In fiscal year 2014, the Air Force recorded payroll obligations of over $23 billion for direct compensation of active duty military personnel, a force of approximately 324,000. This compensation, including, among other things, basic pay, allowances, and incentives, was distributed among the various pay categories, as shown in figure 1. These pay categories are described later in this report. DOD has been unable to prepare auditable department-wide financial statements as required by the Government Management Reform Act of 1994. The National Defense Authorization Act for Fiscal Year 2010 mandated that DOD develop and maintain a Financial Improvement and Audit Readiness (FIAR) plan. The plan is to include, among other things, the specific actions to be taken and costs associated with (1) correcting the financial management deficiencies that impair DOD’s ability to prepare timely, reliable, and complete financial management information and (2) ensuring that DOD’s financial statements are validated as ready for audit by September 30, 2017. Per the FIAR plan, “audit ready” means the department has strengthened internal controls and improved financial practices, processes, and systems so there is reasonable confidence that the information can undergo an audit by an independent auditor. In response to difficulties encountered in preparing for an audit of the Statement of Budgetary Resources, DOD reduced the scope of initial Statement of Budgetary Resources audits beginning in fiscal year 2015 to focus on current-year budget activity reported on a Schedule of Budgetary Activity. This is an interim step toward achieving an audit of multiple-year budget activity required for an audit of the Statement of Budgetary Resources. In July 2014, the Air Force indicated that its fiscal year 2015 Schedule of Budgetary Activity would be audit ready and would be prepared in all material respects in conformity with U.S. generally accepted accounting principles. DOD requires the services to follow the FIAR Guidance methodology in asserting audit readiness. The guidance requires complete documentation that is sufficient, relevant, and accurate. The FIAR methodology also requires that the assertion documentation provide evidence demonstrating that the reporting entity has designed and implemented an appropriate combination of control activities and supporting documentation to mitigate the risk of material misstatement and achieve the financial reporting objectives. The Air Force Personnel Center is responsible for establishing and maintaining military personnel accounts in the personnel system. Once a servicemember’s personnel file is created, it is electronically transferred into the payroll system where a pay account is created for that servicemember. The personnel and payroll systems electronically interface daily to record any changes. Air Force Financial Services Office staff are responsible for submitting changes not driven by personnel actions, such as those concerning housing allowances. Documentation supporting payroll changes for individual servicemembers generally is to be scanned into one of two document management systems: one for personnel actions and another for all other changes. The Defense Finance and Accounting Service (DFAS), a separate component of DOD, processes the Air Force’s active duty military payroll using its Defense Joint Military Pay System-Active Component. DFAS systems also process the associated disbursements and record the entries to the general ledger maintained for the Air Force. Based on our testing, we determined that the Air Force and DFAS had in place systems and processes designed to provide a complete universe of active duty military pay transactions for the period we tested. The Air Force’s documented processes included reconciling payroll information with accounting, financial reporting, and disbursement information, designed to provide reasonable assurance that payroll transactions are properly recorded in the Statement of Budgetary Resources or the Schedule of Budgetary Activity and are consistent with personnel records. The Air Force provided us with transaction data processed by its payroll system for each of the first 10 months of fiscal year 2014 (October 1, 2013, through July 31, 2014) and the related reconciliations. We performed walk-throughs of each type of reconciliation discussed below. Based on those procedures we did not identify any concerns regarding Air Force processes and controls. However, our scope did not include all procedures that might be performed in a financial audit of the Statement of Budgetary Resources or the Schedule of Budgetary Activity. Reconciliation of payroll to personnel. We found that the Air Force performed a monthly reconciliation between the payroll system and personnel system and generally resolved mismatches within 45 days. To determine this, we reviewed documentation covering 1 month of the Air Force’s monthly reconciliation between the individual pay records in the payroll system and personnel system. This reconciliation helps reasonably assure that payees are actual servicemembers and that the characteristics that drive their pay, such as years of service and rank, match what is recorded in the personnel system. We reviewed the Air Force’s reconciliation for 1 month to gain an understanding of how the Air Force matches data elements. For data mismatches between the individual payroll records and personnel records that cannot be immediately resolved, the Air Force creates a tracking record to help reasonably assure that they are researched and resolved within 45 days, in accordance with Air Force guidelines. We tested the Air Force’s process by reviewing documentation detailing the monthly mismatch and aging statistics for open tracking records internally reported by the Air Force and found that the Air Force researches the mismatches. Reconciliation of payroll system to accounting system. We reviewed each of DFAS’s fiscal year 2014 quarterly reconciliations between the payroll and accounting systems and found that they accurately imported data from the payroll system and compared them to disbursement data in the accounting system, helping to reasonably assure that the population of transactions was completely reported in the accounting system. Because the payroll system does not interface directly with the accounting system, DFAS developed the Military Pay Reconciliation Tool (Reconciliation Tool), a Microsoft Access application, to facilitate this reconciliation process. The Reconciliation Tool tracks payroll data from the payroll system to the disbursements recorded in the accounting system. The Reconciliation Tool also allows DFAS to compare an individual servicemember’s Leave and Earnings Statement with detailed data in the payroll system. We tested the reconciliation process by reviewing documentation provided by the Air Force that demonstrated how data are processed through the payroll system in the form of vouchers and subsequently reconciled to the accounting system. Reconciliation of military pay to Fund Balance with Treasury (FBWT). We reviewed the monthly reconciliation DFAS performs for the Air Force between the accounting system and Treasury’s government-wide accounting system. According to Air Force officials, this multi-tiered reconciliation helps to assure that the recorded military payroll transactions were actually disbursed through Treasury accounts. We reviewed key documentation with Air Force personnel to understand the nature, timing, and frequency of the reconciliations. The documentation showed that the Air Force was able to tie military payroll to its FBWT reconciliation. In addition, we traced and agreed payroll system totals that included each of the 10 months to Treasury records. However, our scope did not include tests for all elements of the reconciliation, and we did not assess the accuracy of the recorded balance of FBWT. Reconciliation of accounting records to the Statement of Budgetary Resources. We found that DFAS was able to trace the recorded payroll to the Statement of Budgetary Resources. To determine this, we reviewed DFAS’s quarterly reconciliation between the accounting system and the financial reporting system. DFAS’s reconciliation between these systems helps to reasonably assure the accuracy of amounts reported in the Statement of Budgetary Resources. We reviewed each of DFAS’s fiscal year 2014 quarterly reconciliations of the accounting system and compared them to certain key line items of the Statement of Budgetary Resources— specifically, obligations incurred and gross outlays—of which a portion of the amounts in each included active duty direct compensation. We were able to trace the amounts in the payroll accounting system to the Statement of Budgetary Resources and found that they had been properly recorded. We selected statistical samples of six categories of military pay and, based on the testing we performed, found that while the Air Force could provide adequate supporting documentation for three of the categories, it was not able to provide or readily provide documentation for certain transactions involving Special Pay, Overseas Housing, and Domestic Housing. For fiscal year 2014, these three categories of military pay represented nearly 30 percent of active duty direct compensation obligations. We also tested a statistically selected sample of change order transactions, which represent pay from all categories initiating the start, stop, or update of an entitlement, and found that the Air Force could not provide documentation for certain of these transactions as well. The DOD Financial Management Regulation requires the military components to maintain documentation supporting all transactions recorded in finance and accounting systems. Additionally, Standards for Internal Control in the Federal Government and DOD’s FIAR Guidance require audited entities to document transactions and events, and to reasonably assure that internal controls are effective to help ensure that supporting documentation is maintained and readily available for management and audit purposes. Without adequate documentation to support its military payroll transactions, both the Air Force and DOD are at risk that military personnel may not be paid appropriately and financial statement auditability goals may not be achieved. To test the Air Force’s ability to provide supporting documentation, we selected several random statistical samples—a total of 360 active duty military payroll transactions—from transactions recorded during the first 10 months of fiscal year 2014 (October 1, 2013, through July 31, 2014) except for Domestic Housing for which a single month of transactions was selected. This included a sample of 90 change actions, which represent changes to a servicemember’s status or entitlements that could affect any of the pay categories. We drew separate random statistical samples of 45 transactions from each of the categories of military pay listed below. These six categories, which are defined below, accounted for approximately 94 percent of the Air Force’s fiscal year 2014 total active duty direct compensation obligations. Basic Pay is the primary form of pay for most servicemembers and is based on rank and years of service. In fiscal year 2014, it accounted for over 60 percent of active duty direct compensation obligations.