In October 1991, DOD implemented the Fund, which consolidated the nine existing industrial and stock funds operated by the military services and DOD, as well as the Defense Finance and Accounting Service (DFAS), the Defense Industrial Plant Equipment Service, the Defense Commissary Agency, the Defense Reutilization and Marketing Service, and the Defense Technical Information Service. The Fund’s primary goal is to focus the attention of all levels of DOD management on the total costs of carrying out certain critical DOD business operations and to manage those costs effectively. This goal is in accordance with the objectives of the National Performance Review (NPR), which is aimed at achieving cost efficiencies in the federal government. The Fund is modeled after businesslike operations in that it maintains a contractual (buyer-seller) type of relationship with its customers, primarily the military services. In fiscal year 1995, the Fund will have estimated revenue of $77 billion, which would make it equivalent to one of the largest corporations in the world. The Fund provides such essential goods and services as the (1) overhaul of ships, tanks, and aircraft and (2) sale of over 5 million types of vital inventory items, such as landing gears for aircraft. Many of these services are essential to maintaining the military readiness of our country’s weapon systems. Unlike a private sector enterprise which has a profit motive, the Fund is to operate on a break-even basis by recovering the current costs incurred in conducting its operations. To accomplish our objectives, we reviewed DOD’s quarterly progress reports on the implementation of the plan and DOD’s February 1, 1995, progress report to the congressional defense committees on the Fund. We also met with DOD officials to determine if DOD had completed the following three actions within the milestones established in the plan: (1) complete all Fund policies by December 31, 1994, (2) select the systems to account for Fund resources by September 30, 1994, and begin implementing those systems by December 31, 1994, and (3) improve the accuracy of the financial data in the Fund’s monthly financial reports by December 31, 1994. To evaluate DOD’s efforts to select the Fund’s financial systems, we reviewed the system evaluation reports prepared for the 28 systems reviewed by DOD. We also met with representatives from DFAS, as well as representatives from other DOD components involved in the system selection process, to determine the system selection criteria and their appropriateness. We also determined what plans DOD has in place to (1) implement/enhance the selected systems, (2) estimate the costs to improve the selected systems, and (3) eliminate the systems not selected. To determine whether DOD has improved the data accuracy in the Fund’s monthly financial reports, we met with officials in DFAS to ascertain and evaluate actions taken (or planned) to improve data accuracy, including actions to enable reconciliation between the Fund’s cash balance and the corresponding balance maintained by Treasury. We also analyzed the Fund’s monthly financial reports to determine whether the systems are producing accurate and complete financial data. Further, we obtained the reports of the DOD Inspector General’s audit of the Fund’s fiscal years 1992 and 1993 financial statements required by the Chief Financial Officers (CFO) Act of 1990. We performed our work at the Office of the Secretary of Defense (Comptroller); the Departments of the Army, Navy, and Air Force; the Defense Logistics Agency (DLA); DFAS headquarters; and the Cleveland, Columbus, Denver, and Indianapolis DFAS Centers. Our review was performed from July 1994 through February 1995, in accordance with generally accepted government auditing standards. We discussed the facts, conclusions, and recommendations in our report with cognizant DOD officials and have incorporated their comments where appropriate. DOD has made some progress in addressing the problems that have plagued the Fund’s operations. During the past 16 months, DOD has made decisions such as developing and approving Fund policies, revising the format of the Fund’s financial reports, and selecting 12 interim migratory financial systems to account for the Fund’s resources. However, we disagree with DOD’s assessment in its February 1, 1995, progress report on the Fund that it had made “tremendous progress in rectifying or reducing the problems in the Plan.” Little improvement has yet been made in the actual day-to-day operations of the Fund. Since the Fund began operations in October 1991, it has not been able to meet its financial goal of operating on a break-even basis. The reported loss for fiscal year 1994 will mark the third consecutive year of operating losses. A key element in reducing the cost of operations is the ability to accurately identify total costs. However, DOD lacks the management tools to accomplish this task. Specifically, DOD has not (1) developed a process to ensure the Fund’s policies are consistently implemented, (2) improved the accuracy and reliability of the Fund’s systems, (3) improved the Fund’s monthly financial reports, (4) adequately managed the Fund’s cash, and (5) developed performance measures and goals. These problems are discussed below. DOD has acknowledged that its failure to develop policies and procedures has been one of the most significant weaknesses of the Fund’s implementation. In its September 1993 plan, DOD identified several actions to address this problem. In December 1994, DOD completed and issued the Financial Management Regulation (FMR) on the Fund, which contains the Fund’s financial policies. This regulation is a major step toward standardizing the Fund’s operations. It consolidates all policies of the old industrial and stock funds, changes that have been made to those policies, and new policies that have been issued since the Fund was established. However, confusion exists within DOD regarding the need for implementing procedures to accompany the various policies that have been issued. As a result, the five policies that the Deputy Comptroller for Financial Systems stated were to be effective October 1, 1994, had not been implemented throughout DOD as of January 1995. According to DFAS officials, they are responsible for developing implementing procedures for each Fund policy approved by the DOD Comptroller. DFAS’ position is supported by a memorandum from the Deputy Comptroller for Financial Systems that states that DFAS is developing accounting procedures as necessary to ensure the policies can be implemented. DOD Comptroller officials informed us that it was not necessary for DFAS headquarters to develop implementing procedures because the FMR already contains them. The officials further stated that DOD is trying to avoid the proliferation of procedures by DFAS and its field activities so that the Fund’s policies will not be implemented inconsistently as a result of different interpretations, as has happened in the past. In fact, the improvement plan notes that the Fund’s financial reports reflect the results of applying policies inconsistently across business areas. Given the October 1994 memorandum, other DOD documents on Fund policy implementation, and the opinion of DOD Comptroller officials, it is evident that DOD has not resolved this issue. Until it does so, the FMR may not be implemented in a timely manner. Given the immense size, complexity, and scope of the Fund’s $77 billion operation, the need to complete the development of the policies and consistently implement them is particularly acute. Until consistent implementation is achieved, the benefits of the new policies will not be realized. Without standard policies and procedures, Fund managers are forced to make their own interpretation regarding how to report on the respective operations of their business areas. Therefore, it is imperative that DOD put in place a process which will provide a mechanism for ensuring that Fund policies are implemented in a timely, consistent manner. In addition to implementation issues discussed above, we have concerns about the provisions in several Fund policies that DOD has developed and approved thus far. These concerns are highlighted below and discussed in detail in appendix I. DOD’s policy requires that prior year losses be recovered by increasing the prices charged customers. DOD increased fiscal year 1995 Fund prices by $1.7 billion to recover prior year losses. We have previously stated that the Fund, not the customers, should be required to request additional funds through the congressional appropriation process to recover losses. As part of the justification, DOD should explain differences such as the variances between the budgeted and actual results of operations for each business area. The explanation should also include the causes for the reported gain or loss and the actions being taken to avoid similar gains or losses in the future. Our approach would give the Congress an opportunity to review the Fund’s operations, determine if additional funds are actually needed, and evaluate the effectiveness of DOD’s management of the Fund. It would also provide a strong incentive to properly set prices and would help focus attention on the current costs of operations. DOD’s policy allows for two methods of recognizing revenue for the depot maintenance area: the completed contract method and the percentage of completion method. We disagree with the use of the completed contract method when work done on an order crosses fiscal years. Using the completed contract method for such orders defers the recognition of revenue and related expenses to the period in which they were completed. Therefore, the financial reports distort the financial results of operations for each fiscal year. The military personnel policy provides that the cost of military personnel will be at the civilian equivalent rate, not the actual cost of military personnel. This practice will understate the total military personnel costs since the civilian equivalency rate is 23 percent less than the military personnel cost. This practice also will not further the objectives of the NPR, which stipulates that the full costs be included in the prices that providers, such as the Fund, charge customers so that the total cost of what the government produces can be determined. However, the National Defense Authorization Act for Fiscal Year 1994 directs DOD to base its recovery of military personnel costs on something other than actual costs.