Defense Budget: Improved Reviews Needed to Ensure Better Management of Obligated Funds
Released: 2003-01-30T00:00:00

Letter

Background

Obligations are recorded when an authorized agent of the federal government enters into a legally binding agreement to purchase specific goods or services. As bills are received and payments are made, the recorded obligation is reduced by the amount of the payments made. When all services or goods have been received and paid for, the obligation is considered “liquidated,” and any remaining amount of the unliquidated (unpaid) obligation should be deobligated and reduced to zero. Operating funds must be obligated in the fiscal year for which they are appropriated. However, obligated funds may be spent over a period of 5 additional years, as bills for goods and services are received and paid. If the goods and services are received and paid for in the first year of the obligation, the remaining unliquidated obligation can be reused for other needs consistent with the source appropriation. If the goods and services are received and paid for in the subsequent 5 years, the remaining unliquidated obligation can still be used, if permissible, to modify contracts or to increase existing obligations that might need more funds.

Accurate obligation information is essential for reliable budgeting reports to Congress, agency financial statements, performance measurements, and funds control. Inaccurate obligation data misstates the amount of funds available from the appropriation, contributes to inaccuracies in the Navy’s budget and financial reports, and subsequently leads to inaccuracies in federal financial statements. For example, the Navy’s unliquidated obligations are reported in the Navy Statement of Budgetary Resources, which are in turn incorporated in other DOD and federal budget reports and financial statements.

We have documented weaknesses in DOD’s accounting practices and Navy auditors have documented inaccuracies in the Navy’s obligations data. In our 2001 Performance and Accountability Series report, we stated that because of weaknesses in DOD’s budget execution accounting, the department does not know with certainty the amount of funding it has available. Naval Audit Service reports published in February 1999 and January 2000 reported that Navy fund managers were not complying with obligation review regulations and documented inaccuracies in the Navy’s obligation data. In July 2000 we reported that such inaccuracies in obligation data not only hamper DOD’s ability to produce timely and accurate financial information, but also significantly impair efforts to improve the economy and efficiency of its operations.

To ensure that obligation data are tracked and accurately reported, the DOD Financial Management Regulations (FMR) require that the services, including the Navy, review their unliquidated operating obligations valued $50,000 or more three times a year to ensure that they are accurate and that the funds are still needed. All unliquidated operating obligations, regardless of dollar value, must be reviewed at least once a year. Also, Congress specifically established in chapter 15 of title 31, United States Code, a framework for reviewing, adjusting, certifying to, and reporting on, among other items, the status and amounts of unliquidated obligations. In addition, for many interagency obligations entered under specific statutory authority, such as the Economy Act, the authorizing statute may mandate the deobligation of appropriations at specific times or when certain conditions arise.

The DOD regulation also directs the services to implement effective internal controls to ensure that the required reviews are completed and that identified corrective actions are completed in a timely manner. Further, the Federal Managers’ Financial Integrity Act of 1982 requires that agencies’ controls reasonably ensure that (1) obligations and costs comply with applicable law and (2) revenues and expenditures applicable to agency operations are properly recorded and accounted for so that agency accounts and reliable financial and statistical reports may be prepared and the accountability of assets may be maintained.

Navy Did Not Properly Account for Large Portion of Unliquidated Operating Obligations

An estimated two-thirds of the Navy’s unliquidated operating obligations valued at $50,000 or more from the fiscal years 1997-99 operating appropriations was not properly accounted for. Specifically, we estimated that $929 million of the $1.4 billion in unliquidated operating obligations was not properly accounted for. As shown in table 1, $452 million of the unliquidated operating obligations was no longer needed for its original purpose. These funds could have been used for other permissible purposes of the same appropriation and fiscal year, such as contract modifications. In addition, $477 million was not properly accounted for due to billing and recording errors, including $147 million in problem disbursements and $330 million in unresolved accounting and recording errors. Finally, $489 million in unliquidated operating obligations was properly accounted for and still needed for the original purpose.

The Navy failed to deobligate an estimated $452 million that was no longer needed for the original obligated purpose. According to DOD regulations, these unliquidated funds should have been deobligated once services had been performed, final payment issued, and the funds made available for other purposes consistent with the appropriation. In many of our sample cases, the entire amount of an obligation was not required to meet billing needs and resulted in funds remaining over. For example, in one of the cases we reviewed, $4.7 million had been disbursed from a 1997 obligation, valued at $6 million, to support the San Diego Harbor Tug Charter; however, the last disbursement was made in October 1999. We discovered that the remaining unliquidated funds were no longer needed and the Navy subsequently deobligated the unliquidated $1.3 million. Similarly, we reviewed a 1996 (fiscal year 1997) obligation to fund systems development at the Bureau of Naval Personnel. When the responsible Navy fund manager reviewed the unliquidated obligation at our request, he determined that the outstanding balance of $1.4 million attached to this obligation was no longer required and deobligated it. In both of these cases, if Navy personnel had reviewed these obligations in accordance with DOD regulations, they would have detected the error and deobligated the funds years ago, thereby possibly allowing Navy to use the funds for other permissible purposes, including contract modifications, or other obligation needs of the same appropriation and fiscal year.

The Navy had also not properly accounted for an estimated $147 million in unliquidated operating obligations due to expenditures that were not properly matched to a specific obligation recorded in the Navy’s records— problem disbursements. We previously reported that the Navy’s financial control policy and procedures do not ensure that the Navy can match payments to corresponding obligations before or at the time a payment is made. Consequently, if the Navy cannot resolve these problem disbursements by matching the disbursement to the original obligation, it must record a new obligation to cover the disbursement after a payment is made. For example, one of our sample items had an unliquidated obligation balance of $1,362,790 on September 30, 2001. The fund manager of this 1998 obligation stated that all of the funds had been disbursed; however, the Navy’s Standard Accounting and Reporting System indicated that no disbursements had been made. We discovered that in fact all of the funds had been disbursed for this obligation, but the disbursements had been posted to the wrong obligation in the accounting system. Funds that remain unliquidated due to a problem disbursement may not be deobligated and used for other purposes because the funds are still needed to reimburse the obligation that was erroneously charged for the disbursement.

The Navy had not properly accounted for an estimated $330 million due to unresolved accounting and recording errors. These obligations remained unliquidated for several reasons. Most unresolved errors in our sample occurred because fund managers were unable to identify whether the providers of goods or services had been paid in full for services rendered. The fund managers claimed that providers were often slow to bill or had not sent a final bill. For example, we reviewed a 1997 obligation for aircraft maintenance that had an unliquidated balance of $14.4 million. The fund managers said that they had not received a bill from the Air Force, which provided the maintenance service. In this case, the $14.4 million remained on the books as unresolved, because the fund managers still expected to receive a bill for the services. An example of a recording error is illustrated in a $12 million obligation to support alterations on the USS LaSalle. A disbursement was input twice and then reversed twice instead of once. The second reversal of the disbursement left an unliquidated balance on the obligation that should have been disbursed. Funds that remain unliquidated due to unresolved accounting and recording errors cannot be deobligated and used for other purposes, because the Navy needs to have funds available to pay providers after the errors have been resolved.

Navy Did Not Fully Adhere to DOD Review Regulations

The Navy did not fully adhere to DOD regulations to review all unliquidated operating obligations, including those obligations valued at $50,000 or more three times per year and those obligations valued at less than $50,000 once every year. Furthermore, the Navy did not utilize internal controls to determine the accuracy of the review process or the outcomes of the reviews. As a result, the Navy did not know how much money was tied up in unliquidated operating obligations that could potentially be used for other permissible needs.

According to DOD regulations, obligation reviews are to be conducted by fund managers within 14 days following the end of January, May, and September. DOD regulations also require the services to implement effective internal controls to ensure that the reviews are completed and corrective actions are implemented in a timely manner. The purpose of these reviews is to ensure that the unliquidated balances are accurate and still needed. The Navy issued implementing guidance that (1) restates the three deadlines provided in the DOD regulations, (2) requires that internal controls be implemented by each entity as described in DOD regulations, and (3) requires each fund manager to complete a checklist of the review steps performed. For example, one required step is to follow up and ensure the obligation is still needed. The guidance also requires the comptroller of each major command to consolidate the review results from the fund managers and include a list of all fund managers who did not fully adhere to DOD regulations and the reason why. The major command confirmation statement is to be forwarded to the Assistant Secretary of the Navy (Financial Management and Comptroller), Office of Budget.

Although DOD regulations require Navy fund managers to review all operating obligations once annually and those $50,000 and above three times each year, fund managers have not fully adhered. Fund managers stated that they selectively reviewed some unliquidated operating obligations, but were unable to make all the required reviews or complete all the steps on some of the cases they reviewed. For example, fund managers first prioritize for review the high-value unliquidated operating obligations in the current fiscal year to accommodate immediate funding requirements. That frees the funds for reobligation during the same fiscal year. Unliquidated operating obligations that are approximately 5 years old and, based on appropriations that will cancel at the end of the fiscal year, are also a high priority for review in order to pay outstanding bills while funds are available. As a result of prioritized and selective obligations review, some operating obligations are not reviewed three times a year as required by DOD regulations and some are not reviewed at all.

Navy fund managers provided several reasons why they selectively reviewed obligations and did not review all of them. They stated that the process of reviewing an obligation can be time-consuming due to a lack of automated tools and, often, a lack of accurate billing information needed to assess the validity of an obligation, especially for older obligations. Officials acknowledged that the Navy’s Standard Accounting and Reporting System provides users with the capability to conduct ad hoc queries of the obligation database, but they claim these tools are not user- friendly because users must be familiar with the system’s database- programming code to take full advantage of its capabilities. Few of the staff assigned to perform obligation reviews had the required computer training or knowledge to write queries. Some of the fund managers also told us that they were reluctant to review the large volume of low dollar unliquidated operating obligations because they felt the expected rate of return was not cost beneficial given the magnitude of resources required to conduct the review. To illustrate the large volume, Atlantic Fleet officials reported that they had 579,904 unliquidated operating obligations valued $50,000 or less, and officials at the Pacific Fleet reported 724,266 such unliquidated operating obligations. Further, some fund managers stated that it was impossible for them to comply with the requirement to review all such unliquidated operating obligations even once a year, because they did not have enough staff to review the large number of such obligations.

Officials in the Navy Comptroller Office acknowledged that fund managers have reported difficulties performing obligation reviews. Navy officials also acknowledged that inaccurate obligation data compromises the reliability of their financial statements, and therefore it is reasonable that they review their obligations according to the regulations. Consequently, the Navy has not sought relief from DOD obligation review regulations.

The Navy did not utilize internal control activities necessary to ensure that fund managers performed thorough obligation reviews in accordance with DOD regulations. Although some major commands had developed written standard operating procedures or checklists to track whether fund managers had reviewed their unliquidated operating obligations, they did not hold managers accountable for the accuracy and completeness of the reviews. Fund managers submitted obligation-review confirmation statements to their major commands, but often the commands could not determine specific details about the obligations, including the number of unliquidated operating obligations reviewed, the amount of the obligations reviewed, and the resolution of any problems identified during the review. For example, one major command has a process to review whether fund managers submit the required obligation review paperwork. However, the command does not spot-check obligations to determine if they are valid as claimed by the fund managers and accepts the fund managers obligations review paperwork as is.

Officials in the Navy Comptroller Office stated that fund managers should place more emphasis on reviewing obligations in accordance with DOD regulations. However, they did not think it would be productive to discipline fund managers for failure to adhere to the regulations. Rather, they believe that the Navy should rely on financial system upgrades to improve the accuracy of obligation data.

Conclusions

As highlighted in our 2001 Performance and Accountability Series reports, financial management is one of the major management challenges facing DOD. The large dollar value of unliquidated Navy obligations that were not properly accounted for contributes to inaccuracies in the Navy’s budget and financial reports, and subsequently leads to inaccuracies in federal financial statements and the President’s budget. Moreover, the Navy will not be able to pass the test of an independent financial audit until it corrects inaccurate obligation data.

DOD regulations and Navy guidance provide for unliquidated obligations to be reviewed by fund managers on a regular basis. The fund managers’ ability to deobligate or resolve the errors on many of our sample items demonstrates that the review process could be effective. But the fund managers have chosen to only selectively follow the requirements for review because they said they were constrained by too little time to review the large number of transactions, inaccurate billing information, and the lack of automated tools. Although the Navy recognized the potential benefits of timely identification of funds that are no longer needed or in error, its internal controls have not ensured that required reviews were made and corrective action taken. We note that fund managers were able to successfully resolve nearly all of the unliquidated operating obligations in our sample even though the resolution of some of the obligations required an extensive amount of time and effort. Therefore, it is likely that many of the unliquidated obligations in our sample that were not properly accounted for could have been identified and accounting errors could have been corrected prior to our review had fund managers performed obligation reviews in accordance with the DOD regulations.

Recommendations for Executive Action

We recommend that the Secretary of Defense direct the Secretary of Navy to: adhere to DOD unliquidated operating obligation review regulations; and better apply existing internal control activities to ensure adherence to these regulations, and to hold fund managers accountable for the accuracy and completeness of their reviews.

As you know, 31 U.S.C. requires the head of a federal agency to submit a written statement of the actions taken on our recommendations to the Senate Committee on Government Affairs and the House Committee on Government Reform not later than 60 days after the dare of this report. A written statement must also be sent to the House and Senate Committees on Appropriations with the agency’s first request for appropriations made more than 60 days after the date of this report.

Agency Comments and Our Evaluation

The Director, Office of the Budget, Department of the Navy provided DOD’s written comments on a draft of this report, which are provided in their entirety in appendix II. The Navy partially concurred with our recommendations and noted that more thorough efforts dedicated to the review of obligations would increase the accuracy and reliability of financial reports. It also plans to make the review process a part of its management structure and stress the importance of accurate financial statements. The Navy, however, commented that because numerous factors contribute to problems in financial reports, it has to prioritize its remedial efforts. Specifically, the Navy places a premium on reviewing unliquidated obligations in available appropriations, correcting systemic problems, and pursuing broad improvements in financial management. For example, the Navy stated it made significant improvements in correcting systemic issues—such as problem disbursements—and is working to provide automated tools and correct systemic issues that would positively impact the fund managers’ ability to conduct obligation reviews. While it noted validating unliquidated obligations is desirable and important, the Navy emphasized that systemic improvement of its financial information offers the better opportunity for success.

The Navy did not agree that the difficulty the fund managers have had in reviewing unliquidated obligations precluded the use of funds for other appropriate needs. It noted that Congress has intentionally and progressively limited the availability of funds from prior year appropriations, clearly establishing that the appropriateness of use outweighs the efficiency of use. When appropriate requirements for the application of available funds from prior year appropriations have arisen, the Navy commented that encumbrances for unliquidated obligations have not been an impediment to obtaining necessary funds.

While we understand numerous factors, including systemic issues, affect the accuracy of Navy financial reports, DOD regulations require that fund managers annually review all unliquidated obligations and, as currently written, do not provide for prioritization of such reviews. We recognize the Navy has taken steps to significantly reduce the amount of outstanding problem disbursements; however, as our report points out, problem disbursements are only part of the reason for the significant amount of unliquidated obligations. For example, about $782 million of the $929 million in unliquidated obligations in our sample were improperly accounted for due to reasons unrelated to problem disbursements. Specifically, the aggregate of these transactions involved funds that were no longer needed for their original purpose or involved unresolved accounting and recording errors. While we agree that focusing on systemic issues offers opportunities to improve the Navy’s financial information, we also note that the internal control procedures reflected in DOD’s obligation review regulations are in fact designed to minimize systemic problems such as problem disbursements. To the extent that the Navy’s efforts to make systemic improvements include automated tools designed to assist the fund managers in complying with obligation review requirements, we believe these efforts represent a positive step.

We disagree with the Navy’s views regarding the impact of failing to review all unliquidated obligations as required under current DOD regulations. Regardless of whether the Navy is able to gain the funds necessary from unliquidated obligations to satisfy appropriate requirements as they arise, inaccurate obligation data in the Navy’s financial system has broader implications, such as inaccurate financial reports and misstatements of budgetary information on federal financial statements and in the President’s budget. While we agree Congress has placed statutory limitations on the availability of appropriated funds, DOD, like all agencies, is responsible for effectively and efficiently implementing its activities within the limitations applicable to the appropriations it receives. Indeed, Congress specifically established in chapter 15 of title 31, United States Code, a framework for reviewing, adjusting, certifying to, and reporting on, among other items, the status and amounts of unliquidated obligations. In addition, the Federal Managers’ Financial Integrity Act of 1982 requires that agencies have controls to reasonably ensure that revenues and expenditures applicable to agency operations are recorded and accounted for properly so that accounts and reliable financial and statistical reports may be prepared and accountability of assets may be maintained. Finally, for many interagency obligations entered under a specific statutory authority—such as the Economy Act— the authorizing statute may mandate the deobligation of appropriations at specific times or when certain conditions arise. In this context, the ability of the Navy to access funds encumbered by unliquidated obligations does not relieve it of the responsibility to adhere to existing laws and regulations governing sound financial management. We therefore are making no changes to the recommendations in our report.

We are sending copies of this report to congressional committees with jurisdiction over DOD’s budget and the Secretary of the Navy. We will also 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 about this report, please call me at (202) 512-9619. Key contributors to this report are listed in appendix III.

Appendix I: Scope and Methodology

Our objective was to determine whether the Navy’s unliquidated operating obligations were (1) properly accounted for and (2) periodically reviewed in accordance with DOD regulations.

To determine whether Navy’s unliquidated operating obligations were properly accounted for, we requested that the Defense Finance Accounting Office provide us with a database that identified all unliquidated operating obligations outstanding on September 30, 2001. We relied on the completeness and accuracy of that database based on the office’s representations and did not independently test or reconcile the validity of their database. For our review, we selected unliquidated operating obligations for fiscal years 1997-99. Older obligations are more likely to be in error and thus provided a better test of the Navy’s obligation management practices. We then divided the individual unliquidated operating obligations into two groups—those valued at less than $50,000 and those valued at $50,000 or more. Those valued at $50,000 or more represented $1.4 billion, or 67 percent of the value of all outstanding operating obligations for fiscal years 1997-99.

From the population of obligations valued at $50,000 or more, we drew a stratified random sample of 205 unliquidated operating obligations to review. For each transaction, we obtained the following documentation: (1) documentary support describing each obligation, including amendments and modifications for each sample transaction; (2) responses from Navy officials regarding whether each unliquidated operating obligation in our sample was still needed for its original purpose according to the criteria in the DOD Financial Management Regulation (FMR); and (3) support for how to classify each unliquidated operating obligation in our sample as still needed, no-longer-needed, problem disbursement, or an unresolved accounting and recording error.

The sample was selected from three strata defined by the dollar value of the obligations, as shown in table 3.

To determine whether the amount of each unliquidated operating obligation was properly accounted for, we reviewed support provided by the Navy, discussed the status of the unliquidated obligation with the primary Navy official responsible for the individual transaction, and used the criteria set forth in DOD’s regulations. We classified unliquidated operating obligation transactions as “still needed” and properly accounted for when the Navy provided documentation to support that the contracted goods or services were still needed; thus, the transaction passed a bona fide needs test. Items not properly accounted for fell into three categories. We classified the transaction “no longer needed for original purposes” when the Navy could not provide support that a bona fide need existed. We classified transactions as “problem disbursements” when specific disbursements were not properly matched to corresponding obligations recorded in the department’s records. We classified the remaining unliquidated operating obligation transactions as “unresolved accounting and recording errors” when they did not clearly meet the criteria for needed, no-longer-needed, or problem disbursements.

To determine if the Navy’s unliquidated operating obligations were periodically reviewed in accordance with DOD regulations, we requested that the Navy provide documentation and guidance on the Navy’s implementation of the regulations. We also interviewed officials at 12 locations to discuss (1) their procedures for performing obligation reviews, (2) the magnitude of transactions involved to perform the review as set forth in the DOD obligation review regulations, and (3) whether the officials had difficulty meeting the obligation review requirements, including the reasons why. We visited the Commander in Chief of the Atlantic Fleet in Norfolk, Va.; the Commander, Navy Mid-Atlantic Region in Norfolk, Va.; the Commander, Naval Sea Systems Command in Washington, D.C.; the Naval Facilities Engineering Command in Washington, D.C.; the Director of Strategic Systems Programs in Washington, D.C.; the Commander in Chief of the Pacific Fleet in Pearl Harbor, Hawaii; the Commander, Naval Region in Pearl Harbor, Hawaii; the Commander, Naval Air Force Command of the Pacific Fleet in San Diego, Calif.; the Commander, Naval Surface Force Command of the Pacific Fleet in San Diego, Calif.; the Space and Naval Warfare Systems Command in San Diego, Calif.; the Commander, Naval Air Systems Command in Patuxent River, Md.; and the Bureau of Medicine and Surgery in Washington, D.C.

We conducted our review from October 2001 through October 2002 in accordance with generally accepted government auditing standards.

Appendix II: Agency Comments

Appendix III: GAO Contacts and Staff Acknowledgments

GAO Contacts

Staff Acknowledgments

In addition to the individuals named above, Lori Adams, Linda Garrison, Gregory Kutz, Steve L. Pruitt, Rhonda P. Rose, and R.K. Wild made key contributions to this report.