CFO Act Financial Audits: Increased Attention Must Be Given to Preparing
Navy's Financial Reports (Letter Report, 03/27/96, GAO/AIMD-96-7).
After performing a broad-based review of the Navy's financial management
operations, GAO concludes that the Navy has made little progress in
improving its general funds financial management and reporting since
passage of the Chief Financial Officers Act in 1990. Top military
officials must make achievement of the act's objectives a higher
priority. Preparing reliable financial statements is critical to (1)
safeguarding and effectively managing the public's substantial
investment in Navy operations; (2) providing the Navy, the Defense
Department (DOD), and Congress with a clear understanding of the Navy's
financial condition so that they can control costs while maintaining
military readiness; and (3) ensuring the reliability of agencywide
consolidated financial statements that DOD must prepare beginning with
fiscal year 1996. The Navy, including the Marine Corps, accounts for
about one-third of DOD's gross budget authority, controls nearly half of
DOD's assets, and employs one-third of all DOD personnel. This report
focuses on the challenges that the Navy and the Defense Finance and
Accounting Service (DFAS) face to strengthen the Navy's financial
management and reporting and to adequately plan for preparing auditable
financial statements for the Navy within the required time frame. It
also recommends ways to improve the Navy's and DFAS' financial
management and reporting processes and internal controls.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: AIMD-96-7
TITLE: CFO Act Financial Audits: Increased Attention Must Be Given
to Preparing Navy's Financial Reports
DATE: 03/27/96
SUBJECT: Defense operations
Accounting procedures
Federal agency accounting systems
Reporting requirements
Data integrity
Internal controls
Interagency relations
Financial records
Management information systems
Financial management systems
IDENTIFIER: Defense Business Operations Fund
DFAS Business Plan
Navy Standard Accounting and Reporting System
Navy Centralized Expenditure/Reimbursement Processing System
CIM
Treasury Federal Agencies Centralized Trial Balance System
DOD Corporate Information Management Initiative
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Cover
================================================================ COVER
Report to Department of Defense Officials
March 1996
CFO ACT FINANCIAL AUDITS -
INCREASED ATTENTION MUST BE GIVEN
TO PREPARING NAVY'S FINANCIAL
REPORTS
GAO/AIMD-96-7
CFO Act Financial Audits - Navy
(918855)
Abbreviations
=============================================================== ABBREV
CFO - Chief Financial Officers
CIM - Corporate Information Management
DAO - Defense Accounting Office
DBOF - Defense Business Operations Fund
DFAS - Defense Finance and Accounting Service
DOD - Department of Defense
FACTS - Federal Agencies Centralized Trial-balance System
FMFIA - Federal Managers' Financial Integrity Act
GAO - General Accounting Office
GMRA - Government Management Reform Act of 1994
OMB - Office of Management and Budget
STARS-DR - Standard Accounting and Reporting System-Departmental
Reporting
SGL - U.S. Standard General Ledger
Letter
=============================================================== LETTER
B-258746
March 27, 1996
The Honorable William J. Perry
The Secretary of Defense
The Honorable John J. Hamre
The Under Secretary of Defense (Comptroller)
The Honorable John H. Dalton
The Secretary of the Navy
The Honorable Deborah P. Christie
The Navy Assistant Secretary for Financial
Management and Comptroller
We conducted a broad-based review of various aspects of the
Department of the Navy's financial management operations. We are
reporting on the reliability of the Navy's fiscal year 1994
consolidated financial reports\1 so that the Navy and the Defense
Finance and Accounting Service (DFAS) can
improve the credibility of the Navy's financial reports, starting
with those prepared for fiscal year 1995 and
enhance their ability to prepare required reliable annual financial
statements for the Navy, beginning with those for fiscal year
1996.
The Navy has made little progress in improving its general funds
financial management and reporting since passage of the Chief
Financial Officers (CFO) Act in 1990 (Public Law 101-576). Top
leaders of the Department of Defense (DOD), the Navy, and DFAS must
give a higher priority and instill a sense of urgency for meeting the
objectives of the CFO Act in order to achieve needed improvements.
Preparing reliable financial statements is (1) key to safeguarding
and effectively managing the public's substantial investment in the
Navy's operations, (2) central to the Navy, DOD, and the Congress
having a clear understanding of the Navy's financial condition and
being able to best control costs while maintaining military
readiness, and (3) critical to the reliability of the agencywide
consolidated financial statements DOD is statutorily required to
prepare, beginning with those for fiscal year 1996. The Navy,
including the Marine Corps, accounts for about one-third of DOD's
gross budget authority, controls almost half of DOD's assets, and
employs one-third of all DOD personnel.
This report focuses on the challenges that the Navy and DFAS face to
strengthen the Navy's financial management and reporting and to
adequately plan for preparing auditable financial statements for the
Navy within the required time frame. It also outlines
recommendations for improving the Navy's and DFAS's financial
management and reporting processes and internal controls. Our
objective, scope, and methodology are described in appendix I. We
will communicate the results of our examinations of certain other
Navy financial management operations at a later time.
--------------------
\1 GAO reviewed the consolidated financial reports for the Navy's
general funds, specifically "fund type 5" reported in accordance with
the Treasury Financial Manual (1 TFM 2-4130). General funds
represent the Navy's appropriation accounts established to record
amounts appropriated by the Congress to fund Navy programs and
operations.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :1
The Navy's general fund financial reports should be a primary source
of key information for effectively assessing (1) the results of its
operations, (2) its stewardship over its assets, and (3) its use of
budgetary resources. But, the Navy's fiscal year 1994 consolidated
financial reports lacked credibility and, consequently, were of
little value for these purposes. These reports, which are a measure
of the Navy's ability to prepare reliable financial statements, were
substantially inaccurate and indicate the need for much greater
efforts than the Navy has made over the past 5 years to effectively
implement the CFO Act's requirements.
We identified inaccurate financial information across the board,
involving, for example, tens of billions of dollars in military
equipment, inventory, and accounts receivable and payable. The
Navy's fiscal year 1994 consolidated financial reports, which were
submitted to the Department of the Treasury and used to prepare
governmentwide financial reports, showed $506 billion in assets, $7
billion in liabilities, and $87 billion in operating expenses.
However, each of these amounts was substantially misstated. Overall,
we identified a minimum of $225 billion of errors in the Navy's
fiscal year 1994 consolidated financial reports. These errors
included:
$66 billion of material omissions, including $31 billion of
ammunition, $14 billion of inventories, and $7 billion of
unfunded liabilities for projected environmental cleanup costs
that were omitted altogether and
$43 billion of misrecorded items such as $24 billion of structures
and facilities and $8 billion of government- furnished and
contractor-acquired material that were counted twice and $9
billion of understated revenues due to an erroneous calculation.
The Navy's financial reports also excluded billions of dollars
invested in building aircraft and missiles and modernizing of weapons
systems. However, because of the poor state of Navy and DFAS
financial records, we could not determine the amount of these costs
and we cannot be sure that we identified all significant mistakes in
the Navy's financial reports.
A root cause of the Navy's financial reporting deficiencies is the
long-standing failure to use basic internal controls and to instill
discipline in financial operations. The control practices used in
the Navy's financial operations were fundamentally deficient:
accounts and records were not routinely reconciled; periodic physical
inventories of plant property were not always assured; undocumented
adjustments were common; and the reasonableness of account balances,
adjustments, and data presented in financial reports was not
regularly reviewed.
In September 1995, the DFAS Director instructed the DFAS centers to
pay closer attention to these important control areas. We hope that
this instruction will set a new, positive tone for overcoming
problems that have been repeatedly found in DOD's CFO Act financial
audits. The Director requested the DFAS center directors to be
personally involved in improving DOD's financial statements, prevent
a repetition of reporting errors disclosed by DOD's CFO Act financial
audits, and increase the emphasis on basic internal controls.
DOD has initiatives underway that could help address the fundamental
weaknesses we found that impede effective financial management and
reporting for the Navy.\2 The DFAS Director and the Navy Assistant
Secretary for Financial Management and Comptroller will have to
adequately monitor and enforce DFAS and Navy efforts to effectively
implement improved financial control procedures. Better reporting on
the Navy's financial operations will also require much greater
emphasis than we have seen demonstrated to date on
preparing and executing adequate financial management and reporting
improvement plans;
assessing the skills, experience, and number of financial
management personnel needed; and
concentrating, in the short-term, on procedures to improve existing
financial systems data.
Further, it is important for the Under Secretary of Defense
(Comptroller)\3 to enforce the DOD policy on financial management
roles and responsibilities of the Navy and DFAS as delineated in his
November 15, 1995, guidance. This is necessary to effectively
establish accountability for improving the Navy's financial
management and reporting and preparing financial statements for the
Navy in accordance with statutory requirements.
--------------------
\2 Three of DOD's major initiatives are: business process
reengineering, systems standardization, and consolidation of DFAS
operations.
\3 Hereafter in this report we refer to the Under Secretary of
Defense (Comptroller) as the DOD Comptroller.
BACKGROUND
------------------------------------------------------------ Letter :2
The Navy comprises a very significant amount of total DOD operations.
It accounted for 31 percent, or $78 billion, of DOD's fiscal year
1994 gross budget authority; controls about 50 percent, or a reported
half trillion dollars in DOD's assets, including 540 ships and over
5,200 aircraft;\4 and employs over one million civilian and military
personnel. In addition, the Navy encompasses Marine Corps
operations, which in fiscal year 1994, had about $9 billion in gross
budget authority, or about 11 percent, of the Navy's gross budget
authority that year. The Navy also operates certain Defense Business
Operations Fund (DBOF) activities, which in fiscal year 1994 had $24
billion in reported revenue and were larger than both the Air Force's
or the Army's DBOF activities.
DOD, and especially the Navy, have acknowledged serious and
long-standing financial management and reporting problems. Because
of these problems, in February 1995, GAO designated DOD's financial
management as a high-risk area especially vulnerable to waste, fraud,
and mismanagement.\5
Several organizations are integrally involved in carrying out the
Navy's financial management and reporting: (1) the Office of the
Navy's Assistant Secretary for Financial Management and Comptroller,
which has overall financial responsibility, (2) DFAS, which reports
to the DOD Comptroller and provides accounting and disbursing
services, and (3) Navy components that initiate and authorize
financial transactions. The DFAS Cleveland Center is primarily
responsible for preparing the Navy's financial reports from data
generated by accounting, financial management, and other management
information systems operated by DFAS, the Navy, and the Marine Corps.
The CFO Act requires DOD and the other "CFO Act" agencies to improve
their financial management and reporting operations. Among its
specific requirements is that each agency CFO develop an integrated
agency accounting and financial management system, including
financial reporting and internal controls. Such systems are to
comply with applicable principles and standards and provide for
complete, reliable, consistent, and timely information that is
responsive to the agency's financial information needs. To help
strengthen financial management, the CFO Act also requires that DOD
prepare financial statements for its trust funds, revolving funds,
and commercial activities, including those of the Navy. To test
whether agencywide audited financial statements would yield
additional benefits, the CFO Act also established a 3-year pilot
program for the Army, the Air Force, and eight other "CFO Act"
agencies or components of agencies.
In response to experiences gained under the CFO Act, the Congress
concluded that agencywide financial statements contribute to cost-
effective improvements in government operations. Accordingly, when
the Congress passed the Government Management Reform Act of 1994
(GMRA) (Public Law 103-356), it expanded the CFO Act's requirement
for audited financial statements by requiring that all 24 "CFO Act"
agencies, including DOD, annually prepare and have audited agencywide
financial statements, beginning with those for fiscal year 1996.
GMRA also authorizes the Director of the Office of Management and
Budget (OMB) to identify component organizations of the 24 "CFO Act"
agencies that will also be required to prepare financial statements
for their operations and have them audited. Consistent with GMRA's
legislative history, OMB has indicated that it will identify the
military services as DOD components required to prepare financial
statements and have them audited. Therefore, fiscal year 1996 is the
first year for which the Navy will be required to prepare a full set
of financial statements for its general funds.
--------------------
\4 As of September 30, 1994, the Navy's vessel and aircraft
inventories included 342 active ships and 4,514 active aircraft.
\5 High-Risk Series, An Overview (GAO/HR-95-1, February 1995).
WIDESPREAD WEAKNESSES HAMPER
EFFECTIVE FINANCIAL MANAGEMENT
AND REPORTING
------------------------------------------------------------ Letter :3
To an even greater extent than the other military services, the Navy
is plagued by troublesome financial management problems involving
billions of dollars. These problems include (1) internal control
breakdowns over disbursements, (2) actual and potential violations of
the Anti-Deficiency Act, and (3) widely inconsistent financial
reporting on the results of operating Navy's DBOF activities.\6 The
Navy's serious and widespread financial management problems have been
highlighted in audit reports, and embarrassing fraud cases and have
severely impeded the Navy's effective financial management. The
following are examples of these problems.
In 1989, we reported to the Secretary of the Navy that the Navy's
consolidated financial reports for fiscal year 1986 were
unreliable and understated assets by $58 billion.\7
In 1994, we reported a $163 billion discrepancy between the value
of property, plant, and equipment that the Navy reported for
fiscal year 1993 and the amounts shown in the supporting
information various Navy commands submitted to DFAS.\8
In its fiscal year 1994 Federal Managers' Financial Integrity Act
(FMFIA) (Public Law 97-255) report to the Secretary of Defense,
the Navy reported that none of the 28 operating accounting
systems it evaluated complied with appropriate accounting
standards and related requirements.
Between 1989 and 1992, a former Military Sealift Command supply
officer established a fictitious company, submitted over 100
bogus invoices, and received an estimated $3 million in
fraudulent payments.
With regard to internal control breakdowns over disbursements, over 2
years ago, we reported that the Navy had a severe and persistent
problem with unmatched disbursements, which, in December 1992,
amounted to about $13.6 billion.\9 As of August 31, 1995, the Navy's
unmatched disbursements and other problem disbursements totaled $18.6
billion, by far the most of any DOD component, with over 67 percent
of the DOD total, as shown in table 1.\10
Table 1
DOD and Navy Problem Disbursements as of
August 31, 1995
(Dollars in billions)
Navy's
portion of
DOD's total
Problem DOD Navy (percent)
------------------------- ------------- ------------- -------------
Unmatched disbursements\a $11.6 $8.0 69
Negative unliquidated 5.6 4.4 79
obligations\b
Intransit disbursements\c 10.6 6.2 59
======================================================================
Total $27.8 $18.6 67
----------------------------------------------------------------------
\a Unmatched disbursements are disbursements that cannot be properly
matched with corresponding obligations.
\b Negative unliquidated obligations are disbursements that exceed
amounts of related obligations.
\c Intransit disbursements are disbursements that have been forwarded
to, but not yet received or accepted by, a funding activity for
matching with corresponding obligations.
Particularly troubling, the Navy continues to have difficulty in
solving its problem disbursements. For example, from October 31,
1994, through June 30, 1995, the Navy and DFAS resolved about $7.6
billion in unmatched disbursements, which is significant. This
reduction was, however, largely eclipsed by $6.7 billion in new
unmatched disbursements.
Also, problems in keeping records on Navy disbursements have
distorted governmentwide financial reporting. DFAS, Cleveland
Center, incorrectly recorded billions of dollars of fiscal year 1995
Navy disbursements to a nonbudgetary deposit fund account. According
to Department of the Treasury officials, this error resulted in the
Treasury understating by at least $4 billion the federal government's
overall budget deficit reported as of June 30, 1995. Thus,
maintaining accurate financial records and producing reliable
financial information on the Navy's operations is a meaningful
process with relevance to and significant ramifications for the
government as a whole.
With respect to actual and potential violations of the
Anti-Deficiency Act, for fiscal years 1993 and 1994, and through the
first 10 months of fiscal year 1995, the Navy investigated 25 cases
of potential Anti-Deficiency Act violations involving about $166
million. Of these, 18 cases have been closed with the following
results.
For 15 cases, involving about $87 million, DOD reported to the
Congress that the Navy had violated the Anti-Deficiency Act. In
11 of these cases, the violations were due to misclassifications
between appropriations and four cases represented
overexpenditures of obligational authority. These violations
resulted in disciplinary actions against 58 people. These
actions included 1 removal from office, 2 suspensions, 3 letters
of punitive reprimand, 20 letters of nonpunitive reprimand, and
various other admonishments.
In 3 cases, involving about $63 million, investigators found no
violations of the act but discovered that accounting errors
primarily caused what initially appeared to have been
violations.
Navy DBOF activities should operate in a businesslike manner with the
objective of breaking even. However, in June 1994, we reported that,
given the magnitude of differences reported for DBOF's operating
results, it is difficult for Navy and DOD managers to know the Navy
DBOF activities' actual operating results.\11 Nevertheless, the Navy
has continued to report misleading DBOF financial information. For
fiscal year 1994, the Navy reported (1) a loss of $120 million in the
fund's budget overview, (2) a cumulative loss of $3.2 billion when
the fund's monthly reports for the fiscal year were totaled, and (3)
income of $574 million on the fund's year-end financial statements.
Thus, it is unclear and undeterminable whether, in fiscal year 1994,
the Navy's DBOF activities operated at a gain or a loss, or whether
they broke even as intended.
In addition to these wide fluctuations, comparison of the reported
results of the Navy DBOF activities between fiscal years also shows
readily apparent inconsistencies. For instance, the Navy's DBOF
financial statements for fiscal year 1992 showed a $2.7 billion
operating loss whereas the fiscal year 1993 statements showed
operating income of $2.5 billion. The fiscal year 1994 statement
showed operating income of $574 million. These extreme fluctuations
in annual operating results raise questions regarding the
effectiveness of fund management and the accuracy of reported
amounts.
In addition, the Naval Audit Service has been unable to express
opinions on the Navy's consolidated DBOF activities' financial
statements prepared under the CFO Act. The Service found extensive
problems including that the reported cost of property, plant and
equipment, and related depreciation, were not adequately supported,
and account balances were materially misstated.\12 Also, DFAS
acknowledged in its 1994 FMFIA Statement of Assurance that its
Navy-related accounting systems did not provide adequate general
ledger control. As a result, the DOD Inspector General was unable to
audit DOD's consolidated DBOF financial statements citing significant
deficiencies in accounting systems and the inability of Navy to
submit timely and accurate statements for audit of its DBOF
activities.\13
DOD has initiatives underway that could help address the fundamental
weaknesses we found that impede effective financial management and
reporting for the Navy. Specifically, the June 1995 DFAS Business
Plan includes actions intended to achieve the finance and accounting
improvement goals laid out in Secretary Perry's blueprint for
financial management reform. For example, the DFAS Business Plan
includes 5 actions to address DOD's problem disbursements, 19 actions
to improve compliance with the Anti-Deficiency Act, and 6 actions to
improve the systems supporting DOD's DBOF operations.
--------------------
\6 Navy DBOF activities include, for example, supply management,
naval shipyards, naval aviation depots, naval ordnance facilities,
public works centers, and research and development activities.
\7 Financial Reporting: Navy's 1986 Consolidated Report on Financial
Position Is Unreliable (GAO/AFMD-89-18, April 6, 1989).
\8 Management letter to the Assistant Secretary of the Navy for
Financial Management and Comptroller and the Director, DFAS,
Cleveland Center (GAO/AIMD-94-166R, August 11, 1994).
\9 Financial Management: Navy Records Contain Billions of Dollars in
Unmatched Disbursements (GAO/AFMD-93-21, June 9, 1993).
\10 The August 31, 1995, data was the most recent that was available
at the time of our audit.
\11 Defense Business Operations Fund: Improved Pricing Practices and
Financial Reports Are Needed to Set Accurate Prices (GAO/AIMD-94-132,
June 22, 1994).
\12 Naval Audit Service reports include Financial Audit of the Fiscal
Year 1991 Navy Industrial Fund (17X4912) Property, Plant, and
Equipment Account (075-S-92, June 30, 1992); Fiscal Year 1992
Consolidating Financial Statements of the Department of the Navy
Defense Business Operations Fund (053-H-93, June 30, 1993); Fiscal
Year 1993 Consolidating Financial Statements of the Department of the
Navy Defense Business Operations Fund (053-H-94, June 29, 1994); and
Fiscal Year 1994 Consolidating Financial Statements of the Department
of the Navy Defense Business Operations Fund (044-95, May 30, 1995).
\13 DOD Office of the Inspector General Audit Report No. 95-267
Defense Business Operations Fund Consolidated Statement of Financial
Position for FY 1994, June 30, 1995.
FINANCIAL REPORTS ARE GROSSLY
INACCURATE
------------------------------------------------------------ Letter :4
For fiscal year 1994, the Navy's consolidated financial reports
showed $506 billion in assets, $7 billion in liabilities, and $87
billion in operating expenses. However, each of these amounts was
substantially misstated. Overall, we identified at least $225
billion of errors in the Navy's fiscal year 1994 consolidated
financial reports. As a result, these reports were unreliable and
misleading and, thus, of no use to the Congress and to DOD and Navy
managers. Furthermore, the reports were, in part, prepared from
budgetary data that also contained questionable and abnormal
balances, such as negative unliquidated obligations.
The Navy's financial reports were submitted to the Treasury. The
Treasury used data from the reports to prepare consolidated financial
reports for the federal government. Therefore, the significant
errors and problems we identified in the Navy's financial reports
also affect the reliability of the overall government financial
reports.
We have discussed with DOD, Navy, and DFAS officials and provided to
them our workpapers documenting the errors we identified in the
Navy's reports. Nonetheless, because of the Navy's and DFAS's
inadequate financial records, we cannot be sure that we identified
all significant mistakes.
FINANCIAL DATA WERE OMITTED,
ERRONEOUS, AND MISCLASSIFIED
---------------------------------------------------------- Letter :4.1
Our analysis showed that the Navy's fiscal year 1994 consolidated
financial reports were riddled with billions of dollars in omissions,
errors, and misclassifications. The effects of these misstatements
on the Navy's fiscal year 1994 consolidated Reports on Financial
Position and Operations are summarized in table 2.
Table 2
Net Effects of Misstated Items on Navy's
Fiscal Year 1994 Consolidated Financial
Reports
(Dollars in billions)
Percent
over/
Item Overstated Understated understated
---------------------------- ------------ ------------ ------------
Report on financial condition:
----------------------------------------------------------------------
Structures, facilities, and $25.6 42
leasehold improvements
Military equipment 10.4 3
Funds with Treasury 5.8 8
Accounts payable 1.7 24
Construction in progress .3 1
Other assets .4 100
Inventory $50.9 (394)
Unfunded liabilities 8.6 (100)
Accounts receivable .8 (39)
Payroll and benefits accrued 1.2 (100)
Nonmilitary equipment .2 4
Equity .5 0\a
Report on operations:
----------------------------------------------------------------------
Revenue from federal sources 72.0 92
Operating expenses 26.0 30
Accrued expenditures 82.6 100
Capital expenditures 27.6 100
Net results of operations 9.1 100
----------------------------------------------------------------------
\a The net effect of these misstatements is less than one-half of 1
percent.
Specifically, the Navy's fiscal year 1994 consolidated financial
reports did not depict its true financial status and operating
results because of:
$66 billion in material omissions, including $31 billion in
ammunition held worldwide; $14 billion in supply inventories at
air stations, supply centers, other shore activities, and on
vessels; and $7 billion in unfunded liabilities for projected
environmental cleanup costs for which estimated costs are
available;
$43 billion in errors, including $32 billion in assets, such as
structures and facilities, and government-furnished and
contractor-acquired property that were reported twice; $9
billion of understated revenues due to an erroneous calculation;
and $2 billion in property that were, in fact, DBOF assets, and,
thus, should not have been reported in the Navy's consolidated
financial reports; and
$116 billion in misclassifications, including $72 billion in
accrued expenditures reported as revenue; $28 billion in capital
expenditures reported as operating expenses; and $12 billion in
ammunition reported as military equipment.
Moreover, we found that the Navy's financial reports did not include
billions of dollars invested in building aircraft and missiles and
modernizing weapons systems. Also, while the Navy reported $26.4
billion for ships under construction as of September 30, 1994, it did
not include outfitting and post delivery costs, costs related to
Military Sealift Command vessel construction, and components for
future construction. The Navy did not have sufficient data from
which we could determine amounts for these items.
In commenting on a draft of this report, DOD agreed that
misclassifications and errors were made in the Navy's fiscal year
1994 financial reports, however, DOD stated that it could not concur
with the specifics of the finding regarding the errors until it
completes further research.
REQUIRED DISCLOSURES WERE
NOT MADE
---------------------------------------------------------- Letter :4.2
In addition, the Navy's consolidated financial reports did not
disclose the government's contingent liability for potentially large
losses likely to occur but for which reasonable cost estimates could
not be made at the time the reports were prepared. Disclosing that
these contingent liabilities exist, although they cannot be
quantified at present, is significant because they could ultimately
cost the government billions of dollars.
For example, the Navy's fiscal year 1994 consolidated financial
reports did not describe contingent liabilities for the future costs
to the government of
cleaning up the environment at Navy sites, for which amounts were
not estimable, and the Navy's share ($643 million) of DOD's $2
billion liability for pollution prevention activities which
covers fiscal years 1995 through 1999;
indemnifying contractors under contracts for procurement of
nuclear-powered vessels, missiles, and components, and disposal
of low-level nuclear waste; and
decommissioning ships, including the disposal of nuclear propulsion
plants and closing dozens of naval bases and air stations.
We found that the Navy's fiscal year 1994 consolidated financial
reports did not disclose obligation and disbursement problems.
First, part of the $66 billion in material omissions previously
discussed resulted because the Navy did not disclose an estimated
$888 million that will eventually be required to pay currently
undelivered orders and unpaid obligations associated with
appropriations that were canceled as of September 30, 1994.\14
Second, the Navy did not report its billions of dollars of problem
disbursements as of September 30, 1994.
--------------------
\14 Fixed-year appropriations are canceled 5 years after their
statutory period of availability. During the 5-year period, the
appropriation may be used only to pay obligations properly chargeable
to its period of availability.
REPORTING OF OPERATING
EXPENSES AND CAPITAL
EXPENDITURES IS UNRELIABLE
---------------------------------------------------------- Letter :4.3
The Navy's financial systems, for the most part, do not distinguish
between disbursements made for operating expenses and for capital
expenditures and, thus, the amounts for these items were improperly
reported. DFAS, Cleveland Center, incorrectly (1) used the total
obligations incurred for all appropriations to report the Navy's
operating expenses for fiscal year 1994 and (2) reported no amount
for capital expenditures.
Transaction codes (specifically, object class codes), which are
fundamental for properly classifying disbursements, could be used to
distinguish between, and, thus, properly report, disbursements for
operating expenses and capital expenditures. However, the Navy and
DFAS do not require the consistent use of object class codes when
recording disbursements for these purposes. OMB has recognized the
importance of object class information and encourages its use for
financial statement presentation under the CFO Act.
In this regard, we extracted approximately 174,000 disbursement
transactions totaling about $7.3 billion recorded in the Navy's
Standard Accounting and Reporting System from July through September
1994. Sixty-eight percent of these transactions, representing about
$6.4 billion, did not contain object class codes. Also, we
identified 2.8 million transactions processed through the Navy's
Centralized Expenditure/Reimbursement Processing System for May and
June 1994. We found that 2.2 million of the transactions (78
percent) were processed without object class codes.
A Navy finance official told us that Navy and DFAS activities are
required to use expense element codes to record transactions for
operation and maintenance and research, development, test, and
evaluation appropriations, and that in his opinion, DFAS, Cleveland
Center, should be able to generate expense data, at least for these
appropriations, using these codes. However, similar to object class
codes, our analysis of about 630,000 disbursement transactions for 2
months of fiscal year 1995 for the two appropriations showed that
expense element codes were not consistently used. Of the
transactions we analyzed, about 454,000 either (1) did not have
expense element codes or (2) the recorded codes were invalid.
In the absence of object class and expense element code data, we
believe that information from which to more accurately report these
two types of disbursements could have been derived from the Navy's
budget execution reports as of September 30, 1994. Using these
reports, we estimated amounts for operating expense\15 and capital
expenditures to be $61 billion and $28 billion, respectively, for
fiscal year 1994. As a result, we estimated that the $87 billion
that the Navy reported as operating expenses was overstated by $26
billion, or almost 30 percent.
--------------------
\15 To estimate operating expenses, we used budget execution reports
for military personnel, reserve personnel, and operations and
maintenance (which include civilian personnel costs) and research,
development, test, and evaluation appropriations for both the Navy
and Marine Corps.
LACK OF BASIC INTERNAL CONTROLS
AND DISCIPLINE CAUSE FINANCIAL
REPORTING PROBLEMS
------------------------------------------------------------ Letter :5
A root cause of the Navy's financial reporting deficiencies is the
lack of basic internal controls and well-disciplined financial
operations. Effective financial management requires strong systems
of internal control to help ensure the integrity and reliability of
financial information, safeguard assets, and promote conformity with
accounting requirements and operating procedures. However, we found
that the Navy and DFAS used financial control practices that were
fundamentally deficient.
ACCOUNTS ARE NOT ROUTINELY
RECONCILED
---------------------------------------------------------- Letter :5.1
Reconciliations are a primary control practice to detect differences
between summary and detailed records and accounts. When
independently derived records do not agree, managers are to
investigate the causes, resolve discrepancies, and make appropriate
adjustments. Thus, periodic reconciliations are a first-line defense
to detect potential problems, such as the loss or theft of assets.
However, we found that the Navy and DFAS did not routinely perform
quarterly reconciliations between (1) the Navy's official accounting
records at DFAS's Defense Accounting Offices (DAO) and (2) custodial
property records at Navy activities, as required by the Navy
Comptroller Manual. We found, for instance, that the Navy's official
accounting records at DAO-Arlington, had not been reconciled with any
of the Navy's custodial property records for at least 18 months. We
found unresolved differences of at least $21 million.
FINANCIAL REPORTS AND TRENDS
ARE NOT REVIEWED AND
ANALYZED
---------------------------------------------------------- Letter :5.2
The periodic review and analysis of financial information generated
by an accounting system is a basic control technique to maintain the
integrity of the information by helping to ensure that errors have
not occurred. Typically, this control technique would entail
processes such as (1) reviewing financial reports to detect unusual
information or account balances and (2) analyzing account balance
trends between reporting periods. When abnormal account balances\16
or unexpected trends occur, their cause should be investigated and
any necessary corrections made.
When an agency's records or reports show abnormal information or
account balances, that is a strong indication that errors have
occurred in recording or processing the underlying transactions. In
this respect, for example, the Navy's fiscal year 1994 consolidated
financial reports showed an operating loss of $9.1 billion. This
followed reported losses of $12 billion for fiscal year 1993 and $7.1
billion for fiscal year 1992. Taken at face value, the magnitude of
these losses should have alerted the Navy that it may have overspent
its appropriations during these 3 fiscal years.
Also, the financial reports DFAS used to prepare and support the
Navy's consolidated financial reports for fiscal year 1994 showed
various abnormal account balances, such as the following.
The military construction appropriation report showed a negative
accounts receivable balance of $95 million.
The ship procurement appropriation report showed a negative
accounts receivable balance of $13 million.
Another procurement appropriation report showed an account balance
for uncollectible receivables of $88 million, which exceeded the
reported value of receivables by $30 million.
Although the information and account balances in each of these cases
were highly unusual and unlikely to be correct, the Navy and DFAS did
not investigate and correct them.
Also, we found unusual trends and large variances in account balances
that were not investigated, explained, or resolved, even though the
Navy's regulations require them to be. For example, the Navy's
September 30, 1994, consolidated financial reports showed the value
of structures and facilities to be $62 billion, or more than double
the $29 billion reported a year earlier. A cursory review of these
reports would have identified this unreasonable upward fluctuation.
Once identified, the underlying cause, which in this case was double
counting, could have been readily identified and the financial
reports corrected. Specifically, this double counting occurred
because DFAS personnel inadvertently included in the worksheets used
to prepare the Navy's fiscal year 1994 consolidated financial reports
the same structures and facilities data reported from two
sources--the Naval Facilities Engineering Command, which maintains
Navywide real estate and facilities data, and individual Navy
accounting offices.
In its comments on a draft of this report, DOD stated that Navy's
SF-220 series of reports for fiscal year 1994 provided appropriation
level totals but did not provide breakdowns of financial data by
command or individual activity. DOD also stated that since these
financial reports were prepared only at the total appropriation
levels, errors at an activity or command were difficult to discern.
Finally, DOD stated that it is improbable that errors at the
appropriation level will be found without a breakout by command and
activity data.
Effective financial systems and internal controls would prevent
and/or detect errors in recording and processing transactions,
regardless of the level at which they occurred. Also, it should be
recognized that the fiscal year 1994 SF-220 reports which we
evaluated were prepared at the overall Navy departmental level, not
at the appropriation level as the comments suggest. Contrary to the
department's assertion, most of the errors we identified were not
difficult to discern because they dealt with relatively obvious data
omissions, double-counting, and misclassifications. In most cases,
they occurred because information available at Navy commands was not
requested by DFAS, Cleveland Center, errors were made in recording
information in the correct "line items" of the reports, or
information was entered in the reports twice.
--------------------
\16 Generally, account balances for specific classes of accounts will
carry a normal or predictable balance. For example, asset accounts
will generally carry a positive, or debit, balance.
ADEQUATE PHYSICAL
INVENTORIES OF PLANT
PROPERTY WERE NOT ASSURED
---------------------------------------------------------- Letter :5.3
The Navy Comptroller Manual specifies that (1) DAOs schedule physical
inventories of plant property and monitor their completion at Navy
activities, (2) activities perform such physical inventories at least
once every 3 years and correct their property records for any
differences, and (3) activities inform the DAOs when physical
inventories have been completed. However, we found that
DAO-Arlington and DAO-San Diego, which accounted for $5.2 billion of
the Navy plant property reported in fiscal year 1994, did not ensure
that Navy activities reporting to them had completed the required
physical inventories. The activities did not properly inform the
DAOs as to whether the triennial physical inventories had been
completed, and the DAOs did not follow up with the activities.
Specifically, as of September 30, 1994, 124 Navy activities out of
148, or 84 percent, that DAO-Arlington had scheduled for inventories
in fiscal years 1993 and 1994 had not reported to the DAO that the
inventories had been completed. In February 1995, DAO-Charleston
assumed plant property accounting responsibilities for these
activities. As of September 30, 1995, DAO officials told us that
none of the transferred activities had reported completion of their
physical inventories to DAO-Charleston.
DAO-San Diego reported plant property amounts for 43 activities as of
September 30, 1994. Although the plant property official at the DAO
scheduled the physical inventories at these activities, the official
did not check to see if the activities were reporting the completion
of the physical inventories. Therefore, the DAO had no assurance
that these required inventories were being done and the records
corrected.
We also found that, when inventories were completed, errors were not
always identified and corrected. For example, although an Air
Maintenance Training Group conducted a physical inventory every 6
months, we found over $46 million of operating inventory items
inappropriately included in its plant property records. At a diving
unit, our physical inventory of equipment, which was performed
shortly after the unit had completed its inventory, noted over $1
million in errors. We also found $1 million of discrepancies at a
Naval Computer and Telecommunications Detachment when compared to the
DAO-Pensacola property records for the activity.
We are now completing our review of other categories of inventory,
such as operating materials and supplies, and will report later on
the results of that work.
MANY ADJUSTMENTS ARE
UNSUPPORTED
---------------------------------------------------------- Letter :5.4
There are various sound and necessary reasons for adjusting
accounting records, such as to correct errors or to write off bad
debts. DOD's financial management regulations require that
adjustments be clearly documented to help ensure that only proper
adjustments are made. Otherwise, adjustments could be used to cover
up embezzlements, hide losses, or mask errors. Accordingly, it is
essential to establish and enforce internal controls that (1) allow
only legitimate, authorized adjustments to be made and (2) require
maintenance of documentation that explains their basis and purpose,
and indicates which official approved them.
However, we found that adjustments totaling billions of dollars were
routinely made to accounting records and account balances, largely
without adequate documentation. From October 1994 through January
1995, over $14 billion of adjustments were processed by DFAS
operating locations against the Navy's financial records. From these
transactions, we judgmentally selected 64 adjustments totaling about
$1 billion and requested supporting documentation from the applicable
DFAS operating locations. These locations provided us documenting
records for 33, or about half, of these adjustment transactions,
valued at $498 million. For the remaining $527 million, no
documentation was provided.
SUPERVISORY REVIEWS ARE NOT
ALWAYS PERFORMED
---------------------------------------------------------- Letter :5.5
Supervisory review of staff work and products is a basic internal
control to ensure the quality of work processes and financial
reports. Without supervisory review and approval, adjustments could
be used to circumvent essential internal controls and, thus, hide
errors, fraud, or misuse of assets. Nonetheless, in our view, many
of the inaccuracies in the Navy's financial reports discussed in the
previous section could have been identified if Navy and DFAS managers
had conducted adequate supervisory reviews. Also, many of the
adjustments just discussed were not provided to supervisors for their
review and approval.
By using basic reasoning to assess account and report balances,
evaluate changes from previous periods, and compare reported amounts
with available documentation, we were able to identify numerous
errors, such as the abnormal account balances and unusual trends
previously discussed. The discrepancies in the financial reports and
records we found were not, however, detected and investigated by
either the DFAS, Cleveland Center, or the Navy.
DFAS DIRECTOR LAYS
GROUNDWORK TO IMPROVE
CONTROL PRACTICES
---------------------------------------------------------- Letter :5.6
On September 1, 1995, the DFAS Director requested that the DFAS
center directors be personally involved in improving DOD's financial
statements and in preventing a repetition of reporting errors
disclosed by DOD's CFO Act financial audits. The Director's guidance
noted that many of the errors were preventable if proper validation
steps had been in place before issuance of the reports.
The DFAS Director called for increased emphasis on basic internal
control areas by
ensuring that adequate documentation is available to support the
validity and accuracy of accounting transactions;
identifying and recording accounts receivable, accounts payable,
collections, and disbursements accurately, consistently, and
completely, including reconciliation to supporting subsidiary
ledgers;
obtaining management approval of accounting adjusting entries;
compiling and reporting contingent liabilities; and
ensuring that component reports of property, equipment, and
inventory are promptly submitted and certified as to accuracy.
The Director's guidance is based on DOD's lessons learned in
preparing financial statements under the CFO Act and having them
audited. We believe that the guidance gets to the heart of the
Navy's and DFAS's financial management problems and outlines control
techniques that could have detected or prevented many of the
financial reporting problems we identified. The DFAS Director
stressed that the guidance must be fully and effectively implemented
to prevent all types of reporting deficiencies identified throughout
DOD.
FINANCIAL MANAGEMENT
IMPROVEMENT PLANNING IS
INADEQUATE
------------------------------------------------------------ Letter :6
The Navy and DFAS, Cleveland Center, developed the joint CFO Project
Plan to set out the steps necessary to meet requirements for
preparing consolidated financial statements for the Navy's general
fund operations for fiscal year 1996. The plan
describes tasks to be completed, such as holding project meetings
and visiting DFAS centers;
identifies, for each task, the responsible participating
organization, other participating organizations, and
deliverables, such as plans or summaries; and
includes milestones, such as planned and actual start and
completion dates.
The plan, which had been under development by Navy and DFAS for
approximately 6 months, was approved by the two organizations on
October 4, 1995. At the time of its approval, 58 of the 204 tasks
that had been identified as underway or completed as of that date
were already behind schedule or not yet started. Moreover, given the
scope and depth of the Navy's prior problems, we believe that the
plan is not sufficiently detailed to enable the Navy and DFAS to
successfully meet the requirements for the preparation of auditable
financial statements within the next year. Specifically, the CFO
Project Plan does not specify the:
Specific offices or positions within the Navy and DFAS which are to
be accountable for accomplishing the specific planned actions
required to carry out the identified tasks. Instead, the plan
identifies only organizational responsibilities for each task.
For example, the plan identifies 168 tasks as the responsibility
of DFAS, Cleveland Center, but does not designate a specific
office or position accountable for completing the tasks.
Actions to address previously reported deficiencies. For example,
the plan calls for reviewing reports on financial operations as
a discrete task with the associated deliverable specified as a
summary. However, the plan does not specify the actions to be
taken to deal with previously reported deficiencies identified
as a result of the reviews.
Manner in which it will be coordinated with DOD's requirement to
meet governmentwide financial management improvement
initiatives. These initiatives include meeting the requirements
of the U.S. Standard General Ledger (SGL), which OMB has
required governmentwide for almost a decade. As of September
30, 1994, OMB reported that 34 percent of all executive branch
systems fully implemented the SGL and 18 percent partially
implemented it. Another governmentwide financial management
initiative involves the Treasury's Federal Agencies Centralized
Trial-balance System (FACTS), an automated financial reporting
system using the SGL. For fiscal year 1994, the Treasury began
using FACTS to collect agency standard general ledger account
balances for use in producing the government's consolidated
financial statements. The Treasury gave three DOD organizations
and one other executive branch agency waivers for meeting this
reporting requirement for fiscal year 1994.
In its comments on a draft of this report, DOD did not concur with
this last finding and stated that "task 10" of the Navy/DFAS CFO
Project Plan provides for coordination with the DOD FACTS effort.
The cited task simply reads "Coordinate effort with FACTS effort"
without providing any additional specificity. Even though it did not
concur with this finding, DOD stated that the ongoing FACTS tasks
will be incorporated into the Navy/DFAS plan which should resolve
most of our concerns. The Navy/DFAS plan does not have any tasks
specifically addressing the SGL issue.
An adequate plan would also encompass strategies to provide (1)
enough financial management personnel with adequate financial
management expertise and experience in Navy operations and (2)
short-term solutions to improve the quality of financial data pending
completion of long-term financial systems modernization plans.
MEETING PERSONNEL RESOURCE
NEEDS
---------------------------------------------------------- Letter :6.1
Navy and DFAS officials have told us on numerous occasions that they
do not have enough personnel with the right experience to effectively
implement the CFO Act's requirements. However, neither the Navy nor
DFAS has taken steps to assess the personnel levels, skills, and
experience necessary to effectively carry out Navy-related financial
management responsibilities and prepare the Navy's financial reports
and statements. In addition, the CFO Project Plan does not address
alternatives, such as the use of contractors, for meeting Navy and
DFAS financial management personnel resource needs.
An official from the Navy's Office of the Assistant Secretary for
Financial Management and Comptroller told us that higher priorities,
such as resolving the Navy's continuing unmatched disbursements
problem, have prevented the Navy from dedicating sufficient personnel
to its general fund financial reporting. Similarly, the Director of
DFAS's headquarters Financial Statements Directorate stated that
insufficient personnel is a primary impediment to preparing reliable
financial reports on the Navy's operations.
Regarding personnel resources, we found that DFAS, Cleveland Center's
Departmental Accounting and Analysis Directorate
Had 186 authorized staff positions, but as of June 1995, 57 of
these positions, or 31 percent, were vacant. Of these
vacancies, 13 were at the mid- and senior-level (GS-12 and
above). For generally comparable financial reporting
responsibilities supporting the Air Force and the Army, DFAS,
Denver Center, had 207 authorized staff positions and DFAS,
Indianapolis Center, had 212 positions, with vacancy rates of
about 15 percent.\17
Does not have sufficient personnel experienced in Navy operations.
Before 1991, DFAS, Cleveland Center, served as the Navy's
military payroll processing center. In 1991, DOD began
transferring responsibility for the Navy's departmental
financial reporting from the Navy's Office of the Assistant
Secretary for Financial Management and Comptroller in
Washington, D.C., to DFAS, Cleveland Center. Since then, only
13 personnel experienced in the Navy's financial operations, and
only 3 experienced in Navy financial reporting, transferred to
DFAS, Cleveland Center.
Had 50 mid- and senior-level accountants in the 510 accounting job
classification series allocated to the financial reporting
area.\18 This is fewer than the 60 staff in these positions at
DFAS, Denver Center, and significantly fewer than the 87 at
DFAS, Indianapolis Center. As of October 1995, 22 percent of
DFAS, Cleveland Center's 510 mid- and senior-level staff
positions were vacant.
Had 17, or 30 percent, of its 56 mid- and senior-level positions
filled with personnel in the 501 accounting-related job
classification series, although this series requires no
accounting education.
Ensuring that sufficient numbers of personnel with appropriate
expertise are assigned financial reporting responsibilities at DFAS,
Cleveland Center, is particularly important because of the
deficiencies we noted in that center's financial reporting operations
and the substantial effort that will be required to correct them.
Consequently, an adequate financial management improvement resource
plan would help ensure that the Navy and DFAS, Cleveland Center, have
an adequate allocation of personnel with the requisite technical
skills to effectively carry out financial reporting responsibilities
for the Navy.
In its comments on a draft of this report, DOD stated that DFAS,
Cleveland Center, had recently received personnel resource
authorizations from DFAS headquarters and that 14 accountants and
financial analysts recently started work in the center's CFO area.
DOD further stated that 13 more personnel were expected to join the
center's CFO team by the end of February 1996. Although the hirings
should logically alleviate some of the personnel shortages, a viable
financial management improvement resource plan is still needed to
ensure that adequate CFO technical skills are available at the
center.
--------------------
\17 DFAS, Denver Center, which was successor to the Air Force
Accounting and Finance Center, began preparing financial statements
for the Air Force in 1988, and DFAS, Indianapolis Center, which was
successor to the Army Finance and Accounting Center, began preparing
financial statements for the Army in 1991.
\18 The Office of Personnel Management prescribes minimum education
and experience requirements for professional positions, such as 510
accountants. The 510 accountant classification requires accounting
education and/or experience.
IMPROVING FINANCIAL SYSTEMS
---------------------------------------------------------- Letter :6.2
The CFO Project Plan also does not provide short-term strategies for
improving existing financial systems' operations. Overall, systems
deficiencies substantially increase the difficulty and time required
to develop the Navy's financial reports. Further, such deficiencies
significantly increase the risk of errors, and, without compensating
controls, increase the Navy's and DOD's exposure to undetected fraud,
waste, and mismanagement.
Both DOD and Navy officials have forthrightly acknowledged that
systems deficiencies severely hamper their ability to effectively
carry out accounting and financial reporting for the Navy. For
example, in its fiscal year 1994 report pursuant to the Federal
Managers' Financial Integrity Act, DFAS, Cleveland Center, reported
that it was unable to prepare complete, reliable, and accurate
financial statements because of systems deficiencies. More
specifically, DFAS, Cleveland Center, reported that the nonintegrated
systems it used for the Navy's financial reporting
were not designed to conform with DOD's general ledger
requirements,
did not use the standard data elements needed to ensure consistent
definition of accounts, and
required considerable manual intervention to summarize and
interpret data from subordinate systems.
The absence of a fully integrated general ledger system necessitates
reliance on labor-intensive, error-prone processes to ascertain
whether all required items and accounts are reported in the Navy's
financial reports and statements.\19 Without integrated systems
operating under general ledger control, there is no overall
discipline to ensure the veracity and completeness for the amounts
reported.
As a result, for example, the value of perhaps as much as 83 percent
of Navy's assets--primarily property--cannot be derived from the
existing financial systems structure. To report information on the
dollar value of the Navy's fixed assets, the Navy and DFAS, Cleveland
Center, must rely on "data calls" to various Navy commands and other
organizations, which use their logistics systems and databases to
provide the information.
DOD began its Corporate Information Management (CIM) initiative in
1989 with the objective of improving its business processes and
information systems. With respect to accounting and finance systems,
DFAS's approach to implementing the CIM concept has been to select
and adapt as an interim step the best existing systems for use as
"migratory" financial systems to be followed eventually by "target"
systems. Most recently, DFAS has set out its strategy for
consolidating DOD's accounting systems as part of the July 1995 DFAS
Business Plan.
Although the DFAS strategy calls for systems improvements, few, if
any, improvements have been made in the systems the Navy or the other
military services, will use for financial management and reporting.
Historically, DOD's system improvement plans have fallen far short of
goals and its continuing systems problems are a serious challenge
that will require a number of years to correct.
In the short term, many Navy and DFAS financial management problems
can be successfully remedied without developing new systems. In this
regard, it is imperative that the Navy and DFAS make concerted
efforts now to improve the data produced by their existing systems.
Consequently, an adequate CFO Project Plan would address the specific
actions that both the Navy and DFAS will take to (1) improve data in
existing systems, (2) ensure the use of existing systems'
capabilities to account for transactions by object class or expense
element, and (3) follow existing systems' operating and transaction
processing requirements. It will also be important to have
procedures to monitor throughout the year whether rudimentary
controls, such as those the DFAS Director called for in September
1995, are being used throughout Navy and DFAS financial operations.
In commenting on a draft of this report, DOD stated that the Standard
Accounting and Reporting System-Departmental Reporting (STARS-DR) (a
system currently under development) has been designated as the
"target" system for Navy's general fund financial reporting. It
remains to be demonstrated whether STARS-DR, once developed and
implemented, will adequately serve as the Navy's overall financial
reporting system. We would also note that many of the problems we
identified resulted from Navy and/or DFAS personnel not following
established procedures, a condition that would detrimentally affect
data in even the most well-designed and implemented systems.
--------------------
\19 An integrated general ledger system is a single system, supported
by subsidiary systems, to provide the control necessary to ensure all
financial data are accurately recorded and summarized.
RECENTLY-ISSUED DOD POLICY
INTENDED TO CLARIFY
ACCOUNTABILITY FOR FINANCIAL
MANAGEMENT AND REPORTING
------------------------------------------------------------ Letter :7
In the past, DOD has not clearly defined or strictly enforced
accountability between the Navy and DFAS for the Navy's financial
management and reporting operations and for meeting the CFO Act's
requirements. On November 15, 1995, the DOD Comptroller issued a
departmentwide policy, "Roles and Responsibilities of the DOD
Component and the Defense Finance and Accounting Service Relative to
Finance and Accounting Operations and Departmental Reports."
The policy, for example, requires DFAS to
perform quality control reviews of the financial reports and
statements it prepares;
furnish these documents to its "customers" for review and
concurrence before release;
obtain preapproval from "customers" for any prior period
adjustments to their financial reports that exceed established
thresholds;
adequately and properly document all adjustments, including
appropriate documentation to support the need to correct an
error and adjust the affected balances; and
report potential violations of the Anti-Deficiency Act to the
cognizant military service or other DOD component.
Similarly, the policy mandates specific responsibilities for data
accuracy to the DOD components, such as the military services, for
which DFAS prepares financial statements. This policy establishes
specific requirements for the components with respect to such things
as (1) installing and operating appropriate internal controls to help
ensure the accuracy of data provided to DFAS and (2) assessing the
quality of information in DFAS-prepared reports prior to their
release.
If effectively implemented, the policy, along with the DFAS
Director's September 1995 guidance, should help to resolve many of
the reporting problems we found involving the Navy and DFAS.
However, the policy generally does not impose new requirements, as
many of the provisions were already required by DOD regulations prior
to the Comptroller's issuance of the guidance. Further, neither DFAS
nor the military services have consistently followed required
procedures. We found no evidence that failure to follow established
procedures resulted in disciplinary or other adverse actions except
in instances also involving violations of laws.
Consequently, to make the present arrangement work more effectively,
the policy must be expeditiously and fully implemented so that the
Navy's and DFAS's specific financial management roles and
responsibilities are clearly delineated. To follow through and
determine whether all provisions of the new policy are enforced and
effectively implemented, or whether refinements are necessary, it is
important for the DOD Comptroller to
establish time frames within which to achieve results from the
clarified roles and responsibilities, and establish milestones
for assessing progress toward financial management improvement;
designate specific offices or positions to be held accountable for
actions to improve the Navy's financial management and reports;
and
discipline managers for failing to improve the Navy's financial
management operations and to meet the CFO Act's requirements to
enhance financial systems.
In its comments on a draft of this report, DOD stated that it was
concerned that our finding tends to underplay the importance of the
DOD Comptroller's November 15, 1995, "roles and responsibility"
document by stating that the document generally does not impose new
requirements, as many of the provisions were already required by DOD
regulations. DOD further stated that, prior to the Comptroller's
guidance, it was not always clearly stated whether DFAS or DOD
components were responsible for specific financial management and
reporting requirements. Finally, DOD stated that, due to various
accounting and finance consolidations, DFAS's roles and
responsibilities relative to its customers were not formalized and
therefore, were not clear to all parties.
The need to clarify the respective roles and responsibilities of DFAS
and the military services has existed since DFAS began operations in
1991. In August 1992, we first reported that DOD needed to clearly
define DFAS's role and accountability for financial management and
reporting.\20
While the DOD Comptroller's November 1995 guidance clarifies the
roles and responsibilities of DFAS and the DOD components, it does
not greatly change existing financial management requirements, such
as properly documenting transactions, accurately and completely
processing transactions in a timely manner, and establishing
appropriate internal controls. These and many more requirements
existed prior to the Comptroller's guidance. We recognize that the
guidance now fulfills the need to more clearly define whether DFAS or
DOD components are responsible for implementing the various
requirements. The guidance should provide a vehicle to begin holding
the appropriate DFAS and military service officials accountable for
meeting those requirements.
--------------------
\20 Financial Management: Immediate Actions Needed to Improve Army
Financial Operations and Controls (GAO/AFMD-92-82, August 7, 1992).
CONCLUSIONS
------------------------------------------------------------ Letter :8
The serious financial management and reporting problems we found
place the Navy at significant risk of waste, fraud, and
misappropriation and drain resources needed for military readiness.
We found widespread financial reporting inaccuracies, involving
billions of dollars in erroneous balances covering the spectrum of
key accounts. These inaccuracies undermine the credibility of
financial reports and information on the Navy's operations available
to the Congress and Navy and DOD managers. Equally disturbing, the
Navy's financial reports mask various problems with data, including
abnormal budgetary account balances, used to prepare these reports.
Our work showed little tangible progress toward resolving the Navy's
financial management problems. The pervasive financial management
problems we identified involve both the Navy and DFAS and stem
primarily from these organizations not adequately
observing basic accounting and control conventions;
implementing financial management improvement efforts to achieve
accurate reporting;
addressing serious financial management staffing shortfalls;
using existing systems to their full potential in controlling,
managing, and reporting on the Navy's financial operations; and
exercising effective financial management accountability in the
current arrangement of shared responsibility between DFAS and
the Navy.
The Navy and DFAS have had several years to address the pervasive and
long-standing problems that hamper the Navy's financial management
operations, and, as the CFO Act requires, to begin readying
themselves to prepare reliable financial statements for the Navy for
fiscal year 1996. The Navy has not taken advantage of the 5 years
since the act's passage, or the lessons learned from the experiences
of its counterparts, the Army and the Air Force, in preparing
financial statements. The Navy and DFAS must now "catch up" through
measures that will lead to successfully preparing reliable financial
statements on the Navy's operations within the next year or so.
The DFAS Director has set the underpinnings for improved financial
controls. This groundwork is an important step in finally coming to
grips with a long record of neglect, underscored by the lack of
accounting discipline and of a perceived value in this function. As
a key "CFO Act" agency, it is imperative for DOD to now ensure that
the difficulties the Navy and DFAS have experienced in preparing
reliable Navy financial reports do not prevent DOD from meeting its
statutory responsibility to prepare reliable agencywide financial
statements beginning with those for fiscal year 1996.
RECOMMENDATIONS
------------------------------------------------------------ Letter :9
We recommend that the DOD Comptroller and the Navy's Assistant
Secretary for Financial Management and Comptroller
jointly act to improve the credibility of the Navy's financial
reports and to adequately position the Navy and DFAS to prepare
auditable financial statements for the Navy, beginning with
those for fiscal year 1996, and
periodically report to the Secretary of Defense the status of their
results.
First, to avoid the mistakes made in preparing the Navy's fiscal year
1994 consolidated financial reports, the Navy and DFAS should
diligently attain the greatest degree of accuracy possible in
finalizing the Navy's fiscal year 1995 consolidated financial
reports. This is especially critical because data in these reports
will help establish the opening balances for fiscal year 1996. These
actions would, at minimum, require that
financial statements and reports be compiled in accordance with
applicable Treasury, OMB, and DOD requirements;
financial information be reviewed thoroughly to determine its
reasonableness, accuracy, and completeness;
adjustments to account balances and reports be fully documented as
to their basis and purpose; and
the Assistant Secretary of the Navy for Financial Management and
Comptroller certify that financial reports comply with
applicable requirements.
Second, so that fiscal year 1996 and subsequent financial statements
for Navy operations are auditable, the Navy and DFAS should place
high priority on implementing basic required financial controls over
Navy financial accounts and reports. The minimum requirements to
carry out this step would include assurance that
Navy's periodic physical inventories of equipment, property, and
inventories are taken, the results are reported to DFAS, and any
discrepancies are investigated as to cause and resolved;
reconciliations of accounts and records are made, significant
discrepancies are examined and resolved, and appropriate
adjustments are made;
transactions are clearly and completely documented and such
documentation is retained and readily available to support
account balances; and
account balances are analyzed and financial reports are reviewed to
detect abnormal account balances and unusual fluctuations and
trends, any significant variances are researched and are
explainable, and any necessary corrections are made.
Also, to ensure that these basic internal control requirements are
enforced, the Navy and DFAS should develop and implement strategies
for monitoring progress throughout the year.
Third, the Navy and DFAS should immediately prepare implementing
strategies for producing reliable financial statements for the Navy,
beginning with those for fiscal year 1996. This plan should, at a
minimum
address staffing issues, such as filling financial management
vacancies, upgrading the experience of financial managers, and
using contractors, as necessary, to improve financial management
operations;
include short-term measures to improve the data in existing
financial systems, follow existing systems operating and
transaction processing requirements, and use standard data
elements, such as object class codes;
incorporate strategies for promptly meeting DOD's requirement to
use the U.S. Standard General Ledger and the Treasury's Federal
Agencies Centralized Trial Balance System; and
identify the specific offices or positions accountable for
accomplishing the actions established by the strategies and
provide a means for monitoring implementation throughout the
year.
Finally, given the history of problems in preparing the Navy's
financial reports, we recommend that the DOD Comptroller's November
15, 1995, policy on roles and responsibilities of DOD components and
DFAS be supplemented with
strategies to hold organizations and individuals accountable for
effectively carrying them out,
milestones for monitoring implementation progress during the year,
and
periodic assessments during annual financial reporting cycles to
ensure that the roles and responsibilities are continually
enforced.
AGENCY COMMENTS AND OUR
EVALUATION
----------------------------------------------------------- Letter :10
In commenting on a draft of this report, DOD generally concurred with
our findings and recommendations. However, DOD maintained that both
DFAS and the Navy have taken and are continuing to take enormous
strides in meeting the requirements of the CFO Act and GMRA. DOD
stated that while, ideally, faster progress may be desirable, the
significant progress that the department believes it has made since
1990 should be recognized. DOD stated that actions underway to
better position it for the future, such as the financial management
reform initiatives to improve processes and major reorganizations to
reduce resources, should also be recognized. DOD further stated that
it would be inaccurate to state that the Navy has made little
progress in improving its financial management and reporting since
passage of the CFO Act. DOD cited the progress made by the Navy in
improving financial reporting for its DBOF activities and trust funds
while recognizing that the Navy has not had to previously prepare
financial statements for its general fund operations.
This report acknowledges that the Navy has not previously been
required to prepare financial statements for its general funds and
that fiscal year 1996 is the first year for which the Navy will be
required to prepare such statements. As a result, we focused our
work on the required Treasury reports, not the more extensive
financial statements required by the CFO Act, as expanded by the
GMRA. Navy's and DFAS's inability to accurately prepare the
less-comprehensive financial reports and the extent of the problems
and deficiencies we identified with those reports is the focus of
this report and raises serious questions regarding Navy's and DFAS's
commitment and ability to prepare the fiscal year 1996 financial
statements, which, for the most part, will be based on the same data
sources.
We state in our report that DOD has begun departmentwide initiatives
that could help address the fundamental weaknesses we found in the
Navy's general fund financial management and reporting. However, our
review showed that severe deficiencies, including billions of dollars
in problem disbursements, grossly inaccurate and unreliable financial
reports, and significant internal control breakdowns, pervade the
Navy's general fund financial operations. As a result, a great deal
more progress must be achieved by the Navy and DFAS to meet the
requirements of the CFO Act and prepare reliable financial statements
by the date stipulated in law. Considering the enormity of the
problems and deficiencies to be overcome, the progress made to date
by the Navy and DFAS in the Navy's general funds is relatively small
and, in our view, warrants our finding that little progress has been
made.
DOD fully concurred with 16 of our recommendations and partially
concurred with 2 others. First, DOD partially concurred with our
recommendation that the Assistant Secretary of the Navy for Financial
Management and Comptroller certify that the Navy's financial reports
comply with applicable requirements. DOD stated that the annual Navy
financial statements prepared pursuant to the CFO Act are required to
be accompanied by a management representation letter signed by the
Secretary of the Navy or the Under Secretary of the Navy. In DOD's
view, the management representation letter is the appropriate medium
to provide management comments on financial statements. With respect
to our recommendation, we agree that management representation
letters are an appropriate medium for certification of financial
statements and, therefore, if properly used, should fulfill the
intent of our recommendation. The letters should acknowledge
management's responsibility for the fair presentation of information
in the accompanying financial statements. However, in instances
where management has concerns reagrding the viability of its
financial statements, management representation letters should be
used to highlight and communicate those concerns to the statements'
auditors.
Second, DOD partially concurred with our recommendation that the Navy
and DFAS identify the specific offices or positions accountable for
accomplishing actions established by strategies for preparing the
Navy's financial statements and monitoring progress throughout the
year. Although DOD did not fully concur with the recommendation, its
intended action--revising the Navy and DFAS CFO Project Plan to
indicate participating organizations and responsible elements within
those organizations--fulfills the intent of our recommendation. Once
the participating organizations and responsible elements are
identified, it is important that the Navy and DFAS monitor the
progress of those organizations and elements to ensure that planned
actions are effectively carried out within established milestones.
DOD, for the most part, agreed with our findings in this report
although it partially concurred with several findings and disputed
the facts in one case. We have evaluated and addressed DOD's
comments to the extent necessary in the appropriate sections of this
report.
The full text of DOD's comments is provided in appendix II.
--------------------------------------------------------- Letter :10.1
We are sending copies of this report to the Chairmen and the Ranking
Minority Members of the Senate and House Committees on
Appropriations, Subcommittees on Defense; the Senate Committee on
Armed Services and its Subcommittee on Readiness; the Senate
Committee on Governmental Affairs; and the House Committee on
Government Reform and Oversight as well as its Subcommittee on
Government Management, Information, and Technology. We are also
sending copies to the Director of the Defense Finance and Accounting
Service, the Secretary of the Treasury, and the Director of the
Office of Management and Budget. We will make copies available to
others upon request.
The head of a federal agency is required by 31 U.S.C. 720 to submit
a written statement on actions taken on these recommendations to the
Senate Committee on Governmental Affairs and the House Committee on
Government Reform and Oversight within 60 days of the date of this
report. You must also send a written statement to the House and
Senate Committees on Appropriations with the agency's first request
for appropriations made over 60 days after the date of this report.
If you have questions regarding this report, please call Lisa G.
Jacobson, Director, Defense Financial Audits, at (202) 512-9095, or
Gerald W. Thomas, Assistant Director, Defense Financial Audits, at
(202) 512-8841.
Gene L. Dodaro
Assistant Comptroller General
OBJECTIVE, SCOPE, AND METHODOLOGY
=========================================================== Appendix I
Our objective was to determine the Navy's readiness to prepare
reliable financial statements for fiscal year 1996. We examined
the overall reliability of the Navy's fiscal year 1994 financial
reports, and the adequacy of the processes and controls the Navy
and DFAS used to prepare them;
the adequacy of the Navy's and DFAS's financial management
planning, staffing, and systems; and
the effectiveness of accountability for ensuring the reliability of
the Navy's financial reporting.
We examined the Navy's fiscal year 1994 financial reports (the
Treasury "SF-220" series) because (1) the information for these
reports was derived from the sources the Navy and DFAS would, for the
most part, use to prepare statutorily required financial statements
and (2) the reliability of the fiscal year-end accounts balances used
to prepare these reports is integral to the Navy's accurately
establishing the ending account balances for fiscal year-end 1995
and, consequently, beginning balances for fiscal year 1996.
Inaccurate beginning account balances would affect the reliability of
the Navy's fiscal year 1996 financial statements. We have not,
however, audited the Navy's fiscal year 1994 financial reports and,
therefore, express no opinion on them.
To assess the overall reliability of the Navy's financial reports we
evaluated whether the reported data were logical and presented in
accordance with Treasury, DOD, and Navy guidance and
requirements;
verified the mathematical accuracy of reported amounts; and
traced reported amounts to available supporting documentation and
reports at DFAS, Cleveland Center.
In making our assessment, we considered the Navy's previously
reported financial management problems. We identified these problems
from our prior audit reports and those of the DOD Inspector General
and the Naval Audit Service and determined whether the problems
continued. We also examined DOD and Navy reports of internal control
and accounting systems weaknesses based on self-assessments made
under the Federal Managers' Financial Integrity Act of 1982.
To examine the adequacy of the Navy and DFAS financial reporting
processes and controls, we identified and reviewed pertinent
financial management policies and procedures that the Navy and DFAS
had in place. We also observed whether these processes and controls
were working as the Navy and DFAS intended, and tested selected
transactions affecting reported account balances. We also reviewed
applicable Treasury, OMB, and DOD guidance and requirements for
reporting financial transactions and preparing financial reports.
To determine the adequacy of Navy financial management planning,
staffing, and systems, we
discussed with Navy and DFAS officials current plans and strategies
for preparing the Navy's financial statements for fiscal year
1996. We analyzed available documents relating to these plans
and focused on whether they adequately (1) addressed the types
of deficiencies we noted in assessing the Navy's fiscal year
1994 financial reports and (2) supported meeting the statutory
time frame for preparing financial statements.
discussed financial reporting staffing issues with Navy and DFAS,
Cleveland Center, officials. We also identified DFAS, Cleveland
Center's financial reporting staff level and experience, and
compared them with the financial reporting staff levels and
experience of other DFAS centers.
identified and reviewed previously reported Navy and DFAS financial
management systems deficiencies and financial systems
modernization plans.
To examine the organizational accountability established to ensure
the reliability of the Navy's financial reporting, we determined the
financial management lines of authority and responsibility
established by the Navy, DFAS, and DOD. In addition, we identified
previously reported DOD problems in these areas, and discussed with
DOD and Navy officials the current status of efforts to resolve them.
We also obtained and analyzed a proposed new DOD Comptroller policy,
Roles and Responsibilities of DFAS and Other DOD Components, and a
draft DOD financial management regulation, "Reporting Policies and
Procedures."
In a briefing on November 17, 1994, we advised the Assistant
Secretary of the Navy for Financial Management and Comptroller and
key DOD financial management officials on the preliminary results of
our review. On April 20, 1995, we briefed the Director of the DFAS,
Cleveland Center, and senior officials from the Navy Comptroller's
Office. During both meetings, we made suggestions for correcting
financial management and reporting problems hindering the Navy's
development of reliable financial statements for future fiscal years.
In addition to the adequacy of the Navy's financial reporting, which
is the subject of this report, we are also evaluating certain other
aspects of the Navy's financial management operations. We will
report later on these areas.
We conducted our work primarily at Navy and DFAS Headquarters in
Washington, D.C., and at DFAS, Cleveland Center. Our work was
performed from August 1993 through October 1995 in accordance with
generally accepted government auditing standards.
(See figure in printed edition.)Appendix II
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
=========================================================== Appendix I
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The following are GAO's comments on the Department of Defense letter
dated February 9, 1996.
GAO COMMENTS
1. We have changed the title of this report to CFO Act Financial
Audits: Increased Attention Must Be Given to Preparing Navy's
Financial Reports.
2. The "improvements and progress" listed by DOD represent actions
from which envisioned benefits have yet to be achieved. While these
actions may lead to improvements in the Navy's financial management
operations, in our view they do not materially affect our finding.
3. OMB, under authority established by the CFO Act, prescribes the
form and content of agency financial statements prepared pursuant to
that act and GMRA. Therefore, we have modified our recommendation to
incorporate the OMB requirements.
*** End of document. ***