In 1999, we reported that the preliminary results of the Pearl Harbor pilot were mixed and recommended that DOD and the Navy address unresolved issues related to the financial management of the consolidation as the Navy proceeded with similar consolidations in other locations. In 2001, we updated this assessment and concluded that while the consolidation of shipyard and intermediate maintenance activities offered benefits for using resources more efficiently, financial management issues existed that needed to be resolved. We highlighted problems concerned with inadequate cost visibility and accountability, and with data used to show compliance with applicable statutes. In December 2005, CBO issued an interim report comparing working capital funding and direct funding for Naval shipyards. Its preliminary findings indicated that working capital funding and direct funding each has strengths and weaknesses as shipyard funding systems, but did not conclude whether one system was best. CBO’s report noted concerns that direct funding makes shipyards’ costs and operations less visible. Also in December 2005, the DOD-IG issued a report that raised concerns about the conversion of other shipyards to direct funding. The report’s main findings were that Puget Sound did not routinely accumulate financial information as they had done when financed as a working capital fund activity, metrics and goals used to track results of the transition were unreliable and did not address the impacts of direct funding, and the information systems did not fully support operations. As a result, DOD-IG was unable to determine the effectiveness of the transition of Puget Sound to direct funding. The Navy’s March 2006 report to Congress included sections corresponding to each of the matters specified in Section 322(b)(2) of the National Defense Authorization Act for Fiscal Year 2006. However, although the report addressed the Navy’s assessment of the conversion of Puget Sound to direct funding, it did not provide data and other supporting evidence for the Navy’s overall assessment that direct funding was more advantageous than working capital funding and can best satisfy fleet maintenance priorities. More specifically, the report did not provide evidence that direct funding had provided for a more agile workforce—the ability to more easily move workers among maintenance projects in response to fleet priorities— which was a key benefit the Navy claimed was achieved by converting to direct funding. It did not provide data to support the Navy’s position that direct funding enabled the maintenance activities to quickly respond to emergent operational requirements by reprioritizing work, minimizing the financial impact of unplanned maintenance, and optimizing the use of all resources available in a region. While it said that some sharing of production personnel had occurred prior to consolidation, this required special actions and burdensome administrative processes, all causing delay in accomplishing needed work, but provided no data showing differences before and after the conversion. Regarding operational and financial flexibility, the Navy said that while the working capital fund allows for continued operations on a limited basis, it considered this limited flexibility minor compared to the overall benefits of direct funding, particularly its ability to move workers among projects as workload priorities change, increasing the agility of the workforce and minimizing the administrative burden. Again, no data were provided on increased workforce agility or reduced administrative burden. Moreover, it did not provide data to support the overall conclusion that direct funding can best satisfy fleet maintenance priorities without sacrificing cost visibility, performance accountability, or quality of work. More broadly, the use of direct funding rather than working capital funding as a financing mechanism for shipyard maintenance reflects fundamental choices about how DOD goods and services are provided. Naval shipyards have operated under some type of revolving fund financing system, which includes working capital funds, for decades. Working capital funding requires shipyards to track and report their total costs in order to determine operating results (profits and losses) and future billing rates. In doing so, the working capital fund focuses attention on the total costs of providing a good or service. The fees that a working capital-funded shipyard charges for the services provided are based on total projected costs and projected workload for the year. Total costs include fixed costs and sunk costs that are independent of the amount of work performed as well as costs that vary according to workload. Consequently, the price that shipyards charge may be viewed by the customers as too high. If customers view shipyard rates as too high, they may defer maintenance, reduce the scope, or shift to a new maintenance provider, such as an intermediate maintenance facility that is direct funded or does not include fixed costs in its prices. Under direct funding, direct appropriations authorize DOD to incur obligations for designated purposes, such as ship maintenance or modifications. Direct-funded shipyards provide maintenance services to the fleets for free, but they are still reimbursed for modifications and conversions. Both capital expenditures and military construction at direct-funded shipyards are funded through separate direct appropriations. Thus, direct funding may reduce the availability of data on shipyards’ total costs unless the data are specifically requested or developed. The Navy’s report also did not provide complete information on some specific matters. For example, the Navy’s report did not provide complete information on the capital improvement program. The Navy report noted differences in funding of the shipyard’s capital improvement program since the conversion to direct funding. Under working capital funding, funds function from the fees charged for the services they provide consistent with their statutory authority. Under direct funding, appropriations authorize DOD to incur obligations for designated purposes. However, more information would have helped in understanding whether, after the conversion to direct funding, the approved funding met total shipyard capital improvement program requirements as well as requirements for the shipyard’s sustainment, restoration, and modernization program, which provides funds to keep the facilities in good working order, restores facilities, and makes alterations to meet higher standards or accommodate new functions or missions. As we pointed out in our 2001 report, Pearl Harbor was budgeted for less than 5 percent of the identified capital improvement program requirements for the consolidated facility over 3 fiscal years. In addition, buyout costs for the two East Coast shipyards are still pending because the final amounts have not been negotiated. The Navy report stated that it had not fully resolved buyout costs for converting the two East Coast shipyards. These costs are to be negotiated by the Navy, OSD, and the Defense Finance and Accounting Service after the end of fiscal year 2006. Based on end-of-fiscal-year projections, buyout costs will total $231.5 million for these shipyards. The Navy included $140.1 million in the President’s fiscal year 2007 budget for projected working capital fund buyout costs for the two East Coast shipyards, leaving a projected balance of $91.4 million. The report also did not note that Puget Sound will incur additional buyout costs of more than $53 million due to operating losses for working capital fund projects carried over during the transition to direct funding. The Navy’s March 2006 report did not show data that adequately addressed issues identified as unresolved in prior studies. Specifically, the Navy did not identify (1) methodologies for achieving total cost visibility and (2) performance metrics to measure improved results, such as increased productivity, achieved by the consolidation of maintenance facilities and the conversion to direct funding. The Navy’s report did not discuss the Navy’s approach and methodology for achieving total cost visibility at the consolidated facility. Section 322(b)(2) called for the Navy to address, among other things, the effect of direct funding on (1) the cost visibility of specific work performed and (2) the total cost of consolidated ship maintenance operations on an ongoing basis. The Navy stated that the conversion to direct funding had been made without sacrificing cost visibility because the same information systems used to accumulate costs under the working capital fund have remained in place. The Navy report identified broad cost categories, provided total budget and expenditures figures for the consolidated facility for fiscal years 2004 and 2005, and compared the total percentage of actual to budgeted expenditures. However, the report did not discuss how the conversion to direct funding had changed the way the Navy has to accumulate cost data and achieve total cost visibility for specific work performed. Prior reviews have raised issues about the Navy’s ability to provide data showing total cost visibility. We reported in 2001 that the management and financial systems at Pearl Harbor did not have reliable data on an ongoing basis to determine the cost of delivering a direct labor hour of ship maintenance work, a key metric for evaluating the consolidated facility’s productivity and performance. Determining the total cost of delivering specific ship maintenance is important for other reasons as well. The Statement of Federal Financial Accounting Standard No. 4 states that reporting entities should accumulate and report the costs of their activities on a regular basis for management information purposes and that costs may be accumulated through cost accounting systems or “cost finding” techniques. The full cost of an output is the sums of (1) the cost of resources consumed that directly or indirectly contribute to the output and (2) the cost of identifiable supporting services provided by other entities. Also, we reported that the Navy had not implemented a method to routinely and systematically accumulate and account for the full cost of operations, such as tracking indirect overhead costs as closely under direct funding. We recommended in our 2001 report that the Navy implement a method to account for the total cost of consolidated ship maintenance operations on an ongoing basis. DOD concurred with our recommendation, and our current work supports the validity of this recommendation. The DOD-IG reported in December 2005 that cost information was not collected to determine the total cost (including all associated overhead costs) required to establish an overhead rate to charge non-DOD customers for maintenance performed. The DOD-IG found that, according to Puget Sound officials, under direct funding the consolidated activity no longer routinely accumulated costs necessary to compute an overhead rate to charge its customers. They did not track these costs because Commander, Pacific Fleet, is responsible for funding all overhead costs under mission funding.