Financial Management: Status of the Defense Business Operations Fund
(Letter Report, 03/09/94, GAO/AIMD-94-80).

The Defense Business Operations Fund maintains a contractual
(buyer-seller) relationship with its customers, primarily the military
services. Although the fund could have an estimated $85 billion in
revenues by fiscal year 1994, which would make it one of the largest
corporations in the world, the fund operates on a break-even basis by
recovering the costs incurred in conducting its operations. The fund
provides such essential goods and services as the overhaul of ships,
tanks, and aircraft and the sale of more than five million kinds of
vital inventory items, such as landing gears for aircraft. The Defense
Department's (DOD) 1993 plan to improve fund operations underscored the
need for policies and procedures governing fund operations, better
financial reports, and reliable financial systems to accumulate and
report on operation results. Although DOD has made progress in
implementing the plan, key steps designed to improve the fund's
policies, procedures, and systems are not scheduled to be completed
until later this fiscal year or next fiscal year. As a result, the fund
continues to face operational problems. Antiquated systems and flawed
data will continue to seriously impair DOD's ability to obtain reliable
data on the results of operations. Short-term efforts, such as improving
the accuracy of the financial data in existing systems, must be given
high priority if the fund's current operations are to improve. DOD will
not achieve the fund's objectives until its systems are successfully
upgraded.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-94-80
     TITLE:  Financial Management: Status of the Defense Business 
             Operations Fund
      DATE:  03/09/94
   SUBJECT:  Financial management systems
             Revolving funds
             Defense cost control
             Federal agency accounting systems
             Accounting procedures
             Internal controls
             Financial management
             Computerized information systems
             Financial records
IDENTIFIER:  Defense Business Operations Fund
             Defense Business Operations Fund Improvement Plan
             DOD Corporate Information Management Initiative
             CIM
             
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Cover
================================================================ COVER


Report to Congressional Requesters

March 1994

FINANCIAL MANAGEMENT - STATUS OF
THE DEFENSE BUSINESS OPERATIONS
FUND

GAO/AIMD-94-80

Defense Business Operations Fund


Abbreviations
=============================================================== ABBREV

  CIM - Corporate Information Management
  DFAS - Defense Finance and Accounting Service
  DOD - Department of Defense

Letter
=============================================================== LETTER


B-249045

March 9, 1994

Congressional Requesters

The National Defense Authorization Act for Fiscal Year 1994\1

directed the Secretary of Defense to submit to the congressional
Defense committees a comprehensive management plan to improve the
operations of the Defense Business Operations Fund by December 30,
1993, and to report on progress in implementing the plan by February
1, 1994.  The act further requires that we evaluate and report on the
Department of Defense's (DOD) progress.  In a related matter, Senator
Grassley requested that we evaluate the Fund's cash management
practices.  The purposes of this report are to (1) provide an update
on the status of the Fund's operations, including those related to
cash management, (2) describe DOD's progress in addressing identified
problems through its comprehensive plan, and (3) discuss DOD's
approach to managing the Fund. 

We continue to support the Fund's concept.  If the Fund is operated
in an efficient and effective manner, it can contribute to a
significant improvement in DOD operations.  The Fund's primary goal
is to focus the attention of all levels of management on the total
costs of carrying out certain critical DOD business operations and
the management of those costs.  Better information on business
operations should enable DOD management and the Congress to make more
informed policy decisions as DOD continues to adapt to a much smaller
force structure and a new world environment.  Accomplishing these
objectives will require DOD managers to become more conscious of
operating costs and make fundamental improvements in how DOD conducts
business. 

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.  It is estimated that in
fiscal year 1994, the Fund will have revenue of about $85 billion,
which would make it one of the largest corporations in the world. 
However, unlike a private sector enterprise which has a profit
motive, the Fund should operate on a break-even basis by recovering
the costs incurred in conducting its operations.  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
are essential to maintaining the military readiness of our country's
weapon systems. 

Since the concept of the Fund was first put forth in February 1991,
we have monitored and evaluated its implementation and operation.  We
have previously reported\2 that DOD has not achieved the Fund's
objectives because

  policies critical to the Fund's operations either were not
     developed or needed to be revised;

  the Fund's financial reports were inaccurate; and

  the cost accounting systems were fragmented, costly to maintain,
     and did not provide the cost information necessary for managers
     to better control costs. 

In addition, in an October 1993 letter (GAO/AIMD-94-7R) to the Deputy
Secretary of Defense, we suggested that DOD appoint a Fund director
under the auspices of the Deputy Secretary of Defense to provide the
necessary management focus and resolve the problems confronting the
Fund. 


--------------------
\1 Public Law 103-160, November 30, 1993. 

\2 See Related GAO Products list in the back of this report. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

On September 24, 1993, DOD approved the Defense Business Operations
Fund Improvement Plan.\3 The plan identifies dozens of actions and
related tasks to be taken to improve the operations of the Fund,
assigns responsibility, and establishes milestones for completing the
actions and tasks.  The plan addresses all known problems that have
hindered the operations of the Fund.  For example, the plan
identifies the need for (1) policies and procedures governing the
operations of the Fund, (2) improved financial reports, and (3)
reliable financial systems to accumulate and report on the results of
operations. 

In its February 1, 1994, progress report, DOD stated that it had made
significant progress in improving the operations of the Fund.  We
agree that DOD has made some progress.  However, much work remains to
be done since most of the actions and tasks aimed at correcting the
more difficult fundamental problems with the Fund's policies,
procedures, systems, and financial reports are scheduled to be
completed by the end of fiscal year 1994 or in fiscal year 1995. 

While correcting the Fund's fundamental problems, particularly the
implementation of financial systems, will require a long-term effort,
it is especially important for DOD to also pursue short-term,
building block efforts to begin improving the accuracy of the Fund's
financial information.  Considering the past difficulties DOD has
experienced in implementing the Fund, it is essential that every
effort be made to stay on schedule to meet key milestone dates.  We
believe that completing the following short-term critical actions
within the milestones prescribed by the plan will be key to DOD
making future progress in resolving the Fund's problems and will
build the foundation for further improvements: 

  Complete all Fund policies by December 31, 1994. 

  Select the systems to account for the Fund's resources by September
     30, 1994, and begin implementing these systems by December 31,
     1994. 

  Impose greater discipline to improve the accuracy of the monthly
     financial reports that provide information on the profit/loss of
     each business area by December 31, 1994. 

The problems confronting the Fund are symptomatic of DOD's overall
financial management operations.  In its January 1994 annual report
to the President and the Congress, DOD acknowledged that in the past
its top management considered accounting, business-type efficiency,
and indirect support functions to be of secondary importance.  The
report further noted that the limited attention to improving
financial management threatens our nation's combat forces because it
creates problems that waste money that is needed more than ever to
sustain sufficient military readiness.  The report's recognition of
the problems in financial management represents a marked change in
DOD's management philosophy.  This changed attitude is a step in the
right direction and will contribute to the ultimate success of DOD's
reform initiatives, such as the Defense Business Operations Fund. 


--------------------
\3 On January 4, 1994, DOD provided this plan to the congressional
Defense committees in response to Public Law 103-160. 


   BACKGROUND
------------------------------------------------------------ Letter :2

Over the past 2 years, congressional committees, the DOD Inspector
General, the military services' audit agencies, and our reports have
identified serious weaknesses in DOD's management and operation of
the Fund--long-standing problems that were inherited from the old
stock and industrial funds.  A DOD-wide review of the Fund confirmed
that these problems adversely affected the Fund's operations.  These
problems have resulted in DOD's inability to accurately account for,
control, and report on the Fund's $85 billion annual operation. 
Further, as part of DOD's annual assessment of its internal controls
under the Federal Managers' Financial Integrity Act, the Defense
Finance and Accounting Service (DFAS) reported the Fund's accounting
and reporting as a material weakness in its fiscal year 1993 annual
statement of assurance on its operations to the Secretary of
Defense.\4

On April 20, 1993, the Secretary of Defense directed a comprehensive
and detailed review of the Fund's operations.  To accomplish this,
DOD established a task force of 80 experts from varying levels of DOD
operations and management with financial and functional experience to
review the Fund.  They concentrated on eight areas:  (1)
organization, (2) education and training, (3) budget, (4) accounting
policy, (5) centralized system development, (6) financial management
systems, (7) cash management, and (8) financial reporting.  The task
force issued a report containing its recommendations on July 30,
1993. 

A Steering Committee of senior officials in the Office of the
Secretary of Defense, the Army, the Navy, the Air Force, and DOD
components reviewed the recommendations in the task force report,
candidly discussed the problems hindering the Fund's implementation
and operation, and identified the needed corrective actions.  The
Steering Committee also obtained the views of GAO, the Office of
Management and Budget, the DOD Inspector General, and outside
consultants on the problems hindering the Fund. 

DOD endorsed the continuation of the Fund and developed the Defense
Business Operations Fund Improvement Plan.  On September 24, 1993,
the Deputy Secretary of Defense and the secretaries of the Army,
Navy, and Air Force approved the plan.  This plan consists of 56
actions and 183 tasks aimed at improving the Fund's operations.  In
response to Public Law 103-160, DOD provided this plan to the
congressional Defense committees on January 4, 1994, and reported on
its progress in implementing the actions and tasks in the plan on
February 1, 1994. 


--------------------
\4 As of March 1, 1994, the Secretary of Defense had not filed the
DOD-wide report on internal controls that was due on December 31,
1993, under the Federal Managers' Financial Integrity Act. 
Therefore, we do not know if the Secretary also considers the Fund's
accounting and reporting to be a material weakness for DOD as a
whole. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :3

To accomplish our objectives we reviewed the Fund plan that DOD
approved on September 24, 1993, and DOD's February 1, 1994, progress
report on the Fund.  In reviewing the plan, we determined if (1) it
addressed all known deficiencies identified by GAO, congressional
committees, the DOD-wide review, the DOD Inspector General, and the
military services' audit agencies and (2) specific actions were
identified to correct each of the deficiencies.  We met with DOD
officials to (1) discuss the planned corrective actions and
milestones for completing them and (2) determine if DOD was
completing the corrective actions in accordance with the scheduled
milestone dates.  We also analyzed reports and interviewed DOD
officials to determine the status of DOD's efforts in correcting the
Fund's problems and DOD's approach to managing the Fund. 

To evaluate DOD's management of the Fund's cash balance, we collected
and analyzed financial information related to collections and
disbursements.  Our analysis of the disbursement data included
determining the magnitude and causes of disbursements that had not
been matched to corresponding obligations.  Further, we evaluated
actions being taken to improve the Fund's cash position through
discussions with appropriate Office of the Secretary of Defense
officials and the analysis of pertinent documentation. 

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; the DFAS headquarters; the Columbus,
Denver, Cleveland, and Indianapolis DFAS Centers; and selected Fund
business activities.  Our review was performed from June 1993 through
February 1994 in accordance with generally accepted government
auditing standards. 

We discussed the facts and conclusions in our report with cognizant
DOD officials.  Their comments have been incorporated where
appropriate. 


   PERSISTENT PROBLEMS HINDER FUND
   OPERATIONS
------------------------------------------------------------ Letter :4

The Fund provides a mechanism through which DOD can adopt a
businesslike approach for identifying and reducing its operating
costs.  However, to date, DOD has not achieved this objective.  In
April 1991, we pointed out that DOD did not have the framework in
place to operate the Fund in an efficient and effective manner. 

Today, almost 3 years later, many of the same fundamental problems
continue to exist.  DOD's ability to properly manage the Fund
continues to be hindered because of its inability to (1) manage cash,
(2) develop policies and procedures, (3) enhance financial systems,
and (4) produce accurate financial reports on the results of
operations.  These problems, which DOD is now trying to address
through the plan, are highlighted below and discussed in further
detail in appendix I. 

  Cash Management:  Some problems affecting the Fund's operations are
     also causing difficulties in DOD's management of the Fund's cash
     balance.  Successful operation of the Fund is critical to
     effective cash management.  The Fund did not have sufficient
     cash to make a $5.5 billion transfer directed by the National
     Defense Authorization Act for Fiscal Year 1993.  To alleviate
     this situation, DOD began to advance bill customers in June 1993
     for goods and services to be provided.  If DOD had not advance
     billed, the Fund's cash balance would have been a negative $1.6
     billion as of January 31, 1994. 

In addition, at least $4.7 billion in Fund disbursements had not been
matched with the corresponding obligations as of September 30, 1993. 
Unmatched disbursements put DOD at risk that erroneous payments may
have been made without detection and that total disbursements may
have exceeded the amount authorized by the Congress.  A major cause
of unmatched disbursements is the time it takes from making the
payment to transmitting disbursement data to various DOD activities
to recording the disbursement data against the proper obligations. 
This process can take from 1 to 6 months and, in some cases, is
manually intensive.  The problem with unmatched disbursements is not
unique to the Fund; it also applies to DOD's overall financial
operations. 

  Fund Policies:  DOD acknowledges that one of the most significant
     weaknesses of the Fund's implementation has been the development
     of policies and procedures.  Some policies need to be developed,
     others need to be revised, and all need to be fully coordinated
     (for example, DOD's policy on recognizing revenue and billing
     customers for work performed).  As a result of not having or
     enforcing the Fund's policies, DOD components are performing
     similar functions in different ways.  For example, DOD reported
     that due to insufficient policy guidance, Fund managers were
     forced to make their own interpretation regarding how to report
     on the operations of their respective business areas.  Until the
     Fund's policies are in place and followed, DOD cannot ensure
     that the Fund is operating in a consistent manner, and the Fund
     will continue to be faced with incomplete and inconsistent
     information. 

  Financial Systems:  DOD has acknowledged that the Fund's financial
     systems are inadequate.  The Fund has 80 disparate, unlinked
     financial systems and approximately 200 ancillary systems that
     provide financial data.  Consequently, accounting data are often
     not complete, timely, or useful.  For example, the Fund's fiscal
     year 1993 financial information on the results of operations
     differed by $6.1 billion from the data used in preparing the
     Fund's budget.  These data should be the same.  Systems that
     produce credible cost data on the results of operations are
     essential.  These data are considered in setting the prices the
     Fund will charge its customers.  In turn, the prices should be
     used as a basis for establishing customers' budget requests. 

  Financial Reports:  DOD has acknowledged that the Fund's financial
     reports are inaccurate.  Further, because the fiscal year 1992
     year-end financial statements were incomplete and audit trails
     were inadequate, the DOD Inspector General was unable to express
     an opinion on the Fund's financial statements in performing the
     audit required by the Chief Financial Officers Act.  Financial
     reports can be important tools to better determine, understand,
     explain, and justify the costs of operation.  Accurate and
     reliable financial reports are critical for management to
     analyze trends, make comparisons among similar business areas
     (such as depot maintenance for the military services), and
     measure budget execution.  Meaningful and reliable financial
     reports are also essential for the Congress and the Office of
     Management and Budget in exercising their oversight
     responsibilities. 

DOD has stated, and we agree, that the full achievement of the Fund's
objectives "hinges on standardized and modernized finance and
accounting systems." DOD plans to select, from the existing Fund
systems, those that will be used to account for the Fund's costs and
resources by September 30, 1994, and to begin implementing these
systems for the Fund's operations by December 31, 1994.  Given DOD's
history of difficulty in implementing systems, these time frames,
though achievable, will have to be closely monitored. 

DOD has cited the Corporate Information Management (CIM) initiative
as the long-term solution to its system problems.  CIM is intended to
reduce or eliminate systems in the military services and DOD
components that perform the same function.  While CIM initially
appeared to be a promising undertaking, it has had limited success to
date in enhancing DOD's systems,\5 and it will be several years
before the Fund's systems are fully implemented.  Given today's
environment of budget reductions, DOD cannot afford to let this
critical effort fail. 

Given the pressing need for reliable data and the fact that the
planned system improvement efforts will be a long-term venture, it is
important for DOD to concurrently pursue short-term efforts to
improve the quality of its financial information.  During the course
of our financial audits and in previous reports on the Fund, we have
stressed the need for DOD to improve existing operations and not wait
for the implementation of new systems.  Operating improvements could
be obtained under the present systems. 

For example, the financial reports prepared during fiscal years 1992
and 1993 could have been improved if DOD had (1) exercised more
discipline in following and enforcing existing policies and
procedures, (2) routinely reviewed and analyzed its monthly reports
to identify inaccuracies, and (3) taken the steps needed, such as
providing additional guidance to field activities, to correct the
identified problems.  Our review of the Fund's monthly financial
reports disclosed that the Navy supply management business area had a
reported profit of $23.1 billion as of May 1993.  A review of the
report by DFAS personnel would have shown that the reported profit
was over five times greater than the reported revenue of $4.3 billion
and, therefore, in error.  If DOD does not undertake the necessary
short-term actions, the reports on the Fund's operations in fiscal
years 1994 and 1995 may be no more reliable than those issued for
fiscal years 1992 and 1993. 


--------------------
\5 Financial Management:  Defense Business Operations Fund
Implementation Status (GAO/T-AFMD-92-8, April 30, 1992). 


   PLAN ADDRESSES KNOWN PROBLEMS
   BUT SOME MILESTONES NOT MET
------------------------------------------------------------ Letter :5

According to our analysis, DOD's September 1993 plan on the actions
and tasks to improve Fund operations addresses known deficiencies. 
To correct the Fund's deficiencies, the plan identified 56 actions,
subdivided into 183 specific tasks.  The plan also identified the
offices responsible for performing the tasks and the scheduled task
completion dates.  The actions are divided into four categories:  (1)
accountability and control, (2) Fund structure, (3) policy and
procedures, and (4) financial systems. 

In its February 1, 1994, progress report on the Fund, DOD stated that
it had made significant progress in improving Fund operations.  While
we recognize that DOD has made some progress, (1) the progress report
covers the first 3 months of a plan that will require several years
to complete and (2) DOD completed only 18 of the 44 planned tasks
covering the Fund's policies, procedures, and systems that were
scheduled to be completed by December 31, 1993. 

For the accountability and control and the Fund structure categories,
DOD completed 10 of the 11 actions planned to be accomplished by
December 31, 1993.  For example, under the accountability and control
category, DOD (1) established the Fund's Corporate Board, (2)
identified specific DOD offices to be responsible for certain areas
(for example, DFAS assumed responsibility for the Fund's accounting
procedures and systems), (3) decided that the Office of the Secretary
of Defense should continue to be responsible for the cash
Antideficiency Act\6 controls, and (4) directed that explanations of
budget/cost changes be provided within 30 days of issuing the initial
annual operating budgets to Fund activities. 

Within the policy and procedures and financial systems categories,
DOD completed 6 of the 9 planned actions but only 18 of the 44 tasks
by the December 31, 1993, milestone.  Some tasks not completed
include (1) developing Fund draft policy guidance on management
headquarters cost, military personnel cost, economic analysis for
capital projects, and adjustments to financial reports and (2)
improving the monthly financial report which provides information on
revenue, costs, and profit/loss.  It is critical that all tasks be
completed within the established time frames because undertaking many
scheduled future tasks is contingent upon earlier tasks being
completed promptly. 

In our October 1993 letter to the Deputy Secretary of Defense, we
expressed concern that DOD may not be able to meet the plan's
milestones.  DOD has not successfully completed past actions on
schedule to correct the Fund's problems.  For example, in May 1992,
DOD issued the Defense Business Operations Fund Implementation Plan. 
This document indicated that all but one of the Fund's policies would
be completed by September 1992.  However, as discussed earlier, key
policies, such as cash management, have yet to be finalized.  In
another case, the National Defense Authorization Act for Fiscal Year
1993 required DOD to develop performance measures and corresponding
goals for each of the Fund's business areas by March 1, 1993.  DOD
has developed performance measures for the Fund but has just begun
developing the required corresponding goals for some business areas,
such as the Defense Logistics Agency's supply management and
distribution depots. 

Successful implementation of the Fund will require continued
commitment from DOD's top management to ensure that the milestones in
the plan are successfully met.  We believe that completing the
following critical actions within the milestones prescribed by the
plan will be key to DOD's progress in resolving the Fund's problems: 

  Complete all Fund policies by December 31, 1994.  Subsequently,
     these policies need to be implemented in a uniform manner to
     help ensure that the Fund's business areas operate with standard
     policies and procedures. 

  Select the systems to account for the Fund resources by September
     30, 1994, and begin implementing these systems by December 31,
     1994.  The implementation of these systems, which is a long-term
     effort, will reduce the number of Fund systems and serve as the
     foundation for the implementation of a standard integrated
     system to improve the Fund's operations.  Since DOD will have to
     continue to rely on existing systems and reports in the near
     term, it is imperative that DOD pursue short-term efforts to
     improve the accuracy and reliability of the financial data. 

  Improve the accuracy of the monthly financial reports that provide
     information on the profit/loss of each business area by December
     31, 1994. 

Until the actions and tasks related to the policies, procedures, and
systems categories are completed and fully implemented, DOD will not
be in a position to identify the total cost of operations, and
managers will continue to lack the data needed to reduce these costs. 


--------------------
\6 The Antideficiency Act, 31 U.S.C.  1341(a)(1), 1517, provides that
no officer or employee of the government shall make or authorize an
expenditure or obligation exceeding the amount of an appropriation or
fund available for the expenditure or obligation. 


   STRONG LEADERSHIP AND
   MANAGEMENT NEEDED TO ADDRESS
   FUND PROBLEMS
------------------------------------------------------------ Letter :6

The Fund has been under the direction of the Office of the
Comptroller since its inception.  However, until recently, the
Comptroller did not always have the DOD-wide support needed to
effectively deal with and resolve the long-standing problems that the
Fund inherited from the old stock and industrial funds and that have
continued to impair the operations of the Fund.  From the outset, DOD
management underestimated the magnitude, complexity, and difficulty
of operating an $85 billion enterprise.  DOD now recognizes the
challenges it faces and the need to place priority on financial
management improvements. 

Because of the problems with the operation of the Fund, we suggested
in our October 1993 letter to the Deputy Secretary of Defense that
DOD appoint a Fund director.  In response to that letter, DOD stated
that it has an alternative management approach in place to resolve
the problems with the Fund.  Instead of a Fund manager, DOD has
appointed the DOD Comptroller to oversee the implementation of the
plan.  The Comptroller chairs the Defense Business Operations Fund
Corporate Board, which was established in December 1993.  The
Corporate Board is comprised of functional and financial senior
executives, who represent the interests of the Fund and its
customers--primarily the military services. 

DOD's approach could resolve the problems with the Fund.  However, it
is very similar to the Fund Board the DOD Comptroller established
when the Fund was created over 2 years ago.  Successful
implementation of the current board approach rests heavily upon many
components of DOD working together without specific hierarchical
direction from one manager with overall responsibility and authority
for implementation.  Including outside experts could provide some
additional insights and perspective on resolving the Fund's problems. 

The collaboration of the Comptroller and the Corporate Board is
essential to ensuring that the plan is successfully executed and that
the problems hindering the Fund's operations are corrected.  Because
the Fund involves several functional areas, the Fund's problems can
only be corrected if these areas work in unison.  The most critical
areas involved are the various accounting, financial, logistical, and
personnel systems that provide the information included on the Fund's
financial reports. 

Because this management approach is extremely difficult to manage,
particularly in a highly structured entity as DOD, periodic
assessments would enable the Secretary of Defense to determine
whether the current management approach is resolving the Fund's
problems within the time frames set forth in the plan.  If not, DOD
could reconsider the option of using a Fund director, as we
previously suggested, to oversee the management of the Fund and the
implementation of the plan. 


   CONCLUSIONS
------------------------------------------------------------ Letter :7

DOD has made progress in completing the actions and tasks in the
plan.  Most importantly, DOD has recognized the seriousness of the
problems affecting the Fund.  However, the key tasks aimed at
improving the Fund's policies, procedures, and systems--which are
crucial to satisfying the basic Fund objectives--are not scheduled to
be completed until later this fiscal year or next fiscal year. 

Until these actions are completed, especially the implementation of
enhanced systems, the Fund will continue to be faced with operational
problems.  Antiquated systems and flawed data continue to seriously
impair DOD's ability to obtain reliable data on the results of
operations.  Short-term efforts, such as improving the accuracy of
the financial data in existing systems, must be given a high priority
to improve the Fund's current operations. 

DOD will not fully achieve the Fund's objectives until its systems
are successfully upgraded.  Implementing these systems will require a
long-term commitment by DOD.  In the past, DOD has had limited
success in systems implementation, and many promises of management
improvement that hinge on new systems have remained unfulfilled.  The
continued leadership and commitment of the Secretary of Defense and
key DOD managers will be critical to the success of DOD's planned
improvements. 


---------------------------------------------------------- Letter :7.1

We are sending copies of this report to the Secretary of Defense; the
Director of the Office of Management and Budget; the Chairmen and
Ranking Minority Members of the Senate Committee on Governmental
Affairs and the House Committee on Government Operations; and other
interested parties.  We will make copies available to others upon
request. 

Please contact me at (202) 512-2666 if you or your staffs have any
questions concerning this report.  Major contributors to this report
are listed in appendix II.






David O.  Nellemann
Director, Information Resources
 Management/National Security and
 International Affairs

List of Requesters

The Honorable Sam Nunn
Chairman
The Honorable Strom Thurmond
Ranking Minority Member
Committee on Armed Services
United States Senate

The Honorable Daniel K.  Inouye
Chairman
The Honorable Ted Stevens
Ranking Minority Member
Subcommittee on Defense
Committee on Appropriations
United States Senate

The Honorable Ronald V.  Dellums
Chairman
The Honorable Floyd D.  Spence
Ranking Minority Member
Committee on Armed Services
House of Representatives

The Honorable John P.  Murtha
Chairman
The Honorable Joseph M.  McDade
Ranking Minority Member
Subcommittee on Defense
Committee on Appropriations
House of Representatives

The Honorable Charles E.  Grassley
United States Senate


PERSISTENT PROBLEMS HINDER FUND
OPERATIONS
=========================================================== Appendix I

In April 1991--5 months before the Fund began operations--we
testified that DOD did not have the policies, procedures, and systems
in place to operate the Fund in a businesslike manner.  Today, after
more than 2 years of operations, many of the problems discussed in
our April 1991 testimony persist.  Defense still faces major
challenges in (1) managing the Fund's cash, (2) developing the Fund's
policies, (3) developing and implementing an integrated financial
management system, (4) producing accurate financial reports on the
results of the Fund's operations, and (5) developing performance
measures for the Fund. 

FUND'S CASH MANAGEMENT PROBLEMS
CONTINUE

Although we have testified and reported on many occasions that DOD
needs to develop a cash management policy, DOD still has not done so. 
In general, an effective cash management policy would (1) prescribe
the minimum and maximum amounts of cash needed to support the Fund's
operations, (2) address those functions that affect the Fund's cash
balance, such as billing customers, collecting accounts receivables,
and paying contractors for items procured, (3) provide for cash
forecasting, and (4) hold military services and DOD agencies
accountable for cash outlay targets.  DOD's plan identified several
actions designed to remedy the cash management problems, including
the development of comprehensive cash management policies and
procedures by March 31, 1994. 


      ADVANCE BILLING USED TO
      ALLEVIATE CASH SHORTAGE
------------------------------------------------------- Appendix I:0.1

Effective cash management is critical to the successful operation of
the Fund because of the billions of dollars involved in collections
and disbursements each year.  DOD estimates that the Fund will
collect and disburse over $85 billion and $83 billion, respectively,
in fiscal year 1994.  However, DOD continues to experience
difficulties in effectively managing the Fund's cash. 

Recognizing that the Fund's operations would not generate adequate
cash to complete the transfers of $5.5 billion as required by the
National Defense Authorization Act for Fiscal Year 1993, the DOD
Principal Deputy Comptroller directed in June 1993 that all depot
maintenance and selected research and development activities advance
bill customers for goods and services to be provided.  DOD reported
that approximately $5.6 billion has been advance billed.  If the Fund
had not advance billed customers, the Fund's balance would have been
a negative $1.6 billion as of January 31, 1994.  In our view, advance
billing is more of a stopgap measure than a sound business practice. 
DOD plans to start eliminating the advance billing during fiscal year
1994 and anticipates completely eliminating it during fiscal year
1995.  However, a plan to accomplish this has not been finalized. 


      RESTRICTIONS ON PROCURING
      INVENTORY COULD GENERATE
      CASH FOR THE FUND
------------------------------------------------------- Appendix I:0.2

DOD had anticipated that restrictions imposed on replacing inventory
sold to customers would improve the Fund's cash position since the
Fund would purchase less inventory than it sold.  For fiscal years
1993 and 1994, the Congress imposed a 65-percent limitation on the
amount of inventory DOD could procure to replace inventory the Fund
sold to customers.  The restriction was aimed at reducing DOD
inventory levels. 

For fiscal year 1994, DOD estimated that the Fund's supply management
and commissary business areas would have sales of approximately $47
billion.  However, various types of inventory items or
operations--such as fuel, subsistence, and repair of repairable
inventory--are exempted from the replacement limitation.  Due to the
exemptions, the 65-percent limitation only applies to about $7
billion of the $47 billion in sales.  A DOD official told us that the
65-percent limitation could generate about $1.5 billion to $2 billion
in cash each year.  Although this inventory replacement limitation
could help improve the Fund's cash balance, it will not resolve the
Fund's cash shortage problem. 


      DOD UNABLE TO MATCH
      $4.7 BILLION OF FUND
      DISBURSEMENTS WITH
      OBLIGATIONS
------------------------------------------------------- Appendix I:0.3

Further inhibiting DOD's ability to effectively manage the Fund's
cash balance is its failure to match disbursements with the
corresponding obligations.  Matching disbursements with related
obligations is necessary to ensure that reliable information exists
on the amount of operating funds available for obligation and
expenditure.  The inability to properly match disbursements with
obligations puts DOD at a substantial risk that erroneous payments
may have occurred without detection, cumulative amounts of
disbursements may exceed legal limits, and the Fund's operating cash
balance may be incorrectly stated. 

Based on our review of available documentation, DOD had not matched
at least $4.7 billion in Fund disbursements with the corresponding
obligations as of September 30, 1993.  This amount, however, is
understated.  The following examples illustrate this point. 

  Air Force installations record Fund disbursements in their
     accounting records even when the disbursements do not belong to
     them.  The Air Force calls this practice "forced posting."
     Although these disbursements are not matched to the correct
     corresponding obligations, they are no longer identified as
     unmatched.  Because there is no obligation to record the
     disbursements against, forced posting creates at the
     installation level what are referred to as negative unliquidated
     obligations, which are tracked and researched as such by the
     installation.  These unmatched disbursements are not reported to
     Fund managers at DFAS-Denver for control purposes.  DFAS-Denver
     officials were unaware of the dollar value of unmatched
     disbursements caused by forced posting. 

  Amounts reported by the Fund's business areas are netted as the
     data are "rolled up" for management reporting.  The amounts,
     which are normally positive, are netted against negative amounts
     that occur because of data processing errors, duplicate
     payments, or clearing actions.  This netting takes place from
     the lowest reporting level to the highest reporting level and
     results in incorrect amounts of unmatched disbursements being
     reported.  For example, DFAS-Columbus accounts for nine Fund
     business areas.  One of the business areas reported that it had
     $498 million in unmatched disbursements as of September 30,
     1993.  However, by the time this amount was summarized with the
     other eight areas, the accumulated or total amount reported was
     $296 million. 

DOD officials informed us that a primary cause of unmatched
disbursements is the time it takes to process disbursement
transactions.  Officials told us that the processing of disbursement
transactions can take from 1 to 6 months.  DOD's lengthy processing
time is attributable to the flow of disbursement data and the
manually intensive process used to record that data.  DOD components
routinely make disbursements on behalf of each other.  Even within a
given DOD component, such as the Air Force, one activity will make
disbursements for another activity.  To be recorded in DOD's
accounting records, the disbursement data must flow from the activity
making the disbursement (paying station) to the activity responsible
for recording the disbursement and matching it to the related
obligation (accountable station). 

Further exacerbating the problem is the data flow used by the
individual DOD components to get the disbursement data to their
respective accountable stations for entry into the accounting
records.  For example, Air Force transactions flow from the paying
station through DFAS-Denver to the Air Force accountable station. 
Navy disbursements flow essentially the same way, except the data
flows through DFAS-Cleveland to the accountable station.  The Army
uses a more simplified flow:  its disbursements flow from the paying
station directly to the Army accountable station if the paying
station is an Army activity or DFAS-Columbus.  Disbursements made for
the Army by the Air Force, Navy, and non-DOD organizations flow
through DFAS-Indianapolis to the Army accountable station. 

Disbursement transaction processing time is lengthened because the
recording of data is manually intensive.  For example, at the end of
fiscal year 1993, DFAS-Columbus had approximately 44,000 unprocessed
transaction vouchers valued at $454 million resulting from
cross-disbursing activities.\1 DFAS-Columbus officials estimated that
entering the unprocessed transactions into the system would equate to
about 1 year's worth of work.  DOD officials attribute the manual
entry of data to the lack of integration and automated interfaces
between the Fund's various systems. 

DOD's failure to match disbursements with obligations applies not
only to the Fund, but throughout DOD.  Our past reports have shown
that DOD components have historically had problems in matching
disbursements with the corresponding obligations.  Prompted by our
report on the Navy's $12 billion unmatched disbursements,\2 a
DOD-wide review was initiated to address the unmatched disbursement
problem.  DOD acknowledged that the total amount of DOD disbursements
not properly matched to obligations was about $41 billion.  Further,
DFAS has recognized unmatched disbursements as a material weakness in
its fiscal year 1993 annual statement of assurance to the Secretary
of Defense.\3

CRITICAL POLICIES NOT DEVELOPED

Over the past 3 years, we have pointed out that DOD has not developed
the necessary policies to operate the Fund.  DOD acknowledges that
one of the most significant weaknesses of the Fund's implementation
has been the lack of standard polices.  Given the immense size,
complexity, and scope of the Fund's $85 billion in operations, the
need for such policies is particularly acute.  Fund managers have
lacked the necessary guidance to execute the day-to-day operations of
the Fund's various activities.  This has resulted in problems related
to budgeting, accounting, and reporting for the business areas of the
Fund.  For example, DOD reported that due to insufficient policy
guidance, Fund managers were forced to make their own interpretations
regarding how to report on the operations of their respective
business areas.  Consequently, the Fund's financial reports reflected
the inconsistent application of policies across the business areas. 
DOD further reported that the lack of detailed procedural guidance
contributed to numerous after-the-fact changes and retroactive
adjustments to the reports. 

DOD's plan includes tasks to develop and implement standard Fund
policies and, as a result, DOD has two efforts currently underway. 
First, DOD is drafting Fund guidance, which will be included in the
DOD Financial Management Regulation.  The draft accounting guidance
for the Fund consists of 14 chapters.  According to the Fund's plan,
DOD plans to (1) coordinate the draft guidance with the military
services and DOD components by March 1994 and (2) implement the
guidance by December 1994.  Second, DOD established the Special
Committee for Oversight of Policy Action, which is responsible for
reviewing issues related to the Fund's policies.  DOD plans on this
group's work being completed by June 1994. 

However, issuing the policies will be only the first step.  The
Fund's various field activities will need even more detailed
procedures to implement these policies.  For example, once DOD issues
its revised revenue recognition policy, it will need to develop
procedures on how the policy is to be implemented in a uniform manner
throughout the Fund's business areas.  In addition, a very
substantial effort will be needed to train the people who will be
implementing the policies.  A major action in DOD's plan is aimed at
ensuring proper implementation of policies and procedures through
educating and training personnel on the conceptual framework of the
Fund and the mechanics of its implementation.  Once these policies
are issued, some will require significant revisions to the supporting
information systems.  Until implementation of the new policies is
achieved and changes are made to the systems, the benefits of the new
policies will not be realized. 

FUND LACKS INTEGRATED FINANCIAL
MANAGEMENT SYSTEM

The Fund is supported by the same systems that existed under the old
stock and industrial funds and, consequently, inherited the multiple
problems of those systems.  The Fund has 80 disparate, unlinked
financial systems and approximately 200 ancillary systems that
provide financial data.  As a result, the Fund's accounting systems
do not provide complete and accurate information on the results of
its operations.  These complex, serious, and long-standing problems
adversely affect DOD's ability to accurately account for, control,
and manage billions of dollars of resources.  DOD's plan acknowledged
the serious problems with the Fund's systems. 

The plan identifies numerous tasks aimed at improving the Fund's
financial systems, such as using the DOD standard general ledger and
developing a standard budget accounting and classification code.  DOD
plans to select the systems to account for the Fund's costs and
resources by September 30, 1994, and to begin implementing these
systems by December 31, 1994. 

Developing and implementing systems that produce credible cost data
is essential for successful Fund operation.  Users of the cost data,
such as Fund customers, must be assured that the cost data are
accurate because the data will be used as the basis to bill them for
the goods and services they receive.  Also, the cost data must be
accurate for congressional oversight and control over customers'
budget requests. 

FUND'S FINANCIAL REPORTS CONTINUE
TO CONTAIN INACCURATE INFORMATION

We have previously reported that the Fund's financial reports contain
billions of dollars of errors and cannot be relied on for
decision-making purposes.  The DOD Inspector General also reported
that it could not render an opinion on the Fund's fiscal year 1992
financial statements because the data were not complete and accurate. 
DOD management needs accurate reports on the Fund's operation in
order to properly analyze trends, make comparisons, measure budget
execution, formulate budget requests, and set prices to charge. 

DOD has acknowledged several times that the Fund's financial reports
are inaccurate--in the Acting Comptroller's February 2, 1993, letter
to the congressional Defense committees; in the Fund's task force
report of
July 30, 1993; in the Fund's September 24, 1993, plan; and in DOD's
February 2, 1994, response to our October 1993 letter on the Fund's
plan.  The plan identifies a number of tasks aimed at improving the
accuracy of the Fund's financial reports.  Many of the tasks are not
scheduled to be completed until later in fiscal year 1994 or in
fiscal year 1995.  If DOD management does not ensure that these tasks
are completed as scheduled, the reliability of the financial reports
will not improve in the foreseeable future. 

Our brief and limited analysis of the fiscal year 1993 monthly
financial reports disclosed numerous instances in which the reports
were inaccurate and of questionable use.  The problems with these
reports are similar to those we identified in the fiscal year 1992
reports.  Some examples from the fiscal year 1993 reports follow. 

  The Fund's fiscal year 1993 financial and budget reports reported
     amounts that differ by $6.1 billion for net operating results. 
     If the gains and losses in individual business areas are not
     netted, the gross difference is $7.5 billion.  The fiscal year
     1993 net operating results are a key factor in setting the
     fiscal year 1995 prices the Fund will charge its customers. 
     Since the financial reports should be the basis for preparing
     the budget reports, these vastly different amounts reported for
     the same item should not occur. 

  The Fund's Monthly Report of Operations--the 1307 report-- provides
     information on the revenues, costs, and profits/losses for each
     of the Fund's business areas.  DOD has disclosed in the
     footnotes to the report that the report is not accurate.  The
     footnotes also disclose some causes for the inaccuracies, such
     as the following:  (1) guidance has not been provided on how to
     determine the amount of certain accounts and (2) the accounting
     systems have not been modified to accumulate and report the
     information needed for certain accounts.  However, little or no
     action has taken place to resolve these problems. 

  DOD managers are not receiving accurate financial data on the
     annual $1 billion to $2 billion capital asset program.  The
     monthly 1307 financial report does not provide accurate capital
     asset information on the amount of (1) revenue earmarked for
     purchases of capital assets, (2) capital asset obligations, and
     (3) capital asset outlays.  Our analysis of the fiscal years
     1992 and 1993 accounting and budgeting reports shows that the
     Fund business areas only obligated about $1.8 billion (58
     percent) of the $3.1 billion of the authority provided to them. 
     Because the financial information is not accurate, it is
     extremely difficult, if not impossible, for DOD management and
     the Congress to ascertain if the capital asset program is being
     executed in accordance with the capital asset budget presented
     to the Congress.  DOD officials have acknowledged that the Fund
     activities have not always executed the capital asset program. 
     To try to resolve this problem, DOD specifically listed the
     capital asset projects authorized for execution in the fiscal
     year 1994 annual operating budgets issued to the Fund
     activities. 

Further, DOD has not established, a capital asset subaccount, as
required by the National Defense Authorization Act for Fiscal Year
1993.  The act required that amounts charged for the depreciation of
capital assets be credited to the subaccount.  Moreover, these funds
were to be available only for the payment of capital assets for the
Fund.\4 Because no capital asset subaccount exists and the financial
data on capital assets are inaccurate, DOD cannot determine the
amount of cash that should be set aside in the subaccount.  As a
result, during fiscal year 1993, DOD had no assurance that funds
available only to pay for capital assets were not improperly used to
finance the day-to-day operating expenses of the Fund. 

PERFORMANCE MEASURES HAVE BEEN
DEVELOPED FOR FUND'S BUSINESS
AREAS

DOD included performance measures in the Fund's fiscal year 1994
annual operating budgets.  The measures were developed using the
criteria outlined in the Acting Comptroller's October 29, 1992,
memorandum and data drawn from existing measures used in current
programs.  DOD has just begun developing the corresponding goals for
some business areas, such as the Defense Logistics Agency supply
management and distribution depots.  One of the goals DOD plans to
use is its ability to fill a customer's request for an inventory item
without having to backorder the request.  However, as of the end of
January 1994, DOD had not received any actual execution data on the
performance measures included in the annual operating budget. 

Performance measurements are a valuable tool for managers because
they provide information on an organization's performance.  Managers
can use the data that performance measures provide to help them
account for past activities, manage current operations, or assess
progress toward planned objectives.  Well-designed measures that are
timely, relevant, and accurate are important, but it is also
important that the measures be used by decisionmakers.  Performance
measures will be used as a management tool only if management makes a
commitment that supports their use. 


--------------------
\1 Cross-disbursing is a term used within DOD to refer to one DOD
component or another federal agency, such as the Department of State,
making disbursements on behalf of another DOD component. 

\2 Financial Management:  Navy Records Contain Billions of Dollars in
Unmatched Disbursements (GAO/AFMD-93-21, June 9, 1993). 

\3 As of March 1, 1994, the Secretary of Defense had not filed the
DOD-wide report on internal controls that was due on December 31,
1993, under the Federal Mangers' Financial Integrity Act.  Therefore,
we do not know if the Secretary also considers unmatched
disbursements to be a material weakness for DOD as a whole. 

\4 The National Defense Authorization Act for Fiscal Year 1994
deleted the requirement that these funds be available only for the
payment of capital assets.  DOD is still required to establish a
capital asset subaccount. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II

ACCOUNTING AND INFORMATION
MANAGEMENT DIVISION, WASHINGTON,
D.C. 

Darby W.  Smith, Assistant Director (703) 695-6922
Gregory E.  Pugnetti, Assistant Director
Ron L.  Tobias, Senior Auditor-in-Charge
William A.  Hill, Senior Auditor





RELATED GAO PRODUCTS
=========================================================== Appendix 0

Letter to the Deputy Secretary of Defense (GAO/AIMD-94-7R, October
12, 1993). 

Financial Management:  Opportunities to Strengthen Management of the
Defense Business Operations Fund (GAO/T-AFMD-93-6, June 16, 1993). 

Financial Management:  Opportunities to Strengthen Management of the
Defense Business Operations Fund (GAO/T-AFMD-93-4, May 13, 1993). 

Letter to Congressional Committees (GAO/AFMD-93-52R, March 1, 1993). 

Financial Management:  Status of the Defense Business Operations Fund
(GAO/AFMD-92-79, June 15, 1992). 

Financial Management:  Defense Business Operations Fund
Implementation Status (GAO/T-AFMD-92-8, April 30, 1992). 

Defense's Planned Implementation of the $77 Billion Defense Business
Operations Fund (GAO/T-AFMD-91-5, April 30, 1991). 

