarines awaiting disposal, we estimated a cost

of $1.6 billion to dispose of decommissioned submarines awaiting disposal.
Page 12 GAO/T-AIMD/NSIAD-00-264

Cost estimates should also be refined for changes in cleanup/disposal

schedules. For example, DOD reported a liability of approximately

$8.9 billion in its fiscal year 1999 financial statements for chemical

weapons disposal. Initial estimates to comply with the United Nationssponsored Chemical Weapons Convention were based on a 2007

completion date. However, we recently reported22 that while 90 percent of

the stockpile could be destroyed by the 2007 deadline, schedule slippages

associated with the remaining 10 percent are likely to occur because of

additional time required to validate, certify, and obtain approval of

technologies to dispose of the remaining stockpile of chemical weapons.

These schedule slippages will likely result in additional program costs.

Historically, schedule delays have been found to increase costs such as

labor, emergency preparedness, and program management.

Inconsistent methodologies and inadequate documentation—Each

military service independently estimated its liabilities with, in some cases,

significantly different results, and the lack of documentation hampered

auditors’ ability to verify the estimates. For example, although the Air

Force reported twice as many aircraft as the Navy, it has not yet reported

environmental and disposal liabilities for its aircraft. The Navy’s financial

statements included an initial estimate of $331 million in fiscal year 1999

for its disposal of fixed- and rotary-wing aircraft. In addition, our limited

analysis of DOD’s first-time effort to develop complete cleanup cost

estimates for training ranges, which we view as an important step forward,

showed that the reported amount of $34 billion was comprised primarily

of cost estimates for active, inactive, and closed Navy/Marine Corps ranges

of approximately $31 billion. The Navy reported this to be a minimum

estimate based on assumptions of “low” contamination and

cleanup/remediation to “limited public access” levels, for uses such as

livestock grazing or wildlife preservation but not for human habitation.

Based on these assumptions, the Navy used a cost factor of $10,000 per

acre. Although the Army also has significant exposure for training range

cleanup liabilities, it reported only $2.4 billion for ranges on formerly used

defense sites and closed ranges on active installations. The Army assumed

one closed training range per base for the active installations. However,

because the Army has not developed a complete range inventory nor

recorded any liability for active or inactive ranges, this approach may have

significantly understated its liability. To illustrate the potential magnitude

of Army training range cleanup, applying the cost factor used by the Navy

to estimated range acreage of the Army’s National Training Center at

22Chemical Weapons Disposal: Improvements Needed in Program Accountability and Financial

Management (GAO/NSIAD-00-80, May 8, 2000).
Page 13 GAO/T-AIMD/NSIAD-00-264

Ft. Irwin, California, would result in a cleanup cost estimate of

approximately $4 billion for that installation alone.

Further, DOD has had ongoing problems in adequately documenting its

reported liability—an important control in ensuring its reliability. Last

year, the DOD IG reported that the basis of estimates for significant

recorded liabilities—primarily those related to restoration (cleanup) of

sites contaminated from prior operations—was not adequately supported,

and those problems persist. Military service auditors continue to find that

significant portions of the reported restoration liabilities lack adequate

support for the basis of cost estimates. For example, the Army Audit

Agency found that the Army lacked support for its estimates and

attributed it to the fact that recent guidance on documentation

requirements was not properly disseminated to project managers and

others preparing project cost estimates.

DOD and the Congress are looking at numerous options to provide more—

and more cost-effective—health care to military personnel upon their

retirement. Currently, there are several pilot programs underway to test

the feasibility of providing additional health care benefits to retirees over

65 years, including the Medicare Subvention demonstration and the

TRICARE Senior Supplement project.23 Congress is now considering

expanding these pilot programs to cover greater numbers of retirees or

extending the length of the trial periods. The Congress is also considering

expanding coverage of certain benefits, such as for pharmaceuticals, to

Medicare eligible retirees. Reliable financial and patient care data would

enhance the ability of DOD and the Congress to consider medical care

options.

DOD estimates that, based on its current benefit programs, the cost of

providing future health care benefits for military retirees and their

dependents will be $196 billion;24 however, we have previously testified25

23The Medicare Subvention demonstration allows retirees over 65 to use their Medicare benefit to

receive care from DOD and Medicare will reimburse DOD for a portion of the cost of that care. The

TRICARE Senior Supplement project allows older retirees to use TRICARE programs to supplement

their Medicare coverage, including coverage of prescription drugs.

24DOD’s health benefits liability represents the present value cost of providing future health care

benefits to current retirees and their dependents as well as to that segment of current active duty

personnel and their dependents that DOD estimates will retire from the military. This estimate

generally extends for the lifetimes or covered periods of eligible beneficiaries.

25Department of Defense: Progress in Financial Management Reform (GAO/T-AIMD/NSIAD-00-163,

May 9, 2000).

Better Estimates of

Retiree Health Care

Benefits Could Assist

DOD and the

Congress
Page 14 GAO/T-AIMD/NSIAD-00-264

that this estimate is unreliable because DOD does not have accurate or

complete cost and patient care information. DOD developed its estimate

using an actuarial model that relies on historical information about the

retiree population and the numbers, types, and costs of medical services

provided to them. The model also uses economic, actuarial, and other

assumptions, such as future interest rates and projected rate increases for

medical costs. Improvements to the underlying data or assumptions can

significantly change the liability estimate. DOD has made meaningful

progress in improving the processes and underlying data on which its

liability is based. For example, when better and more complete data about

DOD’s population, medical care costs, and outpatient clinic usage were

used in the model in fiscal year 1999, the revised estimate was lower by

$37.5 billion, or nearly 17 percent, than the fiscal year 1998 estimate.

DOD has used its health care model to determine the long-term impacts of

some benefit changes; for example, DOD recently calculated the long-term

change in the liability of a proposal to provide eligibility for purchased

care to retirees over 65. With better underlying data and some refinements

to its methodology, DOD’s model could be a valuable tool to both the

department and the Congress for estimating the short-term, as well as

long-term, budgetary impacts of complex changes to the retiree health

benefits program. DOD has been using a similar model to calculate its

long-term liability for military retiree pensions for many years, and both

DOD and the Congressional Budget Office rely on the model to analyze the

impact of changes to the retirement program.

As we testified in May 2000, DOD needs to improve the underlying data

used by the model. First, DOD needs actual cost data for its military

treatment facilities. DOD has been using budget obligation information as

a surrogate; however, obligations do not reflect the full cost of providing

health care because they do not, for example, include civilian employee

retirement benefits that are paid directly out of the Civil Service

Retirement and Disability Fund rather than by DOD. Nor do obligations

include depreciation costs for medical facilities and equipment. In

addition, DOD needs to improve the accessibility and reliability of its

patient workload information. The DOD IG has reported26 that medical

services could not be validated either because the medical records were

not available or outpatient visits were not adequately documented. The

DOD IG also reported that outpatient visits are often double counted and

that many telephone consultations have been incorrectly counted as visits.

26Data Supporting the FY 1998 DOD Military Retirement Health Benefits Liability Estimate (DOD IG

Report No. 99-127, Apr. 7, 1999).
Page 15 GAO/T-AIMD/NSIAD-00-264

An accurate count of patient visits by clinic and type is necessary for DOD

to make the proper allocations of medical personnel, supplies, and

funding. DOD has been working with the audit community on health care

cost and workload data deficiencies and currently has several

improvement efforts underway. DOD has been using examples of blatant

data errors, such as negative costs for some surgery clinics and obstetric

services provided to male patients, to stress to its own staff and to health

care contractors the importance of its improvement efforts.

We are currently working with a contractor to assess DOD’s retiree health

benefits estimation methodology, and preliminary results indicate several

areas where the model could be refined. DOD is currently assessing the

feasibility and impact of making the following types of refinements.

• Pharmacy costs for retirees are currently not segregated from those of

non-retirees, even though preliminary evidence suggests that retirees use

more outpatient pharmacy resources. Also, the future trend rate used by

DOD for pharmacy costs is the same as that for general medical costs,

even though we previously estimated that DOD pharmacy costs increased

13 percent from 1995 through 1997 while its overall health care costs

increased only 2 percent for the same period.27

• In the past, DOD has assumed that numbers and types of clinic visits are

adequate measures of outpatient health care usage for purposes of

allocating health care costs to retiree and active duty populations;

however, additional work may show that diagnosis related information is a

better indicator of health resources usage because retirees may have more

complicated diseases and therefore require longer and more resource

intensive procedures.

• DOD’s model currently does not calculate separate liabilities for retirees

under and over 65 years old. DOD applies the same cost and economic

assumptions to the two groups even though Medicare eligible retirees are

offered different benefits than retirees under age 65 and therefore, their

behavior, needs, and costs could be quite different.

27Defense Health Care: Fully Integrated Pharmacy System Would Improve Service and CostEffectiveness (GAO/HEHS-98-176, June 12, 1998).
Page 16 GAO/T-AIMD/NSIAD-00-264

DOD relies on various information systems to carry out its important

stewardship responsibility over an estimated $1 trillion in physical assets,

ranging from multimillion dollar weapon systems to enormous inventories

of ammunition, stockpile materials, and other military items. These

systems are the primary source of information for (1) maintaining visibility

over assets to meet military objectives and readiness goals and

(2) financial reporting. However, these systems have material weaknesses

that, in addition to hampering financial reporting, impair DOD’s ability to

maintain central visibility over its assets and prevent the purchase of

assets already on hand. Overall, these weaknesses can seriously diminish

the efficiency and economy of the military services’ support operations. In

addition, DOD’s systems are not designed to capture the full cost of its

assets, a major component in determining the total costs of its programs

and activities. If reliable, such costs could be important tools for oversight

and performance measurement.

Significant weaknesses in accountability and cost information for DOD’s

three major categories of assets include the following.

Weapons systems— The reported cost of this equipment in fiscal year

1997—the last year for which such information was reported on DOD’s

balance sheet—was more than $600 billion. We have previously testified28

that many of the military services’ logistics information systems used to

track and support weapon systems and support equipment were unable to

be relied on. DOD continues to experience problems in accumulating and

reporting accurate information on its national defense equipment.

For example, because the military services cannot identify all of their

assets through a centralized system, each service had to supplement its

automated data with manual procedures to collect the information. Items

identified as a result of the fiscal year 1999 data call that were not included

in the Army’s centralized systems included 56 airplanes, 32 tanks, and 36

Javelin command-launch units. In addition, the military services have

historically been unable to maintain information on additions and

deletions for most of their national defense assets. While some progress

has been made toward improving this data, auditors found that much of it

was still unreliable for fiscal year 1999. Reliable information on additions

and deletions is an important internal control to ensure accountability

over assets. Without integrated accounting, acquisition, and logistics

systems to provide accounting controls over asset balances, this control is

28DOD Financial Management: More Reliable Information Key to Assuring Accountability and

Managing Defense Operations More Efficiently (GAO/T-AIMD/NSIAD-99-145, Apr. 14, 1999).

Control and

Accountability for

Assets Impaired
Page 17 GAO/T-AIMD/NSIAD-00-264

even more important. For example, property managers should be able to

review information on additions to ensure that all assets acquired are

reported in logistics systems. If such a control is not in place, DOD cannot

have assurance that all items purchased are received and properly

recorded.

Because of the recognized problems with national defense asset

information, the audit community in the past year focused on supporting

and reviewing improvement efforts, rather than conducting any significant

tests of data and systems. Under the National Defense Authorization Act

for Fiscal Year 2000, the DOD Inspector General is required to review

national defense asset data submitted to the Congress for fiscal year 1999.

Such a review should help determine the success of DOD’s improvement

efforts so far, as well as identify those areas requiring further

improvement.

In addition, DOD has acknowledged that the lack of a cost accounting

system is the single largest impediment to controlling and managing

weapon systems costs, including costs of acquiring, managing, and

disposing of weapons systems. Accurate information on the life-cycle

costs of weapon systems would allow DOD officials and the Congress to

make more fully informed decisions about which weapons, or how many,

to buy.

Properly accounting for the revenue associated with the sale of these

assets has also been a significant financial management challenge. Since

October 1998, we have issued four reports identifying internal control

weaknesses in DOD’s foreign military sales program that includes sales of

national defense assets and services to eligible foreign countries. Most

recently, on May 3, 2000, we reported29 that the Air Force did not have

adequate controls over its foreign military sales to ensure that foreign

customers were properly charged. Specifically, our analysis of data

contained in the Defense Finance and Accounting Service’s Defense

Integrated Financial System as of July 1999, indicated that the Air Force

might not have charged FMS customer trust fund accounts for $540 million

of delivered goods and services.

In performing a detailed review of $96.5 million of these transactions, we

found that the Air Force was able to reconcile about $20.9 million.

However, of the remaining $75.6 million, the Air Force had either

29Foreign Military Sales: Air Force Controls Over the FMS Program Need Improvement (GAO/

AIMD-00-101, May 3, 2000).
Page 18 GAO/T-AIMD/NSIAD-00-264

• failed to charge customer accounts ($5.1 million, 22 transactions);

• made errors, such as incorrectly estimating delivery prices ($44 million, 11

transactions); or

• could not explain differences between the recorded value of delivered

goods and services and corresponding value of charges to customer

accounts. ($26.5 million or 19 transactions).

Inventory– DOD’s inability to account for and control its huge investment

in inventories effectively has been an area of major concern for many

years. In its fiscal year 1999 financial statements, DOD reported

$128 billion in inventory and related property. The sheer volume of DOD’s

on-hand inventories impedes the department’s efforts to accumulate and

report accurate inventory data. We reported30 in our January 1999 high-risk

report on defense inventory management that the department needs to

avoid burdening its supply system with large inventories not needed to

support current operations or war reserves. For example, our analysis of

approximately $63 billion of DOD’s reported secondary inventory at

September 30, 1999, showed that 58 percent of the reviewed items, or an

estimated $36.9 billion, exceeded these requirements. Further, during the

fourth quarter of fiscal year 1999, only 2 of the Defense Logistics Agency’s

(DLA) 20 distribution depots reported accuracy rates above 90 percent,

and overall accuracy was reported at 83 percent, with error rates ranging

from 6 percent to 28 percent. DLA’s goal is 95 percent accuracy. The lack

of complete visibility over inventories increases the risk that responsible

inventory item managers may request funds to obtain additional,

unnecessary items that may be on-hand but not reported.

Control weaknesses over inventory can lead to inaccurate reported

balances, which could affect supply responsiveness and purchase

decisions, and result in a loss of accountability. For example, during a

December 1999 visit to one Army ammunition depot, we found weak

internal controls over self-contained, ready-to-fire, handheld rockets, a

sensitive item requiring strict controls and serial number accountability.

As detailed in our recently issued report,31 we and depot personnel

identified 835 quantity and location discrepancies associated with 3,272

rocket and launcher units contained in two storage igloos. The depot had

more items on hand than shown in its records because of control

30Major Management Challenges and Program Risks: Department of Defense (GAO/OCG-99-4, Jan.

1999).

31DOD Inventory: Weaknesses in Controls Over Category I Rockets (GAO/AIMD-00-62R, Apr. 13, 2000).
Page 19 GAO/T-AIMD/NSIAD-00-264

weaknesses over receipt of items, and, in some cases, the records had

location errors. Depot management responded immediately to our

findings, and the depot subsequently accounted for and corrected the

inventory records of all the rocket and launcher units. Regarding this

problem, we identified potentially systemic weaknesses in controls and

lack of compliance with federal accounting standards and inventory

system requirements and made recommendations to the Army to establish

and verify operating procedures to help ensure that systemic weaknesses

are corrected.

DOD has long-standing problems accumulating and reporting the full costs

associated with working capital fund operations that provide goods and

services in support of the military services, its primary customers. The

foundation for achieving the goals of these business-type funds is accurate

cost data, which are critical for management to operate efficiently,

measure performance, and maintain national defense readiness.

With regard to inventory cost information, federal accounting standards

require inventories to be valued based on historical costs or a method that

approximates historical costs. However, DOD systems do not capture the

information needed to report historical cost. Instead, inventory records

and accounting transactions are maintained at a latest acquisition cost or a

standard selling price. Inventory levels are also reported to the Congress at

latest acquisition cost. Although latest acquisition cost data may be

important for budget projection and purchase decisions, this information

may not be appropriate for performance measurement. Latest acquisition

cost can substantially differ from the cost paid for the item. To illustrate

how this occurs, assume a military service had 10 items that cost $10 each,

so each item would be valued at $10, or at $100 in total. However, if the

service then purchased 1 new item at $25, all 11 items would be valued

based upon the latest purchase price of $25, or $275 in total. The former

Commander of Air Force Materiel Command testified in October 1999 that

such valuation practices distort DOD’s progress toward reducing inventory

levels and impact Congressional funding decisions.32 The Commander

stated the following.

“Part of the problem was accounting policy. ...Each year,

inventories of old spare parts were increased in value to

reflect their latest acquisition price (the normal commercial

32Statement of General George T. Babbitt, USAF, Commander, Air Force Materiel Command, Before

the Subcommittee on Military Readiness, Committee on Armed Services, House of Representatives,

October 7, 1999.
Page 20 GAO/T-AIMD/NSIAD-00-264

practice is to deflate, not inflate, the value of long term

assets). Many supply managers who faithfully disposed of

unneeded inventory were surprised at the end of the year to

see their total inventory value increase. As a result, they

were subject to great pressure to further reduce inventory

levels. . . .The new spares were needed but funding

restrictions prevented purchase of these parts for several

years.”

Overall, the effect of increasing prices can be demonstrated by noting that

the Air Force’s $32.6 billion of inventory at latest acquisition cost is

revalued to $18.3 billion to reflect estimated historical costs.

Real and personal property–Audit tests of real property transactions,

additions, deletions, and modifications that occurred during fiscal year

1999 indicated that DOD continues to lack the necessary systems and

processes to ensure that its real property assets are promptly and properly

recorded in its accountability databases. For example, Army auditors

reviewed about $408 million in real property transactions recorded during

fiscal year 1999 and determined that $113 million of those transactions

should have been posted in prior fiscal years. Army auditors also identified

$43 million in unrecorded real property transactions.33 In addition, recent

audits by the military service auditors have continued to find that while

DOD regulations require periodic physical inventories and inspections—a

critical control in safeguarding assets—they are not always performed as

required. Air Force auditors reported that real property personnel did not

perform required inventories at 34 of 99 installations audited in fiscal year

1999. To illustrate the benefit of physical inventories, while implementing

the Navy’s new accountability system, the number of assets recorded in

the accountability database at one Marine Corps location alone increased

by over 35 percent as result of wall-to-wall inventories.

In addition, because DOD does not have the systems and processes in

place to reliably accumulate costs, it is unable to account for several

significant costs of its operations, including its facilities and equipment.

Comprehensive and reliable asset financial information is necessary for

determining the full cost of operations and can be useful for anticipating

the need for additional budgetary resources.

33Army’s General Fund Principal Financial Statements for Fiscal Year 1999, Summary Audit Report

(Army Audit Agency Report No. AA 00-168, Feb. 9, 2000).
Page 21 GAO/T-AIMD/NSIAD-00-264

An analysis of reported asset balances and related depreciation34 can

provide additional information to review specific budget requests. For

example, the Navy reported that 85 percent, or approximately $1.2 billion

of its $1.4 billion of depreciated equipment reported on its fiscal year 1998

financial statements, was fully depreciated. If Navy’s financial information

accurately reflected asset accountability and utilization periods, this

information could be used as a factor in analyzing Navy’s funding requests.

Specifically, if the Navy’s fiscal year 1998 information were accurate, it

would indicate that most of the Navy’s equipment is at or beyond its

anticipated utilization period. This type of information could help support

a funding request or, absent such a request, could be used to question

whether operations would be impaired by the lack of needed capital

equipment.

Our audit of the U.S. government’s consolidated financial statements for

fiscal year 1999 found that the government was unable to support

significant portions of the $1.8 trillion reported as the total net cost of

government operations. Federal accounting standards require federal

agencies to accumulate and report on the full costs of their activities.35

DOD, which represents $378 billion of the $1.8 trillion, was not able to

support its reported net costs. Although we have seen some improvements

in DOD’s ability to produce reliable financial information, as noted

throughout this testimony and discussed in greater detail in my May 9,

2000, testimony, capturing and accurately reporting the full cost of its

programs remains one of the most significant challenges DOD faces.

DOD needs reliable systems and processes to appropriately capture the

required cost information from the hundreds of millions of transactions it

processes each year. To do so, DOD must perform the basic accounting

activities of entering these transactions into systems that conform to

established systems requirements, properly classifying transactions,

analyzing data processed in its systems, and reporting in accordance with

requirements. As I will discuss later, this will require properly trained

personnel, simplified processes, modern integrated systems supporting

operational and accounting needs, and a disciplined approach for

accomplishing these steps.

34Depreciation recognizes the cost of assets over the estimated period of time they are expected to be

used in operations, rather than at the time of acquisition.

35Statement of Federal Financial Accounting Standards No. 4 , Managerial Cost Accounting Standards,

requires accumulating the full cost associated with an entity’s output through appropriate costing

methodologies or cost-finding techniques.

DOD Net Cost

Information Is

Unreliable
Page 22 GAO/T-AIMD/NSIAD-00-264

Because it does not have the systems and processes in place to reliably

accumulate costs, DOD is unable to account for several significant costs of

its operations, as discussed in this testimony. As I have highlighted today,

the accuracy of the department’s reported operating costs was affected by

DOD’s inability to

• complete the reconciliation of its records with those of the Department of

the Treasury,

• identify the full extent of its environmental and disposal liability,

• determine its liability associated with post-retirement health care for

military personnel,

• properly value and capitalize its facilities and equipment, and

• properly account for and value its inventory.

In addition, DOD did not have adequate managerial cost accounting

systems in place to collect, process, and report its $378 billion in total

reported fiscal year 1999 net operating costs by program area consistent

with federal accounting standards.36 Instead it used budget classifications,

such as military construction, procurement, and research and

development, to present its cost data. In general, the data DOD reported in

its financial statements represented disbursement data for those budgetary

accounts, adjusted for estimated asset purchases and accruals. For

financial reports other than the financial statements, DOD typically uses

obligation data as a substitute for cost. As I stated earlier, DOD budget

data are also unreliable.

To manage DOD’s programs effectively and efficiently, its managers need

reliable cost information. This information is necessary to (1) evaluate

programs, such as by measuring actual results of management’s actions

against expected savings or determining the effect of long-term liabilities

created by current programs, (2) make economic choices, such as whether

to outsource specific activities and how to improve efficiency through

technology choices, (3) control costs for its weapons systems and

business activities funded through the working capital funds, and

(4) measure performance.

36Statement of Federal Financial Accounting Standards No. 4, Managerial Cost Accounting Standards

(July 31, 1995) and Internal Controls and Compliance With Laws and Regulations for the DOD AgencyWide Financial Statements for FY 1999 (DOD IG Report No. D-2000-091, Feb. 25, 2000).
Page 23 GAO/T-AIMD/NSIAD-00-264

The lack of reliable, cost-based information hampers DOD in each of these

areas as illustrated by the following examples.

• DOD is unable to provide actual data to fully account for the costs

associated with functions studied for potential outsourcing under OMB

Circular A-76. We reported last year on a long-standing concern over how

accurately DOD’s in-house cost estimates used in A-76 competitions

reflect actual costs.37

• DOD has acknowledged that its Defense Reform Initiative efforts have

been hampered by limited visibility into true ownership costs of its

weapons systems. Specifically, the department cited inconsistent methods

used by the military services to capture support cost data and failure to

include certain costs as limiting the utility of existing weapons system cost

data. As noted previously, DOD has also acknowledged that the lack of a

cost accounting system is the single largest impediment to controlling and

managing weapon systems costs, including costs of acquiring, managing,

and disposing of weapon systems.

• DOD has long-standing problems accumulating and reporting the full costs

associated with its working capital fund operations, which provide goods

and services in support of the military services. Cost is a key performance

indicator to assess the efficiency of working capital fund operations. For

example, we recently reported38 that the Air Force’s Air Mobility

Command—which operated using a working capital fund—lacked

accurate cost information needed to set rates to charge its customers and

assess the economy and efficiency of its operations. We separately

reported that Air Force depot maintenance officials acknowledged that

they lack all the data needed to effectively manage their material costs.39

As a result, DOD is unable to reliably assess the economy and efficiency of

its business-like activities financed with working capital funds.

37DOD Competitive Sourcing: Lessons Learned System Could Enhance A-76 Study Process

(GAO/NSIAD-99-152, July 21, 1999).

38Defense Transportation: More Reliable Information Key to Managing Airlift Services More Efficiently

(GAO/NSIAD-00-6, Mar. 6, 2000).

39Air Force Depot Maintenance: Analysis of Its Financial Operations (GAO/AIMD/NSIAD-00-38,

Dec. 10, 1999).
Page 24 GAO/T-AIMD/NSIAD-00-264

Establishing an integrated financial management system—including both

automated and manual processes—will be key to reforming DOD’s

financial management operations. DOD has acknowledged that its present

system has long-standing inadequacies and does not, for the most part,

comply with federal system standards. DOD has set out an integrated

financial management system goal. Further, the department is now wellpositioned to adapt the lessons learned from addressing the Year 2000

issue and our recently issued survey of the best practices of world-class

financial management organizations40 and to use the information

technology investment criteria included in the Clinger-Cohen Act of 1996.

Establishing an integrated system is central to the framework for financial

reforms set out by the Congress in the Chief Financial Officers (CFO) Act

of 1990 and the Federal Financial Management Improvement Act (FFMIA)

of 1996. Specifically, among the requirements of the CFO Act is that each

agency CFO develop an integrated agency accounting and financial

management system. Further, FFMIA provided a legislative mandate to

implement and maintain financial management systems that substantially

comply with federal financial management systems requirements,

including the requirement that federal agencies establish and maintain a

single, integrated financial management system.41

The department faces a significant challenge in integrating its financial

management systems because of its size and complexity and the condition

of its current financial management operations. DOD is not only

responsible for an estimated $1 trillion in assets and liabilities, but also for

providing financial management support to personnel on an estimated 500

bases in 137 countries and territories throughout the world. DOD has also

estimated that it makes $24 billion in monthly disbursements, and that in

any given fiscal year, the department may have as many as 500 or more

active appropriations. Each service operates unique, nonstandard financial

processes and systems. In describing the scope of its challenge in this

area, DOD recognized that it will not be possible to reverse decades-old

problems overnight.

40Executive Guide: Creating Value Through World-class Financial Management (GAO/AIMD-00-134,

Apr. 2000).

41Office of Management and Budget Circular A-127 defines an integrated financial management system

as a unified set of financial systems and the financial portions of mixed systems encompassing the

software, hardware, personnel, processes (manual and automated), procedures, controls, and data

necessary to carry out financial management functions of an agency, manage financial operations of an

agency, and report on an agency’s financial status to central agencies, Congress, and the public.

Integrated Financial

Management System

Using Year 2000

Approach

Integrated Financial

Management System

Needed
Page 25 GAO/T-AIMD/NSIAD-00-264

DOD submitted its first Financial Management Improvement Plan to the

Congress on October 26, 1998. We reported42 that DOD’s plan represented

a great deal of effort and provided a first-ever vision of the department’s

future financial management environment. In developing this overall

concept of its envisioned financial management environment, DOD took

an important first step in improving its financial management operations.

DOD’s 1999 update to its Financial Management Improvement Plan set out

an integrated financial management system as the long-term solution for

establishing effective financial management. As part of its 1999 plan, DOD

reported that it relies on an inventory of 168 systems to carry out its

financial management responsibilities. This financial management systems

inventory includes 98 finance and accounting systems and 70 critical

feeder systems—systems owned and operated by functional communities

throughout DOD, such as personnel, acquisition, property management,

and inventory management. The inclusion of feeder systems in the

department’s inventory of financial management systems is a significant

landmark because of the importance of the programmatic functions to the

department’s ability to carry out not only its financial reporting but also its

asset accountability responsibilities. The department has reported that an

estimated 80 percent of the data needed for sound financial management

comes from these feeder systems. However, DOD has also acknowledged

that, overall, its financial management systems do not comply with the

FFMIA federal financial management systems requirements.

DOD presently lacks the integrated, transaction-driven, double entry

accounting systems that are necessary to properly control assets and

accumulate costs. As a result, millions of transactions must be keyed and

rekeyed into the vast number of systems involved in a given business

process. To illustrate the degree of difficulty that DOD faces in managing

these complex systems, the following figure shows for one business

area—contract and vendor payments—the number of systems involved

and their relationship to one another.

42Financial Management: Analysis of DOD’s First Biennial Financial Management Improvement Plan

(GAO/AIMD-99-44, Jan. 29, 1999).
Page 26 GAO/T-AIMD/NSIAD-00-264

Figure 1: DOD’s Current Systems Environment for the Contract and Vendor

Payment Process

Source: Department of Defense.

In addition to the 22 financial systems involved in the contract payment

process that are shown in figure 1, DFAS has identified many other critical

acquisition systems used in the contract payment process that are not

shown on this diagram. To further complicate the processing of these

transactions, each transaction must be recorded using a nonstandard,

complex line of accounting that accumulates appropriation, budget, and

management information for contract payments. Moreover, the line of

accounting code structure differs by service and fund type. For example,

the following line of accounting is used for the Army’s Operations and

Maintenance appropriation.

2162020573106325796.BD26FBQSUPCA200GRE12340109003AB22WORNAAS34030

Because DOD’s payment and accounting processes are complex, and

generally involve separate functions carried out by separate offices using

different systems, the line of accounting must be manually entered

multiple times, which compounds the likelihood of errors. An error in any

one character in such a line of code can delay payment processing or

affect the reliability of data used to support management and budget

IPC

GAFS

BCAS

SRD1

ADS

IAPS

CAPS

DJAS

1 Bill

Pay

MOCAS

DPPS

DSDS

SABRS

STARS

STANFINS

APADE

ITIMP

SAACONS

SPS

CEFT Debt

Mgt

Prevalidation
Page 27 GAO/T-AIMD/NSIAD-00-264

decisions. In either case, time-consuming research must then be

conducted by DOD staff or by contractor personnel to identify and correct

the error. Over a period of 3 years, one DOD payment center spent

$28.6 million for a contractor to research such errors.

The combination of nonintegrated systems, extremely complex coding of

transactions, and poor business processes have resulted in billions of

dollars of adjustments to correct transactions processed for functions

such as inventory and contract payments. As stated previously, during

fiscal year 1999, almost one of every three dollars in contract payment

transactions was made to adjust a previously recorded transaction. In

addition, the DOD IG found that $7.6 trillion of adjustments to DOD’s

accounting transactions were required last year to prepare DOD’s financial

statements.

As we testified last year, DOD has a unique opportunity to capitalize on the

valuable lessons it has learned in addressing the Year 2000 issue and apply

them to its efforts to reform financial management. The Year 2000

approach is based on managing projects as critical investments and uses a

structured five-phase process, including awareness, assessment,

renovation, validation, and implementation. Each phase represents a

major program activity or segment that includes (1) specific milestones,

(2) independent validation and verification of system compliance, and

(3) periodic reporting on the status of technology projects. During the

department’s Year 2000 effort, DOD followed this structured approach and

(1) established interim dates or milestones for each significant aspect of

the project, (2) used auditors to provide independent verification and

validation of systems compliance, and (3) periodically reported the status

of its efforts to OMB, the Congress, and the audit community.

To successfully adapt this structured, disciplined process to DOD’s current

financial management improvement initiatives, DOD must ensure that the

lessons learned in addressing the Year 2000 effort and from our financial

management best practices survey are effectively applied. In this regard,

two important lessons should be drawn from the Year 2000 experience—

the importance of (1) focusing on process improvement instead of systems

compliance and (2) strong leadership at the highest levels of the

department to ensure the reform effort becomes an entitywide priority.

Establishing the right goal is essential for success. Initially, DOD’s Year

2000 focus was on information technology and systems compliance. This

process was geared toward ensuring compliance system by system and did

not appropriately consider the interrelationship of all systems within a

DOD Adopts Year 2000

Approach

End-to-End Business Process

Focus
Page 28 GAO/T-AIMD/NSIAD-00-264

given business process. However, DOD eventually shifted to a core

mission and function approach and greatly reduced its Year 2000 risk

through a series of risk mitigation measures including 123 major process

end-to-end evaluations. Through the Year 2000 experience, DOD has

learned that the goal of systems improvement initiatives should be

improving end-to-end business processes, not systems compliance.

This concept is also consistent with provisions of the Clinger-Cohen Act of

1996 and related system and software engineering best practices, which

provide federal agencies with a framework for effectively managing large,

complex system modernization efforts. This framework is designed to help

agencies establish the information technology management capability and

controls necessary to effectively build modernized systems. For example,

the act requires agency chief information officers to develop and maintain

an integrated system architecture. Such an architecture can guide and

constrain information system investments, providing a systematic means

to preclude inconsistent system design and development decisions and the

resulting suboptimal performance and added cost associated with

incompatible systems. The act also requires agencies to establish effective

information technology investment management processes whereby

(1) alternative solutions are identified, (2) reliable estimates of project

costs and benefits are developed, and (3) major projects are structured

into a series of smaller increments to ensure that each constitutes a wise

investment.

The financial management concept of operations included in DOD’s

Financial Management Improvement Plan should fit into the overall

system architecture for the department developed under the provisions of

the Clinger-Cohen Act. In addition, the goal of DOD’s Financial

Management Improvement Plan should be to improve DOD’s business

processes in order to provide better information to decisionmakers and

ensure greater control and accountability over the department’s assets.

However, we reported last year,43 the vision and goals the department

established in its Financial Management Improvement Plan fell short of

achieving basic financial management accountability and control and did

not position DOD to adopt financial management best practices in the

future.

Although the 1999 improvement plan includes more detailed information

on the department’s hundreds of improvement initiatives, the fundamental

43Financial Management: Analysis of DOD’s First Biennial Financial Management Improvement Plan

(GAO/AIMD-99-44, Jan. 29, 1999).
Page 29 GAO/T-AIMD/NSIAD-00-264

challenges we highlighted last year remain. Specifically, a significant effort

will be needed to ensure that future plans address (1) how financial

management operations will effectively support not only financial

reporting but also asset accountability and control, (2) how financial

management ties to budget formulation, (3) how the planned and ongoing

improvement initiatives will result in the target financial management

environment, and (4) how feeder systems’ data integrity will be

improved—an acknowledged major deficiency in the current environment.

For example, to effectively support accountability and control, DOD’s plan

needs to define each of its business processes and discuss the

interrelationships among the functional areas and related systems. To

illustrate, the plan should address the entire business process for property

from acquisition to disposal and the interrelationships among the

functional areas of acquisition, property management, and property

accounting.

In its 1999 Financial Management Improvement Plan, dated September

1999, the department announced its intention to develop a “Y2K like”

approach for tracking and reporting the CFO compliance of its financial

management systems, including critical feeder systems. However, the

department currently has hundreds of individual initiatives aimed at

improving financial management, many of which were begun prior to the

decision that a Year 2000 approach would be used for financial

management reform. These decentralized, individual efforts must now be

brought under the disciplined structure envisioned by the Clinger-Cohen

Act and used previously during the department’s Year 2000 effort. Doing so

will ensure that further investments in these initiatives will be consistent

with Clinger-Cohen Act investment criteria and that the department’s

financial management reform efforts focus on entire business processes

and needed process improvements.

Because of the extraordinarily short time frames involved for the Year

2000 effort, the department rarely had the opportunity to evaluate

alternatives such as eliminating systems and reengineering related

processes. DOD has established a goal of September 30, 2003, for

completing its financial management systems improvement effort. This

time frame provides a greater opportunity to consider all available

alternatives, including reengineering business processes in conjunction

with the implementation of new technology, which was envisioned by the

Clinger-Cohen Act.

Lessons learned from the Year 2000 effort and from our survey of leading

financial management organizations also stressed the importance of strong

Strong Department-Level

Leadership
Page 30 GAO/T-AIMD/NSIAD-00-264

leadership from top leaders. Both these efforts pointed to the critical role

of strong leadership in making any goal—such as financial management

and systems improvements—an entitywide priority. As we have testified

many times before, strong, sustained executive leadership is critical to

changing the culture and successfully reforming financial management at

DOD. Although it is the responsibility of the DOD Comptroller, under the

CFO Act, to establish the mission and vision for the future of DOD

financial management, the department has learned through its Year 2000

effort that major initiatives that cut across DOD components must have

the leadership of the Secretary and Deputy Secretary of Defense to

succeed. In addition, our best practices work has shown that chief

executives similarly need to periodically assess investments in major

projects in order to prioritize projects and make sound funding decisions.

Improving DOD financial management is a managerial, as well as

technical, challenge. The personal involvement of the Deputy Secretary

played an important role in building entitywide support for Year 2000

initiatives by linking these improvements to the warfighting mission. To

energize DOD, the Secretary of Defense directed the DOD leadership to

treat Year 2000 as a readiness issue. This turning point ensured that all

DOD components understood the need for cooperation to achieve success

in preparing for Year 2000 and it galvanized preparedness efforts.

Similarly, to gain DOD-wide support for financial management systems

initiatives, DOD’s top leadership must link the improvement of financial

management to DOD’s mission. For example, DOD stated in its Defense

Reform Initiative that improved business practices will eventually provide

a major source of funding for weapon system modernization. This can

occur through reductions in the cost of performing these activities as well

as through efficiencies gained through better information. To ensure that

this mission objective is realized will require top leadership involvement to

reinforce the relationship between good financial management and

improved mission performance. To build this support across the

organization, many leading organizations have developed education

programs that provide financial managers a better understanding of the

business problems and nonfinancial managers an appreciation of the value

of financial information to improved decision-making. As discussed below,

DOD is taking these first steps in providing training to its financial

personnel, and DOD officials have recently stated that their next annual

financial management improvement plan will begin to address the need for

financial management training for nonfinancial managers.
Page 31 GAO/T-AIMD/NSIAD-00-264

An integral part of financial and information management is building,

maintaining, and marshaling the human capital needed to achieve results.

While DOD has several initiatives underway directed at improving the

competencies and professionalism of its financial management workforce,

it has not yet embraced a strategic approach to improving its financial

management human capital. Our recently issued guide on the results of

our survey of the best practices of recognized world-class financial

management organizations shows that a strategic approach to human

capital is essential to reaching and maintaining maximum performance.

DOD’s 1999 Financial Management Improvement Plan recognized the key

role of financial management training in ensuring that the department has

a qualified and competent workforce. The DOD Comptroller recently

issued a memorandum to the department’s financial management

community emphasizing the importance of professional training and

certification in helping to ensure that its financial managers are wellqualified professionals. Consistent with this recent emphasis, the

department has begun several initiatives aimed at improving the

professionalism of its financial management workforce. For example,

DFAS contracted to have government financial manager training

developed by the Association of Government Accountants provided to

several thousand of its employees over the next 5 years. This training is

aimed at enhancing participants’ knowledge of financial management and

can then be used to prepare for a standardized exam to obtain a

professional certification, such as the Certified Government Financial

Manager (CGFM)44—a designation being encouraged by DOD

management.

In another initiative, undertaken in conjunction with the American Society

of Military Comptrollers, the department reports that it expects to have its

own examination-based certification program for a defense financial

manager in place in the near future. The department has contracted with

the USDA Graduate School—a continuing education institution—to

provide financial management training to an estimated 2,000 DOD

financial personnel in fiscal year 2000 and thousands more over the next 5

years. The department reports that this training will be directed at helping

participants to develop sufficient knowledge so that they can demonstrate

competencies in governmentwide accounting and financial management

systems requirements as they are applied in the DOD financial

management environment.

44The Certified Government Financial Manager (CGFM) is a government financial manager

professional certification awarded by the Association of Government Accountants.

Strategic Human

Capital Investment

Integral to Reform
Page 32 GAO/T-AIMD/NSIAD-00-264

The department is faced with a considerable challenge if it is to improve

its financial management human capital to the performance-based level of

financial management personnel operating as partners in the management

of world-class organizations. While DOD’s financial personnel are now

struggling to effectively carry out day-to-day transaction processing,

personnel in world-class financial management organizations are

providing analysis and insight about the financial implications of program

decisions and the impact of those decisions on agency performance goals

and objectives. To help agencies better implement performance-based

management, we have identified common principles that underlie the

human capital strategies and practices of leading private sector

organizations.45 Further, we have issued a human capital self-assessment

checklist for agency leaders to use in taking practical steps to improve

their human capital practices.46

In closing, as we have noted throughout this testimony, DOD continues to

make incremental improvements to its financial management systems and

operations. At the same time, the department has a long way to go to

address the remaining problems. Overhauling DOD’s financial systems,

processes, and controls and ensuring that personnel throughout the

department share the common goal of improving DOD financial

management, will require sustained commitment from the highest levels of

DOD leadership—a commitment that must extend to the next

administration.

Mr. Chairman, this concludes my statement. We will be glad to answer any

questions you or the other Members of the Task Force may have at this

time.

(924050)

45Human Capital: Key Principles From Nine Private Sector Organizations (GAO/GGD-00-28, Jan. 31,

2000).

46Human Capital: A Self-Assessment Checklist for Agency Leaders (GAO/GGD-99-179, Sept. 1999).
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