DOD Financial Management: The Defense Finance and Accounting Service Needs to Fully Implement Financial Improvements for Contract Pay
Released: 2014-06-23T00:00:00

Letter

Background

DOD established the FIAR Plan as its strategic plan and management tool for guiding, monitoring, and reporting on the department’s ongoing financial management improvement efforts and for communicating the department’s approach to addressing its financial management weaknesses and achieving financial statement audit readiness. To implement the FIAR Plan, the DOD Comptroller issued the FIAR Guidance, which defines DOD’s strategy, goals, roles, and responsibilities and the procedures that the components need to perform to improve financial management and achieve audit readiness. DOD components are expected to prepare a FIP in accordance with the FIAR Guidance for each of their assessable units. The FIPs are intended to both guide and document financial improvement efforts. While the name FIP indicates that it is a plan, as a component implements that plan, it must document the steps performed and the results of those steps, and retain that documentation within the FIP. When a component determines that it has completed sufficient financial improvement efforts for an assessable unit to undergo an audit, it asserts audit readiness for the related assessable unit and submits the FIP documentation to the FIAR Directorate to support the conclusion of audit readiness. The FIAR Directorate is responsible for reviewing and validating the supporting documentation within the FIP to determine whether the component is audit ready.

FIAR Guidance Service Provider Methodology

DOD’s service providers are responsible for a variety of accounting, personnel, logistics, and system development or operations services to support DOD components. Recognizing that the effectiveness of the service providers’ controls affects the auditability of the amounts reported on the components’ financial statements, DOD’s FIAR Guidance outlines the steps service providers are to perform to achieve audit readiness. Specifically, the FIAR Guidance requires service providers to work with the components to execute audit readiness activities on their systems, data, processes, internal controls, and supporting documentation that have a direct effect on the components’ audit readiness state. To support the component audit readiness efforts, a service provider is required to take either of the following steps:

Develop and implement a FIP to improve its processes, systems, and controls so that it can successfully undergo a Statement on Standards for Attestation Engagements (SSAE) No. 16 examination. Specifically, the FIAR Guidance requires the service provider to implement a FIP if three or more components will rely on its processes and systems for their audit readiness assertions, and if the service provider will be able to assert audit readiness prior to the components’ targeted dates for asserting audit readiness.

Directly participate in and support the component’s financial statement audit where the service provider’s processes, systems, internal controls, and supporting documentation are audited as part of the components’ financial statement audits.

The FIAR Guidance service provider methodology requires the FIP to include the following five phases: Discovery, Corrective Action, Assertion/Evaluation, Validation, and SSAE No. 16 Examination. Table 1 provides a list of steps for each of the phases and the required deliverables.

As presented in table 1, the service provider documents, evaluates, and tests its processes, systems, and controls during the Discovery Phase of its FIP, and designs and implements the necessary corrective action plans as part of the Corrective Action Phase. The deliverables from the service provider are then reviewed by the FIAR Directorate during the Assertion/Evaluation Phase. Based on its review of the deliverables, the FIAR Directorate determines whether the service provider is audit ready and, if so, authorizes the service provider to engage an auditor to perform an SSAE No. 16 examination. If the FIAR Directorate determines that the service provider is not audit ready, the FIAR Directorate provides feedback, which the service provider has to address before resubmitting the required deliverables for review. After the auditor completes the SSAE No. 16 examination and issues the report, the service provider submits a copy of the SSAE No. 16 examination report to the FIAR Directorate and evidence that it has implemented corrective actions to remediate the deficiencies identified by the auditor, if any. As part of the Validation Phase, the FIAR Directorate reviews the SSAE No. 16 report and supporting documentation of the implemented additional corrective actions to determine if the service provider is ready for a second SSAE No. 16 examination and, if so, authorizes the service provider to engage an auditor to perform a second SSAE No. 16 examination. If the service provider receives an unqualified opinion on the first SSAE No. 16 examination, the FIAR Directorate will not require the service provider to undergo a second audit as part of the SSAE No. 16 Examination Phase. Figure 1 illustrates a summary of the process in the FIAR Guidance related to the submission, review, and approval of the service providers’ documentation for audit readiness.

DFAS’s Contract Pay End- to-End Business Process

DFAS is the service provider responsible for processing, accounting, and reporting contract pay for DOD components. Figure 2 illustrates the relevant systems and end-to-end process, which includes contract input, invoice entitlements, pre-validation, disbursing, Treasury reporting, accounting and reconciliation, and contract closeout and reconciliation processes. 1. Contract input: The components electronically transmit contract award data and related document images through their contract writing systems into the Mechanization of Contract Administration Services (MOCAS) system. DFAS reported that some contract awards are issued with manually produced documents, which the components mail or fax to DFAS for input into MOCAS. DFAS’s Contract Input Branch personnel validate the contract data before inputting them into MOCAS. 2. Invoice entitlements: Contractors electronically transmit invoices to DFAS for payment processing in MOCAS; however, if these invoices do not pass a series of automatic validation edits in MOCAS, they are rejected by the system. DFAS’s Entitlement branch personnel process these transactions utilizing its Entitlement Automation System (EAS). MOCAS perform edits to validate the invoices in MOCAS or EAS and compare the contract obligations, invoices, and receiving reports. DFAS’s entitlement branch personnel also utilize the Business Activity Monitoring (BAM) tool during the entitlement process to monitor and validate the contractors’ invoices. The BAM tool is a monitoring capability that DFAS uses to identify potential erroneous or improper payments. 3. Pre-validation: The Elimination of Unmatched Disbursements (EUD) system transmits invoice data to the components’ accounting systems. The components review the invoice data transmitted by EUD and approve the invoices for payment. 4. Disbursing: Once the components approve the invoices for payment, the components notify DFAS disbursing operations personnel who input the approval status into MOCAS. MOCAS processes the approved invoices to be paid either by check or electronic funds transfer (EFT). MOCAS generates a disbursement file that identifies all invoices to be paid. A certifying official reviews the disbursement file for accuracy prior to payment being made. After approval by the certifying official, DFAS’s Disbursing Operations personnel either mail the checks to contractors or transmit the EFT file to the Federal Reserve Bank to make the payment. 5. Treasury reporting: Once the disbursements are processed, MOCAS interfaces with the Defense Cash Accountability System (DCAS), which is the system used by DFAS to generate and submit monthly reports on contract pay disbursements to the Department of the Treasury (Treasury). 6. Accounting and reconciliation: DFAS’s Contract Branch personnel generate a disbursement file from MOCAS that is provided to the components to record the contract disbursements into their general ledgers. DFAS is also responsible for the reconciliation of the disbursements transactions in MOCAS to the components’ general ledgers; however, DFAS has yet to implement this process. 7. Contract closeout and reconciliation: DFAS’s Contract Branch personnel assist the components during the contract closeout and reconciliation processes, for example, with paying final vouchers and, when needed, resolving unreconciled balances on a contract. DFAS officials explained that they utilize the Standard Contract Reconciliation Tool (SCRT) to investigate differences in contract payment data between MOCAS and the components’ general ledgers upon request from the components and to process the necessary adjustments. Most of these requests are submitted to DFAS from the components during the contract closeout procedures.

DFAS Did Not Fully Implement Its Contract Pay FIP in Compliance with the FIAR Guidance

DFAS recognized the importance of implementing a FIP to improve its contract pay processes, systems, and controls, and performed steps required by the FIAR Guidance, such as performing internal control, information technology (IT), and substantive testing. However, we found that DFAS did not fully comply with the requirements in the FIAR Guidance to improve its contract pay processes, systems, and controls. For example, our review found that DFAS did not perform adequate planning and testing activities for the Discovery Phase of its FIP. In addition, DFAS did not provide adequate documentation for several corrective action plans to support that it has remediated identified control deficiencies. DFAS asserted in October 2013 that its contract pay controls were suitably designed and operating effectively to undergo an audit, and awarded a contract to an independent public accounting firm prior to fully remediating the deficiencies it identified during the implementation of its contract pay FIP. Without fully implementing the financial improvement steps required in the FIAR Guidance, DFAS does not have assurance that its processes, systems, and controls can produce and maintain accurate, complete, and timely financial management information for contract pay. Further, the deficiencies noted will affect the components’ ability to rely on DFAS’s controls over contract pay, ultimately increasing the risk that DOD’s goal for an auditable SBR will not be achieved in its planned time frame. Figure 3 provides a summary of the results of our review of DFAS’s contract pay FIP.

Discovery Phase: DFAS Did Not Adequately Complete Required Key Tasks

DFAS developed flowcharts and narratives and performed internal control, substantive, and IT testing. Based on the testing performed during the Discovery Phase, DFAS identified a total of 399 deficiencies. Specifically, DFAS identified 20 internal control deficiencies and 379 IT control deficiencies—20 related to general controls and 359 related to application controls. However, we found that DFAS did not (1) adequately perform the required planning activities for its contract pay FIP, such as assessing the materiality of its processes and systems; (2) adequately perform the required testing; and (3) properly classify the identified deficiencies. As a result, additional deficiencies may exist that could negatively affect DFAS processes, systems, and controls that are relied upon by DOD components.

DFAS’s Overall Planning Activities

DFAS developed a high-level end-to-end flowchart for contract pay that identified seven key processes and prepared detailed flowcharts and narratives for four of these seven key processes. However, DFAS did not perform all activities required by the FIAR Guidance. Specifically, based on our review of the contract pay FIP, DFAS did not: prepare a memorandum of understanding for each of the DOD components that documented roles and responsibilities for transactions, supporting documentation retention, and audit readiness activities; prepare detailed flowcharts and narratives for three of the seven key processes: (1) reporting of disbursements to Treasury, (2) accounting and reconciliation of contract pay disbursements to the components’ general ledgers, and (3) contract closeout; and assess the materiality of its processes and systems based on dollar activity and risk factors.

DFAS officials stated that they coordinated with the DOD components to develop the contract pay FIP; however, DFAS did not maintain meeting minutes and was unable to provide documentation to support the components’ input or concurrence with the decisions made. DFAS is developing a Concept of Operations (CONOPS) to supplement existing mission work agreements that it has established with each component to comply with the requirements in the FIAR Guidance for the service providers to develop a memorandum of understanding. However, DFAS has not established a time frame for when the CONOPS will be completed. In addition, our review of the draft CONOPS and existing mission work agreements showed that they do not address all the requirements reflected in the FIAR Guidance. For example, these documents do not: identify the roles and responsibilities for authorizing, initiating, processing, recording, and reporting of transactions; identify the roles and responsibilities for the creation, completion, and retention of supporting documentation; and identify the supporting documentation that should be retained for each business process and transaction type.

DFAS officials stated that they did not assess materiality and risk level for determining what processes, systems, and controls needed to be included in DFAS’s contract pay FIP because their approach consisted of including in the FIP the processes and systems that were common to at least three or more components. By applying this approach, they determined that the three processes that were excluded were used by two or fewer components. For example, each client has a different general ledger system; therefore, DFAS did not consider the general ledger reconciliation process to be a common service. However, this approach did not comply with the requirements in the FIAR Guidance, which requires service providers to determine the processes to be covered in the FIP based on whether the process is critical to the audit readiness efforts as defined by both materiality and risk. As a result, and as shown in figure 4, DFAS excluded from the FIP three of its key contract pay processes: (1) reporting of disbursements to Treasury, (2) accounting and reconciliation of contract pay disbursements to the components’ general ledgers, and (3) contract closeout.

These processes excluded by DFAS from its FIP are intended to help ensure that the contract disbursements processed by DFAS are accurately recorded and maintained in the components’ general ledgers and that the status of DOD’s contract obligations is accurate and up-to- date. At the time of the implementation of its contract pay FIP, DFAS had not established a general ledger reconciliation process. DOD’s Financial Management Regulation (FMR) requires DFAS to reconcile disbursements transactions to the components’ general ledger, and the FIAR Guidance notes that the DOD components will not be able to successfully pass an audit without transaction-level reconciliation to the general ledger. Standards for Internal Control in the Federal Government states that control activities such as reconciliations are an integral part of an entity’s planning, implementing, reviewing, and accountability for stewardship of government resources and achieving effective results. DFAS officials explained that DFAS is evaluating the three processes excluded from its contract pay FIP for each of the components to support their audit readiness efforts and that they will provide the results of these efforts to the affected components before the components assert audit readiness for contract pay. Specifically, these officials indicated that they have established a general ledger reconciliation process and plan to evaluate it and the other two processes (i.e., the reporting of disbursements to Treasury and contract closeout processes) in support of the Departments of the Navy, Air Force, and Army with a completion date of June 2014. However, DFAS did not provide sufficient documentation for us to assess the scope and methodology of these efforts or to confirm the completion status.

Without an adequately scoped and planned FIP, DFAS will not be able to ensure that it is covering all key processes that will materially affect the timeliness, accuracy, and reliability of its contract pay transaction data. As a result, even though DFAS has already asserted audit readiness, DFAS does not have assurance that its FIP will satisfy the needs of the components or provide the expected benefits to the department-wide efforts to assert audit readiness for contract pay as a key element of the SBR.

DFAS Internal Control and Substantive Testing

DFAS performed both internal control and substantive testing; however, DFAS did not validate the populations of transactions used to perform the testing. Therefore, DFAS’s test results cannot be generalized to support the assertion that its controls, and its transaction activities and balances, are audit ready. The FIAR Guidance requires service providers to validate the population of transactions to be tested prior to performing internal control and substantive testing by reconciling the population to the general ledger and assessing it for invalid transactions, abnormal balances, and missing data fields. As noted earlier, at the time of the implementation of its contract pay FIP, DFAS had not established a general ledger reconciliation process.

In response to our inquiries, DFAS officials stated that they had validated the populations and provided to us a copy of a data reliability assessment. According to the FIAR Guidance, a data reliability assessment is intended to document a comparison of the transaction data to the components’ general ledgers and data mining performed to identify any outliers. However, the data reliability assessment provided by DFAS did not contain such a comparison or address data mining activities. Instead, the data reliability assessment provided background information on the Shared Data Warehouse (SDW), which is the database used by DFAS to generate the samples of transactions tested. SDW was developed by DFAS as a tool to generate reports for the disbursements recorded in MOCAS because MOCAS has limited query capabilities. As a result, SDW is used by DFAS to store contract administration and payment data collected from MOCAS, conduct queries, and produce reports. Because SDW is a database that stores data from MOCAS, this comparison is not an adequate reconciliation and, in essence, represents a comparison of the transactions recorded in MOCAS to MOCAS itself. An effective reconciliation process would involve comparing transactions to supporting documentation, systems of record, or both to ensure the completeness, validity, and accuracy of financial information. Even if DFAS had performed an adequate reconciliation process, according to the data reliability assessment that DFAS provided, the population of transactions validated by DFAS only covered the disbursements for 1 day, not the population of data for the entire fiscal year that was used by DFAS to select the samples that were tested.

DFAS did not identify any deficiencies related to its substantive testing of the contract disbursements recorded in MOCAS and identified 20 deficiencies related to its internal control testing. However, because DFAS did not validate the population used to perform internal control and substantive testing, additional deficiencies may exist in DFAS’s contract pay controls and errors may exist in the recorded transactions activity and balances.

DFAS Testing of Information Technology Controls

We found that DFAS did not perform sufficient general and application controls testing. Further, DFAS did not develop an audit plan or strategy for its application-level testing. As a result, DFAS did not have support for the scope of its application-level testing, such as its rationale for excluding a significant number of the controls from the testing of several of the systems DFAS classified as key for contract pay, even though the FIAR Guidance requires consideration of such controls. For the controls it did test, DFAS found numerous deficiencies that needed to be addressed. Specifically, DFAS found issues with 20 entity-level general controls and 359 application-level controls.

General controls: DFAS tested 122 of the 261 entity-level general controls identified in the FIAR Guidance; however, it did not determine whether the remaining 139 controls were relevant and should have been tested. DFAS officials told us that they decided to focus the entity-level testing on the 122 controls identified by the FIAR Guidance as having the highest relevance for a financial statement audit because of resource constraints. Based on the entity-level controls that were tested, DFAS identified 20 general control deficiencies at the entity level that were related to either the design or operation of controls, such as inappropriate segregation of duties and inadequate monitoring of system access privileges. However, because of the limited testing performed, additional deficiencies may exist that were not identified.

DFAS officials acknowledged that they needed to assess the other 139 entity-level controls and planned to perform such an assessment during fiscal year 2014. However, as stated previously, DFAS asserted in October 2013 that its contract pay process was audit ready and did so without having assessed these 139 entity-level controls. Without effective entity-level general controls, application-level controls may be rendered ineffective by circumvention or modification. As a result, these deficiencies can materially affect the effectiveness of DFAS application- level controls. For example, edits designed to preclude users from entering unreasonably large dollar amounts in a payment processing system can be an effective application control. However, this control cannot be relied on if the general controls permit unauthorized program modifications that might allow some payments to be exempt from the edit.

Application-level controls: DFAS performed application-level testing for the six system applications it determined to be key to its contract pay systems. However, DFAS did not develop audit plans or strategies to guide its application-level control testing for all six systems and did not perform sufficient testing for three of its systems—BAM, SCRT, and EUD- Accounting Pre-validation Module (APVM). The FIAR Guidance requires service providers to follow the Federal Information System Controls Audit Manual (FISCAM) to test the IT controls of the systems and applications that are necessary to achieve audit readiness. FISCAM requires a written audit program or strategy that describes the objective, scope, and methodology for the testing of IT controls. Entities are required to use the information documented in the audit plan or strategy to determine the nature, timing, and extent of the IT test procedures. DFAS officials explained that they did not document a plan or strategy for application- level controls because they were performing self-assessments and not audits. They also stated that some of their staff members did not know how to perform a FISCAM audit and that this was a learning experience. However, the FIAR Guidance requires DOD components to follow a process similar to an audit to obtain sufficient evidence that the organization is audit ready. DFAS officials stated that they recognized that the assessments could be improved, but noted that the FIAR Directorate had validated the results of its application-level testing.

In addition, DFAS did not perform sufficient application-level testing for BAM, SCRT, and EUD-APVM. Out of the 163 controls required by the FIAR Guidance to be considered for each system, DFAS tested 40 controls for EUD-APVM, 32 for BAM, and 9 for SCRT. DFAS provided us a document to support how it selected the key controls that were tested for these systems and its reasoning for excluding from the testing most of the controls that are required by the FIAR Guidance. However, this document did not adequately support DFAS’s scope and methodology for testing these systems. For example, the document stated that either limited or no testing was performed of certain control areas, such as the application-level general controls for Security Management and Contingency Planning, because those controls were tested at the entity or system level; however, DFAS’s review of entity-level controls did not cover any application-related controls. Further, as stated earlier, DFAS did not perform sufficient testing of its entity-level controls. Although the Defense Information Systems Agency (DISA)—which is responsible for the mainframe platforms where DFAS’s contract pay systems are executed and maintained—received an unqualified opinion on its SSAE No. 16 examination, this examination did not cover DFAS’s application- level controls. DISA’s SSAE No. 16 report also recognized the need for its user entities to implement complementary controls in different areas, including backup and recovery management. As a result, the application- level testing performed by DFAS for BAM, SCRT, and EUD-APVM was not sufficient and did not comply with the FIAR Guidance.

Based on its limited testing of application-level controls, DFAS identified a total of 359 deficiencies. For example, DFAS found deficiencies in its access controls, such as a lack of processes to ensure that users’ system access is authorized and limited to job responsibilities. DFAS also found a lack of adequate policies and procedures to ensure proper segregation of duties and related monitoring processes. Because DFAS did not use a documented plan or strategy, and did not have adequate evidence on whether its application-level control testing was adequately designed, it did not obtain the necessary assurance that its contract pay data are valid, complete, and accurate. This increases the risk that additional deficiencies exist that were not identified during the application-level testing, which in turn hinders DFAS’s ability to remediate existing deficiencies thus adversely affecting audit readiness.

DFAS Classification of Identified Deficiencies and Coordination with the Components

DFAS did not coordinate and work with the components to assess the impact of the identified deficiencies on the components’ audit readiness efforts and classify the deficiencies as control deficiencies, significant deficiencies, or material weaknesses as required by the FIAR Guidance. DFAS officials explained that they classified the identified deficiencies into high-, medium-, or low-risk categories based on their assessment of the risk to DFAS not being able to achieve its control objectives. These officials indicated that they did not follow the FIAR Guidance for risk classification because SSAE No. 16 states that the service provider will not be able to determine the impact of the identified deficiencies on the components’ financial statements. DFAS officials also stated that in order for them to classify the deficiencies as control deficiencies, significant deficiencies, or material weaknesses as required by the FIAR Guidance, they would need to obtain information from the components regarding their processes and controls affected by the identified deficiencies.

The FIAR Guidance recognizes that this coordination is needed to determine the effect of the identified deficiencies on the components’ financial statements, which is the intent of DOD’s overall FIAR effort. Further, the FIAR Guidance states that because of the complexities inherent in DOD component and service provider relationships and associated audit readiness interdependencies, it is essential that such coordination is documented in a memorandum of understanding. While an SSAE No. 16 examination is intended to provide assurance regarding the control environment of the service providers, the FIAR effort is intended, among other things, to provide assurance that the components are ready for a financial statement audit. To do this, the components must be aware of the impact of the deficiencies in the service provider’s control environment so that they can assess their risks and identify and implement compensating controls if needed. Because DFAS did not adequately classify the identified deficiencies and assess their related impact to the components, DOD components will not be able to obtain a complete understanding of the impact of the deficiencies identified by DFAS on their own control environments and design and implement compensating controls to mitigate the effect of DFAS’s control deficiencies on their financial operations.

Corrective Action Phase: DFAS Did Not Adequately Complete Required Key Tasks

DFAS notified the FIAR Directorate that it had implemented the necessary corrective action plans and developed an audit readiness strategy; however, we found that DFAS did not (1) take the necessary corrective actions or maintain sufficient documentation for 18 of 25 deficiencies DFAS reported as remediated that we reviewed and (2) properly update the Corrective Action Phase section of its FIP status report. DFAS’s audit strategy consisted of its contract pay FIP undergoing an SSAE No. 16 examination and, as stated earlier, DFAS evaluating the three processes excluded from its contract pay FIP for each of the components to support their audit readiness efforts. However, DFAS did not provide documentation (an updated CONOPS or memorandum of understanding) to show that it had coordinated with the components to determine how it would support their audit readiness efforts for those processes excluded from the FIP as required by the FIAR Guidance. Further, additional deficiencies may exist in DFAS’s contract pay processes and systems that were not considered during the Corrective Action Phase because, as discussed previously, DFAS did not (1) validate the population used to perform internal control and substantive testing and (2) perform sufficient general control and application-level testing. As a result of these deficiencies, DFAS’s contract pay FIP did not provide sufficient assurance that all the deficiencies that may materially affect the accuracy and reliability of its contract pay transaction data had been fully remediated. The FIAR Directorate reviewed the DFAS’s supporting documentation for its contract pay FIP and authorized DFAS to undergo an SSAE No. 16 examination.

DFAS Corrective Action Plans

DFAS reported that it had developed and implemented corrective actions to remediate 393 of the 399 deficiencies it identified as part of the Discovery Phase. DFAS officials stated that for the 6 deficiencies that were not remediated as part of the contract pay FIP, DFAS will either address the deficiencies subsequent to its audit readiness assertion or rely on other components to address these deficiencies. The FIAR Guidance requires service providers to remediate each identified deficiency before asserting that they are audit ready. In addition, 2 of these 6 deficiencies were determined by the FIAR Directorate to be material. However, DFAS did not provide evidence that these deficiencies were remediated before asserting audit readiness for contract pay.

We selected a nongeneralizable sample of 25 control deficiencies DFAS reported as remediated to determine whether DFAS had adequately implemented corrective actions to remediate the identified deficiencies. Of these 25 deficiencies, we found that DFAS had adequately developed and implemented the necessary corrective action plans for 7. We found the following for the remaining 18 deficiencies:

For 3 deficiencies, DFAS did not develop corrective action plans. For example, DFAS reported 1 of these deficiencies as closed because it planned to rely on the Defense Contract Management Agency (DCMA) to remediate the identified weaknesses. Although DFAS provided documentation of DCMA’s agreement to address this deficiency, DFAS did not provide documentation to support that this deficiency had been remediated by DCMA. In addition, DFAS reported as closed 2 deficiencies related to the reconciliation of its contract pay activity with the components’ general ledger because, as stated earlier, it decided not to address this reconciliation as part of its contract pay FIP. DOD’s FMR and the FIAR Guidance require DFAS to reconcile disbursement transactions to the components’ general ledgers, and the FIAR Guidance notes the DOD components will not be able to successfully pass an audit without transaction-level reconciliation to their general ledgers. Standards for Internal Control in the Federal Government states that control activities such as reconciliations are an integral part of an entity’s planning, implementing, reviewing, and accountability for stewardship of government resources and achieving effective results.

For eight deficiencies, the corrective action plans developed by DFAS were not adequate. Corrective action plans should include, among other things, the responsible point of contact, the root causes of the deficiency, and resource needs. However, these corrective action plans did not adequately describe the root causes of the identified deficiencies that needed to be corrected. For example, half of these corrective action plans only described the control requirements from FISCAM but did not describe the underlying root cause of the deficiencies identified by DFAS. As a result, these corrective action plans do not provide sufficient information to perform an independent review to determine whether an implemented corrective action remediated the identified deficiency.

For the remaining 7 deficiencies, DFAS did not provide adequate documentation to support that the corrective action plans were adequately implemented. For example, DFAS provided us a copy of a documented procedure as support for the implementation of one of its corrective action plans; however, the documented procedure provided by DFAS was not relevant to the identified deficiency. In addition, DFAS did not provide support that a corrective action had been tested and had successfully remediated the deficiency, and for another deficiency the test results showed that it had not been successfully remediated by the implemented corrective action. Further, the corrective action plan for another deficiency noted that it would not be fully remediated until February 2014, which was 4 months after DFAS asserted audit readiness.

DFAS stated that the actions taken to address these 18 deficiencies were appropriate. However, we found that in 3 of the 18 instances, corrective actions had not been taken as required by the FIAR Guidance and that the documentation provided by DFAS for the other 15 deficiencies was insufficient. Without implementing adequate corrective action plans, DFAS lacks sufficient assurance that these identified control deficiencies were remediated, which will negatively affect the accuracy and reliability of its contract pay transaction data.

DFAS’s FIP Status Report

DFAS submitted its monthly FIP status report for the department to monitor its progress in meeting interim and long-term goals. However, we found that DFAS’s status reports were not accurate and complete. For example, although DFAS has reported since November 2012 on its FIP status report that its Corrective Action Phase was completed in August 2012, DFAS did not assert its Corrective Action Phase as complete until October 2013. Further, DFAS did not include in the status report the information required by the FIAR Guidance for the Corrective Action Phase, such as the identified weaknesses by classification (e.g., material weaknesses), and respective corrective actions with targeted completion dates.

DFAS officials explained that they did not update the contract pay FIP status report to include the information required by the FIAR Guidance for the Corrective Action Phase because of limitations in the software used to maintain the FIP. They explained that the software does not allow them to make significant updates to the FIP and they would have to develop a work-around to update the FIP, such as creating a new project in the software with the required updates. However, this information is key for DOD’s oversight of the components’ audit readiness efforts, as it is used by DOD’s key stakeholders and governing bodies for financial improvement and audit readiness to oversee the FIAR effort and is reported publicly on a biannual basis. Further, because the status information reported by DFAS is inaccurate and incomplete, it could misinform stakeholders as to the status of DFAS’s audit readiness efforts and negatively affect the adequacy and effectiveness of the components’ audit readiness plans for contract pay.

DFAS Strategy for Supporting Components’ Audit Readiness Efforts

DFAS notified the FIAR Directorate that it had implemented the necessary corrective action plans and developed an audit readiness strategy. The FIAR Directorate reviewed the DFAS’s supporting documentation for its contract pay FIP and authorized DFAS to undergo an SSAE No. 16 examination. DFAS’s audit strategy consisted of undergoing an SSAE No. 16 examination for its contract pay FIP and, as stated earlier, evaluating the three processes excluded from its contract pay FIP for each of the components to support their audit readiness efforts. However, DFAS did not provide documentation (an updated CONOPS or memorandum of understanding) to show that it had coordinated with the components to determine how it would support their audit readiness efforts for those processes excluded from the FIP as required by the FIAR Guidance. For example, because DFAS has not implemented a memorandum of understanding with the components, it is unclear whether the Army implemented the necessary compensating controls in the absence of assurance from DFAS that its contract pay processes, systems, and controls were designed and operating as intended. As stated earlier, DFAS has not completed its evaluation of the three processes that were excluded from its contract pay FIP for the components, including the Department of the Army; however, the Army asserted in June 2013 that its processes, systems, and controls for contract pay were audit ready. In addition, DFAS did not assert audit readiness of the processes, systems, and controls included in its contract pay FIP until October 2013. Thus, the usefulness of DFAS’s efforts in support of the Army’s and other components’ audit readiness efforts remains questionable.

Conclusions

DFAS recognized the importance of implementing a FIP to improve its contract pay processes, systems, and controls and performed steps required by the FIAR Guidance, such as performing internal control, IT, and substantive testing. However, DFAS did not fully comply with the requirements in the FIAR Guidance for the Discovery and Corrective Action Phases; therefore, the FIP did not support DFAS’s October 2013 assertion that its contract pay controls were suitably designed and operating effectively. As a result, DFAS did not have assurance that its processes, systems, and controls can produce and maintain accurate, complete, and timely financial management information for the approximately $200 billion of contract pay disbursements it annually processes on behalf of DOD components. For example, DFAS did not perform adequate planning and testing activities for the Discovery Phase of its FIP. In addition, DFAS did not provide adequate documentation demonstrating that it had remediated certain identified deficiencies. Although DFAS asserted audit readiness, correcting the weaknesses identified in this report can help ensure that it effectively carries out its contract pay mission and implements, maintains, and sustains the necessary financial improvements to its contract pay processes, systems, and controls. Until DFAS does so, its ability to properly process, record, and maintain accurate and reliable contract pay transaction data is questionable.

Recommendations for Executive Action

To ensure that DFAS is able to obtain the necessary assurance that its contract pay end-to-end process can produce, maintain, and sustain accurate, complete, and timely information in support of the components’ and DOD-wide financial improvement and audit readiness efforts, we recommend that the Under Secretary of Defense (Comptroller)/Chief Financial Officer direct the Director of the Defense Finance and Accounting Service to take the following nine actions: Address deficiencies in its Discovery Phase planning activities for contract pay by performing the following:

Document its contract pay end-to-end process by developing the necessary flowcharts and narratives for those processes excluded from the FIP.

Assess the materiality (i.e., dollar activity and risk factors) of its processes, systems, and controls.

Complete a memorandum of understanding with each of the components.

Address deficiencies in its Discovery Phase testing activities by performing the following:

Validate the completeness and accuracy of the populations of transactions used to perform testing.

Consider and assess the design and operational effectiveness of the entity-level general controls that were not tested by DFAS, as appropriate.

Document and execute an audit strategy or plan for application-level testing of system controls.

Coordinate with the components to classify all identified deficiencies as control deficiencies, significant deficiencies, and material weaknesses.

Address deficiencies in its Corrective Action Phase activities by performing the following:

Assess the population of implemented corrective action plans to determine whether the deficiencies we found in our nongeneralizable sample of DFAS’s corrective action plans are more wide spread in the population.

Revise its FIAR status reports to accurately reflect the current status of its audit readiness efforts.

Agency Comments and Our Evaluation

We provided a draft of this report to DOD for comment. In its written comments, reprinted in appendix II, DOD concurred with our recommendations. DOD also described planned and ongoing actions that DFAS and the FIAR Directorate are taking to address the recommendations, including developing procedures for the processes excluded from DFAS’s contract pay FIP; performing a materiality assessment of processes, systems, and controls; completing a memorandum of understanding to document roles and responsibilities for each component; validating the completeness and accuracy of populations of transactions used to perform testing; and reviewing and certifying corrective actions.

DOD also stated that significant progress had been made but much work remained to be accomplished to include applying lessons learned in implementing the FIAR Guidance during audit preparations, as our recommendations indicated. Further, DOD commented that there had been positive results and it was expecting a favorable opinion from the ongoing independent public accountant examination being conducted under SSAE No. 16. However, as discussed in our report, the scope of DFAS’s SSAE No. 16 examination was limited and did not cover all key processes that will materially affect the timeliness, accuracy, and reliability of its contract pay transaction data. Therefore, until DFAS completes its other efforts, such as establishing a general ledger reconciliation process, it does not have reasonable assurance that its SSAE No. 16 examination will satisfy the needs of the components or provide the expected benefits to the department-wide effort to assert audit readiness for contract pay as a key element of the SBR.

We are sending copies of this report to the Secretary of Defense, the Under Secretary of Defense (Comptroller)/Chief Financial Officer, the Director of the Defense Finance and Accounting Service, the Director of DFAS-Columbus, the Director of the Office of Management and Budget, and appropriate congressional committees. In addition, the report is available at no charge on the GAO website at http://www.gao.gov.

If you or your staff have any questions about this report, 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 report. GAO staff members who made major contributions to this report are listed in appendix III.

Appendix I: Objective, Scope, and Methodology

To determine the extent to which the Defense Finance and Accounting Service (DFAS) implemented its contract pay Financial Improvement Plan (FIP) in accordance with the Financial Improvement and Audit Readiness (FIAR) Guidance, we compared DFAS’s contract pay FIP with the FIAR Guidance to determine if the FIP contained all steps and supporting documentation that the FIAR Guidance requires the components to complete. Using the FIAR Guidance, we analyzed DFAS’s FIP supporting documentation, such as process narratives and flowcharts, and test plans and test results. We also analyzed DFAS’s efforts to address deficiencies identified during testing. Specifically, we selected a nongeneralizable sample of 25 deficiencies that were reported on the FIAR Directorate’s Tracking Sheet as of September 23, 2013. To ensure the reliability of the data reported on the Tracking Sheet, we (1) interviewed FIAR Directorate officials to obtain an understanding of the process they followed to monitor and validate DFAS’s efforts to remediate identified deficiencies and (2) reviewed the actions taken to ensure that all deficiencies identified during the testing were included in the Tracking Sheet. We also reviewed the data on the Tracking Sheet for outliers, such as the deficiencies reported on the Tracking Sheet as not being fully remediated or controls tested for which DFAS did not identify any deficiencies. As a result, we excluded 174 items from the total of 542 items on the Tracking Sheet for a population of 368 deficiencies. From this population, we selected a random sample of 20 deficiencies with noted corrective action plans that were designated as remediated by DFAS as of September 23, 2013. We also selected from the population of 368 deficiencies an additional 5 deficiencies: (1) 2 to include deficiencies associated with DFAS’s testing of general controls that were not included in the initial random sample and (2) 3 deficiencies identified by DFAS as remediated with a corrective action plan where the FIAR Directorate noted that the controls tested did not apply to DFAS’s contract pay FIP. We also interviewed officials from DFAS’s Office of Audit Readiness, DFAS’s Internal Review, and the FIAR Directorate to obtain explanations and clarifications on the results of our evaluation of the FIP.

We conducted this performance audit from May 2012 to April 2014 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

Appendix II: Comments from the Department of Defense

Appendix III: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact named above, Arkelga Braxton (Assistant Director), Greg Marchand (Assistant General Counsel), Jason Kirwan, Omar V. Torres (Auditor-in-Charge), Jason Kelly, Sabrina Rivera, and Heather Rasmussen made key contributions to this report.