Navy Working Capital Fund: Backlog of Funded Work at the Space and Naval Warfare Systems Command Was Consistently Understated
Published: 2003-07-01T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Space and Naval Warfare Systems Command (SPAWAR) has hundreds of millions of dollars of funded work that its working capital fund activities did not complete before the end of the fiscal year. Reducing the amount of workload carryover at fiscal year-end is a key factor in the effective management of Department of Defense (DOD) resources and in minimizing the "banking" of funds for work to be performed in subsequent years. GAO was asked to analyze SPAWAR's carryover balances. GAO assessed the accuracy of the budgeted amounts, the accuracy of the reported actual carryover balance, and the reliability of underlying financial data on which reported actual carryover is based.
section_title: What GAO Found
paragraphs: The budgeted and reported actual amounts of SPAWAR gross carryover were consistently understated, resulting in the Congress and DOD decision makers not having reliable information to decide on funding levels for working capital fund customers. First, GAO found that SPAWAR centers' budgeted gross carryover for fiscal years 1998 through 2002 was significantly less than the reported actual year-end gross carryover. Budgeted gross carryover was understated primarily due to problems with estimating the underlying customer order data. For example, for fiscal year 2002, SPAWAR's budgeted amount for customer orders was 88 percent less than the reported actual orders received. Second, SPAWAR's reported actual carryover balances were also unreliable and adjusted downward by hundreds of millions of dollars. These adjustments understated carryover and resulted in Navy reports to the Congress showing that SPAWAR carryover balances for fiscal years 1998 through 2002 did not exceed DOD's 3-month carryover standard. SPAWAR was able to report reduced carryover balances for the following reasons. As GAO previously reported, the DOD guidance for calculating the number of months of carryover allowed carryover to be adjusted and understated. DOD agreed with GAO's previous recommendation and in December 2002 changed its carryover guidance. SPAWAR centers used accounting entries to manipulate the amount of customer orders for the sole purpose of reducing reported carryover below the 3-month standard. For example, the centers did this for at least $50 million at the end of fiscal year 2001. SPAWAR officials issued guidance in September 2002 discontinuing this practice. Finally, SPAWAR had not taken key steps to verify the underlying financial data on which reported actual carryover is based. The SPAWAR centers had only recently begun conducting the required tri-annual reviews of such data, which DOD has required since 1996. However, the reviews were ineffective, including the exclusion of slightly less than half of their reported actual carryover from the review process.

section_title: Letter
paragraphs: This is the third in a planned series of reports that discusses the Defense  Working Capital Fund fiscal year-end workload funding issue, generally  referred to as “carryover.”  Section 1051 of the Floyd D. Spence National  Defense Authorization Act For Fiscal Year 2001 required that we review  various aspects of the Department of Defense (DOD) policy that allowed  Defense Working Capital Fund activities to carry over a 3-month level of  work to ensure continuity of operations from one fiscal year to the next.   Excessive amounts of carryover financed with customer appropriations  may indicate excessive or unneeded funds and are subject to reductions by  DOD and the congressional defense committees during the budget review  process.  To the extent that carryover is high, the Congress may redirect the  funds gained from such reductions to other priority initiatives.
In May 2001, we reported that (1) DOD did not have a sound analytical  basis for its 3-month carryover standard, (2) military services used  different methods to calculate the number of months of carryover, and   (3) some activity groups underestimated their budgeted carryover year  after year, thereby providing decision makers with misleading year-end  carryover information resulting in more funding being provided than was intended.  In June 2002, we reported on our review of the contract portion  of the Air Force depot maintenance activity group.  We found that the Air  Force reported carryover balances were not reliable due to (1) faulty  assumptions used in calculating work-in-process and (2) records not  accurately reflecting work that was actually completed by fiscal year-end.
As requested and agreed to with your office, this report assesses carryover  related to the Navy’s Space and Naval Warfare Systems Command  (SPAWAR) systems centers located at Charleston, South Carolina and San  Diego, California.  The SPAWAR systems centers have hundreds of millions  of dollars of carryover and the carryover balance has been steadily  increasing over the last 5 years.  Our objectives were to determine if   (1) differences existed between the budgeted and reported actual gross  carryover and, if so, the reasons for the variances, (2) the reported actual  carryover balances accurately reflected the amount of work that remained  to be accomplished, and (3) the SPAWAR systems centers had reliable  underlying financial information to serve as the basis for reported actual  carryover.  Our review was performed from July 2002 through June 2003 in  accordance with U.S. generally accepted government auditing standards.   However, we did not fully validate the accuracy of the accounting and  budgeting data referred to in this report, all of which were provided by the  Navy.  Further details on our scope and methodology can be found in  appendix I.  We requested comments on a draft of this report from the  Secretary of Defense or his designee.  Written comments from the Under  Secretary of Defense (Comptroller) are reprinted in appendix II.
subsections: section_title: Background
paragraphs: According to the Navy’s fiscal year 2003 budget, the Navy Working Capital  Fund will earn about $20.8 billion in revenue during fiscal year 2003.  The  Navy Working Capital Fund consists of the following six major activity  groups:  depot maintenance, transportation, base support, information  services, supply management, and research and development.  The Navy  estimates that the research and development activity group will earn about  $7.7 billion during fiscal year 2003, the largest activity group in terms of the  dollar amount of revenue earned.  This activity group includes the  following subactivity groups:  (1) the Naval Surface Warfare Center, (2) the  Naval Air Warfare Center, (3) the Naval Undersea Warfare Center, (4) the  Naval Research Laboratory, and (5) the Space and Naval Warfare Systems  Centers.
The SPAWAR systems centers are the Navy’s full-spectrum research,  development, test and evaluation, engineering, and fleet support centers  for command, control, and communication systems and ocean surveillance  and the integration of those systems.  The systems centers (1) support the  fleet in mission and capability by providing capable and ready command  and control systems for the Navy and (2) provide the innovative scientific  and technical expertise and facilities necessary to ensure that the Navy can  develop, acquire, and maintain the warfare systems needed to meet  requirements.  The SPAWAR systems centers’ primary locations are in San  Diego, California and Charleston, South Carolina.
subsections: section_title: Description of the Working Capital Fund Process of Setting Prices and Obligating Customer Funds
paragraphs: As part of the Navy Working Capital Fund, the SPAWAR systems centers  rely on sales revenue rather than direct congressional appropriations to  finance their operations.  DOD policy requires working capital fund activity  groups to (1) establish prices that allow them to recover their expected  costs from their customers and (2) operate on a break-even basis over  time—that is, not make a profit nor incur a loss.  DOD policy also requires  the activity groups to establish their sales prices prior to the start of each  fiscal year and to apply these predetermined or “stabilized” prices to most  orders received from customers during the year—regardless of when the  work is actually accomplished or what costs are actually incurred.
Customers use appropriated funds to finance the orders placed with the  SPAWAR systems centers.  When a systems center accepts the customer  order, its own obligational authority is increased and the customer’s  appropriation is obligated by the amount of the order.  The working capital  fund activity incurs obligations for costs, such as material and labor, to  perform the work.
In addition to receiving orders from customers to do work as part of the  working capital fund, SPAWAR systems centers also award hundreds of  millions of dollars in contracts with the private sector for work to be  performed for the centers’ customers.  These contracts and related work  are not included in the working capital fund from a financial standpoint  because the contractors directly bill the customers for work performed and  the customers directly pay the contractors.  DOD and the Navy refer to this  process of awarding contracts for customers as direct cite orders, since the  SPAWAR systems centers cite the customers’ appropriation(s) on the  contracts.  The customers’ funds are obligated when the systems centers  award the contracts with contractors.
section_title: What Is Carryover and Why Is It Important?
paragraphs: Carryover is the dollar value of work that has been ordered and funded  (obligated) by customers but not yet completed by working capital fund  activities at the end of the fiscal year.  Carryover consists of both the  unfinished portion of work started but not yet completed, as well as  requested work that has not yet commenced.  To manage carryover, DOD  converted the dollar amount of carryover to equivalent months of work.   This was done to put the magnitude of the carryover in proper perspective.   For example, if an activity group performs $100 million of work in a year  and had $100 million in carryover at year-end, it would have 12 months of  carryover.  However, if another activity group performs $400 million of  work in a year and had $100 million in carryover at year-end, this group  would have 3 months of carryover.
The congressional defense committees and DOD have acknowledged that  some carryover is necessary at fiscal year-end if working capital funds are  to operate efficiently and effectively.  In 1996, DOD established a 3-month  carryover standard for all the working capital fund activities except for the  contract portion of the Air Force depot maintenance activity group.  In  May 2001, we reported that DOD did not have a basis for its carryover  standard and recommended that DOD determine the appropriate carryover  standard for the depot maintenance, ordnance, and research and  development activity groups.  Based on our recommendation, in December  2002, DOD revised its carryover policy for working capital fund activities.   Under the revised method, DOD eliminated the 3-month standard, and the  allowable amount of carryover is to be based on the overall disbursement  rate of the customers’ appropriations financing the work.  Too little  carryover could result in some activity groups not having work to perform  at the beginning of the fiscal year, resulting in the inefficient use of  personnel.  On the other hand, too much carryover could result in an  activity group receiving funds from customers in one fiscal year but not  performing the work until well into the next fiscal year or subsequent  years.  By minimizing the amount of the carryover, DOD can use its  resources most effectively and minimize the “banking” of funds for work  and programs to be performed in subsequent years.
section_title: Gross Carryover Budget Estimates Were Consistently and Substantially Understated
paragraphs: For fiscal years 1998 through 2002, SPAWAR systems centers’ budgeted  gross carryover was significantly less than reported actual gross carryover,  thereby providing decision makers, including the Office of the Under  Secretary of Defense (Comptroller) and congressional defense committees,  misleading carryover information.  These decision makers use carryover  information to determine whether the SPAWAR systems centers have too  much carryover.  If the systems centers have too much carryover, the  decision makers may reduce the customers’ budgets and use these  resources for other purposes.  For example, during its review of the fiscal  year 2003 budget, the Office of the Under Secretary of Defense  (Comptroller) noted that the Navy research and development activities  carryover had been steadily increasing from about $2.2 billion in fiscal year  1997 to about $3.4 billion in fiscal year 2003.  Since a significant portion of  the carryover was related to work that was to be contracted out, the Office  of the Under Secretary of Defense (Comptroller) reduced the customer  funding by $161.1 million because these efforts could be funded in fiscal  year 2004 with no impact on performance.
subsections: section_title: Customers’ Underestimated Budgeted Orders Caused Understated Budgeted Gross Carryover
paragraphs: SPAWAR systems centers’ reported actual year-end gross carryover was  substantially greater than their budgeted gross carryover.  Table 1 shows  that from fiscal year 1998 through fiscal year 2002 reported actual gross  carryover exceeded budgeted gross carryover, and the difference has  increased from about $153 million to about $286 million.
The Navy’s budget requests consistently underestimated SPAWAR systems  centers’ gross carryover, in part, because the Navy consistently  underestimated the amount of orders to be received from customers by  hundreds of millions of dollars.  Table 2 shows that the amount of  difference between budgeted and reported actual orders increased from  about $352 million (39 percent) in fiscal year 1998 to about $1.1 billion (88  percent) in fiscal year 2002.  Since orders received from customers are the  major source of funds for SPAWAR and one of the key factors in  determining the amount of carryover at fiscal year-end, it is critical that the  Navy has accurate budget estimates on the amount of orders to be received  from customers.  However, for fiscal years 2000, 2001, and 2002 actual  orders exceeded budgeted orders by at least 68 percent each year.
The data in table 2 indicate that the SPAWAR systems centers’ customers  have not accurately estimated the amount of orders they will place with the  systems centers.  Customers determine and justify their anticipated  requirements for goods and services and the levels of performance they  require from the systems centers to fulfill mission objectives.  Our analysis  of budget and accounting reports that provide information on customer  orders shows that orders financed with three appropriations made up a  large part of the differences in fiscal years 2000, 2001, and 2002.  The  appropriations used by customers to finance 49 percent to 67 percent of the  differences for these 3 fiscal years were the   Other Procurement, Navy appropriation;   Research, Development, Test, and Evaluation, Defense appropriation;   Research, Development, Test, and Evaluation, Navy appropriation.
section_title: Reasons for Variances between Budgeted and Reported Actual Gross Carryover and Orders Received from Customers
paragraphs: Officials from the Charleston and San Diego Systems Centers and SPAWAR  headquarters stated, and our work found, that customers have historically  understated their budget estimates on customer orders that are received by  the SPAWAR working capital fund.  They stated that the systems centers’  budgets for orders are based on what the customers tell them their  requirements would be for a particular fiscal year.  However, they also told  us that customers are hesitant to make a full commitment to the estimated  amount of work that will need to be performed.
SPAWAR and Navy headquarters budget officials acknowledged that the  SPAWAR systems centers’ budgets have consistently understated gross  carryover and orders received from customers (claimants).  They also  stated that the dollar amount of orders that the systems centers receive  from customers must match the dollar amount of orders that customers  submit in their appropriated fund budgets.  Customers only record in their  budgets those orders that they will be sending directly to the systems  centers.  If a customer initially allocates budgeted funds to an activity not  related to the working capital fund—which is a third party—and the third  party places the order with a SPAWAR systems center, the customer’s  budget reflects that these funds went to a third party.  This results in the  amount of budgeted orders that the systems centers receive from  customers being understated.   Navy headquarters officials stated that this  is not an easy problem to resolve because there are many customers and no  one person or office is responsible for fixing the problem and it is hard to  pinpoint which customers are not budgeting correctly.
Navy headquarters budgeting officials also stated that the fiscal year 2001  and 2002 budgets further understated gross carryover and orders for the  following three reasons.  First, the Naval Computers and  Telecommunications Command merged with SPAWAR, which resulted in  about $125 million of additional orders being received in fiscal year 2001  than was reflected in SPAWAR systems centers’ budget.  Second, the Navy  changed its policy on work performed on certain types of work orders  placed with the San Diego Systems Center.  As a result, customers placed  more orders for work that was contracted out by the working capital fund  than was originally budgeted for in fiscal years 2001 and 2002.  Third, the  SPAWAR systems centers received $166.7 million in orders financed by the  Defense Emergency Response Fund in fiscal year 2002 that was not  reflected in the SPAWAR systems centers’ budget.  These funds were  provided via a supplemental appropriation.
Navy headquarters officials were aware of this budgeting problem and  issued guidance in March 2002 on preparing the fiscal 2004/2005 budget  estimates that stressed the importance of customers accurately preparing  budget estimates for orders placed with the Navy Working Capital Fund,  including the SPAWAR systems centers.  The guidance also stated that (1) it  was imperative that all funds to be sent to the Navy Working Capital Fund  be accurately reflected in the budget and (2) customers have historically  underreported the funds to be placed with the Navy Working Capital Fund  (particularly with the research and development business area that  includes the SPAWAR systems centers) and overreported the use of these  funds in other areas.
section_title: Reported Actual Carryover Balances Were Consistently Understated
paragraphs: In addition to understating budgeted gross carryover, SPAWAR systems  centers also consistently understated their reported actual carryover.   Inaccurate carryover information results in the Congress and DOD officials  not having the information they need to perform their oversight  responsibilities, including reviewing DOD’s budget.  Navy reports show that  the systems centers’ fiscal year-end carryover balances for fiscal years 1998  through 2002 did not exceed DOD’s 3-month carryover standard.  However,  we found that the systems centers’ reported carryover balances were  understated because (1) DOD’s guidance for calculating the number of  months of carryover allowed this to happen and (2) the systems centers  used accounting entries to manipulate customer work orders at year-end to  help reduce reported carryover below the 3-month standard.
subsections: section_title: Defense Carryover Policy
paragraphs: Prior to 1996, if working capital fund activity groups’ budgets projected  more than a 3-month level of carryover, their customers’ budgets could be,  and sometimes were, reduced by the Office of the Under Secretary of  Defense (Comptroller) and/or congressional committees.  Because of the  military services’ concerns about (1) the methodology used to compute the  months of carryover and (2) the reductions that were being made to  customer budgets because of excess carryover, Defense performed a joint  review of carryover in 1996 to determine if the 3-month standard should  be revised.  Based on the joint review, DOD decided to retain the 3-month  carryover standard for all working capital fund activity groups except Air  Force contract depot maintenance.  Furthermore, as a result of the review  and concerns expressed by the Navy, DOD also approved several policy  changes that had the effect of increasing the carryover standard for all  working capital fund activities.  Specifically, under the policy implemented  after the 1996 review, certain categories of orders, such as those from non- DOD customers, and contractual obligations, such as SPAWAR system  centers’ contracts with private sector firms for research and development  work, can be excluded from the carryover balance that is used to  determine whether the carryover standard has been exceeded.
These policy changes were documented in an August 2, 1996, DOD decision  paper that provided the following formula for calculating the number of  months of carryover. (See fig.1.)
section_title: Carryover Calculation Understated Reported Carryover
paragraphs: DOD’s 1996 decision to allow certain categories of orders to be excluded  (adjustments) from reported gross carryover has had a significant impact  on SPAWAR systems centers’ reported carryover, particularly the  adjustment for contractual obligations.  As table 3 shows, these  adjustments have allowed the systems centers to significantly reduce  actual reported gross carryover by hundreds of millions of dollars,  resulting in reported carryover below the 3-month standard.  As discussed  below, we do not agree with how the Navy interpreted DOD’s guidance for  using contractual obligations and related revenue in calculating carryover.   Our analysis of the systems centers’ adjustments to their carryover  amounts shown in table 3 found that contractual obligations accounted for  75 percent to 89 percent of the dollar adjustments made.
In May 2001, we reported that the months of carryover reported by Navy  activity groups, which include the SPAWAR systems centers, would more  accurately reflect the actual backlog of in-house work if adjustments for  contract obligations affected both contract carryover and contract  revenue.  As shown in figure 1, DOD’s formula for calculating months of  carryover is based on the ratio of adjusted orders carried over to revenue.   The formula specifies that gross carryover should be reduced by the  amount of contract obligations.  However, DOD did not provide clear  guidance on whether downward adjustments for the revenue associated  with contract services should also be made.  Unless this is done, the  number of months of reported carryover will be understated.
In our May 2001 report we recommended, among other things, that the  revenue used in calculating months of carryover be adjusted (reduced) for  revenue earned for work performed by contractors.  However, as discussed  below, until recently DOD had not changed its policy for calculating  carryover.  As a result, the Navy did not adjust the revenue amount used in  the denominator of the calculation and, therefore, continued to understate  its reported carryover in its budget submissions to the Congress through  fiscal year 2003.  Navy officials informed us that they used total revenue in  their calculation because total revenue represents the full operating  capability of a given activity group to accomplish a full year’s level of  workload.  Further, even though Navy officials acknowledged that the  revenue amount used in the calculation includes revenue earned from  contracts, they stated the reason for not removing contract-related revenue  from the denominator of the calculation was that the numerator of the  calculation includes carryover (funds) related to work for which contracts  would eventually be awarded but which had not yet been awarded at fiscal  year-end.  In addition, Navy officials told us that the accounting systems  cannot readily break out what portion of the total revenue amount is  contract-related.  They further told us that the revenue information can be  extracted from the system, but doing so involves a lot of work to develop  the program(s) necessary to obtain the information.
When the Navy reduces the dollar amount of carryover (numerator) by the  amount of contractual obligations and does not reduce the revenue amount  (denominator) for revenue associated with contracts, it is not being  consistent with the use of adjustments in the formula to calculate  carryover.  Because the Navy cannot readily determine the amount of  contract-related revenue, we asked SPAWAR headquarters to estimate what  the amount would be for the systems centers based on the same criteria  they use to determine the dollar amount of contractual obligations to be  deducted in the carryover calculation.  SPAWAR’s estimate shows that 63  percent of the total revenue amount used in calculating the SPAWAR  systems centers’ number of months of actual carryover reported for fiscal  year 2002 is related to revenue associated with contractual services.  By not  reducing total revenue used in the calculation for revenue related to work  performed by contractors, the systems centers’ reported months of  carryover for that fiscal year were understated.
In response to our May 2001 report, the Under Secretary of Defense  (Comptroller) agreed that the methodology for calculating carryover  needed to be revised.  In December 2002, the Under Secretary of Defense  (Comptroller) issued new guidance on carryover for working capital fund  activities.  Under the revised methodology, the formula shown in figure 1  has been eliminated and, therefore, working capital fund activities can no  longer reduce reported carryover by the amount of their contractual  obligations.  DOD adopted the revised methodology for the Defense  Working Capital Fund fiscal year 2004 budget estimates, but DOD has not  yet issued written procedures to ensure that the services consistently  implement the new policy.  DOD officials informed us that they are  developing the procedures and will update the appropriate regulations in  2004.  We did not evaluate DOD’s revised carryover policy.
section_title: Customer Orders Were Manipulated at Year-end to Reduce Reported Carryover
paragraphs: We also found that the systems centers reduced reported carryover by  simply making accounting entries that took work to be performed by the  working capital fund and turned it into work to be performed outside the  working capital fund.  Customer work that is performed by the working  capital fund is referred to as reimbursable work.  Customer work that is not  performed by the working capital fund is referred to as direct cite work.   Under the direct cite method of performing work, the working capital fund  acts as an agent to get the work done through a private sector contractor.   Customer funds that finance work done on a direct cite basis are not  included in the working capital fund.  Instead, the customer uses the direct  cite funds to directly pay private sector contractors for the work performed  rather than reimbursing or paying the working capital fund.  Because the  funds for direct cite work are not part of the working capital fund, there is  no carryover associated with this work.  Therefore, the work is not subject  to DOD’s 3-month carryover standard.
The two SPAWAR systems centers made some accounting entries at fiscal  year-end that moved customer orders out of the working capital fund for  the sole purpose of reducing reported carryover below the 3-month  standard, which understated the amount of carryover that SPAWAR  reported to the Navy and DOD.  They then reversed these accounting  entries in the beginning of the next fiscal year.  Specifically, the systems  centers did this at fiscal year-end 2000 for customer orders totaling at least  $38 million and at fiscal year-end 2001 for orders totaling at least   $50 million.  SPAWAR systems centers’ officials acknowledged that these  accounting adjustments were made at fiscal year-end to reduce reported  carryover.  The officials told us that this has been a long-standing practice  and was used as a “tool” to manage reported carryover.  For example,  comptroller officials at one systems center told us that as the fiscal year- end grew near, they had a good idea of how much they needed to move  from reimbursable to direct cite in order to get down below the 3-month  carryover standard.  At year-end, if it was determined that they moved more  funds than needed to get below the standard, they would move the excess  back to reimbursable before the accounting period was officially closed.
We do not view these actions as a tool for managing workload as reflected  by the reported carryover but as a misrepresentation of actual carryover  balances in order to mislead decision makers, including DOD budget  officials and the Congress.  After discussing this practice with SPAWAR  headquarters officials, they issued guidance in September 2002, prohibiting  the use of reimbursable/direct cite accounting adjustments to mask year- end carryover balances.  In discussing this with Navy headquarters and  DOD officials, they told us that they were not aware that the systems  centers were doing this and that they did not agree with this practice.
section_title: Reported Actual Carryover Is Based on Unreliable Underlying Financial Data
paragraphs: In addition to understating budgeted and reported actual carryover  information, the two SPAWAR systems centers’ actual carryover data that  were reported to the Congress as part of the President’s budget were based  on some unreliable underlying financial data.  Although many factors could  have contributed to this data problem, a primary cause was that the two  centers had not fully complied with DOD guidance that required them and  all other DOD fund holders to conduct tri-annual reviews of their financial  data (outstanding commitments, obligations, and accrued expenditures).   In fact, although DOD established its tri-annual review requirement in 1996  in order to improve the timeliness and accuracy of its financial data, the  Charleston and San Diego Systems Centers did not conduct their first  reviews until September 2001 and September 2002, respectively.  Further,  as of September 2002, the systems centers were fully complying with only a  few of the 16 specific tasks that they were required to accomplish during  their reviews.
As discussed below, three carryover-related problems with the two systems  centers’ tri-annual reviews are that the centers (1) excluded about 46  percent of their reported actual carryover from their September 2002 tri- annual reviews, (2) were not effectively reviewing dormant obligations  and, therefore, were sometimes returning unneeded funds to customers  after the funds had expired, and (3) were not effectively reviewing accrued  expenditure data (accrued expenditures reduce carryover).  A fourth  problem was that neither SPAWAR headquarters nor the systems centers’  commanders had developed effective policies and procedures for ensuring  that (1) tri-annual reviews are conducted in accordance with DOD  guidance and (2) timely and appropriate corrective action is taken on  problems that are identified during the reviews.
subsections: section_title: Effective Tri-Annual Reviews Can Result in More Informed Carryover-Related Budget Decisions and Other Benefits
paragraphs: The May 1996 memorandum from the Under Secretary of Defense  (Comptroller) that established DOD’s tri-annual review requirement noted  that the timely review of commitments and obligations to ensure the  accuracy and timeliness of financial transactions is a vital phase of  financial management.  To illustrate this point, the Under Secretary stated  that the accurate recording of commitments and obligations (1) forms the  basis for formal financial reports issued by the department and (2) provides  information for management to make informed decisions regarding  resource allocation.
Carryover-related budget decisions are examples of resource allocation  decisions that require reliable obligation data.  This is because there is a  direct link between the (1) carryover data that working capital fund  activities report to the Congress and DOD decision makers and   (2) obligation data contained in the accounting records of working capital  fund activities and their customers.  Specifically,  when working capital fund activities, such as the SPAWAR systems  centers, accept customer orders, obligations are created in the  customers’ accounting records, and the systems centers become the  “fund holders” and  as work is performed and customers are billed, both the unliquidated  obligation balances in the customers’ accounting records and the  working capital fund activities’ reported carryover balances are  reduced.
DOD’s implementing guidance for the tri-annual reviews requires fund  holders, such as the two SPAWAR systems centers, to certify that they  completed 16 specific tasks during their reviews.  For example, the  guidance requires fund holders to confirm, among other things, that they  have (1) traced the obligations and commitments that are recorded in their  accounting systems back to source documents and (2) conducted adequate  follow-up on all dormant obligations and commitments to determine if they  are still valid.  Additionally, the guidance requires fund holders to  (1) identify the problems that were noted during their reviews, (2) advise  their higher headquarters—SPAWAR headquarters for the two systems  centers—whether, and to what extent, adjustments or corrections to  remedy noted problems have been taken, (3) summarize, by type, the  actions or corrections remaining to be taken, (4) indicate when such  actions/corrections are expected to be completed, and (5) identify the  actions that have been taken to preclude identified problems from  recurring in the future.  Thus, if properly implemented, tri-annual reviews  can provide a systematic process that helps fund holders not only improve  the reliability of their financial data but also identify and correct the  underlying causes of their data problems.
subsections: section_title: Tri-Annual Reviews Have Received Very Little Management Emphasis
paragraphs: As noted previously, DOD established the tri-annual review requirement in  May 1996, but the Charleston and San Diego Systems Centers did not  conduct their first reviews until September 2001 and September 2002,  respectively.  Discussions with SPAWAR officials and the centers’ financial  managers indicated that a lack of management emphasis is the primary  reason for this delayed implementation.
For example, SPAWAR headquarters officials pointed out that the Navy’s  implementing guidance was not issued until July 2001—more than 5 years  after DOD established the requirement, and San Diego Systems Center  financial managers stated that they were not aware of the tri-annual review  requirement until fiscal year 2001.  Further, when Charleston and San Diego  financial managers were asked why their centers did not conduct their first  tri-annual reviews until the end of fiscal year 2001 and 2002, respectively,  they stated that their personnel were busy reconciling data problems that  were caused by multiple organizational consolidations and accounting  system conversions, and indicated that their personnel did not have time to  conduct tri-annual reviews.
section_title: DOD Guidance Allows a Substantial Amount of Carryover to Be Excluded from Tri-Annual Reviews
paragraphs: The SPAWAR systems centers’ reported actual carryover falls into two  major categories—obligated carryover and unobligated carryover.   Obligated carryover refers to the portion of customer orders for which the  systems centers have obligated their own funds.  For example, if a  customer submits a $1,000 order for engineering services, and a contractor  will accomplish 10 percent of the work, then the systems center will award  a contract for $100—which will obligate the center’s funds—and the $100  will, therefore, be referred to as obligated carryover.  A customer order’s  unobligated carryover balance is calculated by subtracting obligated  carryover from the total amount remaining on the order—or $900 for this  example.  As of September 30, 2002, the two SPAWAR systems centers had  about $896.1 million of reported actual carryover—$379.5 million of  obligated carryover and $516.6 million of unobligated carryover.
The distinction between obligated carryover and unobligated carryover is  important because (1) neither DOD nor Navy guidance explicitly requires  the systems centers to review unobligated carryover during their tri-annual  reviews (unless the work is recorded as a commitment in their accounting  records) and (2) about $414 million of the systems centers’ September 30,  2002, unobligated carryover was not recorded as a commitment in the  centers’ accounting records.  In other words, even if the tri-annual reviews  were performed effectively and in a timely manner, they would not cover  about 46 percent of the systems centers’ reported actual carryover.
DOD guidance does require customers, as part of their tri-annual reviews,  to validate the orders they have placed with working capital fund activities  because these orders are recorded as obligations in their accounting  records, regardless of whether they are obligated or unobligated carryover  in the working capital fund activities’ records.  However, customers have  limited visibility over whether the unobligated portion of their funded  orders are needed to finance future work, and, therefore, the working  capital fund activities are in a better position than the customers to make  this determination.
If the systems centers were required to review unobligated carryover  balances when performing their tri-annual reviews, they could (1) reduce  the amount of carryover on their records and (2) better identify unneeded  funds and be in a better position to return them to customers before the  funds expired so the customers could use them for new obligations.  For  example, our review of 34 customer orders that (1) had $7 million of  unobligated carryover balances as of September 30, 2001, and (2) were  financed with funds that had already expired as of that date showed that  most of the orders contained unneeded funds that were eventually returned  to customers.  Our analysis showed that (1) 27 of the orders (about 79  percent) had unneeded funds and (2) $2.9 million, or about 41 percent, of  the orders we reviewed represented unneeded funds.
Although most of the unneeded funds we identified were eventually  returned to customers, in some instances the funds were not returned until  long after the funds expired.  For example, $469,916 of unneeded funds on  two Charleston Systems Center orders expired in September 2001, but was  not returned to the customer until September 2002—almost 1 year after the  funds had expired.  Similarly, $71,718 of unneeded funds on a San Diego  order expired in September 1998, but was not returned to the customer  until December 2002—more than 4 years after the funds had expired.
We believe, and a senior DOD accounting official agreed, that the systems  centers and other working capital fund activities should be required to  validate their unobligated carryover during tri-annual reviews because, as  noted previously, they have better visibility over whether unobligated funds  will be needed in the future.  However, neither center requires its managers  to review unobligated carryover during the tri-annual reviews because, as  financial managers at one center pointed out, they are concentrating on the  requirements explicitly identified in the DOD guidance, and they will add  other tasks, such as reviews of unobligated carryover, if and when (1) the  guidance is changed or (2) they have the time and resources to do so.
section_title: More Effective Reviews of Dormant Obligations Could Result in More Effective Use of Customer Funds
paragraphs: A key element of the tri-annual reviews is the requirement to follow up on  all obligations that have been dormant for more than 120 days to determine  if unused funds are still needed.  This task is one of the 16 tri-annual review  requirements and is important from the systems centers’ perspective  because the identification and return of unneeded funds to the customer  will reduce the centers’ reported carryover—thereby reducing the  likelihood of customers’ budget cuts.  Additionally, the task is important  from the customers’ perspective because the funds can be reused for other  purposes if they are returned before they expire.
However, our analysis of the two centers’ financial data and review of  individual customer orders showed that neither center was effectively  identifying unneeded funds and returning them to customers in a timely  manner.  For example, our analysis of the two systems centers’ financial  data showed that, as of September 30, 2002, the two centers had thousands  of obligated carryover balances, valued at more than $7 million, that had  not changed for more than a year.  Further, some of these dormant balances  were financed with customer funds that had long since expired.  For  example, 165 of the dormant carryover balances were financed with fiscal  year 1996 or earlier appropriations.  According to a systems center official,  the monumental financial workload involved with the acquisition of  additional activities and the transition to a consolidated financial  accounting system occurring over the past several years greatly hindered  their efforts to close all expired funding documents and return the unused  funds to customers in a timely manner.  For example, the official pointed  out that the center had almost 13,000 old funding documents needing to be  reconciled and closed at the start of fiscal year 2000 because of these  problems and that the center was still working on them.
section_title: Large Accrued Expenditure Balances Warrant Increased Management Emphasis
paragraphs: At the conclusion of their tri-annual reviews, fund holders are required to  certify that they have conducted adequate research on all accrued  expenditures that are more than 120 days old to determine if they are  valid.  This task is important because   large accrued expenditure balances, in general, and large dormant  accrued expenditure balances, in particular, can indicate either serious  accounting problems or ineffective procedures for developing accrued  expenditure schedules and   accrued expenditures reduce reported carryover balances, and overly  optimistic accrued expenditure schedules can, therefore, cause  reported carryover to understate actual carryover.
The task of validating accrued expenditures is especially important for the  two SPAWAR systems centers because they had about $673 million of  accrued expenditures as of September 30, 2002.
However, the San Diego Systems Center, which had the larger accrued  expenditure balance—about $423 million as of September 2002—is  currently developing a methodology for validating its accrued  expenditures.  Further, although the Charleston Systems Center had  developed a methodology to review its accrued expenditures, the  Charleston Comptroller was concerned about the timeliness and adequacy  of these reviews and, therefore, was unwilling to certify that the center  adequately reviewed its dormant accrued expenditures.
Although the tri-annual review’s tasks related to accrued expenditures  focus primarily on accounting problems, reviews of dormant accrued  expenditures are also important from a carryover perspective.  Overly  optimistic accrued expenditure schedules—which are the basis for  determining when accrued expenditures will be recorded in the accounting  system—can cause reported carryover to understate actual carryover.  For  example, if a contractor is to perform $600 of work, and an accrued  expenditure schedule is based on the assumptions that the work will begin  immediately and will be performed at a uniform rate over a 6-month period,  then (1) $100 of expenditures will be accrued each month and (2) each  accrued expenditure will trigger a $100 customer payment and, in turn, a  $100 reduction in the reported carryover.  Thus, after 4 months, the  reported carryover will be $200, regardless of how much work has actually  been accomplished.  If the work begins later than expected or if it takes  longer than expected to complete, and accrued expenditures are not  adjusted accordingly, reported carryover would be understated.
Two ways to put the magnitude of the systems centers’ accrued  expenditure balances in perspective are to (1) compare the balances with  other financial indicators and (2) show their impact on reported carryover.   For example, the San Diego Systems Center’s September 2002 accrued  expenditure balance of $423 million is the equivalent of about 32 percent of  the orders the center received during fiscal year 2002 ($1.315 billion) and  about 31 percent of the revenue it received during the year ($1.372 billion).   The accrued expenditures allowed the center to reduce its reported  carryover at the end of fiscal year 2002 by about 3.7 months.
A San Diego Systems Center accounting official acknowledged that the  center’s large accrued expenditure balance is a major area of concern.   Specifically, this official indicated that the center’s large accrued  expenditure balance is caused partly by delays in contractor and interfund  billings, but acknowledged that there are other apparent problems that  warrant attention.  For example, the official said that the $405 million  variance between the center’s September 30, 2002, accrued expenditure  and accounts payable balances is an apparent problem that should be  reviewed.
However, the accounting official also pointed out that currently the center  cannot analyze its accrued expenditures because its new accounting  system, which has been tailored to meet its specific needs and is unique  within DOD, cannot provide the data in a format that will allow it to do so.   When asked what the San Diego Systems Center is doing to develop the  data needed to effectively analyze its accrued expenditure data, the  accounting official indicated that the center is developing a “data  warehouse.”  However, the official acknowledged that (1) they have just  begun identifying the specific requirements for the data warehouse,   (2) there will be many competing requirements, (3) due to resource  constraints, the data warehouse will not be able to satisfy all of the center’s  data analysis needs, and (4) they, therefore, do not know when or, for that  matter, if they will ever have the data they need to effectively analyze their  accrued expenditures.
section_title: Improvements Are Needed in SPAWAR’s Tri-Annual Review Procedures
paragraphs: In addition to the major problems identified above, our review of the  procedures that SPAWAR headquarters and its two systems centers use to  conduct their tri-annual reviews identified several areas that need  improvements.  For example, SPAWAR headquarters has not evaluated the  systems centers’ reviews and, as a result, the command (1) does not have a  sound basis for assessing the adequacy of the reviews that the centers have  conducted on individual obligation, commitment, and accrued expenditure  balances and (2) was not aware of the process-related problems discussed  below.
subsections: section_title: San Diego’s Decentralized Review Process Needs to Be Refined
paragraphs: The San Diego Systems Center accomplishes its tri-annual reviews on a  decentralized basis.  During the first step of the process, the Office of the  Comptroller, which has overall responsibility for the reviews, develops  computer lists that contain information on all of the center’s outstanding  obligations and commitments.  The Comptroller’s Office then provides  these lists to the center’s technical departments, which are then required to  conduct the actual reviews.  When the technical departments finish their  reviews, their department heads certify that the reviews have been  completed and then forward this certification to the San Diego Systems  Center’s Comptroller.  On the basis of the technical departments’  certifications, the Comptroller then certifies that the center has completed  its review.
Although this approach seems reasonable on the surface, we found  numerous problems with the process.  For example, because the systems  center’s draft tri-annual review guidance does not specifically require the  technical departments to accomplish many important tasks, the  effectiveness and usefulness of the reviews varied significantly from one  department to another.  For example, two of the center’s technical  departments did not (1) summarize or analyze the results of their reviews,  (2) establish internal controls to ensure that timely and appropriate  corrective action was taken on problems that were identified during the  reviews, or (3) maintain adequate documentation to show who conducted  the reviews, what problems were identified, and/or what additional actions  were required.
Conversely, although it was not required to do so, another department   (1) summarized the results of its reviews in a single Excel spreadsheet to  facilitate analysis of the review results, (2) analyzed the data to determine  if there were any indications of systemic or compliance problems (e.g.,  inadequate reviews by one or more of the department’s divisions or  problems with accrual schedules), and (3) developed internal control  procedures to ensure that timely and appropriate action was taken on  identified problems and/or unresolved research requirements.   Additionally, this department requires its managers to maintain  documentation that (1) shows who conducted the actual reviews (so these  individuals can be held accountable for the adequacy of the reviews),   (2) identifies the additional research or corrective action that is required as  a result of the reviews, and (3) indicates who is responsible for taking the  action.
Managers from this department said that they were initially skeptical about  the benefits of the tri-annual reviews, but indicated that they are now  strong supporters because the reviews have provided a structured way to  address their data problems and have already resulted in significant  improvements in the quality of their data.  Additionally, they acknowledged  that documenting what corrective action is required and who is responsible  for taking it requires additional time, at least in the short term.  However,  they believe this documentation is essential for (1) holding people  accountable and (2) having effective internal controls to ensure that timely  and appropriate corrective action is taken on the problems that are  identified.  Further, they believe that the documentation may save time in  the long term because it will serve as a “memory jogger” for subsequent  reviews.
Additional process-related problems we identified during our assessment  of the San Diego Systems Center’s tri-annual review process include the  following.
As noted previously, although the center had about $423 million of  accrued expenditures as of September 2002, it had not yet developed a  methodology for identifying and reviewing its accrued expenditures.
Fund holders are required to conduct sufficient follow-up on dormant  obligations and commitments to determine if they are still valid.   However, the computer lists that the San Diego Comptroller provides to  the center’s technical departments do not distinguish between the  obligations and commitments that have been dormant and those that  have not.  As a result, the technical departments have no way to focus  their attention on the obligations and commitments that require follow- up action.
The certifications that the department heads sign are much more  general than the one that the Comptroller must sign on behalf of the  system center and they, therefore, do not provide an adequate basis for  the Comptroller’s certification.  For example, the Comptroller is  required, among other things, to (1) advise SPAWAR headquarters  whether, and to what extent, adjustments or corrections to remedy  noted problems have been taken, (2) summarize, by type, the actions or  corrections remaining to be taken, (3) indicate when such  actions/corrections are expected to be completed, and (4) identify the  actions that have been taken to preclude identified problems from  recurring in the future.  However, the Comptroller does not require the  departments to report this information to him and, therefore, cannot  report this information to SPAWAR headquarters.
Although, as noted previously, the Comptroller has overall responsibility  for the center’s tri-annual reviews, his office has not assessed the  adequacy of the reviews that are being conducted by the technical  departments.  As a result, the Comptroller does not have a sound basis  for his certification.
section_title: Charleston’s Basic Approach Is Sound, but Some Improvements Are Needed
paragraphs: The Charleston Systems Center has developed a basic approach for its tri- annual reviews that appears sound.  Charleston’s approach addressed  several of the concerns we noted with the San Diego Systems Center’s  approach.  First, rather than assigning all review requirements to the  technical departments, Charleston divides the responsibilities between the  Comptroller’s Office and the technical departments.  This approach allows  the Comptroller’s Office to concentrate on the tasks it is best qualified to  perform, such as tracing obligations back to source documents, and lets the  technical departments concentrate on those tasks that they are best  qualified to perform, such as verifying that dormant obligations are still  valid.  Second, the Charleston Comptroller provides the technical  departments with a list of all dormant commitments, obligations, and  accrued expenditures so they can easily focus on those that they must  follow up on.  Finally, Charleston’s tri-annual review guidance requires  those who conduct the reviews to document actions taken during the  reviews and is to (1) include corrective actions remaining to be taken and  when such actions will be completed and (2) identify actions that have  been taken to preclude identified problems from recurring in the future.
However, we did identify several problems with Charleston’s overall  approach.  More specifically, we found the following:  Although the Comptroller must sign a certification statement attesting  to the results of the center’s tri-annual review, the systems center has  not conducted all of the required reviews, and the Comptroller has not  developed internal control procedures to ensure that the reviews that  were conducted were performed properly and completely.
Charleston’s technical department heads are responsible for ensuring  that reviews are properly conducted and documented, but they are not  required to certify that this has been done.  Consequently, the  Comptroller does not have a sound basis for certifying that the tri- annual review tasks the center is required to accomplish have been  completed.  In fact, Charleston’s Comptroller acknowledged that our  work shows that the technical departments’ reviews are not adequate,  and he indicated that his concern about the timeliness and adequacy of  the technical departments’ reviews is the reason why he has limited his  tri-annual review certification to the 4 tasks that are under his control  and why he has been unwilling to certify the remaining 12 tasks.  The  Comptroller stated, and we agree, that department heads should be held  accountable for their respective departments’ portion of the tri-annual  review process.   Specifically, he believes they should be required to  complete and sign certification statements similar to the one that he  must complete and sign on behalf of the systems center, and  accordingly, has developed a proposed certification statement for the  department heads to sign.
We also found that DOD’s tri-annual review guidance regarding the dollar  thresholds for reviewing outstanding commitments and obligations was  unclear.  The guidance states that during the January and May reviews,  commitments and obligations of (1) $200,000 or more for investment  appropriations (e.g., procurement funds and the capital budget of the  working capital funds) should be reviewed and (2) $50,000 or more for  operating appropriations (e.g., operation and maintenance funds and the  operating portion of the working capital funds) should be reviewed.
Charleston interpreted the guidance to mean that customer orders—which  are the operating portion of the working capital fund—financed with  investment funds fell into the $200,000 threshold category for review  purposes, rather than the $50,000 category, and conducted its tri-annual  reviews accordingly.  In discussing this issue with the Office of the Under  Secretary of Defense (Comptroller) and Navy headquarters officials, the  officials acknowledged that the guidance was unclear and, thus, open to  interpretation.  They stated that the guidance needed to be examined and  clarified.
section_title: Conclusions
paragraphs: SPAWAR has consistently understated and provided misleading carryover  information to the Congress.  Reliable carryover information is essential  for the Congress and DOD to perform their oversight responsibilities,  including reviewing DOD’s budget.  To provide assurance that SPAWAR  systems centers report reliable carryover information, managers at  SPAWAR headquarters and the systems centers must be held accountable  for the accuracy of reported carryover and ensure the timely identification  of unneeded customer funds.  This includes increased management  attention that would provide more assurance that the systems centers are  effectively reviewing funded orders as part of their tri-annual review  process.  Until these problems are resolved, the Congress and DOD  decision makers will be forced to make key budget decisions, such as  whether or not to enhance or reduce customer budgets, based on  unreliable information.
section_title: Recommendations for Executive Action
paragraphs: We recommend that the Secretary of Defense  direct the Secretary of the Navy to issue guidance to all Navy working  capital fund activities, including SPAWAR, that prohibits them from  deobligating reimbursable customer orders at fiscal year-end and  reobligating them in the next fiscal year for the sole purpose of reducing  carryover balances that are ultimately reported to the Congress;  direct the Under Secretary of Defense (Comptroller) to determine the  extent to which working capital fund activities throughout DOD may be  similarly manipulating customer order data at fiscal year-end to reduce  reported carryover and, if necessary, issue DOD-wide guidance  prohibiting this practice as needed; and  direct the Under Secretary of Defense (Comptroller) to develop and  issue written procedures to implement the December 2002 carryover  policy.
To provide reasonable assurance that the dollar amount of orders to be  received from customers in developing annual budgets are based on more  realistic estimates, we recommend that the Secretary of the Navy direct the  Commander of the Space and Naval Warfare Systems Command to  compare budgeted to actual orders received from customers and consider  these trends in developing the following year’s budget estimates on orders  to be received from customers.
We recommend that the Under Secretary of Defense (Comptroller)  revise the tri-annual review guidance in the DOD Financial Management  Regulation so that working capital fund activities are required to expand  the scope of their tri-annual reviews to include unobligated balances on  customer orders and  review and clarify the tri-annual review guidance for the January and  May reviews in the DOD Financial Management Regulation as it pertains  to the dollar threshold for reviewing outstanding commitments and  obligations for the capital budget and operating portion of the working  capital fund.
We recommend that the Commander of the Space and Naval Warfare  Systems Command establish internal control procedures and  accountability mechanisms that provide assurance that the systems centers  are complying with DOD’s tri-annual review guidance.
We also recommend that the Commander of the Space and Naval Warfare  Systems Command direct the Commanders of the Charleston and San  Diego SPAWAR Systems Centers to  maintain documentation that shows who conducted the tri-annual  reviews so that these individuals can be held accountable for the  reviews;   maintain documentation that identifies (1) any additional research or  corrective action that is required as a result of the tri-annual reviews and  (2) who is responsible for taking the action;  require cognizant managers, such as department heads, to confirm in  writing that they have (1) performed the required tri-annual reviews and  (2) completed the related follow-up actions by signing a statement, such  as the draft certification statement developed by the Charleston  Systems Center Comptroller, that describes the specific tasks that were  accomplished and provide this statement to the systems centers’  comptrollers;  develop and implement internal control procedures to provide  assurance that tri-annual reviews of individual commitment, obligation,  and accrued expenditure balances are adequate; and   develop policies and procedures to capture the information on tri- annual review results, such as the amount of obligations reviewed,  confirmed, and revised, that they are required to report to SPAWAR  headquarters and that SPAWAR headquarters, in turn, is required to  report to Navy headquarters.
We recommend that the Commander, San Diego SPAWAR Systems Center  direct the Center Comptroller to   develop and implement a methodology for identifying and analyzing   identify dormant commitments, obligations, and accrued expenditures  in the tri-annual review computer lists that are provided to the technical  departments.
section_title: Agency Comments and Our Evaluation
paragraphs: DOD provided written comments on a draft of this report.  In its comments,  DOD concurred with 12 of our 14 recommendations and partially  concurred with the remaining 2 recommendations.  For these 2  recommendations, DOD agreed with our intent to ensure that obligations,  unobligated balances, and commitments are reviewed regularly to ensure  effective use of funds.  Our evaluation of DOD’s comments is presented  below.  DOD’s comments are reprinted in appendix II.
For the 12 recommendations with which DOD concurred, it stated that 7 of  them were completed based on the issuance of SPAWAR Instruction  7301.1A on Tri-Annual Reviews of Commitments and Obligations, dated  October 9, 2002.  We believe that the guidance provided in the instruction is  an important step.  SPAWAR and the systems centers now need to develop  and issue implementing procedures because, in most cases, the guidance  provided in the instruction that is related to these 7 recommendations is  too general to fully address our recommendations.  For example, although  the instruction requires those responsible for conducting the review to  report the results to the systems center’s comptroller, the instruction does  not require, as we recommended, that cognizant managers, such as  department heads, sign a written statement to be provided to the  comptroller to confirm that they have performed the required reviews and  certify the results of those reviews.
Further, in concurring with our recommendation that SPAWAR compare  budgeted to actual orders received from customers and consider these  trends in developing budget estimates on orders to be received from  customers, DOD did not state how the Navy would ensure that SPAWAR’s  budget estimates would accurately reflect orders to be received from  customers.  In its comments, DOD stated that the Navy will continue to  refine its budget estimates for customer orders.  We believe that the Navy  must take additional actions to develop more reliable budget estimates.  As  noted in our report, reported actual customer orders received exceeded  budget estimates from 36 percent to 88 percent during fiscal years 1998  through 2002.  For example, for fiscal year 2002, in formulating its budget  request, the Navy expected the SPAWAR systems centers to receive about  $1.3 billion in customer orders, but the Navy reported that the centers  actually received about $2.4 billion in customer orders—a difference of  $1.1 billion, or about 88 percent.  Having reliable budget estimates on  customer orders to be received is critical since this information is used in  calculating carryover using DOD’s new carryover policy.
DOD partially concurred with our recommendation that it revise its tri- annual review guidance in the DOD Financial Management Regulation to  require working capital fund activities to expand their tri-annual reviews to  include unobligated balances on customer orders.  In its comments, DOD  stated that reviewing such balances during the tri-annual reviews was the  responsibility of the customer who placed the order with the working  capital fund and that the working capital fund activity should work in  cooperation with the customer to ensure that unobligated balances are  reviewed.  We agree that the working capital fund activity should work in  conjunction with customers to review unobligated balances.  However, as  stated in our report, working capital fund activities are in the best position  to determine whether unobligated balances are still needed to finance  future work.  To ensure that unobligated balances are properly reviewed  during the tri-annual review process, we continue to recommend that the  DOD Financial Management Regulation be revised to specify the working  capital fund activities’ role in reviewing unobligated balances on customer  orders.
DOD also partially concurred with our recommendation for the SPAWAR  systems centers to review all balances related to dormant customer orders  in excess of $50,000 during the January and May tri-annual reviews.  In its  comments, DOD indicated that the current guidance is not clear with  regard to whether all such dormant balances over $50,000 are to be  reviewed during the specified months.  DOD stated that it will review the  guidance, as it pertains to working capital fund activities, and make  adjustments if appropriate.  We agree that DOD’s tri-annual review  guidance regarding the dollar thresholds for reviewing outstanding  commitments and obligations was unclear.  We have revised our report  accordingly, including the related recommendation, to reflect that DOD’s  tri-annual review guidance was unclear.
In addition, in the cover letter transmitting its comments on our draft  report, DOD took exception to our discussion in the draft report regarding  the methodology used by Navy to determine the levels of carryover— reducing the numerator in the carryover formula by the amount of  contractual obligations, but not reducing the formula’s denominator by the  amount of revenue earned from contractual services.  Because DOD  revised its methodology for calculating carryover in December 2002, DOD  commented that such a discussion in the report was irrelevant and  confusing to the reader and recommended that it be deleted.  We disagree  with DOD’s comment.  Although DOD revised its methodology for  calculating carryover, it was not incorporated into Navy’s budget  submissions until fiscal year 2004.  When we undertook this review in July  2002, one of our objectives was to determine if reported carryover  accurately reflected the amount of work remaining to be accomplished.  As  such, this issue was and still is relevant.  As stated in this report, our May  2001 report recommended that the revenue used in calculating carryover  be adjusted (reduced) for revenue earned for work performed by  contractors.  Unless this is done, reported carryover will be understated.   The Navy did not adjust the revenue amount and, therefore, continued to  understate its reported carryover in its budget submissions to the  Congress.  We continue to believe that this is a reportable issue and have  made a related recommendation for DOD to develop and issue written  procedures to implement the December 2002 carryover policy.  Further, we  believe this issue remains of interest to the Congress since the Navy has  understated SPAWAR’s reported carryover from fiscal year 1998 through  fiscal year 2002.
We are sending copies of this report to the Chairmen and Ranking Minority  Members of the Senate Committee on Armed Services; the Subcommittee  on Readiness and Management Support, Senate Committee on Armed  Services; the Subcommittee on Defense, Senate Committee on  Appropriations; the House Committee on Armed Services; the  Subcommittee on Readiness, House Committee on Armed Services; and the  Ranking Minority Member, Subcommittee on Defense, House Committee  on Appropriations.  We are also sending copies to the Secretary of Defense,  the Secretary of the Navy, and other interested parties.  Copies will be  made available to others upon request.  Should you or your staff have any  questions concerning this report, please contact Gregory D. Kutz, Director,  at (202) 512-9505.  He can also be reached by E-mail at kutzg@gao.gov.
An additional contact and key contributors to this report are listed in  appendix III.
section_title: Scope and Methodology
paragraphs: To determine if differences existed between the budgeted and reported  actual gross carryover and, if so, the reasons for the variances, we obtained  and analyzed budget and accounting documents that provided information  on budgeted and reported actual gross carryover and orders received from  customers from fiscal year 1998 through fiscal year 2002.  When variances  occurred between the budgeted and reported actual information, we met  with accounting and budgeting SPAWAR and Navy headquarters officials to  ascertain why there were differences.  We also discussed with officials  what actions they were taking to develop more reliable budget information  on carryover and orders received from customers.
To determine if the reported actual carryover balances reflected the  amount of work that remained to be accomplished, we obtained and  analyzed the Department of Defense’s (DOD) regulations and guidance on  carryover.  We also obtained and analyzed the SPAWAR systems centers’  calculations for the fiscal year 1998 through fiscal year 2002 actual reported  year-end carryover balances.  We met with officials from SPAWAR and  Navy headquarters to discuss the methodology they used to calculate  carryover.  We (1) obtained explanations about why the Navy made  adjustments in calculating the dollar amount of carryover balances as well  as the number on months of carryover and (2) determined the impact of  those adjustments on the carryover figure.  We also reviewed year-end  transactions that affected the dollar amount and number of months of  carryover.  For these year-end transactions, we met with officials from  SPAWAR and the two systems centers to determine why these transactions  occurred at year-end.
To determine if the Charleston and San Diego SPAWAR Systems Centers  have the financial data they need in order to provide reliable data on actual  carryover levels to DOD and congressional decision makers, we reviewed  the policies and procedures SPAWAR headquarters and the two systems  centers have used to implement DOD’s tri-annual review guidance.   Specifically, we (1) reviewed the DOD, Navy, SPAWAR headquarters, and  the two SPAWAR systems centers’ tri-annual review guidance and  discussed it with cognizant individuals, (2) reviewed the tri-annual review  certifications that the two systems centers have submitted since DOD  issued its tri-annual review guidance in 1996, and discussed these  certifications with cognizant individuals, (3) discussed the systems centers’  tri-annual review procedures with cognizant individuals, including those  who actually accomplished the reviews, and (4) reviewed documentation  on the results of the reviews.  We also obtained data on the status of  unfilled orders and carryover at the end of fiscal year 2001.  Additionally,  from these data, we selected and analyzed 34 orders that had outstanding  carryover balances at the end of fiscal year 2001 to determine if the  carryover balances accurately reflected the amount of work that remained  to be performed.  We selected orders that (1) were financed with expired  appropriations and (2) were unobligated carryover at year-end since these  orders were more likely to have unneeded funds and because a review of  these orders was, therefore, more likely to identify problems with the  systems centers’ review procedures.
We performed our work at the headquarters offices of the Under Secretary  of Defense (Comptroller) and the Assistant Secretary of the Navy  (Financial Management and Comptroller), Washington, D.C.; Space and  Naval Warfare Systems Command, San Diego, California; the Charleston  Space and Naval Warfare Systems Center, Charleston, South Carolina; and  the San Diego Space and Naval Warfare Systems Center, San Diego,  California.  The reported actual year-end carryover information used in this  report was produced from DOD’s systems, which have long been reported  to generate unreliable data.  We did not independently verify this  information.  The DOD Inspector General has cited deficiencies and  internal control weaknesses as major obstacles to the presentation of  financial statements that would fairly present the Defense Working Capital  Fund’s financial position for fiscal years 1993 through 2002.
Our review was performed from July 2002 through June 2003 in accordance  with U.S. generally accepted government auditing standards.  The Navy  provided the budgeting and accounting information referred to in this  report.  We requested comments on a draft of this report from the Secretary  of Defense or his designee.  DOD provided written comments, and these  comments are presented in the Agency Comments and Our Evaluation  section of this report and are reprinted in appendix II.
section_title: Comments from the Department of Defense
paragraphs: The following are GAO’s comments on the Department of Defense’s (DOD)  letter dated June 10, 2003.
subsections: section_title: GAO Comments
paragraphs: 1. See the Agency Comments and Our Evaluation section of this report. 2. As discussed in the Agency Comments and Our Evaluation section of  this report, we have modified this recommendation and the related  section of the report in response to DOD’s comment.
section_title: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: Staff who made key contributions to this report were Francine DelVecchio,  Karl Gustafson, William Hill, Christopher Rice, Ron Tobias, and Eddie  Uyekawa.
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