DOD Contract Payments: Management Action Needed to Reduce Billions in Adjustments to Contract Payment Records
Published: 2003-08-08T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GAO has reported that the Department of Defense's (DOD) inability to accurately account for and report on disbursements is a long-term, major problem. GAO was requested to determine (1) the magnitude of the adjustments and related costs in fiscal year 2002, (2) why contracts, including payment terms, are so complex, (3) the key factors that caused Defense Finance and Accounting Service (DFAS) Columbus to make payment adjustments, and (4) what steps DOD is taking to address the payment allocation problems.
section_title: What GAO Found
paragraphs: For fiscal year 2002, DFAS Columbus data showed that about $1 of every $4 in contract payment transactions in the MOCAS system was for adjustments to previously recorded payments--$49 billion of adjustments out of $198 billion in transactions. To research payment allocation problems, DFAS Columbus reported that it incurred costs of about $34 million in fiscal year 2002. This represents about 35 percent of the total $97 million that DFAS Columbus spent on contract pay services. DFAS Columbus bills DOD activities for contract pay services based on the number of accounting lines on an invoice. Consequently, all DOD activities pay the same line rate, regardless of whether substantial work is needed to reconcile problem contracts and adjust payment records. GAO's analysis of two contracts showed that the contracts were complex because of the (1) legal and DOD requirements to track and report on the funds used to finance the contracts, (2) substantial number of modifications made on the contracts to procure goods and/or services, and (3) different pricing provisions on the contracts. GAO's review of $160 million of adjustments showed that the adjustments were made for four reasons. The Army made an error in accounting for obligations, resulting in about $127 million in payment allocation adjustments. DFAS Columbus did not follow its internal procedures for allocating payments to accounts on an Army contract containing multiple pricing provisions, resulting in about $5 million in adjustments. DFAS made over $2 million in adjustments to correct recording errors on an Army contract due to complex and changing payment instructions. The Air Force frequently changed payment instructions after payments were made on an Air Force contract, resulting in about $26 million in adjustments. DOD has initiated a major long-term effort to improve its business operations, including its acquisition and disbursement activities. If implemented successfully, this initiative may help correct many of the contract payment allocation problems. In the interim, DOD has initiatives under way to address payment allocation problems, including (1) billing DOD contracting offices for contract reconciliation services, (2) providing DOD activities information on the correct method for presenting payment instructions, and (3) establishing a working group to develop options for presenting standard contract payment instructions. While the DOD working group initiative may reduce payment allocation errors associated with misinterpreting contract payment instructions, DOD needs to automate the standard payment instructions to eliminate payment allocation errors associated with manually allocated payments.

section_title: Letter
paragraphs: The reliability of contract disbursing data is critical to the Department of  Defense (DOD) for (1) properly accounting for and accurately making  contract payments, (2) effectively accounting for and controlling billions of  dollars in budget authority, and (3) preparing reliable financial information  on the results of operations to support management and congressional  decision making on programs, operations, and budget requests.  We have  previously reported on DOD’s inability to accurately account for and  report on disbursements, which is a long-term problem that is pervasive  and complex in nature.  For example, Defense Finance and Accounting  Service (DFAS) Columbus fiscal year 1999 data showed that almost $1 of  every $3 in contract payment transactions in the Mechanization of Contract  Administration Services (MOCAS) system was for adjustments to  previously recorded payments—$51 billion of adjustments out of   $157 billion in transactions.
You asked that we determine (1) the magnitude of adjustments that  affected previously recorded payments and DFAS Columbus’s reported  cost to make these adjustments during fiscal year 2002, (2) why contracts,  including payment instructions, were so complex, (3) the key factors that  caused DFAS Columbus to make payment adjustments for the two  contracts that we reviewed in detail, and (4) what steps DOD has taken or  planned to address the adjustment problem.  As agreed with your office, we  analyzed two contracts to determine how complex contracts and related  payment instructions contributed to DOD’s payments not being properly  allocated to the correct obligations.  In selecting these two contracts, we  worked with DFAS Columbus to identify complex contracts for which they  had encountered problems with correctly allocating payments to  obligations.  Thus, the two contracts—a $565 million Army missile contract  and a $49 million Air Force communications contract—are not  representative of all DOD contracts but, based on our experience, have  characteristics similar to other complex contracts.
Our review was performed from August 2002 through July 2003 in  accordance with U.S. generally accepted government auditing standards.   We did not audit the DFAS Columbus data on disbursements, collections,  and adjustments or the costs incurred by DFAS Columbus to reconcile  contracts.  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 Director,  Defense Procurement and Acquisition Policy, Under Secretary of Defense  (Acquisition, Technology, and Logistics), are reprinted in appendix II.
subsections: section_title: Background
paragraphs: DFAS Columbus uses MOCAS to make contract payments for the Army,  Navy, Air Force, and other DOD organizations.  In fiscal year 2002, DFAS  Columbus reported that it made about $87 billion of contract payments.   DOD, including DFAS Columbus, uses a line of accounting to accumulate  appropriation, budget, and management information for contract  payments.  Figure 1 shows a line of accounting on the Air Force contract  that we reviewed.
A line of accounting provides various information, such as (1) department  code (for example, those for the military services) and (2) fiscal year and  appropriation account financing the contract.  For all contracts, the  contracting office assigns an ACRN to each line containing unique  accounting information in accordance with the requirements contained in  the Defense Federal Acquisition Regulation Supplement (DFARS).   Obligations are established at the ACRN level to ensure that funds are  available to cover disbursements.  DFAS Columbus allocates payment  amounts to ACRNs to match contractor payments to the corresponding  obligations.
subsections: section_title: Organizations Involved in the Contract Payment Process
paragraphs: DOD payment and accounting processes are complex, generally involving  separate functions carried out by separate offices in different locations  using different procurement, accounting, and payment systems.  The  processes are not always integrated and require data to be entered and  sometimes reentered manually.  Figure 2 shows the payment process  information flow for the Air Force contract that we reviewed.
As illustrated above, the payment process information flow for the Air  Force contract began when DOD funding activities requested that the Air  Force contracting office procure engineering and technical services as well  as spare parts.  The Air Force contracting office awarded the contract and  modified it to procure additional items.  The Air Force contracting office  forwarded the contract and modifications to several organizations, such as  the communications contractor and DFAS Columbus paying office.  Upon  receipt of the contract and modifications, the communications contractor  performed work for the DOD activities and submitted invoices to DFAS  Columbus for payment.  For goods procured under the contract, the  Defense Contract Management Agency, which is located at the contractor’s  site, accepted the goods on behalf of the DOD activities and provided  receiving report information to DFAS Columbus.  The communications  contractor then forwarded the goods to the DOD activities.  For services  provided by the contractor, the contractor submitted vouchers for services  directly to DFAS Columbus for payment.  The vouchers were subject to  later audit by the Defense Contract Audit Agency.
Before making payments to the contractor, DFAS Columbus matched the  documents—through automated and manual processes—provided by the  Air Force contracting office, the communications contractor, and Defense  Contract Management Agency to ensure that (1) items ordered were  received and (2) funds were obligated and available to make the payments.   Finally, DFAS Columbus paid the contractor, recorded the payment data in  DFAS Columbus records, and forwarded these data to the DFAS  accounting stations responsible for recording the data in the various DOD  organizations’ accounting systems.  When errors occurred in allocating  payments to the correct ACRNs, the DFAS Columbus contract  reconciliation branch made adjustments to correct the payment allocations  in DFAS Columbus and the applicable DFAS accounting station records.
section_title: Description of the Army and Air Force Contracts Reviewed
paragraphs: In order to identify some of the problems DFAS Columbus has experienced  in properly allocating payments to the ACRNs on contracts, we selected an  Army and an Air Force contract for a detailed review.  These contracts  support two programs—the Army Tactical Missile System and the Army  Data Link System.  A description of each of these programs is presented  below.
We reviewed an Army contract (contract number DAAH01-98-C-0093)  with Lockheed Martin Vought Systems Corporation concerning the  Army Tactical Missile System.  This missile system is one of a family of  complementary weapons initially developed by the Army and Air Force  for engaging enemy forces deep behind the front battle lines.  The  missile system was designed to attack those forces that are in a position  to have an immediate or directly supporting impact on the close-in  battle, but are beyond the range of cannon and rocket artillery systems.   It is intended to delay, disrupt, neutralize, or destroy targets, such as  second echelon maneuver units, missile sites, and forward command  posts.
The Army Tactical Missile System consists of a surface-to-surface  ballistic missile that can be launched from and controlled by the Army’s  Multiple Launch Rocket System.  The missile system was initially fielded  with an “antipersonnel/antimaterial warhead” for attacking stationary  targets.  Since the weapon system was first fielded, the missile system  has been modified to increase its range, improve its guidance systems,  and reduce collateral damage.  This missile system was used in the  recent war in Iraq.  Figure 3 is a photograph of the missile system.
We reviewed an Air Force contract (contract number F09604-00-C-0090)  with L-3 Communications to maintain the Army portion of the Army  Data Link System.  The Army and Air Force developed the Army Data  Link System to transfer near-real-time targeting information collected by  aircraft, satellites, and ground stations and provides this information to  aircraft and tactical commanders on the ground in-theater.  The system  consists of three major components—the Army Interoperable Data Link,  the Direct Air to Satellite Relay, and the Reach Back Relay.  The Army  Interoperable Data Link provides two-way secure direct  communications between aircraft and aircraft-to-ground stations.  The  Direct Air to Satellite Relay communicates data gathered by aircraft  through a secure satellite link to an in-theater ground processing facility.   The Reach Back Relay communicates data gathered through a secure  satellite link to ground processing facilities in the continental United  States.  The Data Link System was also used in the recent war in Iraq.   Figure 4 shows how the communications system transfers data.
section_title: DFAS Columbus Made $49 Billion of Adjustments at a Cost of about $34 Million in Fiscal Year 2002
paragraphs: For fiscal year 2002, our analysis of DFAS Columbus data showed that  about $1 of every $4 in contract payment transactions in MOCAS was for  adjustments to previously recorded payments—$49 billion of adjustments  out of $198 billion in disbursement, collection, and adjustment  transactions.  This is an improvement over fiscal year 1999 when DFAS  Columbus data showed that about $1 of every $3 in contract payment  transactions (transactions for disbursements, collections, and  adjustments) in MOCAS was for adjustments to previously recorded  payments—$51 billion of adjustments out of $157 billion in transactions.   While DOD has been working on resolving these problems for years, it has  yet to correct them.
To research the payment allocation problems and make adjustments to  correct the disbursing and accounting records, DFAS Columbus reported  that it incurred costs of about $34 million in fiscal year 2002, primarily for  hundreds of DOD and contractor staff.  This represented about 35 percent  of the $97.4 million that DFAS Columbus spent on contract pay service  operations.  Our review showed that the specific contracting offices that  contributed to payment allocation problems resulting in adjustments did  not pay for all of the work DFAS Columbus performed to make the  adjustments.  This occurred because DFAS Columbus currently bills DOD  activities (for example, the Army) for contract pay services based solely on  the number of lines of accounting on an invoice.  Consequently, all DOD  activities pay the same line rate, regardless of whether substantial work is  needed to reconcile problem contracts and adjust the payment records.  As  a result, the contracting offices that contributed to payment allocation  problems had insufficient incentives to reduce payment errors and  associated costs.  As discussed later in this report, DOD is taking action to  change its billing structure for DOD activities.
section_title: Contracts Were Complex Due to Legal and DOD Requirements, Contract Modifications, and Pricing Provisions
paragraphs: Our analysis of an Army and an Air Force contract showed that the  contracts and related payment instructions were complex because of a  combination of factors, including the (1) legal and DOD requirements to  track and report on the funds used to finance the contract, (2) number of  modifications made to the contract over the years that added goods and/or  services, or added or changed payment instructions for these goods and/or  services, and (3) different pricing provisions to pay for goods and services  on the contract.  While we identified these three factors as unique areas,  the factors are interrelated and contributed to the contracts containing  complex payment instructions and the difficulty DFAS Columbus had in  properly allocating payment amounts to the correct ACRNs, ultimately  contributing to a high rate of adjustments.
subsections: section_title: Legal and DOD Requirements Contribute to Complex Contracts
paragraphs: In order to maintain administrative control over appropriated funds, DOD  has established a system of controls to help ensure that funds obligated and  then expended for the procurement of goods and services were used as  intended and in accordance with applicable laws and regulations.  A system  of controls should be designed to help ensure that agencies do not obligate  or expend more funds than available.  However, DOD’s system contributes  to the complexity of the contracts.
To report on the status of its appropriated funds—including amounts  obligated and expended—DOD uses a line of accounting to accumulate  appropriation, budget, and management information.  For all contracts, the  contracting office assigns a two-digit ACRN to each line containing unique  accounting information in accordance with the requirements contained in  DFARS 204.7107 (c).  DFAS Columbus allocates payments to the ACRNs to  match contract payments to the corresponding obligations.
For the two contracts that we reviewed, the Army contract that was valued  at $565 million contained 74 separate ACRNs funded by 8 different  appropriation accounts and sales to three foreign countries, and the Air  Force contract that was valued at $49 million contained 89 ACRNs funded  by 23 different appropriation accounts.  Each ACRN was established to  comply with the DFARS requirement for a separate ACRN for each unique  line of accounting.  The information on the line of accounting (1) is needed  to track the obligations and disbursements back to the DOD activity  authorizing the work and (2) provides information on the obligations and  disbursement data, such as the organizations providing the funding.  While  DOD created all of these ACRNs to comply with its requirements, our  analysis of the lines of accounting showed that DOD used ACRNs to  provide the information needed to comply with legal requirements to account for obligations by appropriation account and by object class.  On  the Army contract that contained 74 ACRNs, 24 of these ACRNs—about  one-third—were used by DOD to provide the information needed to satisfy  the legal requirements.  Likewise, on the Air Force contract that contained  89 ACRNs, 48 of these ACRNs—or more than half—were used by DOD to  provide the information needed to satisfy the legal requirements.  DOD  accounts for each of these ACRNs separately—in effect treating them as  separate bank accounts—even though they all fund the same contract.   Each additional ACRN increases the risk of incorrectly allocating payments  to the wrong ACRN.
section_title: Frequent Contract Modifications Contribute to Complex Contracts
paragraphs: While accounting requirements and related ACRNs contributed to complex  contracts, frequent contract modifications to procure additional goods and  services are another factor that contributed to complex contracts.  When  DOD orders more goods and/or services than provided on the original  contract, DOD modifies the contract and pays the contractor for the  additional goods and/or services.  Many times different appropriation  accounts are used to pay for these additional goods and/or services  resulting in DOD creating more ACRNs to account for the funds.  Our  analysis of two DOD contracts showed that they were modified many times  over the years to procure additional goods and/or services, as well as to  add or change payment instructions.  Our review found that modifications  that changed payment instructions resulted in DFAS Columbus making  adjustments to correct prior payment allocations to ACRNs.
In 1997, the Army contracted with Lockheed Martin Vought Systems  Corporation to produce an updated version of the Army Tactical Missile  System.  The basic contract was for the procurement of 100 guided  missiles and launching assemblies for the Army missile program.  The  Army program office initially obligated $14.2 million in 1997 for this  effort.  As of September 30, 2002, the estimated contract value increased  to almost $565 million.  Our analysis of this contract showed that it was  modified 122 times over a 5-year period to (1) increase the number and  type of missile systems ordered for the Army and three foreign countries  from 100 to 833, (2) procure over 270,000 engineering service hours to  support the production of the missile systems, and (3) make other  changes necessary to administer the contract.  The Army contracting  office also issued six modifications to provide detailed payment  instructions to DFAS Columbus.  According to the Administrative  Contracting Officer, the payment instructions were issued to resolve  payment allocation errors made by DFAS Columbus and to ensure that  the payments were applied to the correct ACRNs on the contract.
Like the Army contract, the Air Force contract was also modified a  number of times to procure additional goods and services and to  administer the contract.  In October 1999, the Air Force contracted with  L-3 Communications to maintain the Army portion of the Army Data  Link System.  The basic contract contained a description of the  engineering and technical services and spare parts necessary to  maintain the communications system worldwide.  The contract also  stated that funding for the engineering and technical services as well as  miscellaneous spare parts would be included on individual funding  modifications on this contract.  As of September 30, 2002, the estimated  contract value was about $49 million.  Our analysis of this contract  showed that it was modified 82 times over a 3-year period by five  different procurement contracting officers to (1) provide funding for  and/or increase/decrease the requirements for engineering and technical  services and miscellaneous spare parts to maintain the Army assets for  the Army Data Link System and (2) make other changes necessary to  administer the contract.  Furthermore, 73 of the 82 modifications  revised the payment instructions.
section_title: Contract Pricing Provisions Contribute to Complex Contracts
paragraphs: Our analysis of two DOD contracts showed that contract-pricing provisions  were a third factor that contributed to the complexity of these contracts.   As stated previously, the Army and Air Force contracting offices issued  many contract modifications to procure goods and services on behalf of the  military services.  These modifications included several contract line items  that contained numerous goods or services with different pricing  provisions.  Contract pricing provisions can be placed into two broad  categories—fixed price or cost reimbursable.   For example, the Army  contract contained firm-fixed-price provisions for procuring 833 missiles,  and cost-plus-fixed-fee and cost-plus-award-fee provisions for procuring  270,000 engineering service hours to support the missile production.
Our review found that contracts containing different pricing provisions are  more complex, and thus it is more difficult to properly allocate payments to  the correct ACRNs because DFAS Columbus voucher examiners must  allocate payment amounts manually, resulting in a greater opportunity for  error.  When DFAS Columbus voucher examiners manually allocate  payment amounts to contract ACRNs, the voucher examiners must ensure  that the payment amounts associated with fixed price and cost  reimbursable provisions are allocated to those ACRNs funding those  payment provisions only.  However, in some cases it is difficult for the  voucher examiner to readily identify these ACRNs without performing a  labor-intensive review of the contract. As a result, sometimes the voucher  examiner incorrectly applies the payment amounts to ACRNs funding fixed  price provisions instead of ACRNs funding cost reimbursable provisions.   Our review of the Army contract found that it contained 25 separate  contract line items—15 were to be paid for under fixed price provisions  and 10 were to be paid for under cost reimbursable provisions.  Similarly,  the Air Force contract contained 66 separate contract line items—16 were  to be paid for under fixed price provisions and 50 were to be paid for under  cost reimbursable provisions.
section_title: $160 Million of Adjustments to Correct Prior Payment Allocations
paragraphs: As stated previously, the Army and Air Force contracts that we reviewed  were complex due to a number of factors, including legal and DOD  requirements, contract modifications, and pricing provisions.  These  factors contributed to the difficulty DFAS Columbus had in properly  allocating payment amounts to the correct ACRNs.  As a result, payment  amounts on these contracts were not allocated to the correct ACRNs, and  DFAS Columbus made substantial adjustments to correct the payment  allocations.  Our evaluation of $160 million of adjustments showed that  DFAS Columbus made these adjustments to reallocate payments to the  correct ACRNs.  Table 1 summarizes the reasons for the adjustments and  provides the number and dollar amount of adjustment transactions made to  reallocate payments to the correct ACRNs.
subsections: section_title: An Army Contract Writing System Error in Accounting for Contract Obligations
paragraphs: From 1998 through 2001, DFAS Columbus paid 43 invoices totaling   $63.5 million for the procurement of several missile systems.  DFAS  allocated these payment amounts to two ACRNs according to the payment  instructions in effect at the time of the payment.   Subsequently, the  contractor submitted price reductions to the Army for certain contract  items that DFAS Columbus had previously paid.  In response to the price  reductions, the Army issued a contract modification to account for the  reductions.  When the Army processed this modification, the Army contract  writing system incorrectly deobligated the amount for the missiles on the  two ACRNs in error and established two new ACRNs on the contract  containing the reduced amount.  As a result, in January 2002, DFAS  Columbus processed 92 adjustment transactions totaling about   $127.2 million to move payment amounts to the new ACRNs.  In discussing  this problem with Army officials, they informed us that they did not know  that the system error resulted in DFAS Columbus having to do additional  work to make these adjustments.  According to these officials, the system  problem that resulted in the creation of the new ACRNs was corrected in  2001.
section_title: Procedures and Regulations for an Army Contract Containing Multiple Pricing Provisions Were Not Followed
paragraphs: From June 1999 through April 2001, DFAS Columbus paid 38 invoices  totaling about $16 million for engineering services on the Army contract.    When DFAS Columbus paid the contractor, the contract did not contain  specific payment instructions on how to allocate payment amounts to  ACRNs as required by DFARS 204.7107 (e)(3)(i).  According to this  regulation, when a contract line item is funded by multiple ACRNs, the  contracting officer shall provide adequate instructions in the contract to  permit the paying office (DFAS Columbus in this case) to accurately charge  the ACRNs assigned to that contract line item.  Without these payment  instructions, DFAS Columbus voucher examiners should follow DFAS  Columbus internal procedures.  These procedures require voucher  examiners to prorate payment amounts across all available ACRNs under  cost reimbursable provisions when the contract or contractor’s invoice  does not provide specific payment instructions on which ACRNs should be  charged.  However, instead of charging ACRNs funding cost reimbursable  provisions only (engineering services), DFAS Columbus voucher  examiners manually allocated the payment amounts to ACRNs that funded  both engineering services (cost reimbursable provisions) and missiles  (fixed price provisions).  As a result, some payment amounts for  engineering services were incorrectly allocated to ACRNs funding the  procurement of missiles.
According to Army contracting officials, in April 2001—almost 2 years after  DFAS Columbus paid the first invoice—the Army issued a modification  containing detailed payment instructions once it became aware that DFAS  was having difficulty in allocating payment amounts to the correct ACRNs.   These instructions were different from the payment allocation procedures  followed by DFAS Columbus.  However, by that time, DFAS Columbus had  made 38 payments to the contractor for engineering services and allocated  these payments to several ACRNs.  To correct payment allocation problems  associated with 7 of the previous 38 payments, DFAS Columbus processed  88 adjustment transactions totaling about $4.7 million to reallocate  previously recorded payments according to the new instructions.
section_title: Complex and Changing Payment Instructions for the Army Contract
paragraphs: DFAS Columbus also processed 16 transactions totaling about $2.4 million  in adjustments to correct payment errors made by DFAS Columbus  voucher examiners when they manually applied payment amounts to  ACRNs on the Army contract.  In April 2001, the Army issued a contract  modification that provided specific payment instructions to ensure that  funds were used prior to cancellation.  DFAS Columbus officials told us  that these payment instructions were complex and changed several times  after the modification was first issued.  For example, the following  instructions were included in contract modifications to provide payment  instructions for contract line item number (CLIN) 0030.
Contract modification 74 dated April 2001 stated that, “Subclins under  CLIN 0030 – prorate across ACRNs BR, BS, and BT.”
Seven months later, in November 2001, contract modification 89 added  additional payment terms for CLIN 0030 by incorporating instructions  for CLIN 0031 and instructions for contract award fees under these two  CLINs.  The modification stated, “Subclins under CLIN 0030/0031 –  prorate across ACRNs BR, BS, BT, BX, BY, and CD, unless voucher  identifies award fee then prorate across ACRNs CE, CF, CG, and CH.”
Seven months later, in June 2002, contract modification 109 provided  more payment instructions for CLIN 0030/0031.  The modification noted  that, “Subclins under CLIN 0030/0031 – prorate across ACRNs BR, BS,  BT, BX, CD, CN, CT, CU, CW and DA, unless voucher identifies award  fee then prorate across ACRNs CE, CF, CG, CH and CV, or if voucher  identifies technical publications then prorate across ACRNs BY, CR, and  DA.”
Our analysis of the payment instructions showed that the instructions were  complex, changed several times, and were difficult to administer properly.   We found that $2.4 million of adjustment transactions were the result of  errors made by voucher examiners.  These errors occurred because the  examiners did not follow the complex, frequently changed, and  nonstandard payment instructions correctly.  In order for DFAS Columbus  to properly allocate payments on CLIN 0030, our work showed that the  voucher examiner must (1) identify the current modification in effect at the  time of payment to ensure payments are allocated in accordance with the  payment instructions, (2) determine the type of invoice to ensure the  allocations are made against the correct ACRNs, for example, technical  publications or award fee, (3) identify the current available balance  associated with ACRNs funding the services, and (4) calculate a prorated  balance to be distributed to each ACRN funding the services.  For example,  for one invoice totaling $350,635 on the Army contract, DFAS Columbus  paid two contract line items and allocated the payment amounts to 23  ACRNs in an attempt to comply with the payment instructions on the  contract that were in effect on the payment date.  This condition resulted in  errors in the contract records when voucher examiners incorrectly  allocated payment amounts to the wrong ACRNs.
In discussing this problem with DFAS Columbus officials, they confirmed  our analysis that the payment instructions were complex and difficult to  administer properly.  The officials stated that when a contract contains  payment instructions similar to the instructions presented above, DFAS  Columbus voucher examiners must manually allocate the payment  amounts to contract ACRNs.  The officials also stated that the instructions  on this contract were very complicated and could easily be misinterpreted  if voucher examiners do not carefully review the payment instructions  prior to allocating the payment amount to ACRNs on the contract.
section_title: Frequent Contract Modifications to Change Payment Instructions for Air Force Contract
paragraphs: In March 2001, DFAS Columbus processed 1,262 transactions totaling over  $26 million to adjust previously recorded payment allocations on the Air  Force contract.  At the time these adjustments were made, the Air Force  had already issued 42 modifications, which changed the payment  percentages that DFAS Columbus was required to follow to make correct  payment allocations.  Because the number and frequency of the payment  percentages changed, DFAS Columbus did not allocate payment amounts  to the correct ACRNs in many cases.
The Air Force awarded a contract in October 1999 to procure engineering  and technical services and spare parts to maintain the Army Data Link  System.  Over the next 3 years, the contract was modified numerous times  to increase the requirements for engineering and technical services and  spare parts, along with the necessary incremental funding amounts to  support these requirements.  As additional funds were added to the  contract, (1) new ACRNs were added or obligation balances for existing  ACRNs increased and (2) the payment percentages were modified to reflect  the new obligation balances of the affected ACRNs.  For example, the Air  Force modified contract line item number 0006 for engineering services  three times over a 2-month period to incrementally fund these services.   Each time, the Air Force changed the ACRN payment percentages funding  the contract line item.
Our analysis of the contract showed that allocating payments on this  contract has been very difficult, and voucher examiners could easily  misinterpret the payment instructions because of the numerous contract  modifications that changed ACRN payment percentages.  These  instructions were complex and difficult to administer because   (1) modifications frequently changed the payment instructions and   (2) many ACRNs were financing numerous contract line items.  The  percentages changed so frequently that DFAS Columbus voucher  examiners could not keep track of ACRN balances in order to allocate  payment percentages properly.  Also, when many ACRNs financed  numerous contract line items, DFAS Columbus had difficulty identifying  how much of an ACRN’s obligation amount related to each line item.   Therefore, many payments were not allocated in accordance with the  current modification, and adjustments were needed to correct these  allocations.  Figure 5 illustrates the current funding structure for 3 of the 66  contract line items on the Air Force contract.
As shown above, the relationship of CLINs to ACRNs is complex because  there is not a one-to-one relationship.  This makes it difficult for DFAS  Columbus to accurately allocate payments to ACRNs.  Because the  contract funding structure was complex, DFAS Columbus voucher  examiners did not properly allocate payments to the correct ACRNs.  Thus,  DFAS Columbus sent the contractor’s invoices to its contract reconciliation  branch for payment.  In addition, beginning in the fall of 2001, the  contractor began providing a detailed payment distribution schedule with  each invoice submitted to DFAS Columbus to assist it in properly allocating  payments to the correct ACRNs.  We found that an invoice totaling  $94,237.18 contained 31 pages of contractor costs and billing charges for 45  contract line items charging 56 different ACRNs.  The amounts charged to  the ACRNs by the contractor were as little as $.59 to as much as $88,107.03.
section_title: DOD Initiatives to Address Payment Allocation Problems
paragraphs: DOD officials acknowledged that there have been long-standing contract  payment allocation problems that have required DFAS Columbus to  undertake time-consuming and costly reconciliations to correct allocation  errors.  DOD has initiated a major long-term effort to develop and  implement an enterprise architecture, which is intended to improve its  business operations, including its acquisition and disbursement activities.   If implemented successfully, this initiative may help correct many of the  contract payment allocation problems.  In the interim, DOD has several  initiatives under way to address the payment allocation problems caused  by complex contracts with confusing payment instructions.  First, DFAS  plans to bill reconciliation costs to contracting offices that contribute to  payment allocation problems.  Second, DFAS Columbus is briefing the  DOD acquisition community on methods for presenting payment  instructions in contracts.  Finally, a DOD working group is examining  payment allocation problems and plans to develop and implement payment  allocation options for presenting standard payment instructions on  contracts DOD-wide to address these problems.
subsections: section_title: System Improvement Initiatives
paragraphs: Since 1995, DOD had been attempting to develop a new system—DPPS—to  replace MOCAS, which was developed in the 1960s.  DPPS was being  designed to resolve DOD’s long-standing disbursement problems,  streamline contract and vendor payment processes, and reduce manual  interventions.  However as we previously reported, DOD terminated  DPPS in December 2002, after 7 years in development at a cost of over   $126 million, because of poor program performance and increasing life  cycle costs.  DOD officials informed us that enhancements to MOCAS are  now being considered to provide some of the automated capabilities that  DPPS had been attempting to achieve.
The failure of DPPS to become DOD’s standard procurement payment  system is indicative of DOD’s long-standing inability to efficiently and  effectively modernize its financial management and business systems.  For  example, we recently reported that over $300 million has been invested to  develop several DFAS financial management systems and that DOD has not  demonstrated that this investment will substantially improve the financial  management information needed for decision-making and financial  reporting purposes.  To help avoid this type of result, we recommended in  2001 that DOD develop and implement an enterprise architecture, an  essential modernization management tool.
As part of its current effort to transform its business operations, DOD is  developing a business enterprise architecture.  A key area of focus is DOD’s  acquisition and disbursement activities.  As we have previously reported,  DOD contract management has been a high-risk area within the department  since 1992.  To address these problems, DOD’s business enterprise  architecture development effort is intended to (1) incorporate federal  accounting and financial management requirements, (2) consider leading  practices in procurement and contract payments, and (3) reengineer its  business processes.  If implemented as planned, this initiative has the  potential to address many of the contract payment allocation problems  discussed in this report.  However, this is a long-term effort that will take  many years to implement.
section_title: DFAS Plans to Bill Contracting Offices That Contribute to Payment Allocation Problems
paragraphs: As pointed out earlier, the contracting offices that contributed to payment  allocation problems have insufficient incentives to structure their  contracts, including payment instructions, in a manner that would reduce  payment errors and related reconciliation costs.  This condition exists  because DFAS Columbus currently bills DOD activities (for example, the  Army) for contract pay services based solely on the number of lines of  accounting on an invoice.  DFAS Columbus officials recognized this  shortcoming in establishing their billing rates and have informed us that  they plan to use a separate billing rate, based on DFAS contract  reconciliation costs, to bill customers for reconciling, adjusting, and  correcting contract payments beginning in fiscal year 2004.  According to  the officials, the direct billing hour rate for reconciliation services will be  $74.55 in fiscal year 2004 and will be billed to the contracting offices  responsible for writing the contracts that require reconciliation.  According  to the Deputy Director of DFAS Columbus’s Commercial Pay Services,  separately billing contracting offices for the reconciliation work should  provide an incentive to those offices to reduce the number of payment  allocation problems that result in adjustments.  In our view, this billing  initiative should encourage contracting offices to structure contracts,  including payment instructions, in a manner that should help reduce  payment errors and reconciliation costs.
section_title: DFAS Columbus Briefs DOD Acquisition Community on Contract Administration, Payment, and Closeout Issues
paragraphs: DFAS Columbus, in partnership with the Defense Contract Management  Agency, is providing formal briefings to the DOD acquisition community on  various issues related to contract administration, payment, and closeout.   These briefings are designed to give contracting, procurement, and budget  personnel throughout DOD better insight into the contract entitlement,  payment, and accounting processes provided by DFAS Columbus.  They  also help to promote teamwork between DFAS Columbus and the  acquisition community and provide an opportunity to enhance the  communications link that is necessary for these organizations to  interoperate efficiently and effectively.  These briefings began in November  2001 and have been provided to numerous activities across the military  services.  As of March 2003, presentations had been provided to 18 major  acquisition organizations, such as the Army Aviation and Missile Command,  the Navy Space and Naval Warfare Systems Command, and the Air Force  Space and Missile Systems Center.
Among the topics included in these briefings are methods for correctly  presenting payment instructions in contracts.  The briefing materials  emphasize that payment instructions provide a method for assigning  payments to the appropriate ACRNs, based on anticipated work  performance.   Specifically, the materials discuss payment instruction  requirements for fixed price and cost reimbursement contracts and provide  recommendations for contracting officers to consider when they develop  payment instructions.  Reference materials that provide additional  payment instruction information, available on the Internet, are also cited in  these briefings.
section_title: DOD Working Group Examines Payment Instruction Problems
paragraphs: In September 2002, DOD formed a working group to review contract  payment instructions.  The working group’s results were incorporated into  a broader DOD initiative to identify needed improvements and reductions  to procurement policies, procedures, and processes in DFARS.  The  working group completed the first phase of its work by researching the  types of payment instructions that have caused payment allocation  problems and developing proposed changes to DFARS.  The working group  concluded that payment allocation errors at DFAS Columbus (1) were  often the result of problems experienced with confusing payment  instructions and (2) were further compounded because DOD did not have  payment allocation options for including standard contract payment  instructions for use on DOD contracts.  As illustrated earlier in this report,  payment instructions can be unique to each contract.  For example, DFAS  Columbus made $2.4 million in payment allocation errors on the Army  contract because the voucher examiners made errors when they manually  applied payment amounts to ACRNs following complex, nonstandard  payment instructions that changed several times.  This makes it difficult for  DFAS Columbus personnel—who must process the payments and make the  adjustments manually—to properly allocate the payments to the correct  ACRNs.
In the second phase of this effort, the working group developed proposals  for regulatory changes to address the types of standard payment  instructions applicable to specific contracting situations.  Depending on  their specific requirements, contracting officers would be able to choose a  contracting option that would include the standard payment instructions  applicable to that particular situation.  For example, the working group is  evaluating several different standard payment instructions that DOD  contracting offices may use on contracts, including standard payment  instructions (1) for ensuring that funds are used before they are no longer  available for expenditure and (2) for ensuring that funds can be allocated to  the various contract ACRNs based on the balance available on each  contract ACRN.  The group’s consensus was that such standardization  should enable DFAS Columbus to substantially increase its level of  automated payments.
During phase three, the final phase that began in May 2003, the working  group’s proposals will be presented to the Defense Acquisition Regulations  Council and other experts for review.  The results from this review  process will eventually determine whether the working group’s proposals  will be accepted.  DOD has not yet established a milestone date for  completing the third phase of this effort and has not yet made the final  decision to implement the options for presenting standard payment  instructions.  While the working group did not study the possibility of  automating the standard payment instructions, it informed us that  automating them would be the next logical step if they were implemented.
Our analysis of the working group initiative to develop standard payment  instructions showed that it is a good first step because it should reduce  some of the payment allocation errors that were the result of DFAS  Columbus voucher examiners misinterpreting contract payment  instructions.  However, even with the standard payment instructions, DFAS  Columbus will still manually allocate payments to contract ACRNs on  complex contracts such as the two mentioned in this report.  As we  previously stated, manual payment allocations increase the opportunity for  errors.  In order to eliminate payment allocation errors, DFAS should take  the next step and automate the standard payment instructions so that  DFAS Columbus can electronically process the payments with minimal  manual intervention.
section_title: Conclusions
paragraphs: Resolving DOD’s long-standing contract payment problems will require  major improvements to its processes and systems.  One key element of  DOD’s efforts to improve its business operations is its effort to develop an  enterprise architecture to guide and constrain its ongoing and planned  investments in business systems.  Another key element to resolving  contract payment problems would be to determine whether DOD can  reengineer the way its contracts are written, including the length of time  covered by a contract as well as the number of modifications made to the  contract.  If successful, these efforts could result in reengineered business  processes and financial management systems that could address many of  DOD’s long-standing contract payment allocation problems that have  required DFAS Columbus to undertake time-consuming and costly  reconciliations to correct allocation errors.  However, these reengineered  processes and systems are years from becoming reality.
In the interim, DOD is addressing some of the fundamental weaknesses  that have resulted in billions of dollars of adjustments to correct contract  payment allocations annually.  However, DOD has not yet completed its  work to (1) provide information to the procuring activities on the correct  methods for presenting payment instructions on contracts, (2) develop and  implement standardized payment instructions to be used DOD-wide, and  (3) fully automate the payment process using these instructions.  Without  standardized and automated payment instructions, DOD will continue to  spend millions of dollars each year to process payments manually and then  adjust those payments.  Further, DOD activities must follow existing  regulations and procedures covering payment instructions to help ensure  that payment data are accurately recorded against the correct obligations.   Until DOD successfully modernizes its business operations, these interim  steps will help avoid the inaccurate contract payment data that have  hindered DOD’s ability to accurately account for and report on contract  disbursements.
section_title: Recommendations for Executive Action
paragraphs: We recommend that the Secretary of Defense direct the Under Secretary of  Defense (Acquisition, Technology, and Logistics) to  develop payment allocation options for presenting standard payment  instructions in contracts containing multifunded contract line items and   issue guidance to the contracting community reiterating the  requirement in DFARS that all contracts containing multifunded  contract line items contain payment instructions and that these  instructions be revised when additional ACRNs are added.
We also recommend that the Secretary of Defense direct the Under  Secretary of Defense (Comptroller) to direct the Director of the Defense  Finance and Accounting Service to   automate the standardized payment instructions in MOCAS once the  standard payment instructions are adopted and  issue guidance reiterating DFAS’s internal requirement that when a  contract does not contain payment instructions and the contractor  invoice does not contain payment instructions, the payments for costs  and services must be allocated to ACRNs financed on a cost  reimbursable basis in accordance with DFAS’s desk procedures.
section_title: Agency Comments and Our Evaluation
paragraphs: DOD provided written comments on a draft of this report.  In its comments,  DOD concurred with two of the four recommendations and partially  concurred with the remaining two recommendations.  DOD’s comments  are reprinted in appendix II.
For the two recommendations with which it concurred, DOD stated that  the department will issue memorandums to (1) contracting personnel  reiterating the requirements contained in DFARS and (2) DFAS personnel  to adhere to DFAS policies and procedures, especially as they relate to the  lack of definitive payment instructions in the contractual documents.
Regarding the two partial concurrences, DOD stated that it would establish  a standard section of the contract for placement of payment provisions,  which would include any payment allocation provisions.  In addition, DOD  agreed that it would, as part of the working group effort referred to in this  report, evaluate the feasibility of developing and automating payment  allocation options to include in standard payment instructions.  However,  until the coordination and review process within DOD is complete, DOD  stated that it could not commit to the development and automation of  standard payment instructions.
We understand that actions to develop and automate standard payment  instructions must be coordinated with interested parties throughout DOD.   At the same time, a clear commitment to completing this effort in a timely  manner is critical if DOD is to resolve its long-standing problem of  spending tens of millions of dollars each year to make tens of billions of  dollars in adjustments to correct the payment allocation problems.  When  $1 out of every $4 in contract payment transactions continues to be for  adjustments to previously recorded payments, decisive steps towards a  lasting solution are essential.  One concern that we have is that DOD has  not indicated any time frame for completing the coordination and review  process referred to in its response.  As we recently testified, cultural  resistance to change, military service parochialism, and stovepiped  operations have played a significant role in previous failed attempts to  implement management reforms at DOD.  Breaking down these barriers  will be critical to successfully reforming DOD’s contract payment  processes and saving the millions of dollars currently spent annually on  inefficient and inaccurate manual processes.
In addition, DOD stated that our findings were based on a review of only  two contracts that had known problems.  DOD recommended that the  report specifically state that, due to the nature of this review, the results  cannot be extrapolated to other DOD contracts.  The draft report already  included such a statement.  The report states that the two contracts we  reviewed are not representative of all DOD contracts but, based on our  experience, have characteristics similar to other complex contracts.  DFAS  Columbus provided these contracts as examples of complex contracts with  which they had encountered problems in correctly allocating payments to  ACRNs.  We selected these two contracts so we could identify the root  cause of payments not being properly allocated to ACRNs and to determine  what actions DOD is taking to address the problem.  We believe that the  two contracts provide a good perspective regarding the types of serious  problems that have long plagued DOD’s contract payment process.
As agreed with your office, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days from its  date.  At that time, we will send copies of the report to interested  congressional committees.  We will also send copies of this report to the  Secretary of Defense; the Under Secretary of Defense (Comptroller); the  Under Secretary of Defense (Acquisition, Technology, and Logistics); the  Secretaries of the Army, Navy, and Air Force; and the Director of the  Defense Finance and Accounting Service.  We will make copies available to  others upon request.  In addition, the report will be available at no charge  on the GAO Web site at http://www.gao.gov.  If you or your staff have any  questions regarding this report, please contact me at (202) 512-9505 or  kutzg@gao.gov or Greg E. Pugnetti, Assistant Director, at (703) 695-6922 or  pugnettig@gao.gov.  Major contributors to this report are acknowledged in  appendix III.
section_title: Scope and Methodology
paragraphs: To determine the magnitude of adjustments that affected previously  recorded payments and Defense Finance and Accounting Service (DFAS)  Columbus’s reported cost to make these adjustments in fiscal year 2002, we  obtained and analyzed a Mechanization of Contract Administration  Services (MOCAS) database of contract payment transactions, including  disbursements, collections, and adjustments, made for fiscal year 2002.  We  then determined the dollar amount and percentage of those adjustments  that were made to previously recorded payments.  We also interviewed and  obtained cost information from DFAS officials to determine the costs for  the DFAS Columbus commercial pay services, including the cost incurred  by DFAS Columbus to make adjustments to previously recorded payments.
To determine why contracts, including payment instructions, were  complex, we reviewed applicable laws, Department of Defense (DOD)  memorandums, regulations, administrative guidelines, policies, and  procedures governing contract payments.  These included a review of the  key contract payment provisions provided in the Defense Federal  Acquisition Regulation, DOD acquisition guidance, and DFAS policies.  We  also requested that DFAS Columbus provide us with several contracts that  created problems for DFAS Columbus technicians when recording  payments.  DFAS Columbus officials provided us with 10 contracts that  contained problems that DFAS Columbus was having with properly  allocating payments to accounting classification reference numbers  (ACRN), such as (1) missing payment instructions, (2) complex payment  instructions, or (3) the contracting office changing payment instructions.   Based on our review of contract documentation and interviews with DFAS  Columbus officials, we selected two contracts for a detailed review to  determine why the contracts, including payment instructions, were  complex and caused payment allocation problems.
The two contracts selected were an Army missile contract (contract  number DAAH01-98-C-0093) and an Air Force communications contract  (contract number F09604-00-C-0090).  In selecting these two contracts, we  considered several factors, including (1) goods and/or services purchased,  (2) the dollar amount of obligations and disbursements made on the  contract, (3) the number of modifications made to the contract, (4) the  number of ACRNs financing the contract, (5) payment provisions on the  contract, and (6) the number of contract reconciliations performed by  DFAS Columbus.  Because contract data were constantly changing, we  used a cutoff point of September 30, 2002, to gather, review, and analyze  data on the two contracts.
To determine the key factors that caused DFAS Columbus to make  payment adjustments for the two contracts reviewed, we obtained the  contracts, purchase requests, contract modifications, vouchers, invoices,  and other contract documentation.  We reviewed this information and  analyzed in detail (1) the payment instructions contained in the contract  and contract modifications, (2) the purpose for and the number of ACRNs  funding the contract, and (3) the number, dollar amount, and reasons for  adjustments on the contracts.  To determine why these adjustments were  necessary, we analyzed 2 of the 67 reconciliations performed by DFAS  Columbus (1 review for each contract), which resulted in $160 million of  the $264 million in adjustments.
Finally, to determine what steps DOD has taken or planned to address the  adjustment problem, we (1) reviewed applicable DOD policies to identify  changes in payment instruction guidance, (2) interviewed DFAS officials  responsible for system development projects that affected MOCAS  payments, and (3) interviewed DFAS officials on a working group formed  to improve payment instructions.  In addition, we discussed with officials  from DFAS and the Office of the Under Secretary of Defense (Acquisition,  Technology, and Logistics) why the contract payment instructions were so  complex, whether they needed to be so complex, and what the officials  were doing to address this problem.
We performed our review at the headquarters Offices of the Under  Secretary of Defense (Comptroller) and the Under Secretary of Defense  (Acquisition, Technology, and Logistics), Washington D.C., and DFAS,  Arlington, Virginia; DFAS, Columbus, Ohio; Army Aviation and Missile  Command, Redstone Arsenal, Alabama; and Air Force Materiel Command,  Robins Air Force Base, Georgia.  Our review was performed from August  2002 through July 2003 in accordance with U.S. generally accepted  government auditing standards, except that we did not validate the  accuracy of (1) DFAS Columbus disbursement data pertaining to the dollar  amount and percentage of those adjustments that were made to previously  recorded payments and (2) the cost incurred to reconcile DFAS Columbus  contracts.  We also did not review the DOD acquisition process, including  how contracts are written.  We did analyze the payment instructions in the  two contracts that we reviewed.  We requested comments on a draft of this  report from the Secretary of Defense or his designee.  DOD provided  written comments on July 3, 2003, which are discussed 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
section_title: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: Staff members who made key contributions to this report were Francine M.  DelVecchio, Francis L. Dymond, Dennis B. Fauber, Keith E. McDaniel, and  Harold P. Santarelli.
section_title: Related GAO Products
paragraphs: Canceled DOD Appropriations:  Improvements Made but More Corrective  Actions Are Needed. GAO-02-747.  Washington, D.C.: July 31, 2002.
DOD Contract Management:  Overpayments Continue and Management  and Accounting Issues Remain.   GAO-02-635.  Washington, D.C.: May 30,  2002.
Canceled DOD Appropriations:  $615 Million of Illegal or Otherwise  Improper Adjustments.   GAO-01-697.  Washington, D.C.: July 26, 2001.
Financial Management:  Differences in Army and Air Force Disbursing  and Accounting Records.  GAO/AIMD-00-20.  Washington, D.C.: March 7,  2000.
Financial Management:  Seven DOD Initiatives That Affect the Contract  Payment Process.   GAO/AIMD-98-40.  Washington, D.C.: January 30, 1998.
Financial Management:  Improved Reporting Needed for DOD Problem  Disbursements.   GAO/AIMD-97-59.  Washington, D.C.: May 1, 1997.
Contract Management:  Fixing DOD’s Payment Problems Is Imperative.    GAO/NSIAD-97-37.   Washington, D.C.: April 10, 1997.
Financial Management:  Status of Defense Efforts to Correct  Disbursement Problems.   GAO/AIMD-95-7.  Washington, D.C.: October 5,  1994.
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