For Release on Delivery

Expected at

2 p.m.

Tuesday,

May 9, 2000

GAO/T-AIMD/NSIAD-00-163

DEPARTMENT OF

DEFENSE

Progress in Financial

Management Reform

Statement of Jeffrey C. Steinhoff

Acting Assistant Comptroller General

Accounting and Information Management Division

Testimony

Before the Subcommittee on Government Management,

Information and Technology, Committee on Government

Reform, House of Representatives

United States General Accounting Office

GAO
Page 1 GAO/T-AIMD/NSIAD-00-163

Mr. Chairman and Members of the Subcommittee:

I appreciate the opportunity to discuss the status of financial management

at the Department of Defense (DOD). This is the third year that we have

participated in such a hearing before this Subcommittee, and we believe

that your sustained commitment to financial management reform

governmentwide and at DOD, in particular, has resulted in the steady

improvement we have seen across government. At the same time, as we

testified1 before the Subcommittee on March 31, 2000, on the results of our

review of the fiscal year 1999 Financial Report of the U.S. Government,

significant financial systems weaknesses, problems with fundamental

recordkeeping and financial reporting, incomplete documentation, and

weak internal controls, including computer controls, continue to prevent

the government from accurately reporting a significant portion of its

assets, liabilities, and costs. 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. Ineffective asset accountability and

control adversely affect DOD’s visibility over weapon systems and

inventory, and unreliable cost and budget information affects DOD’s

ability to effectively measure performance, reduce costs, and maintain

adequate funds control. We have worked closely and constructively with

1Auditing the Nation’s Finances: Fiscal Year 1999 Results Continue to Highlight Major Issues Needing

Resolution (GAO/T-AIMD-00-137, Mar. 31, 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-00-163

the DOD Inspector General (IG) and the military service audit agencies to

help provide further clarification of the scope and magnitude of the

department’s problems and recommendations to correct them.

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 addressing

long-standing, deeply rooted problems. For example, significant areas of

improvement include (1) increased accountability over property, plant,

and equipment, (2) more complete reporting of environmental and

disposal liabilities, (3) increased understanding and documentation of the

Fund Balance With Treasury reconciliation process, and (4) development

of a detailed concept of operations included in the department’s Financial

Management Improvement Plan. At the same time, DOD has a long way to

go. Major problems remain—problems that are pervasive, deeply rooted,

and complex in nature. My testimony today outlines DOD’s most difficult

financial management challenges and describes the initiatives that are in

place or planned to address many of them. These challenges include

DOD’s inability to

• properly account for and report (1) billions of dollars of inventory and

property, plant, and equipment and (2) national defense assets, primarily

weapon systems and support equipment;

• estimate and report material amounts of environmental and disposal

liabilities and their related costs;

• determine the liability associated with post-retirement health benefits for

military employees;

• accurately report the net costs of its operations and produce accurate

budget data; and

• provide adequate controls over sensitive computer information.

DOD has hundreds of initiatives under way to address these key

challenges, with many of the planned fixes designed to result in a onetime, year-end number for financial statement purposes. However,

achieving an unqualified or “clean” financial audit opinion, while an

important milestone, is not the final goal and must be accomplished

through real improvements in the underlying financial management

systems and operations that affect DOD’s ability to manage its day-to-day

activities effectively. The substantial efforts needed to work around DOD’s

serious systems and control weaknesses to derive year-end balances will
Page 3 GAO/T-AIMD/NSIAD-00-163

not produce the timely and reliable financial and performance information

DOD needs to manage its operations every day.

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

game”—systems and processes that routinely generate good financial

information for management purposes—will require a major systems and

reengineering effort. In this regard, the lessons learned from DOD’s Year

2000 experience can prove to be a valuable teacher. Specifically, the

successful Year 2000 effort demonstrated that DOD can resolve complex,

entitywide problems through top management leadership working across

functional lines. Similarly, our Executive Guide: Creating Value Through

World-class Financial Management3 notes that building a sound financial

management organization begins with leadership that clearly defines and

communicates the organization’s mission and vision for the future. Finally,

I will discuss actions DOD is taking to address training its personnel and

the importance of having a strong human capital investment strategy.

As discussed in our recent report on the fiscal year 1999 consolidated

financial statements, the federal government—one of the world’s largest

holders of physical assets—does not have accurate information about the

amount of assets held to support its domestic and global operations.

Material weaknesses in DOD’s ability to carry out its stewardship

responsibilities over an estimated $1 trillion in physical assets—ranging

from enormous inventories of ammunition, stockpile materials, and other

military items to buildings and facilities to multimillion dollar weapons

systems—were a major factor in the federal government’s inability to

account for and report on its assets. The following sections discuss DOD’s

problems and ongoing improvement efforts in accounting for inventory

and related property; property, plant, and equipment; and national defense

assets.

DOD inventory includes ammunition (such as machine gun cartridges,

mines, and grenades), repairable items (such as navigational computers,

landing gear, and hydraulic pumps), consumables (such as clothing, bolts,

and medical supplies), and national defense stockpile materials (such as

industrial diamonds, rubber, and beryllium). 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

3GAO/AIMD-00-134, Apr. 2000.

Control and

Accountability Over

Assets Impaired

Accountability Over

Inventory and Related

Property Remains a

Concern
Page 4 GAO/T-AIMD/NSIAD-00-163

reported4 in our January 1999 high-risk report on defense inventory

management that the department needs to avoid burdening its supply

system with large unneeded inventories. For example, our analysis of

DOD data as of September 30, 1999, showed that 58 percent of on-hand

items, or an estimated $36.9 billion of DOD’s reported secondary

inventory, exceeded requirements.

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

inventories effectively has been an area of major concern for many years.

Audit results for fiscal year 1999 again demonstrate that DOD does not

know the actual amount and value of inventory for which it is responsible

due to three critical deficiencies: (1) physical controls over inventory are

inadequate, (2) DOD does not capture all inventories in its records, and

(3) reported inventory values are questionable. DOD recognizes the

seriousness of this problem and has a number of initiatives under way to

address these issues, as well as several broad initiatives intended to

simplify the complicated processes it currently uses to account for

inventory.

We, the DOD Inspector General, and the audit services have repeatedly

reported on weak controls over DOD supply inventory. The Defense

Logistics Agency’s (DLA) distribution depots store approximately 75

percent of DOD’s consumable and repairable items. DLA is responsible for

conducting physical counts of inventory in its depots and measuring and

ensuring inventory record accuracy. In June 1999, we reported on

significant control weaknesses in DLA’s inventory count process that

affected the integrity of the physical counts and the reliability of the

reported inventory record accuracy.5 Specifically, 14 DLA distribution

depots we visited had reported accuracy rates below DLA’s goal of 95

percent and error rates of up to 28 percent, with only 2 depots having

accuracy rates above 90 percent. Similar weaknesses continue. During the

fourth quarter of fiscal year 1999, only two of DLA’s 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 has a number of initiatives under way to address the inventory

accuracy issue. For example, during 1999, DLA initiated the development

of a statistical sampling plan to measure the dollar accuracy of DLA4 Major Management Challenges and Program Risks: Department of Defense (GAO/OCG-99-4, Jan. 1999).

5Financial Management: Better Controls Essential to Improve the Reliability of DOD’s Depot Inventory

Records (GAO/AIMD-99-132, June 28, 1999).

Physical Controls Over

Inventory
Page 5 GAO/T-AIMD/NSIAD-00-163

owned inventory. DLA is working with us and the DOD audit community

in the design, implementation, and execution of the plan. After refining the

plan to address any problems encountered in applying this approach to

valuing DLA inventories, DOD plans to expand the statistical sampling

plan to include the valuation of the assets it stores for the military

services. Further, section 347 of the Strom Thurmond National Defense

Authorization Act for Fiscal Year 1999 requires the secretary of each

military department to set up a schedule to implement best commercial

inventory practices for secondary supply items by 2003. The statute

defines commercial best practices as including those that will enable the

military departments to reduce inventory levels while improving

responsiveness to user needs. While not specifically initiated to address

this new requirement, DLA’s recent contract with the University of

Arkansas to examine private sector business practices, including obtaining

data on performing and controlling physical counts, should help the

department identify and implement commercial best practices in this area.

Physical control weaknesses have also been reported for military service

locations that hold inventory. For example, for fiscal years 1997 and 1998,

Navy auditors reported 23 percent and 14 percent error rates, respectively,

for the Supply Fund storage locations they visited. Because of these poor

results and acknowledgment by Navy management that better results

could not be expected for fiscal year 1999, Navy auditors limited their tests

for the fiscal year 1999 audit. The Naval Audit Service performed limited

physical inventory counts at nine selected non-Supply Fund locations to

determine if internal controls were in place and functioning well enough to

be relied upon to provide accurate and complete inventory records.

Results at seven of the nine locations visited indicated that controls were

not in place or were not functioning as designed. For example, three of the

locations visited had error rates in excess of 10 percent.

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,6 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

6DOD Inventory: Weaknesses in Controls Over Category I Rockets (GAO/AIMD-00-62R, Apr. 13, 2000).
Page 6 GAO/T-AIMD/NSIAD-00-163

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.

Over the years, we have reported billions of dollars of materials that were

not “visible” to managers—that is, they were not captured in DOD’s central

visibility records and therefore managers did not know they existed and

could not ensure accountability. These kinds of omissions adversely

affected the department’s financial reporting and its reporting to the

Congress on inventory reductions. Further, 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. Recent audit results indicate that these

problems continue. Examples of these visibility issues include the

following.

• In recent years, we and the audit services have reported weak controls

over inventory in transit. For example, the Air Force Audit Agency (AFAA)

reported7 in 1998 that the Air Force did not accurately account for

inventory items being shipped from one location to another and did not

know the value of this inventory. In addition, the Army Audit Agency

reported8 for fiscal year 1999 that the Army could not determine the value

of in-transit inventory and that audit trails did not exist. We reported9 in

1999 that the Navy had not followed established internal control

procedures to notify inventory mangers of inventory shipments or receipts

and instead had reported these items as lost during shipment. As a result,

the Navy lost visibility of $3 billion of in-transit inventory over the past 3

years. In our February 2000 follow-up report, we reported10 that the

7Compliance with Federal Financial Accounting Standards Numbers 1 and 3 (AFAA Project 97068017,

Sept. 15, 1998).

8Army Working Capital Fund Principal Financial Statements for Fiscal Year 1999: Auditors Report

(Army Audit Agency Report No. AA-00-177, Feb. 10, 2000).

9Defense Inventory: Navy’s Procedures for Controlling In-Transit Items Are Not Being Followed

(GAO/NSIAD-99-61, Mar. 31, 1999).

10Department of the Navy: Breakdown of In-Transit Inventory Process Leaves It Vulnerable to Fraud

(GAO/OSI/NSIAD-00-61, Feb. 2, 2000).

Inventory Visibility
Page 7 GAO/T-AIMD/NSIAD-00-163

majority of the items that the Navy reported as lost were delivered and

that there was no evidence of theft in the shipments we reviewed.

However, we also found that the inventory process was vulnerable and

that Navy may have made procurements during this period for some of

these items on hand but not visible to item managers. For example, a

commercial repair facility in Singapore received 3 shipments of 67

generators (valued at $593,620) for Navy aircraft that were written off in

fiscal year 1997 as an in-transit loss. In October 1999, the Navy purchased

88 generators (valued at $1.2 million) and initiated purchase orders for an

additional 145 generators (valued at $1.9 million) Among other items not

visible to inventory managers were classified and sensitive items, such as

aircraft guided-missile launchers, and unclassified items, such as cockpit

video recorders.

On September 14, 1999, the department submitted a plan to the Congress

containing 18 proposed actions, performance measures, and

implementation schedules. DOD’s overall objective is to achieve 100

percent visibility of inventory in transit at all times. As discussed in our

February 2000 report on the results of our analysis of DOD’s plan,11 DOD’s

proposed actions in this area represent a necessary first step to

improvement, but the plan does not adequately address how the

department will overcome underlying weaknesses that have led to the lack

of control over inventory shipments. In any case, the department’s efforts

to implement the plan are ongoing and are expected to take several years

to complete.

• The Naval Audit Service reported12 that the Navy did not include material

turned into stores in its fiscal 1999 financial statements because the

inventory was not processed promptly and therefore had not been

recorded in the inventory system. At one distribution depot, the Navy had

a backlog of materials turned into that depot of an estimated 122,000 line

items as of September 30, 1999. This represented a backlog of

approximately 10 months, according to the Deputy Commander of the

depot. These items were not recorded in any inventory record and were

therefore not visible to the item managers for management and planning.

This backlog could result in the Navy purchasing items that it does not

need because item managers do not have information on all items that are

already on hand.

11Defense Inventory: Plan to Improve Management of Shipped Inventory Should Be Strengthened

(GAO/NSIAD-00-39, Feb. 22, 2000).

12Fiscal Year 1999 Consolidated Financial Statements of the Department of the Navy Working Capital

Fund (Naval Audit Service Report No. N2000-0019, Feb. 14, 2000).
Page 8 GAO/T-AIMD/NSIAD-00-163

• In its fiscal year 1999 financial reporting, the Navy included for the first

time, several key categories of inventory, such as sponsor-owned

material13 valued at $5.5 billion and inventory items at redistribution sites

valued at $600 million. At the same time, deficient logistics systems

continue to impair the Navy’s ability both to maintain visibility and

prepare reliable financial reports for these assets effectively. For example,

one command could only estimate a value for its sponsor-owned inventory

because it did not have a system in place to capture and report this

material. The command’s estimate of $2 billion represented over a third of

the Navy’s reported $5.5 billion of sponsor-owned material. Further, while

the Navy’s inclusion of several key inventory categories has substantially

improved the completeness of its inventory reporting, not all categories of

Navy inventory are yet included. Specifically, Navy auditors reported in

February 200014 that the Navy’s fiscal year 1999 reporting omitted

$9.2 billion of shipboard inventories because logistical systems could not

fully support the required accounting methodology. Lacking effective

financial management systems that can provide the information needed to

produce financial reports, various Navy commands rely on data calls and

error-prone manual reentry of inventory data. For example, one Navy

command did not report any inventory. However, after a follow-up review

by Navy auditors, the command reported inventory of $550 million. During

fiscal year 1999, the Navy began an effort to identify and evaluate the

logistics systems used to account for and control its inventories. The Navy

established a working group of senior Navy financial and program

managers and audit community representatives to address this issue. To

start, the working group is focused on evaluating existing systems to

identify opportunities to consolidate and substantially reduce the number

of systems. In the next phase, the group is to work on improving the asset

visibility and financial reporting capabilities of the remaining systems.

• Air Force auditors could not verify the accuracy of $2.9 billion in inventory

in the hands of contractors.15 The Air Force extracted that amount from

the Contract Property Management System for financial reporting.

However, the auditors could not determine whether the $2.9 billion of

inventory shown in the system was reliable because the system did not

provide a sufficient audit trail.

13The Navy defines sponsor-owned materials as items outside of the supply fund that support weapon

systems and equipment.

14Fiscal Year 1999 Department of the Navy Principal Statements for Fiscal Year 1999 (Naval Audit

Service Report No. N2000-0018, Feb. 10, 2000).

15Opinion on Fiscal Year 1999 Air Force Consolidated Financial Statements (Air Force Audit Agency

Report No. 9953002, Feb. 9, 2000).
Page 9 GAO/T-AIMD/NSIAD-00-163

DOD is making efforts to improve its inventory management and ability to

report reliable inventory levels to the Congress and in financial

statements. DOD’s Total Asset Visibility initiative is designed among other

things to, link inventory information systems to improve asset visibility

and provide the capability for inventory redistribution among DOD

components. Our recent work has shown that DOD has made limited

progress in achieving departmentwide asset visibility. Specifically, we

reported the Department’s implementation plan for its Total Asset

Visibility initiative did not address DOD-wide problems with systems

critical to the initiative’s successful implementation.16 The Secretary of

Defense’s 2000 Annual Report to the President and the Congress

incorporated a Total Asset Visibility goal of 90 percent. The longer term

Total Asset Visibility goal is 100 percent visibility by 2004.

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.

Federal accounting standards require inventories to be valued based on

historical costs or a method that approximates historical costs. Valuation

is of particular importance to capture the cost of operations in DOD

working capital funds, which in turn is critical to the usefulness of related

performance measures. DOD working capital funds charge their

customers for the support operations provided, including administrative

and overhead costs. Every dollar that the military services spend

inefficiently on DOD working capital fund purchases results in fewer

resources available for other defense spending priorities. Simply stated,

working capital fund overcharges could result in the military services

using more Operations and Maintenance appropriations in the current year

than anticipated; undercharges could result in unanticipated future pricing

increases and additional funding requests.

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. Because

systems do not capture historical costs, DOD working capital funds have

attempted to estimate historical cost through the use of a spreadsheet

16Defense Inventory: DOD Could Improve Total Asset Visibility Initiative With Results Act Framework

(GAO/NSIAD-99-40, Apr. 18, 1999).

Inventory Valuation
Page 10 GAO/T-AIMD/NSIAD-00-163

application. This methodology takes general ledger data at standard price

values or latest acquisition values and revalues the general ledger data to

estimated historical costs. This methodology is dependent, therefore, on

accurate general ledger data. Auditors have previously reported that the

logistical systems and general ledger systems are not integrated. As a

result, large adjustments are necessary to bring general ledger records into

agreement with logistical records. For example, for fiscal year 1999, the

Navy recorded $1.5 billion, the Army recorded $3.8 billion, and the Air

Force recorded $15.5 billion in adjustments to bring general ledger records

into agreement with logistical records. To illustrate the magnitude of these

adjustments, the Air Force Supply Fund revenue for the year was only

$10.2 billion.

Further, the Naval Audit Service reported17 that an error in the valuation

methodology in 1998 resulted in overstating the cost of goods sold by

$1.2 billion. The Navy was unable to correct this error in applying the

methodology in 1999. Moreover, even if general ledger data are accurate,

the valuation methodology may lack the necessary precision to produce a

reliable estimate of cost of goods sold. For example, the Navy

methodology revalued inventory from $34 billion (selling price) to

$16 billion (historical cost estimate). A 5-percent error in this estimate

would result in a misstatement of $900 million in the Navy’s Supply Fund

reported net operating loss of $976 million and reported inventory of

$15.8 billion for fiscal year 1999.

Army auditors reported18 for fiscal year 1998 that they were unable to

audit the Army’s application of the methodology because there was

insufficient documentation to support the calculation. Further, Army

auditors reported that inventory balances at year-end improperly included

inventory losses of $5.1 billion and inventory gains of $4.5 billion. Such

gains and losses should be recognized in the net cost of operations in the

period in which they occurred. In fiscal year 1999, Army auditors

reported19 that these problems continued to exist and that removing these

period costs are necessary before an accurate estimate of historical cost

can be developed.

17Department of the Navy Working Capital Fund, Inventory Records and Valuation (Naval Audit

Service Report No. N2000-0014, Dec. 30, 1999).

18Army Working Capital Fund FY 98 Financial Statements, Inventory Allowance Accounts (Army Audit

Agency Report No. AA 00-63, Nov. 17, 1999).

19Army Working Capital Fund, Principal Financial Statements for Fiscal Year 1999 (Army Audit

Agency Report No. AA 00-177, Feb. 10, 2000).
Page 11 GAO/T-AIMD/NSIAD-00-163

Further complicating the inventory valuation issue, inventory levels

reported to the Congress are reported 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 Commander of Air Force

Materiel Command recently testified that such valuation practices distort

DOD’s progress toward reducing inventory levels. The Commander stated

the following.

“Each year, inventories of old spare parts were increased in value

to reflect their latest acquisition price (the normal commercial

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.”20

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.

Accurate inventory cost data are also important to measuring operational

performance. A key performance measure is net operating results, the

difference between revenue and expenses related to that revenue. Net

operating results are an important factor in setting prices charged to

customers. Navy management has acknowledged that due to unreliable

inventory cost data, the reported net operating results for the supply fund

are unreliable and cannot be used in the price-setting process. Several

initiatives are ongoing to address inventory valuation issues, as noted in

the following section.

In addition to the specific initiatives discussed previously, DOD has a

number of broad-based initiatives that are intended to simplify its

20Statement 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.

Broad Simplification Initiatives
Page 12 GAO/T-AIMD/NSIAD-00-163

complicated processes for accounting for inventory. Initiatives such as

these, if effectively implemented, could help achieve the kind of wideranging process changes throughout the department that will result in

long-term improvements in this area.

• The Air Force has begun an initiative to revise current inventory systems

to capture historical costs. Senior Air Force financial management officials

believe that historical cost data by inventory item provide the best

information by which to manage the supply fund business. A working

group of Navy senior financial and logistical managers is also considering

the benefits of moving to a historical cost system.

• One impediment to valuing inventory at historical cost is establishing a

beginning value for DOD inventory. Much of DOD inventory has been on

hand for many years, and supporting documents may not be available

within DOD systems. We are currently working with DOD officials to

evaluate procurement data available within DOD and other sources to

address this issue.

• The Air Force is considering the adoption of private sector practices to

account for repairables, which represent the majority of supply fund

inventory. The Air Force had a contractor review DOD inventory

accounting and valuation processes versus those of the private sector. The

contractor concluded that adoption of private sector practices, including

the use of historical cost, would simplify accounting transactions. For

example, under DOD’s current accounting procedures, logistical actions,

such as transfers of inventory between locations, changes in condition

code, and turn-in of an asset for repair, result in adjustments to the

financial systems. Under private sector practices, the same transactions

would be recorded in the logistical systems but not in the financial

systems because they have no impact on inventory valuation. The

contractor estimated that adoption of such private sector accounting

practices would eliminate 155 million general ledger transactions currently

processed by the Air Force. This is an estimated 78 percent reduction over

current Air Force accounting practices for these types of logistical actions.

• The Army has initiated an effort to consolidate supply fund inventory into

a single stock fund. The Single Stock Fund initiative will integrate

separately managed wholesale and retail stock fund inventories into a

single Army stock fund. By October 2000, stock-funded supplies owned

and managed by installations—currently retail stock fund—are expected

to become wholesale assets to be managed by the Army Material

Command. This initiative is intended to improve the acquisition and

distribution of supply items by eliminating numerous inefficiencies, such
Page 13 GAO/T-AIMD/NSIAD-00-163

as duplicative levels of stock and several automated systems managing the

same inventory, and a lack of central item manager visibility over

inventory at Army bases and installations. Further, this initiative will

eliminate multiple points of sale and credit, billings, and general ledgers,

thus reducing the number of accounting transactions. Army financial

managers expect significant dollar savings to result from this initiative,

although program officials have not yet estimated those savings.

• Similarly, in an effort to improve visibility and financial management of

inventory, the Navy changed ownership of over $2 billion of shipboard

repairables from general fund commands to the supply fund during 1998

and 1999. This change provides central visibility and transaction-based

reporting of this inventory.

DOD is responsible for almost one-half of the government’s reported

general property, plant, and equipment (PP&E).21 For fiscal year 1999,

DOD reported a gross value of about $208 billion of general property

assets, including $151 billion in real property (land, buildings, facilities,

capital leases, and improvements to those assets), $35 billion in personal

property (such as computer software, computer mainframes, and

equipment), and $22 billion in construction-in-progress. For the past 2

years, we have testified before this Subcommittee concerning Defense

financial management and have detailed numerous problems that affected

DOD’s ability to value and account for real and personal property,

including property in the possession of contractors. Unless DOD knows

the actual (historical) costs of its facilities and equipment, the department

cannot properly depreciate and assign costs to the programs and activities

that benefit from use of those assets. Further, until its systems can

accurately account for the existence and movement of general property,

DOD cannot know the location and condition of those assets or safeguard

them from physical deterioration, theft, or loss.

To address accountability and financial reporting issues, DOD has begun

several initiatives over the past year. Due to the department’s enormous

size and complexity, however, most of its PP&E initiatives are still in

21Statement of Federal Financial Accounting Standards No. 6 states that general PP&E is any property,

plant, and equipment used in providing goods and services. It typically has one or more of the

following characteristics: (1) it could be used for alternative purposes (e.g., by other federal programs,

state, or local governments, or nongovernmental entities) but is used to produce goods or services, or

to support the mission of the entity, (2) it is used in business-type activities, or (3) it is used in

activities whose costs can be compared to those of other entities performing similar activities (e.g.,

federal hospital services in comparison to other hospitals).

General PP&E Amounts

Are Still Unreliable But

Efforts Are Underway to

Address Deficiencies
Page 14 GAO/T-AIMD/NSIAD-00-163

process and have not yet fully affected its operations or the reliability of

amounts reported.

DOD’s real property represented more than 70 percent of its reported

PP&E for fiscal year 1999. Last year, DOD took a step forward to address

one of its long-standing PP&E problems, the valuation of its beginning real

property balances. Specifically, the department obtained contractor

assistance in validating its recorded real property amounts (or

recommending ways to develop auditable values), compiling reported

PP&E data, and helping to maintain accurate property records. The

contractor sampled and surveyed nearly 1,300 real properties, estimated a

current replacement cost for each, deflated that cost back to the

property’s acquisition date, and compared the deflated replacement cost to

the cost recorded in DOD’s property database. All major DOD components

except for the Corps of Engineers were included in this effort.

The contractor has finished its work and reported the results of its

validation effort.22 Because we and the DOD audit community have not yet

completed our reviews of the contractor’s work, we cannot address the

methodology or conclusions at this time. It is our understanding that the

valuation effort has provided results at a DOD and servicewide level

(Army, Navy, and Air Force) but not at lower levels that are used for

reporting, such as the Army Working Capital Fund or DLA. Therefore, the

results may not support determining the cost of many DOD activities or

the calculation of user fees and other reimbursable charges.

As agreed, the contractor’s valuation effort was limited to real property on

DOD’s books at September 30, 1998. Therefore, in order to evaluate the

reliability of recorded values at September 30, 1999, DOD auditors needed

to test real property transactions—additions, deletions, and

modifications—that occurred during that fiscal year. Having valuation

results as of September 30, 1998, will not be useful to DOD if it cannot

maintain a reliable balance going forward. Component audit tests showed

that DOD continues to lack the necessary systems and processes to ensure

that its real property assets are promptly and properly recorded in real

property databases. For example, auditors found the following

deficiencies.

• Real property transactions are not promptly recorded. As reported, Army

auditors reviewed about $408 million in real property addition, deletion,

22Department of Defense Real Property Validation Phase II, Accuracy Test Results (PWC Contract No.

GS23F-8126H, Delivery Order MDA 210-99-F-001, Task 2.2, Deliverable 2.3, Dec. 9, 1999).

Real Property
Page 15 GAO/T-AIMD/NSIAD-00-163

and modification 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.23 Air Force auditors identified

backlogs of unprocessed real property transactions totaling approximately

$781 million at 46 of the 99 locations audited.24 In addition, Air Force

auditors found that real property constructed under multi-facility

construction contracts was not always recorded until construction was

completed on all facilities under the contract. Navy auditors also found

that real property assets were not being recorded when construction was

completed. Because Navy activities did not consider contracts complete

for purposes of removing assets from construction-in-progress until the

final payment was made, auditors found over $55 million of unrecorded

new construction or improvement costs at two locations.

Navy auditors also found that Base Realignment and Closure (BRAC)

funded property transactions were not always recorded in Navy databases.

While costs associated with closing activities should be expensed, some

costs incurred to realign activities should be capitalized, such as new

construction or major improvements. Navy auditors identified millions of

dollars of newly constructed or improved assets paid for by BRAC funds

that were not captured in the Navy’s accountability and financial reporting

databases. For example, the $4.3 million renovation costs associated with

a building that the Naval Audit Service moved into in June 1999 and

$18.4 million in capital improvements at the Naval Facilities Engineering

Command (NAVFAC) headquarters building were not recorded in the

Navy’s database.

• Sufficient controls over processing and reporting real property amounts

did not exist. For example, Navy auditors found that reconciliations

between accountability and financial reporting systems are not always

performed. Navy auditors identified over $10 million in discrepancies

between the Navy working capital fund accountability and financial

reporting records at one location and noted a more than $13 million

difference at another location. Air Force auditors found that acquisition

costs reported by the Air Force for fiscal year 1999 were overstated by

$3.4 billion due to compilation errors related to the costs of buildings and

other structures at 15 installations. In addition, Air Force auditors could

23Army’s General Fund Principal Financial Statements for Fiscal Year 1999, Summary Audit Report

(Army Audit Agency Report No. AA 00-168, Feb. 9, 2000).

24Opinion on Fiscal Year 1999 Consolidated Financial Statements (Air Force Audit Agency Report No.

99053002, Feb. 9, 2000).
Page 16 GAO/T-AIMD/NSIAD-00-163

not obtain supporting documentation for about $1.8 billion of the Air

Force’s $2.8 billion of construction-in-progress amounts reported for fiscal

year 1999.

DOD must quickly address the problems that the auditors identified during

their fiscal year 1999 testing related to backlogs and the proper recording,

reconciling, and reporting of new property transactions. Until DOD has the

systems and processes in place to maintain accurate, up-to-date property

records, any valuation baseline will not be sustainable and accountability

for real property will not be ensured.

As discussed in our testimony last year, the most important issue related

to personal property is the accuracy of the underlying accountability

records. DOD’s draft accountability regulations support this position and

require that all assets valued at $2,500 or more be in property databases

for accountability purposes. Also in line with this, the DOD Comptroller

and the military services have redirected their personal property efforts to

first ensure the accuracy and sustainability of personal property databases

before attempting to address any valuation issues. The audit community

and the Office of Management and Budget have agreed to and support this

approach as prudent and consistent with the goals of the Chief Financial

Officers Act.

DOD and the military services have recognized that major changes, such

as implementation of standard automated systems and operating

procedures, are necessary to ensure accountability and financial control of

personal property. To move toward these goals, the military services

general fund activities, which are responsible for most personal property

reported by DOD, have begun implementing short-term initiatives over the

past year, such as performing or testing personal property inventories,

providing training to personnel responsible for maintaining the data, and

developing procedures and controls to ensure the reliability of future

transaction processing.

For example, the Department of the Navy has been working to ensure the

reliability of its personal property records by standardizing its personal

property processes and procedures and actively implementing the Defense

Property Accountability System (DPAS) at locations worldwide. Over the

past year, the Marine Corps has performed and reconciled the results of

wall-to-wall physical inventories of assets valued at $2,500 or more and has

fully implemented DPAS at 30 sites. The benefits of the wall-to-wall

inventories are easily understood when you consider that at one location

alone, the number of assets recorded in the accountability database

increased by over 35 percent, which added 478 items to the originally

Personal Property
Page 17 GAO/T-AIMD/NSIAD-00-163

reported 1,375 items, while the dollar amount increased by 28 percent, or

about $700,000 more than the beginning value of $2.4 million. The Navy’s

efforts to conduct inventories and implement DPAS at Navy sites are still

ongoing.

The Army and Air Force general fund activities are also beginning to focus

on accountability. The Army has begun to implement DPAS to report its

personal property. However, during fiscal year 1999, it temporarily

suspended implementation of DPAS at some of its major installations due

to problems encountered in converting logistical data from existing

databases. As a result, as it had for fiscal year 1998, the Army relied on

data calls to obtain information on equipment balances for financial

reporting because it had no central system. Although the percentage of

units responding to the Army’s data calls increased from 78 percent for

fiscal year 1998 to approximately 97 percent for fiscal year 1999, only

$857 million was reported for equipment—an over $800 million decrease

from the prior year.25 Army officials were unable to explain this 48 percent

decrease. To address these problems, the Army remains committed to

DPAS and hopes to complete its implementation at general fund sites by

the end of fiscal year 2000. They have also hired a contractor to test the

accuracy of the assets reported in DPAS.

Rather than implement DPAS, the Air Force has chosen to modify its three

personal property systems, the primary one being the Air Force Equipment

Management System (AFEMS), to meet accountability and reporting

requirements for assets that individually equal or exceed DOD’s financial

reporting capitalization threshold of $100,000. Over the past year, the Air

Force has added data fields to AFEMS to establish detailed records for

these higher valued assets. Also, during fiscal year 1999, Air Force

activities verified the existence of assets recorded in AFEMS that were

valued at $100,000 or more. Assets in AFEMS that were less than DOD’s

$100,000 capitalization threshold, but exceeded DOD’s $2,500

accountability threshold, were not included in this verification effort. As of

March 2000, personal property assets that did not meet DOD’s $100,000

financial reporting threshold accounted for over 99 percent of the total

number of personal property assets recorded in AFEMS and

approximately 45 percent (or $6.4 billion) of the total reported personal

property value. Many of these assets are “pooled” in AFEMS rather than

controlled at a serial number level, which may impede any efforts to

ensure that assets below $100,000 are recorded in the database for

25Army’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 18 GAO/T-AIMD/NSIAD-00-163

visibility and accountability purposes. Air Force officials have indicated

they have initiated a change in their systems and processes to eliminate

these pools and provide individual accountability for items over $2,500. In

addition, they have hired contractors to validate that the existing assets

are properly reflected in AFEMS.

Although issues such as DOD’s capitalization threshold, depreciation

periods, and systems integration do not affect current personal property

efforts as long as those efforts focus on accountability consistent with

DOD regulations, they do affect financial control and reporting for both

real and personal property. To begin addressing some of these issues,

DOD hired contractors to advise the department on appropriate

capitalization thresholds and depreciation periods for real and personal

property. The contractors have issued their reports concurring with DOD’s

current $100,000 threshold for financial reporting and depreciation

periods, but they noted that the databases they analyzed may not have

been appropriate, complete, and accurate. For example, as we previously

discussed, the Marine Corps’ wall-to-wall inventories have identified

significant numbers of assets not included in their personal property

databases. In addition, the databases that were analyzed may not have

included approximately $20 billion of personal property held by

contractors—an amount that was not reported in DOD’s financial

statements but which represents more than half the gross value for

personal property that was reported for fiscal year 1999. The contractors

also recommended that if adjustments are made to the underlying

databases or if data integrity is improved, DOD should reevaluate the

study’s results. We have not yet reviewed the contractors’ work but we

agree that the limitations they cite could directly affect the materiality and

appropriateness of the recommended capitalization threshold and the

effect of the current depreciation periods. To ensure that the contractors’

recommendations are appropriate, DOD needs to evaluate the accuracy of

the databases that were used and analyze the full impact of property

excluded from the study.

Although each of the services has various short-term initiatives to improve

accountability, long-term sustainability and efficiency require systems

integration—acquisition and payment systems must be linked with

property accountability systems. The Navy, recognizing the usefulness of

system interfaces to maintain accountability and financial control, has

established a working group with DOD’s DPAS office to begin developing

electronic interfaces in accordance with the financial management

systems requirements of the Federal Financial Management Improvement
Page 19 GAO/T-AIMD/NSIAD-00-163

Act of 1996.26 The Army also has efforts under way and systems under

development to provide needed interfaces. The Air Force has asked audit

personnel to review its property systems under development and ensure

that required integration is considered during development. To support

these efforts, DOD has established a Property System Implementation

Steering Committee, chaired by the Director of Acquisition Resources and

Analysis, to emphasize property issues affecting the department and begin

addressing those issues.

Beginning with fiscal year 1998, DOD was required by federal accounting

standards to report its national defense assets27 in a stewardship report,

which is treated as required supplementary information in its financial

statements, rather than on its balance sheet. The reported cost of this

equipment in fiscal year 1997–the last year for which such information was

reported on its balance sheet–was more than $600 billion. In its fiscal year

1999 financial report, DOD did not report on its national defense assets in

accordance with accounting standards. Instead of reporting total costs of

these assets as required by the standards, DOD reported quantities only for

major weapons systems and real property, and yearly disbursements for

items bought with procurement funds. This reporting is based in part on

proposed amendments to the accounting standards, but the amendments

were not passed when voted on in October 1999. In addition, DOD

continues to experience problems in accumulating and reporting accurate

information on its national defense equipment, as well as foreign sales

activity related to these assets. The military services have made some

improvements on these issues and are continuing to work toward more

reliable logistical data for these assets.

Information on national defense assets remains a concern because, for

fiscal year 1999, (1) it is incomplete and (2) activity during the year is not

properly recorded.

The national defense asset quantities reported for fiscal year 1999 are

incomplete primarily for two reasons. First, DOD policy instructed the

services to report only certain categories of national defense assets and

26The Federal Financial Management Improvement Act of 1996 provides a legislative mandate to

implement and maintain financial management systems that substantially comply with federal

financial management systems requirements, applicable federal accounting standards, and the U.S.

Standard General Ledger.

27National defense assets consist of weapons systems, weapons systems support equipment, mission

support equipment, and weapons systems support real property.

Problems Persist With

Data and Reporting on

National Defense Assets

Incomplete Data and Financial

Reporting
Page 20 GAO/T-AIMD/NSIAD-00-163

specifically excluded two of the major categories—support principal end

items,28 such as aircraft engines and radars, and mission support

equipment,29 such as nontactical vehicles and cryptographic systems. As a

result, thousands of different types of support equipment costing billions

of dollars were not reported anywhere in DOD’s financial report. For

example, the Army reported quantities for only 279 types of equipment out

of more than 1,600 types. Unreported items include

• Army communication equipment with an estimated value of $5.7 billion,

• Navy aircraft engines with an estimated value of $7.6 billion, and

• over 2,300 Air Force electronics systems pods that attach to aircraft, with

costs ranging from over $1 million to $5 million each.

Second, some items may not have been reported because they are not

recorded in any centralized asset visibility system. Because the 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. For example, the Army again conducted an Armywide data call as it had in fiscal year 1998 to capture items not reported in

its centralized systems. Items identified as a result of this data call that

were not included in the Army’s centralized systems included 56 airplanes,

32 tanks, and 36 Javelin command-launch units. The Air Force had to use

manual procedures to compile its missile data from a number of different

systems and to try to avoid double counting and/or omissions. The Navy

had to obtain data on ballistic missiles from inventory control personnel

who maintain local spreadsheets on the missiles at two Navy facilities. The

use of manual procedures, such as data calls, results in less reliable

information because it is dependent on individuals responding promptly

and accurately. For example, only 78 percent of Army units responded to a

data call in time for its fiscal year 1998 reporting. Although this percentage

increased to 97 percent for fiscal year 1999, the reliability of the

information from the data call was not tested. Furthermore, the necessity

for manual procedures prevents DOD from having visibility over all of its

assets and the day-to-day information needed to effectively manage its

28Support principal end items are items acquired to support weapons systems and may ultimately be

incorporated in weapons systems.

29Mission support equipment is deployable equipment that (1) is essential to the effective operation of

a weapon system or is used by the military services to carry out their military missions, (2) has an

indeterminate or unpredictable useful life, and (3) is at very high risk of being destroyed or becoming

prematurely obsolete.
Page 21 GAO/T-AIMD/NSIAD-00-163

operations. For example, DOD’s lessons learned studies from Operation

Desert Storm highlighted combat support problems associated with

tracking the status and location of personnel and supplies. As previously

mentioned, DOD has a goal of 100 percent visibility over its assets by 2004.

The 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 even more important. For example,

acquisition personnel 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.

Further, 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 reported30 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

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

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

million, 11 transactions); or

30 Foreign Military Sales: Air Force Controls Over the FMS Program Need Improvement (GAO/AIMD00-101, May 3, 2000).
Page 22 GAO/T-AIMD/NSIAD-00-163

• could not explain differences between the recorded value of delivered

goods and services and corresponding value of changes to customer

accounts. ($26.5 million or 19 transactions).

Each military service has taken some actions to improve its national

defense asset data. Some of these actions are short-term solutions, while

others are intended to provide longer term, permanent improvements in

the way the data are maintained. For example, the Navy is currently taking

a servicewide inventory of all of its aircraft engines to improve its data for

these assets. While this might result in accurate data for a given point in

time, longer term—both with respect to the design of the systems and to

basic transaction processing—logistics system changes are needed to

ensure that the data remain accurate. An ongoing, longer-term

improvement effort involves a new working group that is trying to improve

ship and boat data. The group is developing new software and has

developed new guidance for managing ship and boat information,

including guidance for an annual inventory validation and for boat

disposals. In another effort intended to improve all of the Navy’s national

defense asset data, the Navy has hired a contractor to evaluate its systems,

methods, processes, and procedures used to account for its national

defense assets.

The Army has made several short-term improvements in its national

defense asset information and is also developing a long-term solution.

Most of the short-term efforts stemmed from lessons learned during the

fiscal year 1998 financial reporting process. For example, the Army

improved its method for determining which assets should be reported as

national defense, and it gained a better understanding of the types of

information available in its myriad logistics systems. These lessons learned

should help it develop needed systems improvements in the future,

including the development of its Logistics Integrated Database (LIDB),

which is intended to eventually replace and/or integrate many of its

existing logistics systems. Army logistics officials have commented that

the efforts taken to comply with the reporting requirements for national

defense assets have been very beneficial to the Army because the process

has resulted in more accurate property records which are used for

procurement and deployment decisions.

The Air Force acknowledged that it was not able to identify all of its

national defense assets for fiscal year 1999, but it is working to improve

several of its logistics systems. It has reported that it is developing

interfaces for all of its munitions systems so that manual procedures will

not be necessary in the future to develop accurate missile data. It also

Improvement Initiatives
Page 23 GAO/T-AIMD/NSIAD-00-163

expects to have complete, reliable information on all of its electronics

systems pods in one logistics system by the end of this fiscal year.

Each of the services also made some progress toward improving

information on additions and deletions activity during the year. For

example, according to Air Force auditors, the Air Force now has accurate

additions and deletions for its aircraft engines. The Army has considered a

number of different options for tracking additions and deletions to its

equipment, and while it does not yet have a solution in place, Army

officials expect to have a plan to incorporate this information into their

new Logistics Integrated Database by June 30, 2000. The Navy has

developed new forms to better document additions and deletions for its

boats and new procedures for documenting the transfer or disposal of

aircraft engines.

In addition to the services’ individual efforts, DOD is continuing to

undertake initiatives to improve departmentwide asset visibility and

tracking. The department’s Global Combat Support System (GCSS)

strategy—its approach to providing the technological base needed to

rapidly deploy support to the warfighter—incorporates a number of such

initiatives. For example, its Total Asset Visibility (TAV) initiative is

intended to provide department-level access to timely and accurate

information on the status, location, and movement of all assets, including

national defense assets.

Because of the recognized problems with national defense asset

information, and the lack of an audit requirement for these assets, 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.
Page 24 GAO/T-AIMD/NSIAD-00-163

DOD has taken important steps to implement the federal accounting

standards31 requiring recognition and reporting of liabilities associated

with environmental cleanup and disposal. The department issued

accounting policy32 consistent with these standards and has begun

implementing those policies for nuclear weapons systems and training

ranges, in addition to efforts already taken to address environmental

restoration and chemical weapons disposal. In addition, working groups

comprised of officials from the responsible DOD functional areas (such as

Comptroller, Environmental Security, and Acquisition, Technology, and

Logistics) and the audit community have been established.

DOD still faces significant challenges in this area. Specifically, (1) all

potential liabilities were not considered, (2) estimates need to be refined

to ensure that assumptions and methodologies are consistently applied,

and (3) support for the basis of reported estimates continues to be

inadequate. To ensure that the reported amounts of environmental and

disposal liabilities are complete and reliable, adequately reflecting DOD’s

obligation to clean up and dispose of hazardous and other wastes, DOD

will need to address these issues. While DOD has made great progress

toward developing more complete estimates of these costs, until these

efforts are complete, the Congress will not know the full extent of future

resource requirements necessary to fund cleanup and disposal efforts

based on current laws and policies.

DOD reported approximately $80 billion in estimated liabilities in its fiscal

year 1999 financial statements, including for the first time approximately

$34 billion for training range cleanup and nearly $11 billion for disposal of

nuclear-powered aircraft carriers and submarines. For fiscal year 1998,

only $34 billion was reported for estimated environmental liabilities. The

time frame in which the fiscal year 1999 estimates were developed did not

permit the audit community to perform adequate audit procedures to

determine their reasonableness. DOD’s failure to report these costs in

prior years was among the most significant deficiencies that we previously

reported to this Subcommittee.

31Statements of Federal Financial Accounting Standards No. 5, Accounting for Liabilities of the

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

32DOD Financial Management Regulation, volume 4, chapter 13, Accrued Environmental and

Nonenvironmental Disposal Cost Liabilities and chapter 14, Accrued Environmental Restoration

(Cleanup) Liabilities.

Improvements in

Environmental/

Disposal Liability

Reporting But

Additional Issues

Need to Be Addressed
Page 25 GAO/T-AIMD/NSIAD-00-163

To date, DOD has focused on those liabilities expected to involve the

largest amounts (nuclear weapons systems and training ranges). Going

forward, DOD will need to address estimates for other weapons systems

and conventional munitions. DOD needs to analyze the potential liability

for disposing of these types of items and determine whether these

estimates would be significant and thus need to be reported. If so, it will

need to develop methodologies to support such estimates. Further, DOD

has just begun to consider the significance of costs associated with the

ultimate disposition of ongoing operations.

The Congress has also recognized the potential for significant costs

associated with disposal. The National Defense Authorization Act for

Fiscal Year 199533 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.34 These disposal cost

estimates are important to consider before proceeding with a major

acquisition because this information can contribute to the ongoing

dialogue on funding comparable weapons systems. Compliance with the

Fiscal Year 1995 Defense Authorization Act would also provide data

critical to ensuring more complete and reliable financial statement

reporting. In addition, the Senate Committee on Appropriations has

required that DOD develop disposal cost estimates for munitions.35

DOD must also ensure consistent application of methods and assumptions

regarding aircraft disposal cost estimates. The Navy’s financial statements

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

of fixed-wing and rotary-wing aircraft. However, although it reported twice

as many aircraft as the Navy, the Air Force has not yet reported

environmental and disposal liabilities for these weapons systems.

We are working with the department to identify other weapons systems

that might have significant cleanup and disposal liabilities and approaches

for estimating those liabilities. For example, the department’s costs to

33Public Law 103-337, Oct. 5, 1994.

34Hazardous 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).

35Report on the Fiscal Year 1995 Defense Appropriations Bill (Senate Committee on Appropriations,

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

Potential Liabilities Not

Considered in Current Year

Estimate
Page 26 GAO/T-AIMD/NSIAD-00-163

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.36

With regard to ongoing operations, costs of cleaning up and disposing of

assets used in these operations may be significant. Significant

environmental and disposal costs are 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. In addition, post-closure

maintenance costs, such as monitoring in excess of $200,000 annually for

30 years, are not included in this estimate. 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.

Further, environmental and disposal costs must also 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.

Information on the estimated training range cleanup costs was not

available in sufficient time prior to the statutory release date of the

financial statements to enable the audit community to perform adequate

work to determine the reasonableness of reported estimates. However, we

were able to perform a limited analysis of DOD’s first-time effort to

develop complete cleanup cost estimates for training ranges. We

previously testified on the significance of the department’s unreported

liability for training range cleanup, including removal and/or containment

of unexploded ordnance and remediation of chemical contamination. DOD

took initial steps to address this deficiency in fiscal year 1999 by reporting

approximately $34 billion for cleanup of training ranges, accounting for

36Financial Management: DOD’s Liability for the Disposal of Conventional Ammunition Can Be

Estimated (GAO/AIMD-98-32, Dec. 19, 1997).

Cleanup and Disposal Cost

Estimates Need to Be

Refined
Page 27 GAO/T-AIMD/NSIAD-00-163

over 40 percent of its total reported environmental/disposal liabilities,

which we view as an important step forward.

The training range cleanup liability is 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 Ft.

Irwin, California, would result in a cleanup cost estimate of approximately

$4 billion for that installation alone.

DOD has cited the lack of guidance on the scope of range cleanup

requirements as an impediment to reporting the cost of cleaning up the

ranges. In this regard, DOD has been working with the Environmental

Protection Agency (EPA) for several years to finalize the Range Rule that

will provide a framework for developing an inventory of ranges and

assessing the level of cleanup required.37 After finalizing this rule, DOD

will need to develop specific implementation guidance to ensure

consistent application across the military services. This guidance will need

to address the assumptions to be applied in estimating cleanup costs,

including those related to risk levels and cleanup thresholds.

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

37On March 7, 2000, DOD and the Environmental Protection Agency issued Interim Final Management

Principles to address ongoing range response actions until the final version of the Range Rule is

promulgated.
Page 28 GAO/T-AIMD/NSIAD-00-163

completion date. However, we recently reported38 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 direct costs such

as labor, emergency preparedness, and program management.

Last year the DOD IG reported39 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. Service auditors continue to find that

significant portions of the reported restoration liabilities lack adequate

support for the basis of cost estimates. To address this deficiency, the

Deputy Under Secretary of Defense (Environmental Security) issued a

policy requiring that the basis of cost estimates be properly documented.40

While this step is critical to resolving this issue, implementation issues

remain, such as ensuring that the appropriate personnel receive the

guidance and are properly trained on its implementation. For example, the

Army Audit Agency found that the guidance was not properly

disseminated to project managers and others preparing project cost

estimates.41

DOD provides health care benefits to military retirees and their families

through its own military treatment facilities (MTF) and by using civilian

providers. Each year, the DOD Office of Actuary and its contractors

develop an estimate of DOD’s future liability for providing these benefits.

At September 30, 1999, the expected cost for future retiree health care

benefits was estimated at $196 billion.

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

Management (GAO/NSIAD-00-80, May 8, 2000).

39Data Supporting the DOD Environmental Line Item Liability on the FY 1998 Financial Statements

(DOD IG Report No. 99-209, July 9, 1999).

40Supplemental Management Guidance for the Defense Environmental Restoration Program (DOD

Deputy Under Secretary of Defense (Environmental Security) Aug. 1999).

41Army’s General Fund Principal Financial Statements for Fiscal Year 1999: Financial Reporting of

Liabilities (Army Audit Agency Report No. AA 00-220, Apr. 21, 2000).

Support for the Basis of

Estimates Remains

Inadequate

Progress in

Estimating Military

Post-Retirement

Health Care Liability
Page 29 GAO/T-AIMD/NSIAD-00-163

In last year’s testimony, we reported that DOD’s estimated retiree health

benefits liability was unreliable because DOD did not have accurate and

complete cost data on which to base its calculation, used old and

incomplete historical claims data, and relied on unsupported clinic

workload data related to outpatient visits. Although these problems still

exist, the Office of Actuary and Office of Health Affairs have made

meaningful progress in improving the processes and underlying data on

which the liability estimate is based. For example, the liability reported in

fiscal year 1998 was based on 1994 claims data—a 4-year lag—while the

1999 liability was based on 1997 data—a 2-year lag. Moreover, the 1998

liability used outpatient claims data from only 15 of 121 MTFs while the

1999 liability had outpatient information for all MTFs. Better and more

complete data resulted in a $37.5 billion decrease, nearly 17 percent, in

DOD’s estimated liability for retiree health benefits. These kinds of

improvements in claims and workload data will also benefit DOD’s ability

to manage its health care programs, make health care-related decisions,

such as whether to outsource certain medical treatments or provide them

in MTFs, and evaluate legislative options regarding benefit changes.42

To help focus improvement efforts, the Office of Actuary recently

conducted a thorough analysis of the various factors that affect the

magnitude and reliability of its actuarial estimate. The analysis identified

assumptions regarding future interest rates and medical trends, program

withdrawal and death rates, and measures of current cost and services

provided as the key drivers of the future cost of health care benefits. This

type of analysis is important because it shows that, for example, if current

MTF costs change by only 1 percent, DOD’s future liability will change by

more than a billion dollars.

Despite the sensitivity of the liability to current costs, DOD has had to use

obligations in its calculation and for making many program decisions

because it does not have actual cost information for its MTFs. However,

budget obligations do not reflect the full cost of providing health care

because they do not include, among other things, civilian employee

retirement benefits that are paid directly out of the Civil Service

Retirement and Disability Fund rather than by DOD or depreciation costs

for medical facilities and equipment. In addition, health program budget

obligations attributable to wartime readiness are not distinguishable from

42In recent testimony before the House Subcommittee on Military Personnel, we discussed several

legislative proposals that have been introduced to expand and enhance military health benefits for

older retirees. See Defense Health Care: Observations on Proposed Benefit Expansion and

Overcoming TRICARE Obstacles (GAO/T-HEHS/NSIAD-00-129, Mar. 15, 2000).
Page 30 GAO/T-AIMD/NSIAD-00-163

those associated with peacetime care.43 Consistent with our prior advice,

DOD now agrees that full cost should be used to estimate the retirement

health benefits liability and plans to do so for fiscal year 2000. To this end,

representatives from Health Affairs, the Comptroller’s Office, Office of

Actuary, DOD Inspector General and GAO have established a Full Cost

Working Group, which has begun addressing the completeness and

accuracy of recorded costs as well as determining the portion of health

care costs associated with retirees. In addition to improving the liability

estimate, DOD needs reliable cost data to properly allocate health care

resources, decide whether to outsource certain services, set third-party

billing and interagency cost rates, and benchmark its health care delivery

system with those of other providers.

The proper allocation and growth rate of pharmacy costs are other factors

that could have a significant impact on future retiree health care costs. For

purposes of calculating the liability, DOD has been making the assumption

that its patient population uses pharmacy resources equally; however,

preliminary evidence suggests that retirees use more outpatient pharmacy

resources than nonretirees. Furthermore, pharmacy costs are increasing at

a faster rate than other medical costs, yet DOD has been applying the same

medical trend rate to all outpatient costs. We estimated that DOD

pharmacy costs increased 13 percent from 1995 through 1997, while its

overall health care costs increased 2 percent for that period.44 DOD is

currently analyzing the effect of separately estimating the pharmaceutical

component of the health benefits liability. This analysis will be even more

important if legislation currently being proposed, which includes

increased pharmacy benefits for retirees eligible for Medicare, is enacted.45

DOD and its auditors have identified other needed improvements in

patient care and demographic data. DOD has been using examples of

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

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

to health care contractors the importance of its improvement efforts.

43Wartime readiness refers to maintaining the health of service members and treating wartime

casualties, whereas peacetime care refers to providing for the health care needs of the families of

active-duty members, retirees, and their families and survivors.

44Defense Health Care: Fully Integrated Pharmacy System Would Improve Service and CostEffectiveness (GAO/HEHS-98-176, June 12 , 1998).

45Proposed legislation to expand Medicare-eligible uniformed services retirees’ eligibility for certain

Defense pharmacy programs was introduced in the Senate on January 27, 2000, as S.2013, the

“Honoring Health Care Commitments to Servicemembers Past and Present Act of 2000.”
Page 31 GAO/T-AIMD/NSIAD-00-163

Similarly, the DOD IG46 has reported that workload data are problematic—

medical services cannot be validated either because medical records are

not readily available or outpatient visits are not adequately documented.

The DOD IG also reported that MTF outpatient visits are often double

counted and that many telephone consultations have been incorrectly

counted as visits, perhaps due to the lack of standardized appointment

types. 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.

To address access and workload shortcomings, DOD recently issued a

letter directing MTFs to ensure that medical records are readily available

and has begun moving toward standardized appointment types and to

electronic patient records that would be accessible by all MTFs. DOD also

established a Data Quality Integrated Program Team, which is currently

considering other data quality improvements. In addition, DOD has

developed procedures for reconciling financial, workload, and labor hours

to the data sources. When fully and effectively implemented, these

procedures should improve the reliability of underlying data used in

managing DOD’s health care programs.

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.47

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, 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

46Data Supporting the FY 1998 DOD Military Retirement Health Benefits Liability Estimate (DOD IG

Report No. 99-127, Apr. 7, 1999).

47Statement 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 32 GAO/T-AIMD/NSIAD-00-163

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 discussed later, this will require properly trained

personnel, simplified processes, systems supporting operational and

accounting needs, and a disciplined approach for accomplishing these

steps.

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. Specifically, the accuracy of

the department’s reported operating costs was affected by DOD’s inability

to

• properly value and capitalize its facilities and equipment,

• properly account for and value its inventory,

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

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

military personnel, and

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

the Treasury.

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.48 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 discussed later in this

testimony, DOD budget data are also unreliable.

48Statement 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 33 GAO/T-AIMD/NSIAD-00-163

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.

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 recently reported on a long-standing concern over how

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

reflect actual costs.49

• 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. 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 reported50 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

49DOD Competitive Sourcing: Lessons Learned System Could Enhance A-76 Study Process

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

50Defense Transportation: More Reliable Information Key to Managing Airlift Services More Efficiently

(GAO/NSIAD-00-6, Mar. 6, 2000).
Page 34 GAO/T-AIMD/NSIAD-00-163

they lack all the data needed to effectively manage their material costs.51

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

its business-like activities financed with working capital funds.

In its financial statements, DOD is required to report the activity in and

status of its budget accounts. The Statement of Budgetary Resources, one

of the basic financial statements, presents information, such as outlays

and obligated and unobligated balances, at the end of the year. This

statement also should reconcile to Fund Balance with Treasury accounts,

which represent DOD’s balances available for disbursement. In addition,

DOD’s outlays should agree with the activity in these Treasury accounts

for the year.

DOD auditors were unable to complete their audits of the Statements of

Budgetary Resources because they found that obligated balances were not

correct, disbursements were not properly recorded, and Fund Balances

with Treasury remained unreliable. In addition to the specific

improvement initiatives referred to in this section, the ultimate resolution

of DOD’s long-standing problems in maintaining reliable budgetary data

will depend on the process improvements, enhanced training, and systems

efforts discussed later in this testimony.

In their testing of obligated balances, auditors found evidence of

unsupported obligations and poor internal controls over obligations, as

illustrated by the following examples.

• The Army Audit Agency found52 that internal controls over the recording

of obligations were not adequate to ensure that amounts reported in the

Army’s General Fund Statement of Budgetary Resources for fiscal year

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

21 could not be supported.

• For fiscal year 1999, audit results53 show that the Air Force Working

Capital Fund had $211 million of obligations out of approximately

51Air Force Depot Maintenance: Analysis of Its Financial Operations (GAO/AIMD/NSIAD-00-38,

Dec. 10, 1999).

52Army’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).

53Opinion on Fiscal Year 1999 Air Force Working Capital Fund Financial Statements (Air Force Audit

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

Reliability of Budget

Data Impaired

Obligated Balances Were

Incorrect and Unsupported
Page 35 GAO/T-AIMD/NSIAD-00-163

$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. However, this represents 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.54 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.

Further, major Navy commands were deobligating funds from subordinate

commands without the subordinate’s knowledge and approval. As a result,

valid obligations could have been deobligated. These procedures

demonstrate a lack of adequate internal controls over the obligation

process, which is intended to ensure that liabilities are recognized against

available funding and that overspending does not occur.

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

54The 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.

Disbursements Not

Properly Recorded
Page 36 GAO/T-AIMD/NSIAD-00-163

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 DOD Comptroller’s Office stated in the fiscal year 1999 financial

statements that 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 reported55 $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)56 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

without incurring a potential Antideficiency Act violation57 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.

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

55Defense Finance and Accounting Service reports to the DOD Comptroller on problem disbursements

and in-transits as of September 30, 1999.

56Negative 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.

57The 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)).
Page 37 GAO/T-AIMD/NSIAD-00-163

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

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

previously reported58 on this issue and recommended that DOD revise its

problem disbursement policies and procedures to ensure that accurate

and reliable balances are maintained.

Finally, due to improper and unsupported DOD payments, such as the

problem disbursement issues previously discussed, the true magnitude of

DOD’s payment problems is unknown. For example, our work continues

to identify problems with overpayments and erroneous payments to

contractors. For fiscal years 1994 through 1999, defense contractors

returned over $5.3 billion to the DFAS Columbus Center, including $675

million during fiscal year 1999, due to contract administration actions and

payment processing errors.

DOD frequently adjusts recorded payments to record 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 March 2000, we

reported59 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.

These adjustments were often made to original entries that were recorded

years earlier. Many of the adjustments selected during our review were

made to canceled accounts.

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

Act and the bona fide needs rule60 to expired appropriations and to ensure

58Financial 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).

59Financial Management: Differences in Army and Air Force Disbursing and Accounting Records

(GAO/AIMD-00-20, Mar. 7, 2000).

60The 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.

Frequent Adjustments

Affect Reliability
Page 38 GAO/T-AIMD/NSIAD-00-163

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

books indefinitely. Under 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.61 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.

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.62 However, our

decision emphasized that “Treasury’s authority to correct the accounts

relates only to obvious clerical errors such as misplaced decimals,

transposed digits, or transcribing errors that result in inadvertent

cancellations of budget authority, and is not meant to serve as a palliative

for deficiencies in DOD’s accounting systems.”63 The decision also

concluded that Treasury may adjust 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 a closed account.64

Adjusting disbursements previously recorded to current or expired

accounts by moving those transactions to canceled accounts can change

balances available for obligation in the current accounts or obligated

balances in expired accounts. Since the 1991 account closing law was

enacted, DOD has requested that Treasury reopen 333 closed accounts,

restoring a total of $26 billion. These accounts remained open as of

61Obligation adjustments and liquidations (expenditures) that an agency would otherwise have

charged against the expired appropriation are, at this point in time, chargeable against a current

appropriation for the same purpose, but only to the extent of the lesser of 1 percent of the current

appropriation or unexpended balance of the closed account (31 U.S.C. 1553(b)).

6272 Comp. Gen. 343 (1993).

6372 Comp. Gen. at 346 (1993).

6472 Comp. Gen. at 347 (1993).
Page 39 GAO/T-AIMD/NSIAD-00-163

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

have requested that Treasury reopen 21 closed accounts, restoring a total

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

net 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. We expect to begin a review in this area to

ensure that DOD’s adjustments to closed accounts comply with the

account closing law and the 1993 Comptroller General decision.

Although an agency is responsible for determining and maintaining its

available fund balance, Treasury also has information about activity in the

agency’s account, and Treasury’s and the agency’s records must be

periodically reconciled to determine the actual amount of funds available.

Although DOD has made some improvements in its accountability over

these funds, the amount of funds available at DOD remains questionable

because significant differences between DOD and Treasury’s records

remain and items in suspense accounts may or may not reflect DOD

activity.

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

improvement plans last year. DFAS began standardizing the reconciliation

procedures and adjusting the differences. This effort resulted in a drop in

the absolute value of unresolved differences from $9.6 billion at

September 30, 1998, to $7.3 billion at September 30, 1999. In addition,

some DOD components have significantly improved the process and

reduced the amount of unreconciled differences. The Army’s Corps of

Engineers, Civil Works, formed special teams to research and resolve

differences identified by Treasury on a monthly basis. The efforts of these

special teams resulted in a substantial reduction in unreconciled

differences. For example, the absolute value of unreconciled differences

for the Corps of Engineers at September 30, 1999, was $64 million—down

from $423 million on September 30, 1998.

Although some of these unreconciled differences may be due to the timing

of transaction processing at Treasury versus DOD, an aging of the

difference demonstrates that reconciliation issues remain. For example,

although $4.8 billion of the absolute difference is less than 60 days old,

$1.2 billion is 60 days to 1 year old, and $1.3 billion is over 1 year old.

Differences over 60 days old are generally not expected to be attributable

to timing.

At least some of the decrease in the total differences can be attributed to

the practice of some DFAS center staff to routinely adjust their records

Fund Balance With

Treasury Remains

Unreliable
Page 40 GAO/T-AIMD/NSIAD-00-163

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 have been

addressed and resolved. For example, one Army disbursing station

recorded $608 million in differences to a suspense account.65 These

differences were ultimately charged to Operations and Maintenance at

year-end to avoid showing this amount on the Statement of Differences.

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. DOD reported $823 million in suspense accounts at the

end of fiscal year 1998. Until suspense account transactions are posted to

the proper appropriation account, the department will have little

assurance that it has a right to the 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.

DOD relies on a vast and complex computerized information

infrastructure to support virtually all aspects of its operations, including

strategic and tactical operations, weaponry, intelligence, and security. This

reliance extends to its business operations that support the department,

including financial management. In recent years, internal and external

evaluations have identified weaknesses in information security that could

seriously jeopardize DOD’s operations and compromise the

confidentiality, integrity, or availability of sensitive information, including

data that are recorded in or transmitted by the department’s financial

management systems. In September 1996, we issued a report with limited

distribution that identified pervasive information security weaknesses in

DOD. We reported that DOD lacked a departmentwide information

security program to comprehensively address the general control

weaknesses we had identified.

While not unmindful of the computer security weaknesses of its financial

management and other critical computer system operations, until recently,

65A suspense account is a temporary holding account for problem transactions—for example, those

rejected because of system edit controls.

Computer Security

Weaknesses Continue

to Undermine

Financial

Management and

Other Operations
Page 41 GAO/T-AIMD/NSIAD-00-163

the department has necessarily focused its efforts on preparing its

computer infrastructure for the Year 2000. However, with that challenge

successfully addressed, DOD can now turn even greater attention to

countering cyber threats and protecting its information systems in support

of both warfighting and its financial management and other business

missions.

In some areas, the Year 2000 effort has laid a foundation for long-term

improvement in the way federal agencies view, manage, and protect

computer systems supporting critical missions. Among the lessons learned

were the importance of understanding the significance of computersupported operations and the extensive dependence agencies have on

computers. This dependence has heightened DOD’s exposure and

vulnerability to a rapidly growing number of sophisticated internal and

external cyber threats. As such, DOD reports that it is firmly embarked on

improving its overall information assurance posture. For example, we

recently reported to the Special Committee on the Year 2000 Technology

Problem66 that DOD expects funding for computer-network defense to

increase significantly for fiscal years 2001 through 2005. DOD reports that

this funding is in support of its efforts to improve computer security

capabilities and to manage and strengthen its information assurance

posture.

As laid out in our 1998 Executive Guide67 on information security

management, establishing and effectively implementing a computer

security program should establish a process and assign responsibilities for

systematically (1) assessing risk, (2) developing and implementing

effective security policies and controls, (3) promoting security awareness,

(4) monitoring the appropriateness and effectiveness of these policies and

related controls, and (5) providing feedback to managers who may then

make needed adjustments. In February 1997, we included information

security in our list of government program areas at high risk for waste,

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

year’s update.68

66Computer Security: Reported Appropriations and Obligations for Four Major Initiatives (GAO/

AIMD-00-92R, Feb. 28, 2000).

67 Executive Guide: Information Security Management—Learning From Leading Organizations

(GAO/AIMD-98-68, May 1, 1998).

68High-Risk Series: Information Management and Technology (GAO/HR-97-9, Feb. 1997); High-Risk

Series: An Update (GAO/HR-99-1, Jan. 1999); and Major Management Challenges and Program Risks:

Department of Defense (GAO/OCG-99-4, Jan. 1999).
Page 42 GAO/T-AIMD/NSIAD-00-163

Although many factors contribute to these weaknesses, audits by GAO and

Inspectors General have found that an underlying cause of weak

information security is poor management of security programs. In August

1999, we reported69 that serious weaknesses in DOD’s information

security–at both the department and component levels–continued to

provide hackers and hundreds of thousands of authorized users the

opportunity to modify, steal, inappropriately disclose, and destroy

sensitive data. Moreover, they endanger other important DOD-wide

functions, such as weapons and supercomputer research, logistics,

procurement, personnel management, and military health. In fact,

attackers have stolen, modified, and destroyed both data and software at

DOD. They have installed “back doors” that circumvented normal system

protection and allowed attackers unauthorized future access. They have

also shut down and crashed entire systems and networks.

In particular, we found that DOD lacked adequate (1) controls over access

to sensitive systems and data, (2) controls over software development and

changes, (3) segregation of duties, (4) system software controls, and

(5) continuity of service plans. For example, we found that users were

granted access to computer resources that exceeded what they required to

carry out their job responsibilities, including sensitive system privileges

for which they had no need. In addition, we found that personnel were still

being assigned both systems programming and security administration

duties. This dual assignment would enable users for example, to modify

payroll records or shipping records to generate unauthorized payments or

misdirect inventory shipments and to suppress the related system audit

data to avoid detection.

At the time of our 1999 review, in response to our recommendations, DOD

was developing but had not yet implemented a departmentwide security

program—known as the Defense-wide Information Assurance Program

(DIAP). DIAP planning documents, which incorporate at a high level most

of the best practices associated with information security management,

indicate that DOD recognizes and is attempting to establish the

departmentwide structure needed to manage the complex information

security risks associated with its heavy reliance on computer systems.

Also, in December 1998, a newly created Joint Task Force for Computer

Network Defense began coordinating and directing the defense of DOD

computer systems and networks against strategic attack. Its functions

include (1) situation monitoring and assessment, (2) directing DOD

69DOD Information Security: Serious Weaknesses Continue to Place Defense Operations at Risk

(GAO/AIMD-99-107, Aug. 26, 1999).
Page 43 GAO/T-AIMD/NSIAD-00-163

actions to stop attacks, contain damage, restore functionality, and provide

feedback to users, (3) coordinating DOD defensive actions with other

government agencies and private organizations, as appropriate,

(4) participating in joint training exercises, and (5) developing contingency

plans and techniques. We currently have a review under way to determine

how well these improvements are being implemented and whether they

are being effectively coordinated.

We also made recommendations in our earlier reports aimed at ensuring

that information security programs of the military departments and

Defense agencies were consistent with the departmentwide security

program. This recommendation came partly as a result of persistent

general control weaknesses at many military installations, including

unauthorized access to sensitive information and weak controls over key

automated data processing operations used to support accounting and

operational systems. Our recently completed general and application

control review of one DOD component’s key financial management system

identified similar weaknesses.

Preliminary results of this review identified serious weaknesses in access

controls and systems software. For example, we gained access to sensitive

information through a file that was publicly available over the Internet.

Without valid user authentication, we gained access to employees’ social

security numbers, addresses, and pay information, as well as budget,

expenditure, and procurement information on projects. This component is

taking corrective actions consistent with DOD’s overall information

assurance initiatives.

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 organizations70 and to use the information

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

70Executive Guide: Creating Value Through World-class Financial Management (GAO/AIMD-00-134,

Apr. 2000).

Integrated Financial

Management System

Using Year 2000

Approach
Page 44 GAO/T-AIMD/NSIAD-00-163

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.71

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.

DOD submitted its first Financial Management Improvement Plan to the

Congress on October 26, 1998. We reported72 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

71Office 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.

72Financial Management: Analysis of DOD’s First Biennial Financial Management Improvement Plan

(GAO/AIMD-99-44, Jan. 29, 1999).

Integrated Financial

Management System

Needed
Page 45 GAO/T-AIMD/NSIAD-00-163

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.
Page 46 GAO/T-AIMD/NSIAD-00-163

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 47 GAO/T-AIMD/NSIAD-00-163

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 48 GAO/T-AIMD/NSIAD-00-163

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,73 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

73Financial Management: Analysis of DOD’s First Biennial Financial Management Improvement Plan

(GAO/AIMD-99-44, Jan. 29, 1999).
Page 49 GAO/T-AIMD/NSIAD-00-163

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.

The department recently announced its intent 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

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

Strong Department-Level

Leadership
Page 50 GAO/T-AIMD/NSIAD-00-163

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 51 GAO/T-AIMD/NSIAD-00-163

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)74—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.

74The 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 52 GAO/T-AIMD/NSIAD-00-163

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.75 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.76

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 Subcommittee may have at this

time.

(919504)

75Human Capital: Key Principles From Nine Private Sector Organizations (GAO/GGD-00-28, Jan. 31,

2000).

76Human Capital: A Self-Assessment Checklist for Agency Leaders (GAO/GGD-99-179, Sept. 1999).
Orders by Internet

For information on how to access GAO reports on the Internet, send

an e-mail message with “info” in the body to:

Info@www.gao.gov

or visit GAO’s World Wide Web home page at:

http://www.gao.gov

Contact one:

Web site: http://www.gao.gov/fraudnet/fraudnet.htm

E-mail: fraudnet@gao.gov

1-800-424-5454 (automated answering system)

Ordering Information

To Report Fraud,

Waste, and Abuse in

Federal Programs