In October 1990, the Federal Accounting Standards Advisory Board (FASAB) was established by the Secretary of the Treasury, the Director of the Office of Management and Budget (OMB), and the Comptroller General of the United States to consider and recommend accounting standards to address the financial and budgetary information needs of the Congress, executive agencies, and other users of federal financial information. Using a due process and consensus building approach, the nine-member Board, which has since its formation included a member of DOD, recommends accounting standards for the federal government. Once FASAB recommends accounting standards, the Secretary of the Treasury, the Director of OMB, and the Comptroller General decide whether to adopt the recommended standards. If they are adopted, the standards are published as Statements of Federal Financial Accounting Standards (SFFAS) by OMB and GAO. In addition, the Federal Financial Management Improvement Act of 1996 requires federal agencies to implement and maintain financial management systems that will permit the preparation of financial statements that substantially comply with applicable federal accounting standards. Also, the Federal Managers’ Financial Integrity Act of 1982 requires agency heads to evaluate and report annually whether their financial management systems conform to federal accounting standards. Issued on November 30, 1995, and effective for the fiscal years beginning after September 30, 1997, SFFAS No. 6, Accounting for Property, Plant, and Equipment, requires the disclosure of deferred maintenance in agencies’ financial statements. SFFAS No. 6 defines deferred maintenance as “maintenance that was not performed when it should have been or was scheduled to be and which, therefore, is put off or delayed for a future period.” It includes preventive maintenance and normal repairs, but excludes modifications or upgrades that are intended to expand the capacity of an asset. The deferred maintenance standard applies to all property, plant, and equipment, including mission assets—which will be disclosed on the supplementary stewardship report. For the Department of Defense (DOD), mission assets, such as submarines, ships, aircraft, and combat vehicles, is a major category of property, plant, and equipment. In fiscal year 1996, DOD reported over $590 billion in this asset category, of which over $297 billion belonged to the Navy, including 338 active battle force ships such as aircraft carriers, submarines, surface combatants, amphibious ships, combat logistics ships, and support/mine warfare ships. The Navy spent a little over $2 billion on ship depot maintenance for its active fleet in fiscal year 1996. SFFAS No. 6 recognizes that there are many variables in estimating deferred maintenance amounts. For example, the standard acknowledges that determining the condition of the asset is a management function because different conditions might be considered acceptable by different entities or for different items of property, plant, and equipment held by the same entity. Amounts disclosed for deferred maintenance may be measured using condition assessment surveys or life-cycle cost forecasts.Therefore, SFFAS No. 6 provides flexibility for agencies’ management to (1) determine the level of service and condition of the asset that are acceptable, (2) disclose deferred maintenance by major classes of assets, and (3) establish methods to estimate and disclose any material amounts of deferred maintenance. SFFAS No. 6 also has an optional disclosure for distinguishing between critical and noncritical amounts of maintenance needed to return each major class of asset to its acceptable operating condition. If management elects to disclose critical and noncritical amounts, the disclosure must include management’s definition of these categories. The objective of our work was to identify information on specific issues to be considered in developing implementing guidance for disclosing deferred maintenance on ships. We reviewed financial and operational regulations and documentation related to managing and reporting on the ship maintenance process. The documentation we reviewed included fleet spreadsheets used to track depot-level maintenance requirements and execution by specific ship. We also reviewed Navy Comptroller budget documents. We discussed this information with officials at DOD and Navy headquarters and at various organizational levels within the Department of the Navy. While the deferred maintenance standard applies to all levels of maintenance, this report addresses ship depot-level maintenance because it is the most complicated and expensive. (See the following section for a discussion of the Navy ship maintenance process, including the levels of maintenance.) The amounts for deferred depot level maintenance presented in this report were developed using information provided by Navy managers. We did not independently verify the accuracy and completeness of the data. We conducted our review from July 1996 through November 1997 in accordance with generally accepted government auditing standards. We requested written comments on a draft of this report from the Secretary of Defense or his designee. The Under Secretary of Defense (Comptroller) provided us with written comments, which are discussed in the “Agency Comments” section and are reprinted in appendix I. The Navy accomplishes maintenance on its ships (including submarines) at three levels: organizational, intermediate, and depot. Organizational-level maintenance includes all maintenance actions which can be accomplished by a ship’s crew. For example, the ship’s crew may replace or fix a cracked gasket or leaks around a hatch or doorway aboard ship. Intermediate-level maintenance is accomplished by Navy Intermediate Maintenance Activities (IMAs) for work that is beyond the capability or capacity of a ship’s crew. For example, an IMA performs calibration or testing of selected ship systems for which the ship’s crew may not have the equipment or capability to perform. Depot-level maintenance includes all maintenance actions that require skills or facilities beyond those of the organizational and intermediate levels. As such, depot-level maintenance is performed by shipyards with extensive shop facilities, specialized equipment, and highly skilled personnel to accomplish major repairs, overhauls, and modifications. The Navy determines what depot-level maintenance is needed for its ships through a requirements process that builds from broad maintenance concepts outlined in Navy policy and culminates with the execution of an approved schedule. There are three types of maintenance requirements that are executed: (1) time-directed requirements, (2) condition-based requirements, or (3) modernization requirements. Time-directed requirements are derived from technical directives and include those that are periodic in nature and are based on elapsed time or recurrent operations. Condition-based requirements are based on the documented physical condition of the ship as found by the ship’s crew or an independent inspection team. Lastly, modernization requirements include ship alterations, field changes, and service changes that either add new capability or improve reliability and maintainability of existing systems through design improvements or replacements. Initial depot-level maintenance requirements are determined and a proposed maintenance schedule is developed and approved based on overall ship maintenance policy, specific maintenance tasks, operational requirements, force structure needs, and fielding schedules. These approved maintenance schedules undergo numerous changes as new requirements are identified, others are completed or canceled, operational priorities change, and budgets fluctuate. Thus, these factors result in many deviations from the plan once actual maintenance is executed and complicate the measurement of exactly what maintenance should be considered deferred. Less flexibility in scheduling is permissible with submarines than surface ships because prescribed maintenance must be done on submarines periodically for them to be certified to dive. If the specified maintenance is not done by the time required, the submarine is not to be operated until the maintenance is accomplished. Neither DOD nor the Navy has developed implementing guidance for determining and disclosing deferred maintenance on financial statements. Navy officials said that they are reluctant to develop their procedures until DOD issues its guidance. As we reported to DOD in our September 30, 1997, letter, DOD guidance is important to ensure consistency among the military services and to facilitate the preparation of DOD-wide financial statements. We also stated that the guidance needs to be available as close to the beginning of fiscal year 1998 as possible so that the military services have time to develop implementing procedures and accumulate the necessary data to ensure consistent DOD-wide implementation for fiscal year 1998. We found that operations and comptroller officials from both DOD and the Navy have varying opinions concerning the nature of unperformed maintenance that should be reported as “deferred.” The differences in opinions arise from various interpretations of how to apply the standard to the maintenance process. The views on how to apply the deferred maintenance standard to the ship maintenance process ranged from including only unfunded ship overhauls to estimating the cost of repairing all problems identified in each ship’s maintenance log. Brief descriptions of various views of how SFFAS No. 6 could be applied to disclosing deferred depot-level maintenance for ships follow. The descriptions explain what would be considered deferred maintenance for ships and the rationale for each option. In its budget justification documents, the Navy reports deferred depot-level maintenance for unfunded ship overhauls. The Navy Comptroller officials’ rationale for excluding other types of depot-level maintenance not done is that overhauls represent the Navy’s top priority for accomplishing ship depot-level maintenance and, therefore, should be highlighted for the Congress when a lack of funds prevents them from occurring when needed. While overhauls consumed most of the depot-level maintenance funding in past years, the Navy is performing fewer overhauls as it moves toward a more incremental approach of doing smaller amounts of depot-level work more frequently. Consequently, overhauls now represent a relatively small part of the Navy’s ship depot-level maintenance budget. In fiscal year 1996, over 80 percent of the Navy’s ship depot-level maintenance budget was spent on work other than ship overhauls. Specifically, the Navy reported spending almost $1.7 billion for other ship depot-level maintenance and $367.8 million for ship overhauls. The Navy officials’ rationale for disclosing only unfunded overhauls as deferred depot-level maintenance in financial statements is that the data are readily available and are consistent with what is being reported in budget justification documents.