DOD Financial Management: Effect of Continuing Weaknesses on Management and Operations and Status of Key Challenges
Released: 2014-05-13T00:00:00

Letter

Background

In the face of continuing reports of financial management weaknesses across the federal government, including wasteful spending, poor management, and losses totaling billions of dollars, the Chief Financial Officers (CFO) Act of 1990 was signed into law. The act focuses on establishing a leadership structure; improving systems of accounting, financial management, and internal control; and enabling effective management and oversight through the production of complete, reliable, timely, and consistent financial information.

With the foundation of the CFO Act and the Government Management Reform Act of 1994 (GMRA), with its goal “to provide a more effective, efficient and responsive government,” along with other federal agency management reform legislation, such as the Government Performance and Results Act of 1993 (GPRA) and FFMIA, a framework was put in place to improve stewardship, accountability, and transparency in the executive branch. Major goals of the reform legislation have included the following:

Strengthening internal control. Accountability is part of the organizational culture that goes well beyond receiving an unmodified or “clean” audit opinion on agency financial statements; the underlying premise is that agencies must become more results oriented and focused on internal control. Thousands of internal control problems have been identified and corrected in executive branch agencies over the past two decades. A disciplined and structured approach to assessing and dealing with internal controls over the critical flow of funds through the entire agency provides a mechanism that over time mitigates potential damaging breakdowns in financial integrity and mismanagement of funds. Such breakdowns can affect the ability of the agency or entity to carry out its mission and can severely damage public confidence.

Accurate accounting and financial reporting. The CFO Act and FFMIA provide for financial management systems that support reliable financial reporting on the results of operations on a day-to-day basis. This functionality, in turn, supports management decision making on budgets, programs, and overall mission performance and goals. Accurate accounting and financial reporting are also a major element of any effort to achieve auditable financial statements.

Improving performance information. A key goal of much of the federal management reform legislation enacted over the past 25 years, such as the CFO Act and GPRA, is the ability to have reliable information to measure performance against mission goals. Federal agencies have made progress in the preparation of annual performance and accountability reports (PAR). By linking financial and performance information, the PARs provide important information about the return on the taxpayers’ investment in agency programs and operations.

Enhancing transparency. Achieving clean audit opinions evidencing sound financial management practices is an overall outcome of effective implementation of these reforms. For example, the achievement of a clean audit opinion on the first-ever annual financial statements for the Troubled Asset Relief Program (TARP) was a significant accomplishment. This provided important accountability and transparency to the public regarding TARP activities.

Many of the problems that preceded passage of the CFO Act also led us to issue our first high-risk list in 1990, designating certain DOD and other federal programs as high risk because of their vulnerability to fraud, waste, abuse, and mismanagement. DOD areas designated as high risk in 1990 included Supply Chain Management and Weapon System Acquisition, followed by Contract Management in 1992, Financial Management and Business Systems Modernization in 1995, Support Infrastructure Management in 1997, and Business Transformation in 2005.

As we reported in our latest high-risk update, DOD is one of the few federal entities that cannot accurately account for its spending or assets and it is the only federal agency that has yet to receive an opinion on at least one of its department-wide financial statements. Without accurate, timely, and useful financial information, DOD is severely hampered in making sound decisions affecting its operations. Further, to the extent that current budget constraints and fiscal pressures continue, the reliability of DOD’s financial information and ability to maintain effective accountability for its resources will be increasingly important to the federal government’s ability to make sound resource allocation decisions. Effective financial management is also fundamental to achieving DOD’s broader business transformation goals in the areas of asset management, acquisition and contract management, and business systems modernization.

Effect of Continuing Financial Management Weaknesses on DOD Management and Operations

As we have previously reported, long-standing weaknesses in DOD’s financial management adversely affect the economy, efficiency, and effectiveness of the department’s operations.and related business management and system deficiencies continue to adversely affect its ability to control costs; ensure basic accountability; anticipate future costs and claims on the budget; measure performance; maintain funds control; prevent and detect fraud, waste, and abuse; and address pressing management issues. As we have previously recommended, the successful transformation of DOD’s financial management processes and operations is necessary for DOD to routinely generate timely, complete, and reliable financial and other information for DOD’s pervasive financial day-to-day decision making, including the information needed to effectively (1) manage its assets, (2) assess program performance and make budget decisions, (3) make cost-effective operational choices, and (4) provide accountability over the use of public funds.

Asset Management

Since 1990, we have identified DOD supply chain management as a high-risk area in part because of ineffective and inefficient inventory management practices and procedures, weaknesses in accurately forecasting demand for spare parts, and challenges in achieving widespread implementation of key technologies aimed at improving asset visibility.of dollars in spare parts that are excess to current needs, wasting valuable resources. DOD has made moderate progress in addressing its supply chain management weaknesses, but several long-standing problems have not yet been resolved. To provide high-level strategic direction, DOD issued its Logistics Strategic Plan in July 2010, which among other things, established a goal to improve supply chain processes, including inventory management practices and asset visibility.

These factors have contributed to the accumulation of billions With respect to inventory management, in November 2010, as required by the Congress, DOD issued its Comprehensive Inventory Management Improvement Plan, which is aimed at reducing excess inventory by improving inventory management practices. We reported in 2012 and 2013 that DOD had made progress in reducing its excess inventory and implementing its Comprehensive Inventory Management Improvement Plan. DOD established overarching goals in the plan to reduce the enterprise-wide percentages of on-order excess inventory, those items already purchased that may be excess due to subsequent changes in requirements, and on-hand excess inventory, those items categorized for potential reuse or disposal. Since DOD was exceeding its initial goals for reducing excess inventory, we recommended that DOD’s efforts would benefit from establishing more challenging, but achievable, goals for reducing excess inventory and that the department periodically reexamine and update its goals. DOD agreed with our recommendations and revised its on-hand excess inventory goal from 10 percent of the total value of inventory to 8 percent in fiscal year 2016. However, DOD did not make any changes to its on-order excess inventory goals and maintained that its current goals of 6 percent of the total value of on-order inventory in 2014 and 4 percent in 2016 were sufficient. Our work determined that DOD has made progress in reducing on-hand and on order excess inventory. For example:

Data from the end of fiscal year 2009 showed that of the about $94.5 billion in on-hand inventory, 9.4 percent, or about $8.8 billion, was excess. DOD’s most recent fiscal year-end data from September 2013, showed that of the about $98.9 billion in on-hand inventory, 7.3 percent was considered excess.

Data from the end of fiscal year 2009 through 2013 showed that the department had reduced its percentage of on-order excess inventory from $13.6 billion to about $10.2 billion, from 9.5 to 7.9 percent, with $812 million considered as excess.

With respect to asset visibility, we found that DOD needs to take additional actions to improve asset visibility, to include completing and implementing its strategy for coordinating improvement efforts across the department for asset tracking and in-transit visibility. In February 2013, we reported that DOD had taken steps to improve in-transit visibility of its assets through efforts developed by several of the defense components, but no one DOD organization was fully aware of all such efforts across the department, because they are not centrally tracked.began developing a strategy for asset visibility and in-transit visibility; however, as of February 2013 this strategy did not include all key elements of a comprehensive strategic plan. We recommended that the department finalize its strategy and in doing so ensure complete, accurate, and consistent information for all in-transit visibility efforts is captured, tracked, and shared, and the strategy contains all of the key elements of a comprehensive strategic plan, including resources and investments and key external factors. DOD agreed with our recommendation and revised and finalized its asset visibility strategy. We are currently reviewing the new strategy and the department’s efforts to improve asset visibility.

GAO, Defense Logistics: Improvements Needed to Enhance DOD’s Management Approach and Implementation of Item Unique Identification Technology, GAO-12-482 (Washington, D.C.: May 3, 2012). implementing a comprehensive management approach for using IUID technology.

Effective asset management controls are essential for asset accountability and safeguarding and financial reporting on asset values. DOD primarily relies on various logistical systems to carry out both its stewardship and financial reporting responsibilities for an estimated $1.5 trillion in physical assets, ranging from enormous inventories of ammunition, stockpile materials, and other military items to multimillion- dollar weapon systems. These systems are the primary source of information for maintaining visibility over assets to meet military objectives and readiness goals and for financial reporting. However, our prior reports and DOD Inspector General (IG) reports have shown that these systems have serious weaknesses that in addition to hampering financial reporting, impair DOD’s ability to (1) maintain central visibility over its assets; (2) safeguard assets from physical deterioration, theft, or loss; and (3) prevent the purchase of assets already on hand. Collectively, these weaknesses can seriously diminish the efficiency and economy of the military services’ support operations.

For example, we have continued to monitor the implementation of the Army’s Logistics Modernization Program (LMP) system, which supports both inventory management and financial reporting. In November 2013, we reported that the Army’s LMP, which replaced two aging Army systems, is supporting the Army’s industrial operations. However, the current system—LMP Increment 1—does not support certain critical requirements, such as automatically tracking repair and manufacturing operations on the shop floor of depots and arsenals. In addition, according to Army officials, the current system will not enable the Army to generate auditable financial statements by 2018, the statutory deadline for this goal. The Army is in the process of developing LMP Increment 2 to, among other things, address some of the identified weaknesses and expects to complete fielding by September 2016. To determine whether the Army is achieving its estimated financial benefits in LMP, we recommended that the Army develop and implement a process to track the extent of financial benefits realized from the use of LMP during the remaining course of its life cycle. The Army agreed with our recommendation and stated that it would develop a process to track the extent of financial benefits recognized within LMP. We are continuing to monitor the Army’s actions.

Program Performance and Budgeting

Reliable performance and budget information are essential to ensure that DOD has effectively budgeted for its needs so that operations can proceed smoothly to meet mission readiness demands. Accurate and timely performance and budget information also is critical to effective oversight and decision making on DOD’s numerous reform initiatives.

The following examples illustrate some of the serious weaknesses we have identified in our past work on DOD’s performance management and budget information.

In our February 2014 report on the audit of the U.S. government’s consolidated financial statements, we discussed as a material weakness, DOD’s inability to estimate with assurance key components of its environmental and disposal liabilities. Deficiencies in internal control supporting the process for estimating environmental and disposal liabilities could result in improperly stated liabilities as well as adversely affect the ability to determine priorities for cleanup and disposal activities and to appropriately consider future budgetary resources needed to carry out these activities. In addition, DOD could not support a significant amount of its estimated military postretirement health benefits liabilities for federal employee and veteran benefits. These unsupported amounts related to the cost of direct health care provided by DOD-managed military treatment facilities. Problems in accounting for liabilities affect the determination of the full cost of the federal governments operations and the extent of its liabilities. DOD is addressing these issues through its implementation of its FIAR Plan.

In June 2013, we reported that problems with the accuracy of outstanding work orders at fiscal year-end for the Army’s Industrial Operations activities resulted in inaccurate budget estimates. To the extent that Industrial Operations does not complete work at year-end, the work and related funding are carried over into the next fiscal year. Carryover is the reported dollar value of work that has been ordered and funded by customers but not completed by Industrial Operations at the end of the fiscal year. We found that the Army did not adequately evaluate program needs and performance management constraints or the budgetary impact of the implementation of its LMP when budgeting for its Industrial Operations. As a result, unreliable information on the scope of work and the lack of available parts affected mission readiness. Further, the overstated Industrial Operations carryover amounts resulted in unreliable estimates of Operations and Maintenance funding levels. For example, the Industrial Fund carryover amounts more than doubled from fiscal years 2006 through 2012, exceeding budget estimates by more than $1.1 billion each year. We made three recommendations aimed at implementing the Army’s planned corrective actions to (1) establish a timetable for implementing new policy guidance, (2) improve the budgeting for new orders, and (3) establish procedures for evaluating work orders received to ensure that resources are available to perform the work. DOD agreed with our recommendations and has actions planned or under way to address them.

The Office of Management and Budget (OMB) requires that federal agency budget submissions reflect anticipated reductions in improper payments in their PARs or agency financial reports (AFR) pursuant to legal requirements for the estimation of improper payments. For years, DOD has reported over $1 billion annually in improper payments. Improper payments degrade the integrity of government programs, compromise citizens’ trust in government, and drain resources away from the missions and goals of the government. As we reported in May 2013, although DOD has reported billions of dollars in improper payments, it does not know the extent of its improper payments because of flaws in its estimating methodology. We found that DOD’s improper payment estimates reported in its fiscal year 2011 AFR were neither reliable nor statistically valid because of long-standing and pervasive financial management weaknesses and significant deficiencies in the department’s procedures to estimate improper payments. The flawed methodology for estimating improper payments also limits the effectiveness of DOD’s corrective actions. We recommended that DOD take steps to (1) improve improper payment estimating procedures, such as developing valid sampling methodologies and error projections; (2) identify programs susceptible to improper payments and perform a risk assessments; (3) develop and implement corrective action plans in accordance with best practices; (4) implement recovery audits; and (5) ensure the accuracy and completeness of improper payment and recovery audit reporting. DOD agreed with our recommendations and cited planned actions to address them.

Cost-effective Choices

Reliable information on the cost of operations is critical to provide accountability for and to efficiently and economically manage DOD’s vast resources. Reliable cost information is essential for making important decisions, such as reallocating resources to fighting forces and considering whether to continue, modify, or discontinue programs and activities. However, DOD’s legacy financial management systems were not designed to capture the full cost of its activities and programs, and DOD’s enterprise resource planning (ERP) systems continue to experience schedule slippages and cost overruns and are not estimated to be fully implemented until the end of fiscal year 2016 or later.

As our prior work has found, to effectively, efficiently, and economically manage DOD’s programs, its managers need reliable cost information for (1) evaluating programs (for example, measuring actual results of management’s actions against expected savings or determining the effect of long-term liabilities created by current programs); (2) making cost- effective choices, such as whether to outsource specific activities and how to improve efficiency through technology choices; and (3) controlling costs for its weapon systems and business activities funded through working capital funds. The lack of reliable, cost-based information has hampered DOD in each of these areas, as described in the following examples.

In a February 2014 report on our audit of the U.S. government’s consolidated financial statements, we reported that DOD was responsible for the majority of the federal government’s inventories and property, plant, and equipment and that DOD did not maintain adequate systems or have sufficient records to provide reliable information on these assets. Further, deficiencies in internal control over such assets could affect the federal government’s ability to fully know the assets it owns, including their location and condition, and its ability to (1) safeguard assets from physical deterioration, theft, or loss; (2) account for acquisitions and disposals of such assets and reliably report asset balances; (3) ensure that the assets are available for use when needed; (4) prevent unnecessary storage and maintenance costs or purchase of assets already on hand; and (5) determine the full costs of programs that use these assets. DOD is addressing these issues through implementation of its FIAR Plan.

With the nation facing fiscal challenges and the potential for tighter defense budgets, the Congress and DOD have placed more attention on controlling the billions of dollars spent annually on weapon system operating and support costs, including costs for repair parts, maintenance, and personnel, which account for 70 percent of the total costs of a weapon system over its life cycle. The Selected Acquisition Report (SAR) is DOD’s key recurring status report on the cost, schedule, and performance of major defense acquisition programs and is intended to provide authoritative information for congressional oversight of these programs. Oversight of operating and support costs is important because many of the key decisions affecting these life cycle costs are made during the acquisition process. In February 2012, we reported that DOD’s reports to the Congress on estimated weapon system operating and support costs are often inconsistent and sometimes unreliable, limiting visibility needed for effective oversight of these costs. To enhance the visibility of weapon system costs during acquisition, we recommended that DOD improve its guidance to program offices on cost reporting and also to improve its process for reviewing these costs prior to final submission of the SAR to the Congress. DOD concurred with our recommendations and noted actions it was taking to address them. We are continuing to monitor DOD’s progress in addressing our recommendations.

In December 2012, DOD canceled the Air Force’s Expeditionary Combat Support System after having spent more than a billion dollars and missing multiple milestones, including failure to achieve deployment within 5 years of obligating funds. The system was to provide the Air Force with a single, integrated logistics system that was to control and account for about $36 billion of inventory. We issued several reports on this system and found that among other things, the program was not fully following best practices for developing reliable schedules and cost estimates. We also reported that independent Air Force technical evaluations identified operational deficiencies that impaired the system’s efficiency and effectiveness in accounting for business transactions and reporting reliable financial information.

Accurate and complete cost information also is key to making effective and economical investment decisions. We reported that one- time implementation costs for Base Realignment and Closure (BRAC) 2005 grew from $21 billion originally estimated by the BRAC Commission in 2005 to about $35.1 billion, or by 67 percent, through fiscal year 2011, primarily because of higher-than-anticipated military construction costs. Military construction costs for the BRAC 2005 round increased from $13.2 billion based on original estimates by the BRAC Commission to $24.5 billion, an 86 percent increase, through fiscal year 2011, while over the same period, general inflation increased by 13.7 percent. In certain cases, DOD did not include some significant military construction requirements that were needed to implement the recommendations as envisioned, resulting in the identification of additional requirements and related cost increases after the recommendations were approved by the BRAC Commission. Consequently, the increase of $11.3 billion in military construction costs drove about 80 percent of the total cost increases of $14.1 billion for BRAC 2005. Further, because some additional requirements were driven by events after the BRAC Commission’s approval, the Congress had limited visibility into the potential costs of the original recommendations. Another reason we identified for the growth in implementation costs over DOD’s initial BRAC estimates was that DOD had difficulties accurately anticipating information technology requirements for many recommendations, leading to significantly understated information technology costs for some BRAC recommendations—particularly those that involved missions with considerable reliance on such capabilities. We made 10 recommendations for improving the BRAC process. DOD concurred with 3 of our recommendations, partially concurred with 2, and did not concur with 5 of them. In disagreeing with certain recommendations, DOD expressed concern that our recommendations precluded optimizing military value and stated that the current process was sufficient to address our concerns. We continue to believe that although DOD’s BRAC process was fundamentally sound, our recommendations did not preclude opportunities for improvements or the potential for cost savings.

Accountability over Use of Public Funds

We recently reported that our analysis of 333 reports related to DOD funds control issued in fiscal years 2007 through 2013 identified over 1,000 funds control weaknesses related to (1) training, supervision, and management oversight; (2) proper authorization, recording, documentation, and reporting of transactions; and (3) business system compliance with federal laws and accounting standards. We found that these weaknesses led DOD to make program and operational decisions based on unreliable data and impaired DOD’s ability to improve its financial management. Specifically, fundamental weaknesses in funds control significantly impaired DOD’s ability to (1) properly use resources, (2) produce reliable financial reports on the results of operations, and (3) meet its audit readiness goals as discussed in the following examples.

Continuing reports of violations of the Antideficiency Act (ADA) and other fiscal laws, such as the Purpose Statute, underscore DOD’s inability to assure that obligations and expenditures are properly recorded and do not exceed statutory levels of control. The ADA requires, among other things, that no officer or employee of DOD incur obligations or make expenditures in excess of the amounts made available by appropriation, by apportionment, or by further subdivision according to the agency’s funds control regulations. According to copies of ADA violation reports we reviewed, DOD reported 75 ADA violations from fiscal year 2007 through fiscal year 2012, totaling nearly $1.1 billion. We received reports of 2 additional ADA violations in 2013 totaling $148.6 million. However, we determined that the number of violations and dollar amounts reported may not be complete because of weaknesses in DOD’s funds control and monitoring processes that may not have allowed all violations to be identified or reported. For example, DOD IG reports issued in fiscal years 2007 through 2012 identified $5.5 billion in potential ADA violations that required further investigation to determine whether an ADA violation had, in fact, occurred, or if adjustments could be made to avoid a violation. Further, while DOD’s Financial Management Regulation (FMR) limits the time from identification to reporting of ADA violations to 15 months, our analysis identified several examples of time spans for investigations of potential ADA violations taking several additional months to several years before determinations of actual violations were reported. For example, as of September 30, 2013, three of the DOD IG-reported potential violations totaling $713.1 million could not be fully corrected and, consequently, resulted in $108.8 million in actual, reported ADA violations. To the extent that ADA violations are not identified, corrected, and reported, DOD management decisions are being made based on incomplete and unreliable data.

DOD has stated that its major financial decisions are based on budgetary data (e.g., the status of funds received, obligated, and expended). We have found that the department’s ability to improve its budgetary accounting has historically been hindered by its reliance on fundamentally flawed financial management systems and processes and transaction control weaknesses. In its November 2013 AFR, DOD self-reported 16 material weaknesses in financial reporting, noting that it has no assurance of the effectiveness of the related controls. These weaknesses affect reporting on budgetary transactions and balances, including budget authority, fund balance, outlays, and categories of transactions, such as civilian pay, military pay, and contract payments. As a result, we have concluded that DOD’s reports on budget execution and reports on the results of operations that could have a material effect on budget, spending, and other management decisions are unreliable.

For example, we found that DOD continues to make billions of dollars of unsupported, forced adjustments, or “plugs,” to reconcile its Fund Balance with Treasury (FBWT). In the federal government, an agency’s FBWT accounts are similar in concept to corporate bank accounts. The difference is that instead of a cash balance, FBWT represents unexpended budget authority in appropriation accounts. Similar to bank accounts, the funds in DOD’s appropriation accounts must be reduced or increased as the department spends money or receives collections that it is authorized to retain for its own use. For fiscal year 2012, DOD agencies reported making $9.2 billion in unsupported reconciling adjustments to agree their fund balances with the Department of the Treasury’s (Treasury) records. DOD’s unsupported reconciling adjustments to agree its fund balances to Treasury records grew to $9.6 billion in fiscal year 2013. We recommended that the Navy develop and implement standard operating procedures for performing FBWT reconciliations with Treasury records and that it provide training on the new procedures to personnel performing FBWT reconciliations. The Navy has actions under way to address our recommendations.

Further, we have reported that over the years, DOD has recorded billions of dollars of disbursement and collection transactions in suspense accounts because the proper appropriation accounts could not be identified and charged, generally because of coding errors. Accordingly, Treasury does not accept DOD reporting of suspense transactions, and suspense transactions are not included in DOD component FBWT reconciliations. We have concluded that it is important that DOD accurately and promptly charge transactions to appropriation accounts since these accounts provide the department with legal authority to incur and pay obligations for goods and services. We recommended that the Navy perform periodic testing of systems for reporting transactions to Treasury and prioritize and address identified deficiencies. The Navy agreed with our recommendations and has actions under way to address them. We are monitoring the Navy’s progress.

While DOD has actions under way to address its department-wide funds control weaknesses, several are not expected to be completed until 2017. Until fully resolved, these weaknesses will continue to adversely affect DOD’s ability to achieve its goals for financial accountability, including the ability to produce consistent, reliable, and sustainable financial information for day-to-day decision making. Sustained leadership commitment will be critical to achieving success. In commenting on our most recent report released this week, DOD stated that while our report recommended no new actions based on the numerous actions that DOD already has under way, the department’s commitment to building a stronger business environment via its people, processes, and systems remains paramount.

DOD’s Actions to Improve Financial Management and Achieve Audit Readiness, and Remaining Challenges

FIAR Plan Implementation

In 2005, the Under Secretary of Defense Comptroller/CFO (DOD Comptroller) established the FIAR Directorate, consisting of the FIAR Director and his staff, to develop, manage, and implement a strategic approach for addressing financial management deficiencies, achieving audit readiness, and integrating those efforts with other initiatives. In accordance with the NDAA for Fiscal Year 2010, DOD provides reports to relevant congressional committees on the status of DOD’s implementation of the FIAR Plan twice a year—no later than May 15 and November 15. In August 2009, the DOD Comptroller sought to focus FIAR efforts by giving priority to improving processes and controls that support the financial information most often used to manage the department. Accordingly, the DOD Comptroller revised the FIAR Plan strategy to focus on two priorities—budgetary information and asset accountability. The first priority was to strengthen processes, controls, and systems that produce DOD’s budgetary information. The second priority was to improve the accuracy and reliability of management information pertaining to the department’s mission-critical assets, including military equipment, real property, and general equipment. In May 2010, the DOD Comptroller first issued the FIAR Guidance, which provided the standard methodology for the components to implement the FIAR Plan. According to DOD, the components’ successful implementation of this methodology is essential to the department’s ability to achieve full financial statement auditability.

In October 2011, the Secretary of Defense directed the department to achieve audit readiness for its SBR for general fund accounts by the end of fiscal year 2014, and the NDAA for Fiscal Year 2012 required that the next FIAR Plan update include a plan to support this goal. Further, the NDAA for Fiscal Year 2013 made the 2014 target for SBR auditability an ongoing component of the FIAR Plan by amending the NDAA for Fiscal Year 2010 such that it now explicitly refers to describing the actions and costs associated with validating as audit ready both DOD’s SBR by the end of fiscal year 2014 and DOD’s complete set of financial statements by the end of fiscal year 2017.

In response to component difficulties in preparing for a full SBR audit, the November 2012 FIAR Plan Status Report and the March 2013 FIAR Guidance included a revision to narrow the scope of initial audits to only current-year budget activity and expenditures on a Schedule of Budgetary Activity. Under this approach, beginning in fiscal year 2015, reporting entities are to undergo an examination of their Schedules of Budgetary Activity reflecting the amount of SBR balances and associated activity related only to funding approved on or after October 1, 2014. As a result, the Schedules of Budgetary Activity will exclude unobligated and unexpended amounts carried over from prior years’ funding as well as information on the status and use of such funding in subsequent years (e.g., obligations incurred and outlays). These amounts will remain unaudited. Over the ensuing years, as the unaudited portion of SBR balances and activity related to this funding decline, the audited portion is expected to increase. However, the NDAA for Fiscal Year 2010, as amended by the NDAA for Fiscal Year 2013, requires that the FIAR Plan describe specific actions to be taken and the costs associated with ensuring that DOD’s SBR is validated as ready for audit by not later than September 30, 2014. We have reported that because the audit of the Schedule of Budgetary Activity is an incremental step building toward an audit-ready SBR, the FIAR Plan does not presently comply with this requirement. Furthermore, all material amounts reported on the SBR will need to be auditable in order to achieve the mandated goal of full financial statement audit readiness by September 30, 2017. It is not clear how this can be accomplished if activity related to funding provided prior to October 1, 2014, remains unaudited.

DOD defines an assessable unit as any part of the financial statements, such as a line item or a class of assets, a class of transactions, or a process or a system, that helps produce the financial statements. generally accepted accounting principles. We found that while DOD has made progress toward financial audit readiness, according to DOD’s November 2013 FIAR Plan Status Report, milestone dates for the Navy have slipped and SBR milestone dates for the Army and defense agencies have been compressed, making it questionable whether corrective actions for these DOD components will be completed by September 2014 for all assessable units. Further, the Air Force has revised its milestone dates for achieving SBR audit readiness to the third quarter of fiscal year 2015. With a reported $187.8 billion in fiscal year 2013 General Fund budgetary resources, the Air Force is material to DOD’s SBR, and if the Air Force cannot meet DOD’s September 2014 SBR audit readiness goal, DOD will not be able to meet its goal. This in turn raises substantial concerns about DOD’s ability to undergo an audit on a full set of financial statements for fiscal year 2018.

In addition, our recent reports have identified several major challenges to DOD’s ability to successfully implement the FIAR Plan and meet its audit readiness goals. The following discussion summarizes these challenges.

Process for identifying and mitigating risks to the FIAR effort. In August 2013, we reported that DOD’s FIAR effort would benefit from a risk management strategy to help program managers and stakeholders make decisions about assessing risk, allocating resources, and taking actions under conditions of uncertainty.six department-wide risks to the FIAR Plan’s implementation: (1) lack of DOD-wide commitment, (2) insufficient accountability, (3) poorly defined scope and requirements, (4) unqualified or inexperienced personnel, (5) insufficient funding, and (6) information systems control weaknesses. DOD officials stated that risks are discussed on an ongoing basis during various FIAR oversight committee meetings; however, the risks DOD initially identified were not comprehensive, and DOD provided no evidence of efforts to identify additional risks. Further, we found little evidence that DOD analyzed risks it identified to assess their magnitude or that DOD developed adequate plans for mitigating the risks. DOD’s risk mitigation plans, published in its FIAR Plan Status Reports, consisted of brief, high-level summaries that did not include critical management information, such as specific and detailed plans for implementation, In January 2012, DOD identified assignment of responsibility, milestones, or resource needs. In addition, information about DOD’s mitigation efforts was not sufficient for DOD to monitor the extent of progress in mitigating identified risks. We concluded that without effective risk management at the department-wide level to help ensure the success of the FIAR Plan implementation, DOD is at increased risk of not achieving its audit readiness goals. We recommended that the department design and implement department- level policies and detailed procedures for FIAR Plan risk management that incorporate the five guiding principles for effective risk management. DOD acknowledged that it does not have a risk management program that is specifically related to its FIAR effort and cited planned actions that if effectively and efficiently implemented, would address some aspects of the five guiding principles of risk management that are the basis for our recommendations. We are continuing to monitor DOD’s actions on our recommendation.

Component implementation of the FIAR Guidance. The FIAR Guidance provides a methodology for DOD components to use in developing and implementing their Financial Improvement Plans (FIP). The guidance details the roles and responsibilities of the DOD components, and prescribes a standard, systematic process for assessing processes, controls, and systems. DOD’s ability to achieve department-wide audit readiness greatly depends on its military components’ ability to effectively develop and implement FIPs in compliance with the FIAR Guidance. However, we have reported on concerns with the department’s efforts to implement this methodology. For example, our review of the Navy’s civilian pay and Air Force’s military equipment audit readiness efforts identified significant deficiencies in the components’ execution of the FIAR Guidance, resulting in insufficient testing and unsupported conclusions. We recommended that DOD take various actions to improve the development, implementation, documentation, and oversight of DOD’s financial management improvement efforts. DOD generally concurred with recommendations and noted actions being taken to implement them. We are continuing to monitor Navy and Air Force audit readiness actions.

In reviews of other DOD components, we also found internal control weaknesses in DOD’s procedures for maintaining accountability for billions of dollars in funds and other resources. For example, the Army and DFAS could not readily identify the full population of payroll accounts associated with the Army’s $46 billion active duty military payroll because of deficiencies in existing procedures and nonintegrated personnel and payroll systems. We recommended that the Army identify documents needed to support military payroll transactions affecting the pay of millions of active duty Army military personnel and that it develop and implement procedures for maintaining those documents. As a first step, the Army has developed a matrix of supporting documents for its military pay. However, the Army has not yet completed action to populate a central repository with these records.

Preliminary results from our ongoing work to assess the Army’s progress in implementing its FIP for budget execution to help guide its SBR readiness efforts indicate that the Army did not fully complete certain tasks in accordance with the FIAR Guidance to ensure that its FIP adequately considered the scope of efforts required for audit readiness. For example, the Army did not consider the risks associated with excluding prior year balances and current year activity associated with legacy systems and did not adequately identify significant SBR activity attributable to service-provider business processes and systems or obtain sufficient information to assess their audit readiness. These activities may continue to represent material portions of future SBRs, which if not auditable, will likely affect the Army’s ability to achieve audit readiness goals as planned. Our review of the Army’s monthly tests to assess the effectiveness of selected budget execution controls show that the Army identified extensive deficiencies, such as a lack of appropriate reviews or approvals, and had an average failure rate of 56 percent for control tests from June 2012 through May 2013, the period covered by our review. Further, the Army’s corrective actions were not linked to specific corrective action plans to address the causes of identified deficiencies. The deficiencies and gaps we have identified in our preliminary findings throughout various phases of the Army’s SBR audit readiness efforts demonstrate a focus on meeting scheduled milestone dates and asserting audit readiness instead of completing actions to resolve extensive control deficiencies.

Further, the military services rely heavily on DOD’s internal service providers to perform a variety of accounting, personnel, logistics, and system operations. For example, DFAS performs accounting and disbursement functions for the military services and defense agencies. The FIAR Guidance requires the service providers to have their control activities and supporting documentation examined by the DOD IG or an independent auditor in accordance with Statement on Standards for Attestation Engagements (SSAE) No.16 so that components have a basis for relying on the service provider’s data for their financial statement audits. In August 2013, we reported that DOD did not have an effective process for identifying audit-readiness risks, including risks associated with its reliance on service providers for much of its components’ financial data, and it needed better department-wide documentation retention policies. We identified two DOD component agencies—the Navy and the Defense Logistics Agency (DLA)—that had established practices consistent with risk management guiding principles. Because effective service-provider controls are critical to ensuring improvements in DOD funds control, we recommended that DOD consider and incorporate, as appropriate, Navy and DLA practices in department-level policies and procedures. DOD agreed with our recommendation and is taking actions to address it.

DOD has identified contract pay as a key element of its SBR. DFAS, the service provider responsible for disbursing nearly $200 billion annually in the department’s contract pay, has asserted that its processes, systems, and controls over contract pay are suitably designed and operating effectively to undergo an audit. Preliminary results from our ongoing assessment of DFAS’s implementation of its FIP for contract pay audit readiness indicate that DFAS has numerous deficiencies that have not yet been remediated. For example, DFAS did not adequately perform certain planning activities, such as assessing dollar activity and risk factors of its processes, systems, and controls, which resulted in the exclusion of three key processes from the FIP, such as the reconciliation of its contract pay data to components’ general ledgers. As a result, DFAS did not obtain sufficient assurance that the contract disbursements it processed were accurately recorded and maintained in the components’ general ledgers and that the status of DOD’s contract obligations was up- to-date. Although DFAS has asserted audit readiness for contract pay, until it corrects the weaknesses we identified, its ability to process, record, and maintain accurate and reliable contract pay transaction data is questionable. Therefore, our preliminary results indicate that DFAS does not have assurance that its FIP will satisfy the needs of DOD components or provide the expected benefits to department-wide efforts to assert audit readiness for contract pay as a key element of the SBR.

Modern Business Information Systems

In May 2014, we reported that DOD continued efforts to improve its business enterprise architecture (BEA)—a modernization blueprint—and transition plan and modernize its business systems and processes, consistent with key statutory provisions. However, we found that even though DOD has spent more than 10 years and at least $379 million on the architecture, DOD has not yet demonstrated that the BEA has produced business value for the department. For example, while DOD has established a tool that can assist in identifying potential duplication and overlap among business systems, the department has not demonstrated that it has used this information to reduce duplication and overlap. Accordingly, we recommended that the department develop guidance requiring military departments and other defense organizations to use existing BEA content to more proactively identify potential duplication and overlap. DOD agreed with our recommendation. Collectively, the limitations described in our May 2014 report put the billions of dollars spent annually on approximately 2,100 business system investments that support DOD functions at risk.

Further, DOD has identified several, multifunctional ERP systems as critical to its financial management improvement efforts. In a 2012 report on four of these ERPs, we found deficiencies in areas such as data quality, data conversion, system interfaces, and training that affect their capability to perform essential business functions. DFAS personnel also reported difficulty in using the systems to perform day-to-day activities. We recommended that DOD ensure that (1) any future system deficiencies identified through independent assessments are resolved or mitigated prior to further deployment of the systems, (2) timelines are established and monitored for those issues identified by DFAS that are affecting their efficient and effective use, and (3) training on actual job processes are provided in a manner that allows users to understand how the new processes support their job responsibilities and the work they are expected to perform.recommendation, stating that based on the nature of an identified system deficiency, it will determine whether to defer system implementation until it is corrected. DOD agreed with our recommendations to establish and monitor timelines and provide training on user roles and responsibilities. We are continuing to monitor DOD’s actions.

DOD partially concurred with our first If these business systems do not provide the intended capabilities on schedule, DOD’s goal of establishing effective financial management operations and becoming audit ready could be jeopardized. We recently reported that the Air Force did not meet best practices in developing a schedule for the Defense Enterprise Accounting and Management System (DEAMS) program. We believe that this raises questions about the credibility of the deadline for acquiring and implementing DEAMS to provide needed functionality for financial improvement and audit readiness. We recommended that the Air Force update the cost estimate as necessary after implementing our prior recommendation to adopt scheduling best practices. DOD concurred with our recommendation.

Competent Financial Management Workforce

A key principle for effective workforce planning is that an agency needs to define the critical skills and competencies that it will require in the future to meet its strategic program goals. Once an agency has identified critical skills and competencies, it can develop strategies to address gaps in the number of personnel, needed skills and competencies, and deployment of the workforce.

In April 2014, we reported that DOD is addressing financial management workforce competencies and training through complementary efforts by (1) the Office of the Under Secretary of Defense for Personnel and Readiness (Personnel and Readiness) to develop a strategic civilian workforce plan that includes financial management, pursuant to requirements in the NDAA for Fiscal Year 2010, as amended, and (2) the DOD Comptroller to develop and implement a Financial Management Certification Program, pursuant to requirements in the NDAA for Fiscal Year 2012. Financial management personnel are expected to possess the competencies that are relevant to and needed for their assigned positions. These competencies include fundamentals of accounting, accounting analysis, budget execution, financial reporting, and audit planning and management, among others. Personnel and Readiness is currently working on a competency assessment tool that will be used by the department, including the financial management functional community. The tool is to capture information related to competencies, such as proficiency level, importance, and criticality, and to identify any gaps in support of the Comptroller’s Financial Management Certification Program. Phased implementation of the program began in June 2013, and the current target date for full implementation is the end of fiscal year 2014. The certification program is to be mandatory for DOD’s approximately 54,000 civilian and military financial management personnel and may take up to 2 years to complete, depending on the extent to which an individual’s prior course work and level of experience to meet the new certification requirements. In April 14, 2014, the Deputy CFO stated that the newly implemented Financial Management Certification Program has already enrolled 22,300 financial managers and certified over 30.

Without a competent workforce and effective implementation of financial management processes, systems, and controls, DOD and its components are at risk that DOD’s other financial management reform activities will not be successful, resulting in incomplete and unreliable data for decision making. To the extent that these challenges are not addressed, DOD financial management will continue to be at high risk for waste, fraud, abuse, and mismanagement.

In conclusion, while DOD has several financial management improvement efforts under way and is monitoring progress against milestones, as the dates for validating audit readiness approach, DOD has emphasized asserting audit readiness by a certain date over making sure that effective processes, systems, and controls are in place to ensure that its components have improved financial management information for day-to- day decision making. However, several significant factors—including DOD component milestone slippages in meeting audit readiness dates; continuing, uncorrected DOD-wide financial management weaknesses; and inadequate risk management efforts—make it increasingly unlikely that DOD’s SBR will be audit ready by September 2014. While establishing and working toward milestones are important to measure progress, DOD should not lose sight of the ultimate goal of implementing lasting financial management reform to ensure that it has the systems, processes, and personnel to routinely generate reliable financial management and other information critical to decision making and effective operations for achieving its missions. Overcoming DOD’s long- standing financial management challenges will require strong commitment and top leadership support.

Chairman Carper, Ranking Member Coburn, and Members of the Committee, this completes my prepared statement. I would be pleased to respond to any questions that you may have at this time.

GAO Contacts and Staff Acknowledgments

If you or your staff have any questions about this testimony, please contact me at (202) 512-9869 or khana@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this testimony. GAO staff members who made key contributions to this testimony include Gayle L. Fischer (Assistant Director), Gregory Marchand (Assistant General Counsel), Arkelga Braxton, Michael Bingham, Francine DelVecchio, Jason Kirwan, Susan Mata, Sheila D. M. Miller, Roger Stoltz, and Heather Rasmussen.

Related GAO Products

Defense Business Systems: Further Refinements Needed to Guide the Investment Management Process. GAO-14-486. Washington, D.C.: May 12, 2014.

DOD Financial Management: Actions Under Way Need to Be Successfully Completed to Address Long-standing Funds Control Weaknesses. GAO-14-94. Washington, D.C.: April 29, 2014.

Defense Logistics: Army Should Track Financial Benefits Realized from its Logistics Modernization Program. GAO-14-51. Washington, D.C.: November 13, 2013.

DOD Financial Management: Ineffective Risk Management Could Impair Progress toward Audit-Ready Financial Statements. GAO-13-123. Washington, D.C.: August 2, 2013.

Information Technology: OMB and Agencies Need to More Effectively Implement Major Initiatives to Save Billions of Dollars. GAO-13-796T. Washington, D.C.: July 25, 2013.

Army Industrial Operations: Budgeting and Management of Carryover Could Be Improved. GAO-13-499. Washington, D.C.: June 27, 2013.

DOD Financial Management: Significant Improvements Needed in Efforts to Address Improper Payment Requirements. GAO-13-227. Washington, D.C.: May 13, 2013.

Major Automated Information Systems: Selected Defense Programs Need to Implement Key Acquisition Practices. GAO-13-311. Washington, D.C.: March 28, 2013.

Military Bases: Opportunities Exist to Improve Future Base Realignment and Closure Rounds. GAO-13-149. Washington, D.C.: March 7, 2013.

Defense Logistics: A Completed Comprehensive Strategy is Needed to Guide DOD’s In-Transit Visibility Efforts. GAO-13-201. Washington, D.C.: February 28, 2013.

High-Risk Series: An Update. GAO-13-283. Washington, D.C.: February 2013.

Defense Logistics: DOD Has Taken Actions to Improve Some Segments of the Materiel Distribution System. GAO-12-883R. Washington, D.C.: August 3, 2012.

Military Base Realignments and Closures: Updated Costs and Savings Estimates from BRAC 2005. GAO-12-709R. Washington, D.C.: June 29, 2012.

Defense Inventory: Actions Underway to Implement Improvement Plan, but Steps Needed to Enhance Efforts. GAO-12-493. Washington, D.C.: May 3, 2012.

Defense Logistics: Improvements Needed to Enhance DOD’s Management and Approach and Implementation of Item Unique Identification Technology. GAO-12-482. Washington, D.C.: May 3, 2012.

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