The Air Force depot maintenance activity group supports combat readiness by providing depot repair services necessary to keep Air Force units operating worldwide. The group generates between $5 billion to $6 billion in annual revenue principally by repairing and overhauling a wide range of assets including aircraft, missiles, aircraft engines, software, and exchangeable inventory items for military services, other government agencies, and foreign governments. In performing these services, the group performs the work in-house at its depots or through contracts with private industry or other government agencies. The group operates under the working capital fund concept, where customers are to be charged the anticipated actual costs of providing goods and services to them. Customers place orders with the Air Force depot maintenance activity group. When the activity group accepts the order, the customer’s funds are obligated. The customer uses the activity group as its purchasing agent when it needs a contractor to perform depot-level maintenance work. The activity group awards the contract and manages the work performed by the contractor. The contract portion of the depot maintenance activity group generates between $2 billion and $3 billion in annual revenue. In accomplishing this work, the Air Force has about 5,000 contracts with about 750 contractors that are located in the United States as well as overseas. The Air Force air logistics centers use the contract depot maintenance production and cost system (known as G072D) as a means of combining financial and production data for the management of work that is being performed by contractors. The Air Force has also established procedures and internal controls for the contract portion of the depot maintenance activity group, which are described in two Air Force Materiel Command Instructions. Command Instruction 21-113 discusses the contract maintenance program for the depot maintenance activity group and Command Instruction 21-134 discusses the end item transaction reporting system (known as G009) and the reporting procedures for contractors. Some of the procedures and controls in these two instructions follow. Contracts can be awarded for a 12-month period anytime during the year. All the items to be repaired will be funded from the appropriation of the initial fiscal year. However, work must be started on at least one item during the initial fiscal year for the entire job cost to be properly charged to appropriated funds for that year. At a minimum, assets planned to be sent to contractors for repair should be reviewed quarterly. If the assets are not received by the contractors and will not be received within a reasonable amount of time (60 days), the planned quantities to be repaired and related obligated dollars must be reduced accordingly and the contract amended, if necessary. Contractors are required to report, at least monthly, on the status of the assets being repaired, such as when the (1) assets were received, (2) assets were inducted for repair, and (3) work was completed on the assets. The production management specialists at the air logistics centers are responsible for ensuring that the information provided by the contractors is accurate. A review of the contract maintenance ledger produced from the production and cost system must be performed quarterly. Particular attention should be directed to (1) contractors beginning work on assets compared to the plan and (2) contractors completing work on assets compared to the plan. Any questionable information must be annotated and reviewed and corrections made prior to the next monthly processing cycle. Carryover is the dollar value of work that has been ordered and funded (obligated) by customers but not yet completed by working capital fund activities at the end of the fiscal year. Carryover consists of both the unfinished portion of work started but not yet completed, as well as requested work that has not yet commenced. To manage carryover, DOD converts the dollar amount of carryover to months of work. This is done to put the magnitude of the carryover in proper perspective. For example, if an activity group performs $100 million of work in a year and had $100 million in carryover at year-end, it would have 12 months of carryover. However, if another activity group performs $400 million of work in a year and had $100 million in carryover at year-end, this group would have 3 months of carryover. A DOD regulation allows for some carryover at fiscal year-end to allow working capital funds to operate efficiently and effectively. In 1996, DOD established a 3-month carryover standard for all the working capital fund activities except for the contract portion of the Air Force depot maintenance activity group. The Air Force is the only military service that includes its contract depot maintenance operation in its working capital fund. To reflect this difference, DOD established a 4.5-month carryover standard to account for the additional administrative functions associated with awarding contracts. In May 2001, we reported that DOD did not have a basis for its carryover standard and recommended that Defense determine the appropriate carryover standard for the depot maintenance, ordnance, and research and development activity groups. DOD is in the process of assessing its carryover standards. Too little carryover could result in some depot maintenance activity not having work to perform at the beginning of the fiscal year, resulting in the inefficient use of personnel. On the other hand, too much carryover could result in an activity group receiving funds from customers in one fiscal year but not performing the work until well into the next fiscal year or subsequent years. By minimizing the amount of the carryover, DOD can use its resources most effectively and minimize the “banking” of funds for work and programs to be performed in subsequent years. In February 2002, the Air Force began to consider financing the contract portion of the depot maintenance activity group with direct appropriations. In an April 19, 2002, memorandum, the Air Force stated that the overall financial health of the depot maintenance activity group has been negatively impacted by the contract operations. Further, without direct control over contractor costs, the working capital fund mechanism is an inappropriate choice for the contract operations. The memorandum directed the Air Force Materiel Command to begin planning for the transition of contract depot maintenance operations out of the working capital fund immediately. This would be a significant change in the financing and accounting for these contracts. Under the plan, contracts would be financed with direct appropriations, which is how the Army and Navy finance contract depot maintenance work, and carryover would no longer be associated with the work being performed by the contractor. Instead, funds would be managed in terms of the percent of funds obligated and expensed during a fiscal year. Further, the Air Force plans on using existing direct appropriation fund systems to track repairs and account for the funds and would not use its current working capital fund systems. The lack of accurate carryover information results in the Congress and DOD officials not having the information they need to oversee and manage the repair of assets. Air Force reports show that the contract portion of the depot maintenance activity group exceeded the 4.5-month carryover standard at the end of fiscal years 2000 and 2001 by about $44 million and $134 million, respectively, thereby resulting in more funds being provided than allowed by the DOD carryover standard. However, we found that the reported carryover balance did not accurately reflect the amount of unfinished work on hand at the end of fiscal year 2000 due to (1) faulty assumptions used in calculating work-in-process and (2) records not accurately reflecting work that was actually completed by year-end. As a result, the amount of carryover reported by the Air Force was understated by tens of millions of dollars. Air Force reports show that the contract portion of the depot maintenance activity group exceeded the 4.5-month carryover standard at the end of fiscal years 2000 and 2001. The Air Force reported that it had about $835 million, which is 4.7 months, of carryover at the end of fiscal year 2000, and about $1.1 billion, which is 5.1 months, at the end of fiscal year 2001. In the past, the Office of the Under Secretary of Defense (Comptroller) and/or the congressional defense committees used carryover information to determine whether the working capital fund activity groups had too much carryover. For example, the Congress reduced the Army’s and Air Force’s fiscal year 2001 Operation and Maintenance appropriations by $40.5 million and $52.2 million, respectively, because the depot maintenance operations in their working capital funds had too much carryover. Similarly, in 2001, the Under Secretary of Defense (Comptroller) reduced the Air Force’s fiscal year 2003 customers’ budget requests by $185 million because the contract portion of the depot maintenance activity group would have too much carryover at the end of fiscal year 2003. As stated previously, carryover is the amount of unfilled orders less the amount of work-in-process. We found that the Air Force does not have actual information on the amount of work-in-process performed by contractors and, therefore, uses a formula to estimate the amount based on the assumption that the contractor will start and complete work as planned. However, the assumptions were faulty because the contractors did not always start and/or complete the work as planned. Using its formula, the Air Force reduced the amount of unfilled orders due to work- in-process by about $1 billion, which is 5.6 months, and $835 million, which is 4.1 months, in fiscal year 2000 and fiscal year 2001, respectively, to determine the amount of carryover for these 2 years. The amount of work-in-process recorded monthly is affected or is determined by the nature of the work, the estimated/actual start date of the work, and the expected time to complete the work. For work that is planned to be completed in less than 150 days, the Air Force assumes that one-fifth of the work will be completed each month and records work-in- process accordingly. The calculation for the different workload categories is outlined below.