The Defense Information Systems Agency (DISA) is responsible for managing the Defense Information Services business area. This business area provides a wide range of services relating to computer center operations and voice, data, and video telecommunications. For fiscal year 1998, DISA estimated that the business area will have revenues of about $2.7 billion. Business area operations are financed as part of the Defense-wide Working Capital Fund, which was formerly called the Defense Business Operations Fund (DBOF). In December 1996, the Under Secretary of Defense (Comptroller) dissolved DBOF and created four working capital funds (WCF) to clearly establish the military services’ and DOD components’ responsibilities for managing the functional and financial aspects of their respective business areas. As currently specified in the Department of Defense’s (DOD) Financial Management Regulation, Volume 11B, Reimbursable Operations, Policy and Procedures-Defense Business Operations Fund, the funds are to charge customers the full costs of providing goods and services. The primary goal of the working capital fund is to focus management’s attention on the full costs of carrying out certain critical DOD business operations and the management of those costs. Unlike a private sector enterprise, which has a profit motive, the working capital funds are to operate on a break-even basis over time by recovering the full costs incurred in conducting business operations. Accomplishing this requires DOD managers to become more conscious of operating costs and to make fundamental improvements in how DOD conducts business. It is critical for the working capital funds to operate efficiently since every dollar spent inefficiently results in fewer resources available for other defense spending priorities. The Defense Information Services business area consists of two components—the Defense megacenters (DMC) and the Communications Information Services Activity (CISA). The DMCs’ primary mission is to provide computer processing services to DOD and other federal government agencies. The primary mission of CISA is to provide telecommunications services to DOD and non-Defense customers. These two entities differ markedly in mission, as highlighted in the following sections. Mainframe processing comprises the core of the DMC services. DISA refers to them collectively as A-Goal services, and they include data processing on IBM and UNISYS mainframe computers, data transfers between computers, and data storage. DMCs provide a variety of other services to their customers, referred to collectively as C-Goal services, which include mainframe processing on computers made by other manufacturers (such as Burroughs), telecommunications, and database management. Table 1.1 summarizes the DMCs’ reported revenues, cost of operations, and the net operating results for fiscal years 1995 through 1997. Currently, there are 16 megacenters located throughout the Unites States.DISA has designated DISA Western Hemisphere as the responsible entity for managing the DMCs. As part of DOD’s ongoing efforts to reduce infrastructure cost, DISA has efforts underway to further reduce the number of megacenters. Over the next 2 years DISA plans to complete the consolidation of its mainframe processing centers from 16 to 6 and at the same time introduce Regional Information Services. This is a continuation of DOD efforts to consolidate its computer center operations. Between fiscal years 1990 and 1996, DOD consolidated workload and equipment from 194 computer centers to 16 DISA DMCs. While the remaining DMCs will provide mainframe processing services, the Regional Information Services will concentrate on nonmainframe services, such as local area network support and personal computer operations and maintenance. According to DISA’s Defense Megacenter Business Strategy, dated October 1997, DOD estimates that the planned consolidation will result in savings over a 10-year period (fiscal years 1998 through 2007) of approximately $1.5 billion. Of the $1.5 billion, approximately $1 billion will accrue after fiscal year 2002. CISA is responsible for acquiring services that connect base-level and deployed telecommunications networks within and between the continental United States, Europe, Pacific, and the Caribbean. These services are provided within the United States primarily through leased telecommunications lines and overseas by a mixture of government-owned and leased lines. Table 1.2 provides information on CISA’s reported revenues, cost of operations, and net operating results for fiscal years 1995 through 1997. CISA can provide its customers—DOD and other federal entities, such as the Federal Aviation Administration—all forms of secure and nonsecure voice, data, video, and bulk transmission telecommunications. If CISA is unable to provide the requested services directly, it will contract, on behalf of the requesting activity, with the commercial sector or another federal entity to provide the services. For example, some voice services are provided by the General Services Administration under its FTS-2000 contract for services not available through CISA. The objectives of our review were to (1) evaluate DISA’s processes for establishing the prices DMCs and CISA charge for the services provided to customers of the Defense Information Services business area, (2) ascertain if DISA is being reimbursed for all services provided, and (3) ascertain the accuracy of DISA’s financial management information. To evaluate the price-setting process for the DMCs and CISA, we reviewed the policies and procedures DOD established for setting prices. We identified the cost elements included in the prices and determined whether these elements are in conformance with the guidance set forth in DOD’s Financial Management Regulation, Volume 11B, Reimbursable Operations, Policy and Procedures-Defense Business Operations Fund. We also collected and analyzed workload data obtained from DISA-WESTHEM. We discussed the reliability of this data on DMC operations with DISA-WESTHEM and determined the difference between the projected and actual workload for IBM and UNISYS mainframe services for fiscal year 1997. In addition, we obtained and reviewed a study performed by a private contractor related to CISA’s pricing of services. To determine if the information service business area is being reimbursed for all services provided, we collected, reviewed, and analyzed selected financial information related to collections, disbursements, and accounts receivable. We determined whether DISA pursued collection of accounts receivable in accordance with the guidance set forth in DOD’s Financial Management Regulation. We also contacted DISA customers to discuss amounts they owed DISA for services provided. In addition, through our discussion with DISA personnel, review of the financial reports, and review of relevant federal accounting standards, we determined whether amounts owed DISA were being properly recorded. To evaluate the accuracy of DISA’s financial management information we (1) obtained and analyzed the Defense Working Capital Fund Accounting Reports and (2) DISA’s Chief Financial Officer Annual Financial Statement for FY 1996. We also reviewed the DOD IG’s audit report on the business area financial statements for fiscal year 1997, to identify any problems they found with the business area’s financial information. We also reviewed DOD’s fiscal year 1997 Federal Managers’ Financial Integrity Act (FMFIA) report and the Defense Finance and Accounting Service (DFAS) Chief Financial Officer’s Financial Management Status Report and Five Year Plan 1997-2001 to identify any accounting and reporting weaknesses related to DISA. The quantitative financial information used in this report was produced by DOD’s systems, which have long been reported to generate unreliable data. We did not independently verify the data. The DOD IG was unable to render an opinion on DISA’s financial statements for fiscal year 1997. We performed our work at the Office of the Under Secretary of Defense (Comptroller), Washington, D.C.; DISA Headquarters, Arlington, Virginia; DFAS Headquarters, Crystal City, Virginia; DISA-WESTHEM, Denver, Colorado; Defense Logistics Agency, Ft. Belvior, Virginia; Federal Aviation Administration, Washington, D.C.; and the Department of State, Washington, D.C.. Our work was performed from August 1997 through August 1998, in accordance with generally accepted government auditing standards. We requested comments on a draft of this report from the Secretary of Defense. The Office of the Secretary of Defense provided written comments on a draft of this report that are discussed in chapters 2, 3, 4, and 5 and are reprinted in appendix I. DOD also provided technical comments on the draft report, which we have incorporated where appropriate, but have not included. Chapter 2 of this report discusses pricing issues related to the Defense megacenters. Chapter 3 discusses issues primarily related to pricing telecommunications services offered by CISA. Chapter 4 discusses DISA’s ability to be reimbursed in a timely manner for services provided and the nonreimbursement for services provided to customers. Chapter 5 discusses the accuracy and reliability of DISA’s financial management information. One of the goals of the working capital fund is to break even over time. To achieve this, prices are supposed to include all direct and indirect costs incurred in providing services to the customers. To ensure that customers have sufficient funds to pay for the requested services, prices are to be established before the start of the fiscal year and remain in effect for the entire year. In order to set prices that will enable the business area to operate on a break-even basis, it is extremely important that the business area accurately estimate the work it will perform and the cost of performing that work. This task is made more difficult because the process that business areas use to develop prices begins up to 2 years before the prices go into effect. In developing prices for mainframe processing services, each DMC collects cost data on direct labor, depreciation, contracts, software, and the indirect cost incurred by the DMC and headquarters (such as base support costs and centralized contract administration) to arrive at the activity’s estimated cost of doing business. The workload data are derived through discussions with customers and utilization data collected by DISA.